Edgar Filing: HARRIS PREFERRED CAPITAL CORP

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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2004
FORM 10-K

ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004

COMMISSION FILE NUMBER 1-13805

HARRIS PREFERRED CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)

MARYLAND 36-4183096
(State or other jurisdiction (I.R.S. Employer
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:

TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------

7 3/8% Noncumulative Exchangeable Preferred Stock, Series New York Stock Exchange
A, par value $1.00 per share

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 checkmark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (229.405 of this chapter) is not contained herein, and
will not be contained to the best of registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [X]

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 March
28, 2005 was 1,000. No common equity is held by nonaffiliates.

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HARRIS PREFERRED CAPITAL CORPORATION

TABLE OF CONTENTS

PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 7
Item 3. Legal Proceedings........................................... 7
Item 4. Submission of Matters to a Vote of Security Holders......... 7
PART II
Item 5. Market for the Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities.................................................. 7
Item 6. Selected Financial Data..................................... 8
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 8
Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 12
Item 8. Financial Statements and Supplementary Data................. 12
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 12
Item 9A. Controls and Procedures..................................... 13
Item 9B. Other Information........................................... 13
PART III
Item 10. Directors and Executive Officers of the Registrant and
Related Stockholder Matters................................. 13
Item 11. Executive Compensation...................................... 15
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.................. 15
Item 13. Certain Relationships and Related Transactions.............. 15
Item 14. Principal Accounting Fees and Services...................... 16
PART IV
Item 15 Exhibits, Financial Statement Schedules..................... 17
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
Signatures..................................................................... 19

PART I

Forward-Looking Information

Forward-looking statements contained in this Annual Report on Form 10-K
("Report") of Harris Preferred Capital Corporation (the "Company") may include
certain forward-looking information, within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended, including (without limitation) statements with respect
to the Company's expectations, 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 statements.

ITEM 1. BUSINESS

General

Harris Preferred Capital Corporation is a Maryland corporation incorporated
on September 24, 1997, pursuant to the Maryland General Corporation Law. The
Company's principal business objective is to acquire, hold, finance and manage
qualifying real estate investment trust ("REIT") assets (the "Mortgage Assets"),
consisting of a limited recourse note or notes (the "Notes") issued by Harris
Trust and Savings Bank (the "Bank") secured by real estate mortgage assets (the
"Securing Mortgage Loans") and other obligations secured by real property, as
well as certain other qualifying REIT assets. The Company's assets are held in a
Maryland real estate investment trust subsidiary, Harris Preferred Capital
Trust. The Company has elected to be treated as a REIT under the Internal
Revenue Code of 1986 (the "Code"), and will generally not be subject to federal
income tax if it distributes 90% of its adjusted REIT ordinary taxable income
and meets all of the qualifications necessary to be a REIT. All of the shares of
the Company's common stock, par value $1.00 per share (the "Common Stock"), are
owned by Harris Capital Holdings, Inc. ("HCH"), a wholly-owned subsidiary of the
Bank. The Company was formed by the Bank to provide investors with the
opportunity to invest in residential mortgages and other real estate assets and
to provide the Bank with a cost-effective means of raising capital for federal
regulatory purposes.

On February 11, 1998, the Company, through a public offering (the
"Offering"), issued 10,000,000 shares of its 7 3/8% Noncumulative Exchangeable
Preferred Stock, Series A (the "Preferred Shares"), $1.00 par value. The
Offering raised $250 million less $7.9 million of underwriting fees. The
Preferred Shares are traded on the New York Stock Exchange under the symbol "HBC
Pr A". Holders of Preferred Shares are entitled to receive, if declared by the
Company's Board of Directors, noncumulative dividends at a rate of 7 3/8% per
annum of the $25 per share liquidation preference (an amount equivalent to
$1.8438 per share per annum). Dividends on the Preferred Shares, if authorized
and declared, are payable quarterly in arrears on March 30, June 30, September
30 and December 30 of each year. The Preferred Shares may be redeemed for cash
at the option of the Company, in whole or in part, at any time and from time to
time, at the principal amount thereof, plus the quarterly accrued and unpaid
dividends, if any, thereon. The Company may not redeem the Preferred Shares
without prior approval from the Board of Governors of the Federal Reserve System
or the appropriate successor federal regulatory agency.

Each Preferred Share will be automatically exchanged for one newly issued
preferred share of the Bank ("Bank Preferred Share") in the event (i) the Bank
becomes less than "adequately capitalized" under

regulations established pursuant to the Federal Deposit Insurance Corporation
Improvement Act of 1991, as amended, (ii) the Bank is placed into
conservatorship or receivership, (iii) the Board of Governors directs such
exchange in writing because, in its sole discretion and even if the Bank is not
less than "adequately capitalized," the Board of Governors anticipates that the
Bank may become less than adequately capitalized in the near term, or (iv) the
Board of Governors in its sole discretion directs in writing an exchange in the
event that the Bank has a Tier 1 risk-based capital ratio of less than 5%. In
the event of an exchange, the Bank Preferred Shares would constitute a new
series of preferred shares of the Bank, would have the same dividend rights,
liquidation preference, redemption options and other attributes as the Preferred
Shares, except that the Bank Preferred Shares would not be listed on the New
York Stock Exchange and would rank pari passu in terms of cash dividend payments
and liquidation preference with any outstanding shares of preferred stock of the
Bank.

On June 4, 2004, Harris Bankcorp, Inc., the Bank's parent company,
announced its plan to consolidate twenty-five of its Illinois bank charters
(including the Bank) into one national bank charter, Harris N.A. This
transaction is expected to be completed in May 2005. After that time and under
the same conditions as described in the prior paragraph, each Preferred Share
will be automatically exchangeable for one newly issued preferred share of
Harris N.A. except that Harris N.A. will be subject to regulation by the Office
of the Comptroller of the Currency. References herein to the Bank for those
times subsequent to the charter consolidation are intended to refer to Harris
Bank N.A.

Concurrent with the issuance of the Preferred Shares, the Bank contributed
additional capital of $241 million, net of acquisition costs, to the Company.
The Company and the Bank undertook the Offering for two principal reasons: (i)
the qualification of the Preferred Shares as Tier 1 capital of the Bank for U.S.
banking regulatory purposes under relevant regulatory capital guidelines, as a
result of the treatment of the Preferred Shares as a minority interest in a
consolidated subsidiary of the Bank, and (ii) lack of federal income tax on the
Company's earnings used to pay the dividends on the Preferred Shares, as a
result of the Company's qualification as a REIT. On December 30, 1998, the Bank
contributed the common stock of the Company to HCH, a newly-formed and
wholly-owned subsidiary of the Bank. The Bank is an indirect wholly-owned U.S.
subsidiary of Bank of Montreal. The Bank is required to maintain direct or
indirect ownership of at least 80% of the outstanding Common Stock of the
Company for as long as any Preferred Shares are outstanding.

The Company used the Offering proceeds and the additional capital
contributed by the Bank to purchase $356 million of notes (the "Notes") from the
Bank and $135 million of mortgage-backed securities at their estimated fair
value. The Notes are obligations issued by the Bank that are recourse only to
the underlying mortgage loans (the "Securing Mortgage Loans") and were acquired
pursuant to the terms of a loan agreement with the Bank. The principal amount of
the Notes equals approximately 80% of the principal amounts of the Securing
Mortgage Loans.

Business

The Company was formed for the purpose of raising capital for the Bank. One
of the Company's principal business objectives is to acquire, hold, finance and
manage Mortgage Assets. These Mortgage Assets generate interest income for
distribution to stockholders. A portion of the Mortgage Assets of the Company
consists of Notes issued by the Bank that are recourse only to Securing Mortgage
Loans that are secured by real property. The Notes mature on October 1, 2027 and
pay interest at 6.4% per annum. Payments of interest are made to the Company
from payments made on the Securing Mortgage Loans. Pursuant to an agreement
between the Company and the Bank, the Company, through the Bank as agent,
receives all scheduled payments made on the Securing Mortgage Loans, retains a
portion of any such payments equal to the amount due on the Notes and remits the
balance, if any, to the Bank. The Company also retains approximately 80% of any
prepayments of principal in respect of the Securing Mortgage Loans and applies
such amounts as a prepayment on the Notes. The Company has a security interest
in the real property securing the Securing Mortgage Loans and will be entitled
to enforce payment on the loans in its own name if a mortgagor should default.
In the event of such default, the Company would have the same rights as the
original mortgagee to foreclose the mortgaged property and satisfy the
obligations of the Bank out of the proceeds.
3

The Company may from time to time acquire fixed-rate or variable-rate
mortgage-backed securities representing interests in pools of mortgage loans.
The Bank may have originated a portion of any such mortgage-backed securities by
exchanging pools of mortgage loans for the mortgage-backed securities. The
mortgage loans underlying the mortgage-backed securities will be secured by
single-family residential properties located throughout the United States. The
Company intends to acquire only investment grade mortgage-backed securities
issued by agencies of the federal government or government sponsored agencies,
such as the Federal Home Loan Mortgage Corporation ("FHLMC"), the Federal
National Mortgage Association ("Fannie Mae") and the Government National
Mortgage Association ("GNMA"). The Company does not intend to acquire any
interest-only, principal-only or similar speculative mortgage-backed securities.

The Bank may from time to time acquire or originate both conforming and
nonconforming residential mortgage loans. Conventional conforming residential
mortgage loans comply with the requirements for inclusion in a loan guarantee
program sponsored by either FHLMC or Fannie Mae. Nonconforming residential
mortgage loans are residential mortgage loans that do not qualify in one or more
respects for purchase by Fannie Mae or FHLMC under their standard programs. The
nonconforming residential mortgage loans that the Company purchases will be
nonconforming because they have original principal balances which exceed the
limits for FHLMC or Fannie Mae under their standard programs. The Company
believes that all residential mortgage loans will meet the requirements for sale
to national private mortgage conduit programs or other investors in the
secondary mortgage market. As of December 31, 2004 and 2003 and for each of the
years then ended, the Company did not directly hold any residential mortgage
loans.

The Company may from time to time acquire commercial mortgage loans secured
by industrial and warehouse properties, recreational facilities, office
buildings, retail space and shopping malls, hotels and motels, hospitals,
nursing homes or senior living centers. The Company's current policy is not to
acquire any interest in a commercial mortgage loan if commercial mortgage loans
would constitute more than 5% of the Company's Mortgage Assets at the time of
its acquisition. Unlike residential mortgage loans, commercial mortgage loans
generally lack standardized terms. Commercial real estate properties themselves
tend to be unique and are more difficult to value than residential real estate
properties. Commercial mortgage loans may also not be fully amortizing, meaning
that they may have a significant principal balance or "balloon" payment due on
maturity. Moreover, commercial properties, particularly industrial and warehouse
properties, are generally subject to relatively greater environmental risks than
non-commercial properties, generally giving rise to increased costs of
compliance with environmental laws and regulations. There is no requirement
regarding the percentage of any commercial real estate property that must be
leased at the time the Bank acquires a commercial mortgage loan secured by such
commercial real estate property, and there is no requirement that commercial
mortgage loans have third party guarantees. The credit quality of a commercial
mortgage loan may depend on, among other factors, the existence and structure of
underlying leases, the physical condition of the property (including whether any
maintenance has been deferred), the creditworthiness of tenants, the historical
and anticipated level of vacancies and rents on the property and on other
comparable properties located in the same region, potential or existing
environmental risks, the availability of credit to refinance the commercial
mortgage loan at or prior to maturity and the local and regional economic
climate in general. Foreclosures of defaulted commercial mortgage loans are
generally subject to a number of complicated factors, including environmental
considerations, which are generally not present in foreclosures of residential
mortgage loans. As of December 31, 2004 and 2003 and for each of the years then
ended, the Company did not hold any commercial mortgage loans.

The Company may invest in assets eligible to be held by REITs other than
those described above. In addition to commercial mortgage loans and mortgage
loans secured by multi-family properties, such assets could include cash, cash
equivalents and securities, including shares or interests in other REITs and
partnership interests. At December 31, 2004, the Company held $10.5 million of
short-term money market assets and $45 million of U.S. Treasury securities. At
December 31, 2003, the Company held $11.5 million of short-term money market
assets and $230 million of U.S. Treasury securities.

The Company intends to continue to acquire Mortgage Assets from the Bank
and/or affiliates of the Bank on terms that are comparable to those that could
be obtained by the Company if such Mortgage Assets
4

were purchased from unrelated third parties. The Company may also from time to
time acquire Mortgage Assets from unrelated third parties.

The Company intends to maintain a substantial portion of its portfolio in
Bank-secured obligations and mortgage-backed securities. The Company may,
however, invest in other assets eligible to be held by a REIT. The Company's
current policy and the Servicing Agreement (defined below) prohibit the
acquisition of any Mortgage Asset constituting an interest in a mortgage loan
(other than an interest resulting from the acquisition of mortgage-backed
securities), which mortgage loan (i) is delinquent (more than 30 days past due)
in the payment of principal or interest at the time of proposed acquisition;
(ii) is or was at any time during the preceding 12 months (a) on nonaccrual
status or (b) renegotiated due to financial deterioration of the borrower; or
(iii) has been, more than once during the preceding 12 months, more than 30 days
past due in payment of principal or interest. Loans that are on "nonaccrual
status" are generally loans that are past due 90 days or more in principal or
interest. The Company maintains a policy of disposing of any mortgage loan which
(i) falls into nonaccrual status, (ii) has to be renegotiated due to the
financial deterioration of the borrower, or (iii) is more than 30 days past due
in the payment of principal or interest more than once in any 12 month period.
The Company may choose, at any time subsequent to its acquisition of any
Mortgage Assets, to require the Bank (as part of the Servicing Agreement) to
dispose of the mortgage loans for any of these reasons or for any other reason.

The Bank services the Securing Mortgage Loans and the other mortgage loans
purchased by the Company on behalf of, and as agent for, the Company and is
entitled to receive fees in connection with the servicing thereof pursuant to
the servicing agreement (the "Servicing Agreement"). The Bank receives a fee
equal to 0.25% per annum on the principal balances of the loans serviced.
Payment of such fees is subordinate to payments of dividends on the Preferred
Shares. The Servicing Agreement requires the Bank to service the loans in a
manner generally consistent with accepted secondary market practices, with any
servicing guidelines promulgated by the Company and, in the case of residential
mortgage loans, with Fannie Mae and FHLMC guidelines and procedures. The
Servicing Agreement requires the Bank to service the loans solely with a view
toward the interest of the Company and without regard to the interest of the
Bank or any of its affiliates. The Bank will collect and remit principal and
interest payments, administer mortgage escrow accounts, submit and pursue
insurance claims and initiate and supervise foreclosure proceedings on the loans
it services. The Bank may, with the approval of a majority of the Company's
Board of Directors, as well as a majority of the Company's Independent
Directors, subcontract all or a portion of its obligations under the Servicing
Agreement to unrelated third parties. An "Independent Director" is a director
who is not a current officer or employee of the Company or a current director,
officer or employee of the Bank or of its affiliates. The Bank will not, in
connection with the subcontracting of any of its obligations under the Servicing
Agreement, be discharged or relieved in any respect from its obligations under
the Servicing Agreement. The Company may terminate the Servicing Agreement upon
the occurrence of such events as they relate to the Bank's proper and timely
performance of its duties and obligations under the Servicing Agreement. As long
as any Preferred Shares remain outstanding, the Company may not terminate, or
elect to renew, the Servicing Agreement without the approval of a majority of
the Company's Independent Directors.

The Company entered into an advisory agreement with the Bank (the "Advisory
Agreement") pursuant to which the Bank administers the day-to-day operations of
the Company. The Bank is responsible for (i) monitoring the credit quality of
Mortgage Assets held by the Company, (ii) advising the Company with respect to
the reinvestment of income from and payments on, and with respect to the
acquisition, management, financing and disposition of the Mortgage Assets held
by the Company, and (iii) monitoring the Company's compliance with the
requirements necessary to qualify as a REIT, and other financial and tax-
related matters. The Bank may from time to time subcontract all or a portion of
its obligations under the Advisory Agreement to one or more of its affiliates.
The Bank may, with the approval of a majority of the Company's Board of
Directors, as well as a majority of the Company's Independent Directors,
subcontract all or a portion of its obligations under the Advisory Agreement to
unrelated third parties. The Bank will not, in connection with the
subcontracting of any of its obligations under the Advisory Agreement, be
discharged or relieved in any respect from its obligations under the Advisory
Agreement. The Advisory Agreement is renewed annually. The Company may terminate
the Advisory Agreement at any time upon 60 days' prior

written notice. As long as any Preferred Shares remain outstanding, any decision
by the Company either to renew the Advisory Agreement or to terminate the
Advisory Agreement must be approved by a majority of the Board of Directors, as
well as by a majority of the Company's Independent Directors.

The Advisory Agreement in effect in 2004 and 2003 entitled the Bank to
receive advisory fees of $124,000 and $56,000, respectively. The increase in
costs is primarily attributable to increased costs for processing, recordkeeping
and administration. In 2005, advisory fees of $148,000 have been approved.

The Company may from time to time purchase additional Mortgage Assets out
of proceeds received in connection with the repayment or disposition of Mortgage
Assets, the issuance of additional shares of Preferred Stock or additional
capital contributions with respect to the Common Stock. The Company may also
issue additional series of Preferred Stock. However, the Company may not issue
additional shares of Preferred Stock senior to the Series A Preferred Shares
either in the payment of dividends or in the distribution of assets on
liquidation without the consent of holders of at least 67% of the outstanding
shares of Preferred Stock at that time or without approval of a majority of the
Company's Independent Directors. The Company does not currently intend to issue
any additional shares of Preferred Stock unless it simultaneously receives
additional capital contributions from HCH or other affiliates sufficient to
support the issuance of such additional shares of Preferred Stock.

Although the Company does not currently intend to incur any indebtedness in
connection with the acquisition and holding of Mortgage Assets, the Company may
do so at any time (although indebtedness in excess of 25% of the Company's total
stockholders' equity may not be incurred without the approval of a majority of
the Company's Independent Directors). To the extent the Company were to change
its policy with respect to the incurrence of indebtedness, the Company would be
subject to risks associated with leverage, including, without limitation,
changes in interest rates and prepayment risk.

Employees

As of December 31, 2004, the Company had no paid employees. All officers of
the Company were employed by the Bank.

Environmental Matters

In the event that the Company is forced to foreclose on a defaulted
Securing Mortgage Loan to recover its investment in such loan, the Company may
be subject to environmental liabilities in connection with the underlying real
property, which could exceed the value of the real property. Although the
Company intends to exercise due diligence to discover potential environmental
liabilities prior to the acquisition of any property through foreclosure,
hazardous substances or wastes, contaminants, pollutants or sources thereof (as
defined by state and federal laws and regulations) may be discovered on
properties during the Company's ownership or after a sale thereof to a third
party. If such hazardous substances are discovered on a property which the
Company has acquired through foreclosure or otherwise, the Company may be
required to remove those substances and clean up the property. There can be no
assurance that in such a case the Company would not incur full recourse
liability for the entire costs of any removal and clean-up, that the cost of
such removal and clean-up would not exceed the value of the property or that the
Company could recoup any of such costs from any third party. The Company may
also be liable to tenants and other users of neighboring properties. In
addition, the Company may find it difficult or impossible to sell the property
prior to or following any such clean-up. The Company has not foreclosed on any
Securing Mortgage Loans.

Qualification as a REIT

The Company elected to be taxed as a REIT commencing with its taxable year
ended December 31, 1998 and intends to comply with the provisions of the Code
with respect thereto. The Company will not be subject to Federal income tax to
the extent it distributes 90% (95% for years prior to January 1, 2001) of its
adjusted REIT ordinary taxable income to stockholders and as long as certain
assets, income and stock ownership tests are met. For 2004 as well as 2003, the
Company met all Code requirements for a REIT, including the asset, income, stock
ownership and distribution tests. Cash distributions in the amount of $1.8438
per Preferred
6

Share were paid in 2004 and 2003. For the year ended December 31, 2004 there
were no common stock dividends declared as there were no earnings available
after payment of the preferred dividends. A cash dividend on common stock of $2
million was declared on December 2, 2003 to the stockholder of record on
December 15, 2003 and paid on December 31, 2003. In addition, on September 13,
2004 and September 12, 2003, the Company paid a cash dividend of $904 thousand
(declared December 2, 2003) and $530 thousand (declared December 4, 2002), on
the outstanding common shares to the stockholder of record on September 6, 2004
and September 3, 2003, respectively. These dividends completed the 2003 and 2002
REIT tax compliance requirements.

ITEM 2. PROPERTIES

None as of December 31, 2004.

ITEM 3. LEGAL PROCEEDINGS

The Company is not currently involved in any material litigation nor, to
the Company's knowledge is any material litigation currently threatened against
the Company or the Bank other than routine litigation arising in the ordinary
course of business. See Note 8 to Financial Statements on page 30.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth
quarter of 2004.

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES

HCH presently owns all 1,000 shares of the common stock of the Company,
which are not listed or traded on any securities exchange. For the year ended
December 31, 2004 there were no common stock dividends declared, as there were
no earnings available after payment of the preferred dividends. On December 2,
2003, the Company declared $2 million in cash dividends on common stock, which
were paid in December 2003. In addition, on September 13, 2004 and September 12,
2003, respectively the Company paid a cash dividend of $904 thousand (declared
December 2, 2003) and $530 thousand (declared December 4, 2002), on the
outstanding common shares to the stockholder of record on September 6, 2004, and
September 3, 2003, respectively. These dividends completed the 2003 and 2002
REIT tax compliance requirements regarding income distributions.

The Preferred Shares are traded on the New York Stock Exchange under the
symbol "HBC Pr A". During 2004 and 2003, the Company declared and paid cash
dividends to preferred stockholders of approximately $18.4 million in each year.
Although the Company declared cash dividends on the Preferred Shares for 2004
and 2003, no assurances can be made as to the declaration of, or if declared,
the amount of, future distributions since such distributions are subject to the
Company's financial condition and capital needs; the impact of legislation and
regulations as then in effect or as may be proposed; economic conditions; and
such other factors as the Board of Directors may deem relevant. Notwithstanding
the foregoing, to remain qualified as a REIT, the Company must distribute
annually at least 90% of its ordinary taxable income to preferred and/or common
stockholders.

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected financial data for the Company and
should be read in conjunction with the Consolidated Financial Statements and
notes thereto and Management's Discussion and Analysis of Financial Condition
and Results of Operations contained in this Report.

FOR THE YEARS ENDED DECEMBER 31
----------------------------------------------------
2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

Statement of Operations Data:
Interest income............................. $ 16,998 $ 17,678 $ 19,934 $ 28,715 $ 32,312
Noninterest income.......................... 1,062 4,158 2,677 4,796 257
Operating expenses:
Loan servicing fees....................... 44 70 131 243 373
Advisory fees............................. 124 56 43 35 57
General and administrative................ 362 362 314 300 290
-------- -------- -------- -------- --------
Total operating expenses............... 530 488 488 578 720
-------- -------- -------- -------- --------
Net income.................................. 17,530 21,348 22,123 32,933 31,849
Preferred stock dividends................... 18,438 18,438 18,438 18,438 18,438
-------- -------- -------- -------- --------
Net income available (loss allocated) to
common stockholder........................ $ (908) $ 2,910 $ 3,685 $ 14,495 $ 13,411
======== ======== ======== ======== ========
Basic and diluted net income (loss) per
common share.............................. $ (908) $ 2,910 $ 3,685 $ 14,495 $ 13,411
======== ======== ======== ======== ========
Distributions per preferred share........... $ 1.8438 $ 1.8438 $ 1.8438 $ 1.8438 $ 1.8438
======== ======== ======== ======== ========
Balance Sheet Data (end of period):
Total assets........................... $489,022 $494,318 $502,042 $489,342 $489,939
======== ======== ======== ======== ========
Total liabilities...................... $ 134 $ 84 $ 96 $ 100 $ 115
======== ======== ======== ======== ========
Total stockholders' equity............. $488,888 $494,234 $501,946 $489,242 $489,824
======== ======== ======== ======== ========
Cash Flows Data:
Operating activities........................ $ 15,998 $ 18,046 $ 19,440 $ 28,736 $ 31,638
======== ======== ======== ======== ========
Investing activities........................ $ 2,825 $ 3,120 $ 2,440 $ 4,035 $ (419)
======== ======== ======== ======== ========
Financing activities........................ $(19,342) $(20,968) $(21,658) $(33,084) $(31,662)
======== ======== ======== ======== ========

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion should be read in conjunction with the
Consolidated Financial Statements and notes thereto appearing later in this
Report.

SUMMARY

YEAR ENDED DECEMBER 31, 2004 COMPARED TO DECEMBER 31, 2003

The Company's net income for 2004 was $17.5 million. This represented an
18% decrease from 2003 net income of $21.3 million. Earnings declined primarily
because of a substantial decrease in gains from security sales compared to last
year and lower interest income on earning assets.

Interest income on securities purchased under agreement to resell for the
year ended December 31, 2004 was $1.1 million compared to $1.3 million a year
ago. Interest income on the Notes for 2004 totaled $907 thousand and yielded
6.4% on $14 million of average principal outstanding compared to $1.5 million
and a 6.4% yield on $24 million average principal outstanding for 2003. The
decrease in income was attributable to a reduction in the Note balance because
of customer payoffs in the Securing Mortgage Loans. The average outstanding
balance of the Securing Mortgage Loans was $18 million for 2004 and $29 million
for 2003. Interest income on securities available-for-sale for 2004 was $15.0
million, resulting in a yield of 4.3% on an average balance of $353 million
compared to interest income of $14.9 million with a yield of 4.6% on an average
balance of $326 million for 2003. The increase in interest income on securities
available-for-sale was primarily attributable to an increase in the average
mortgage-backed securities portfolio partially offset by lower yields than the
prior year. Gains from investment securities sales were $1.1 million in 2004 and
$4.2 million in 2003. There were no Company borrowings during either year.

Operating expenses for the year ended December 31, 2004 totaled $530
thousand compared to $488 thousand a year ago. Loan servicing expenses for 2004
totaled $44 thousand, a decrease of $26 thousand or 37% from 2003. This decrease
was attributable to the reduction in the principal balance of the Notes.
Advisory fees for the year ended December 31, 2004 were $124 thousand compared
to $56 thousand for the same period a year ago, due to higher internal
processing, record-keeping and overhead costs. General and administrative
expenses totaled $362 thousand for both 2004 and 2003.

On December 30, 2004, the Company paid a cash dividend of $0.46094 per
share on the outstanding Preferred Shares to the stockholders of record on
December 15, 2004 as declared on December 2, 2004. On December 30, 2003, the
Company paid a cash dividend of $0.46094 per share on the outstanding Preferred
Shares to the stockholders of record on December 15, 2003 as declared on
December 2, 2003. On a year-to-date basis, the Company declared and paid $18.4
million of dividends to holders of Preferred Shares for 2004 and 2003,
respectively. For the year ended December 31, 2004 there were no common stock
dividends declared, as there were no earnings available after payment of the
preferred dividends. A cash dividend on common stock of $2.0 million was
declared on December 2, 2003 to the stockholder of record on December 15, 2003
and paid on December 31, 2003. In addition, on September 13, 2004 and September
12, 2003, the Company paid a cash dividend of $904 thousand (declared December
2, 2003) and $530 thousand (declared December 4, 2002), on the outstanding
common shares to the stockholder of record on September 6, 2004 and September 3,
2003, respectively. These common share dividends completed the Company's 2003
and 2002 REIT tax compliance requirements.

At December 31, 2004 and 2003, there were no Securing Mortgage Loans on
nonaccrual status and there was no allowance for loan losses.

YEAR ENDED DECEMBER 31, 2003 COMPARED TO DECEMBER 31, 2002

The Company's net income for 2003 was $21.3 million. This represented a 4%
decrease from 2002 net income of $22.1 million. Earnings decreased primarily
because of reduced interest income on earning assets, partially offset by
increased gains on securities sales from $2.7 million in 2002 to $4.2 million in
2003.

Interest income on the Notes for 2003 totaled $1.5 million and yielded 6.4%
on $24 million of average principal outstanding compared to $2.8 million and a
6.4% yield on $43 million average principal outstanding for 2002. The decrease
in income was attributable to a reduction in the Note balance because of
customer payoffs in the Securing Mortgage Loans. The average outstanding balance
of the Securing Mortgage Loans was $29 million for 2003 and $53 million for
2002. Interest income on securities available-for-sale for 2003 was $14.9
million, resulting in a yield of 4.6% on an average balance of $326 million
compared to interest income of $15.1 million with a yield of 4.9% on an average
balance of $309 million for 2002. The decrease in interest income on securities
available-for-sale was primarily attributable to a reduction in yield, partially
offset by growth in the investment portfolio. As securities matured or were
sold, proceeds were invested in lower yielding securities as market interest
rates declined. Gains from investment securities sales were $4.2 million in 2003
and $2.7 million in 2002. There were no Company borrowings during either year.

Operating expenses for both of the years ended December 31, 2003 and 2002
totaled $488 thousand. Loan servicing expenses for 2003 totaled $70 thousand, a
decrease of $61 thousand or 47% from 2002. This decrease was attributed to the
reduction in the principal balance of the Notes. Advisory fees for the year
ended December 31, 2003 were $56 thousand compared to $43 thousand for the same
period a year ago, due to higher internal processing, record-keeping and
overhead costs. General and administrative expenses for the same period totaled
$362 thousand, an increase of $48 thousand or 15% from 2002, due to increased
reporting and compliance governance costs.

On December 30, 2003, the Company paid a cash dividend of $0.46094 per
share on the outstanding Preferred Shares to the stockholders of record on
December 15, 2003 as declared on December 2, 2003. On December 30, 2002, the
Company paid a cash dividend of $0.46094 per share on the outstanding Preferred
Shares to the stockholders of record on December 15, 2002 as declared on
December 4, 2002. On a year-to-date basis, the Company declared and paid $18.4
million of dividends to holders of Preferred Shares for 2003 and 2002,
respectively. A cash dividend on common stock of $2.0 million was declared on
December 2, 2003 to the stockholder of record on December 15, 2003 and paid on
December 31, 2003. A cash dividend on common stock of $3.090 million was
declared on December 4, 2002 to the stockholder of record on December 15, 2002
and paid on December 27, 2002. In addition, on September 12, 2003 and September
12, 2002, the Company paid a cash dividend of $530 thousand and $130 thousand,
respectively, on the outstanding common shares to the stockholder of record on
September 3, 2003 and September 4, 2002, respectively. These common share
dividends completed the Company's 2002 and 2001 REIT tax compliance
requirements.

At December 31, 2003 and 2002, there were no Securing Mortgage Loans on
nonaccrual status and there was no allowance for loan losses.

QUARTER ENDED DECEMBER 31, 2004 COMPARED TO QUARTER ENDED DECEMBER 31, 2003

The Company's net income for the fourth quarter of 2004 was $5.0 million
compared to $4.6 million in the fourth quarter of 2003. Earnings increased
primarily because of increased interest income on earning assets, partially
offset by a decline in security gains of $808 thousand from the fourth quarter
2003.

Fourth quarter 2004 interest income on the Notes totaled $199 thousand and
yielded 6.4% on $12 million of average principal outstanding compared to
interest income of $282 thousand and a 6.4% yield on $18 million average
principal outstanding for the fourth quarter of 2003. 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 the fourth quarter of 2004 and 2003 was $16 million
and $22 million, respectively. Interest income on securities available-for-sale
for the current quarter was $4.6 million resulting in a yield of 4.2% on an
average balance of $441 million, compared to interest income of $3.1 million
with a yield of 4.6% on an average balance of $265 million for the same period a
year ago. The increase in interest income is primarily attributable to the
increase in higher-yielding mortgage-backed securities with an offsetting
decline in lower-yielding money market assets and short-term U.S. Treasury
securities.

There were no Company borrowings during the fourth quarter of 2004 or 2003.

Fourth quarter 2004 operating expenses totaled $162 thousand, a decrease of
$17 thousand from the fourth quarter of 2003. Loan servicing expenses totaled
$10 thousand, a decrease of $3 thousand or 23% from the prior year's fourth
quarter, attributable to the reduction in the principal balance of the Notes.
Advisory fees for the fourth quarter of 2004 were $38 thousand compared to $26
thousand in the prior year's fourth quarter, due to increased costs for
processing, recordkeeping and administration. General and administrative
expenses totaled $114 thousand in the current quarter compared to $140 thousand
for the same period in 2003, partially attributable to lower legal fees and
external auditing costs.

ALLOWANCE FOR LOAN LOSSES

The Company does not currently maintain an allowance for loan losses due to
the over-collateralization of the Securing Mortgage Loans and the prior and
expected credit performance of the collateral pool.

CONCENTRATIONS OF CREDIT RISK

A majority of the collateral underlying the Securing Mortgage Loans is
located in Illinois. The financial viability of customers in this state is, in
part, dependent on the state's economy. The collateral may be subject to a
greater risk of default than other comparable loans in the event of adverse
economic, political or business developments or natural hazards that may affect
such region and the ability of property owners in such region to make payments
of principal and interest on the underlying mortgages. The Company's maximum
risk of accounting loss, should all customers in Illinois fail to perform
according to contract terms and all collateral prove to be worthless, was
approximately $11 million at December 31, 2004 and $12 million at December 31,
2003.

INTEREST RATE RISK

The Company's income consists primarily of interest payments on the
Mortgage Assets and other securities it holds. If there is a decline in interest
rates during a period of time when the Company must reinvest payments of
interest and principal with respect to its Mortgage Assets and other interest
earning assets, the Company may find it difficult to purchase additional earning
assets that generate sufficient income to support payment of dividends on the
Preferred Shares. Because the rate at which dividends, if, when and as
authorized and declared, are payable on the Preferred Shares is fixed, there can
be no assurance that an interest rate environment in which there is a decline in
interest rates would not adversely affect the Company's ability to pay dividends
on the Preferred Shares.

COMPETITION

The Company does not engage in the business of originating mortgage loans.
While the Company will acquire additional Mortgage Assets, it anticipates that
such Mortgage Assets will be acquired from the Bank and affiliates of the Bank.
Accordingly, the Company does not expect to compete with mortgage conduit
programs, investment banking firms, savings and loan associations, banks, thrift
and loan associations, finance companies, mortgage bankers or insurance
companies in acquiring its Mortgage Assets.

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 liquidity needs are to maintain the current
portfolio size through the acquisition of additional Notes or other qualifying
assets and 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 from repayment of principal balances by
individual mortgages or maturities of securities held for sale on a reinvested
basis. The payment of dividends on the Preferred Shares will be made from
legally available funds, principally 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 and mortgage-backed securities. 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 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 Statement of Cash Flows, the primary
sources of funds in addition to $16.0 million provided from operations during
2004 were $4.4 million provided by principal payments received
11

on the Notes and $673.8 million from the maturities and sales of securities
available-for-sale. In 2003, the primary sources of funds other than $18.0
million provided from operations were $14.5 million provided by principal
payments received on the Notes and $743.0 million from the maturities and sales
of securities available-for-sale. The primary uses of funds for 2004 were $676.7
million in purchases of securities available-for-sale and $18.4 and $904
thousand in preferred stock dividends and common stock dividends paid,
respectively. In 2003, the primary uses of funds were $765.4 million in
purchases of securities available-for-sale and $18.4 and $2.5 million in
preferred stock dividends and common stock dividends paid, respectively.

ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards ("SFAS") No. 123 (revised 2004), "Share-Based
Payments" in 2004. The Statement replaces SFAS No. 123, "Accounting for
Stock-Based Compensation," and supersedes Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS 123(R) applies
primarily to accounting for transactions where an entity obtains employee
services in share-based payment transactions using the fair value based method
of accounting. The Statement is effective as of the beginning of the first
interim or annual reporting period that begins after June 15, 2005. The Company
does not expect the implementation of this Statement to have a material effect
on its financial position or results of operations.

OTHER MATTERS

As of December 31, 2004, the Company believes that it is in full compliance
with the REIT tax rules, and expects to qualify as a REIT under the provisions
of the Code. The Company expects to meet all REIT requirements regarding the
ownership of its stock and anticipates meeting the annual distribution
requirements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

As of December 31, 2004, the Company had $12 million invested in Notes, a
decrease of $5 million from December 31, 2003. The decline was attributable to
customer payoffs in the Securing Mortgage Loans. At December 31, 2004, the
Company held $419 million in mortgage-backed securities compared to $234 million
at December 31, 2003. At December 31, 2004, the Company held $45 million in U.S.
Treasuries compared to $230 million at December 31, 2003. At December 31, 2004,
the Company held an investment of $10.5 million in securities purchased from the
Bank under agreement to resell compared to $11.5 million at December 31, 2003.
The Company is subject to exposure for fluctuations in interest rates. Adverse
changes in interest rates could impact negatively the value of mortgage-backed
securities, as well as the levels of interest income to be derived from these
assets.

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 prepayments, repurchases, defaults and liquidations), the
pass-through rate and interest rate fluctuations. Changes in interest rates
could impact 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.

The Company currently has no outstanding borrowings.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Refer to the Index to Consolidated Financial Statements on page 18 for the
required information.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

There have been no disagreements with accountants on any matter of
accounting principles, practices or financial statement disclosure.

On January 27, 2004, the audit committee of the Company dismissed
PricewaterhouseCoopers, LLP as its independent accountants effective upon
completion of audit services related to the Company's December 31, 2003
financial statements and appointed KPMG LLP as the audit firm for the 2004 year.

ITEM 9A. CONTROLS AND PROCEDURES

As of December 31, 2004, Paul R. Skubic, the Chairman of the Board, Chief
Executive Officer and President of the Company, and Janine Mulhall, the Chief
Financial Officer of the Company, evaluated the effectiveness of the disclosure
controls and procedures of the Company and concluded that these disclosure
controls and procedures are effective to ensure that material information
required to be included in this Report has been made known to them in a timely
fashion. There was no change in the Company's internal controls over financial
reporting identified in connection with such evaluations that occurred during
the quarter ended December 31, 2004 that have materially affected or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.

ITEM 9B. OTHER INFORMATION

Not Applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT AND RELATED
STOCKHOLDER MATTERS

The Company's Board of Directors consists of five members. The Company does
not anticipate that it will require any additional employees because it has
retained the Bank to perform certain functions pursuant to the Advisory
Agreement described above. Each officer of the Company currently is also an
officer of the Bank and/or affiliates of the Bank. The Company maintains
corporate records and audited financial statements that are separate from those
of the Bank or any of the Bank's affiliates. None of the officers, directors or
employees of the Company will have a direct or indirect pecuniary interest in
any Mortgage Asset to be acquired or disposed of by the Company or in any
transaction in which the Company has an interest or will engage in acquiring,
holding and managing Mortgage Assets.

Pursuant to terms of the Preferred Shares, the Company's Independent
Directors will consider the interests of the holders of both the Preferred
Shares and the Common Stock in determining whether any proposed action requiring
their approval is in the best interests of the Company.

The persons who are directors and executive officers of the Company are as
follows:

NAME AGE POSITION AND OFFICES HELD
---- --- -------------------------

Paul R. Skubic.......................................... 56 Chairman of the Board, President
Janine Mulhall.......................................... 43 Chief Financial Officer
Frank M. Novosel........................................ 58 Treasurer, Director
Teresa L. Patton........................................ 57 Vice President of Operations
Margaret M. Sulkin...................................... 46 Assistant Treasurer
Delbert J. Wacker....................................... 73 Director
David J. Blockowicz..................................... 62 Director
Forrest M. Schneider.................................... 57 Director

The following is a summary of the experience of the executive officers and
directors of the Company:

Mr. Skubic has been Vice President and Controller of the Bank and Chief
Accounting Officer for Harris Bankcorp, Inc., and the Bank since 1990. Prior to
joining Harris Bankcorp, Inc., Mr. Skubic was employed by Arthur Andersen & Co.
He is a certified public accountant.

Ms. Mulhall, has been Senior Vice President and Chief Financial Officer of
Harris Bankcorp, Inc. since July 2003. From November 1995 to that time she held
several positions in the Finance area of Harris Bankcorp's parent company, Bank
of Montreal, including most recently Vice President and Chief Accountant. From
1984 to 1995, Ms. Mulhall was with KPMG LLP in Toronto. She is a Canadian
Chartered Accountant.

Mr. Novosel has been a Vice President in the Treasury Group of the Bank
since 1995. Previously, he served as Treasurer of Harris Bankcorp, Inc.,
managing financial planning. Mr. Novosel is a Chartered Financial Analyst and a
member of the Investment Analysts' Society of Chicago.

Ms. Patton has been a Vice President in Residential Mortgages at the Bank
for 16 years and is currently the Director of Secondary Marketing. Prior to this
position she was the Manager of Sales and Delivery for the Residential Mortgage
Division. She currently serves on the Bank's Asset/Liability Committee, and has
been employed by the Bank for over 27 years holding positions in Consumer and
Commercial Banking.

Ms. Sulkin has been a Vice President in the Taxation Department of the Bank
since 1992. Ms. Sulkin has been employed by the Bank since 1984. Prior to
joining the Bank, she was employed by KPMG, LLP. She is a certified public
accountant.

Mr. Wacker retired as a partner from Arthur Andersen & Co. in 1987 after 34
years. From July 1988 to November 1990, he was Vice President -- Treasurer,
Parkside Medical Services, a subsidiary of Lutheran General Health System. From
November 1990 to September 1993, he completed various financial consulting
projects for Lutheran General.

Mr. Blockowicz is a certified public accountant and is a partner with
Blockowicz & Del Guidicie LLC. Prior to forming his firm, Mr. Blockowicz was a
partner with Arthur Andersen & Co. through 1990.

Mr. Schneider is President and Chief Executive Officer of Lane Industries,
Inc. Mr. Schneider is a director of Lane Industries and director of General
Binding Corporation. He has been employed by Lane Industries since 1976. He is a
graduate of the University of Illinois where he received his B.S. and masters
degree in finance.

INDEPENDENT DIRECTORS

The terms of the Preferred Shares require that, as long as any Preferred
Shares are outstanding, certain actions by the Company be approved by a majority
of the Company's Independent Directors. Delbert J. Wacker, David J. Blockowicz
and Forrest M. Schneider are the Company's Independent Directors.

If at any time the Company fails to declare and pay a quarterly dividend
payment on the Preferred Shares, the number of directors then constituting the
Board of Directors of the Company will be increased by two at the Company's next
annual meeting and the holders of Preferred Shares, voting together with the
holders of any other outstanding series of Preferred Stock as a single class,
will be entitled to elect two additional directors to serve on the Company's
Board of Directors. Any member of the Board of Directors elected by holders of
the Company's Preferred Shares will be deemed to be an Independent Director for
purposes of the actions requiring the approval of a majority of the Independent
Directors.

AUDIT COMMITTEE

The Board of Directors of the Company has established an audit committee,
with an approved Audit Committee Charter, which will review the engagement of
independent accountants and review their independence. The audit committee will
also review the adequacy of the Company's internal accounting controls. The
audit committee is comprised of Delbert J. Wacker, David J. Blockowicz and
Forrest M. Schneider. The Company's Board of Directors has determined that each
member of the audit committee is an audit committee financial expert as defined
in rules of the Securities and Exchange Commission. Each audit committee member
is independent as defined in rules of the New York Stock Exchange.

COMPENSATION OF DIRECTORS AND OFFICERS

The Company pays the Independent Directors of the Company fees for their
services as directors. The Independent Directors receive annual compensation of
$10,000 plus a fee of $750 for each attendance (in person or by telephone) at
each meeting of the Board of Directors or the audit committee.

The Company has adopted a code of ethics for its senior officers and which
is filed as an Exhibit hereto.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Based on a review of reports filed with respect to the year ended December
31, 2004, the Company believes that all ownership reports were filed on a timely
basis.

ITEM 11. EXECUTIVE COMPENSATION

The Company will not pay any compensation to its officers or employees or
to directors who are not Independent Directors.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

(a) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS

No person owns of record or is known by the Company to own beneficially
more than 5% of the outstanding 7 3/8% Noncumulative Exchangeable Preferred
Stock, Series A.

(b) SECURITY OWNERSHIP OF MANAGEMENT

The following table shows the ownership of 7 3/8% Noncumulative
Exchangeable Preferred Stock, Series A, by the only officer or director who owns
any such shares.

NAME OF AMOUNT OF PERCENT
TITLE OF CLASS BENEFICIAL OWNER BENEFICIAL OWNERSHIP OF CLASS
-------------- ------------------- -------------------- --------

Preferred Stock................................. Paul R. Skubic 300 Shares .003%
Preferred Stock................................. Forrest Schneider 2,200 Shares .022%
Preferred Stock................................. David J. Blockowicz 1,000 Shares .01%

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

(a) TRANSACTIONS WITH MANAGEMENT AND OTHERS

The Bank, through its wholly-owned subsidiary, HCH, indirectly owns 100% of
the common stock of the Company.

A substantial portion of the assets of the Company initially consisted of
Notes issued by the Bank. The Notes mature on October 1, 2027 and pay interest
at 6.4% per annum. During 2004, the Company received repayments on the Notes of
$4 million compared to 2003 repayments of $15 million. In years ended December
31, 2004, 2003 and 2002, the Bank paid interest on the Notes in the amount of
$907 thousand, $1.5 million and $2.8 million, respectively, to the Company.

The Company purchases U.S. Treasury and Federal agency securities from the
Bank under agreements to resell identical securities. At December 31, 2004, the
Company held $10.5 million of such assets and had earned $1.0 million of
interest from the Bank during 2004. At December 31, 2003, the Company held $11.5
million of such assets and earned $1.3 million of interest for 2003. The Company
receives rates on these assets comparable to the rates that the Bank offers to
unrelated counterparties under similar circumstances.

The Bank and the Company have entered into a Servicing Agreement and an
Advisory Agreement, the terms of which are described in further detail on page 5
of this Report. In 2004, the Bank received payments of

$44 thousand and $124 thousand, respectively, compared to $70 thousand and $56
thousand for 2003, under the terms of these agreements.

(b) CERTAIN BUSINESS RELATIONSHIPS

Paul R. Skubic, Chairman of the Board of the Company, and all of its
executive officers, Janine Mulhall, Frank M. Novosel, Teresa L. Patton and
Margaret M. Sulkin, are also officers of the Bank.

None.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

AUDIT FEES

For year ended December 31, 2004, the Company's principal accountant billed
$42 thousand, for the audit of the Company's annual financial statements and
review of financial statements included in Form 10-Q filings. For year ended
December 31, 2003 the Company's principal accountant billed $72 thousand, for
the audit of the Company's annual financial statements and review of financial
statements included in Form 10-Q filings.

AUDIT-RELATED FEES

There were no fees billed for services reasonably related to the
performance of the audit or review of our financial statements outside of those
fees disclosed above under "Audit Fees" for years ended December 31, 2004 and
2003.

ALL OTHER FEES

There were no other fees billed by the Company's principal accountants
other than those disclosed above for years ended December 31, 2004 and 2003.

PRE-APPROVAL POLICIES AND PROCEDURES

Prior to engaging accountants to perform a particular service, this Board
of Directors obtains an estimate for the service to be performed. All of the
services described above were approved by the audit committee and Board of
Directors in accordance with its procedures.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a) Documents filed with Report:

(1) Consolidated Financial Statements (See page 18 for a listing of all
financial statements included in Item 8)

(2) Financial Statement Schedules

All schedules normally required by Form 10-K are omitted since they are
either not applicable or because the required information is shown in the
financial statements or notes thereto.

(3) Exhibits:

*3(a)(I) Articles of Incorporation of the Company
*3(a)(ii) Form of Articles of Amendment and Restatement of the Company
establishing the Series A Preferred Shares
*3(b) Bylaws of the Company
*4 Specimen of certificate representing Series A Preferred
Shares
*10(a) Form of Servicing Agreement between the Company and the Bank
*10(b) Form of Advisory Agreement between the Company and the Bank
*10(c) Form of Bank Loan Agreement between the Company and the Bank
*10(d) Form of Mortgage Loan Assignment Agreement between the
Company and the Bank
14 Code of Ethics for Senior Officers (incorporated by
reference to Exhibit 14 to the Company's Annual Report on
Form 10-K for the year ended December 31, 2003)
21 Subsidiaries
24 Power of attorney
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

---------------
* Incorporated by reference to the exhibit of the same number filed with the
Company's Registration Statement on Form S-11 (Securities and Exchange
Commission file number 333-40257)

(b) No reports on Form 8-K were filed.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

The following consolidated financial statements are included in Item 8 of
this Annual Report on Form 10-K:

HARRIS PREFERRED CAPITAL CORPORATION

Consolidated Financial Statements

Reports of Independent Registered Public Accounting Firm

Consolidated Balance Sheets

Consolidated Statements of Operations and Comprehensive Income

Consolidated Statements of Changes in Stockholders' Equity

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

HARRIS TRUST AND SAVINGS BANK

Financial Review

Consolidated Financial Statements

Independent Auditors' Report

Consolidated Statements of Condition

Consolidated Statements of Income

Consolidated Statements of Comprehensive Income

Consolidated Statements of Changes in Stockholders' Equity

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

All schedules are omitted since the required information is not present or
is not present in amounts sufficient to require submission of the schedule or
because the information required is included in the consolidated financial
statements and notes hereof.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Harris Preferred Capital Corporation has duly caused this
Report to be signed on its behalf by the undersigned, thereunto duly authorized
on the 28th day of March 2005.

/s/ PAUL R. SKUBIC
--------------------------------------
Paul R. Skubic
Chairman of the Board and President

/s/ JANINE MULHALL
--------------------------------------
Janine Mulhall
Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by Paul R. Skubic, Chairman of the Board and President of
the Company, as attorney-in-fact for the following Directors on behalf of Harris
Preferred Capital Corporation of the 28th day of March 2005.

David J. Blockowicz Forrest M. Schneider
Frank M. Novosel Delbert J. Wacker

Paul R. Skubic
Attorney-In-Fact
Supplemental Information

No proxy statement will be sent to security holders in 2005.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors
of Harris Preferred Capital Corporation

We have audited the accompanying consolidated balance sheet of Harris Preferred
Capital Corporation and subsidiary (the Company) as of December 31, 2004, and
the related consolidated statements of operations and comprehensive income,
changes in stockholders' equity, and cash flows for the year then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 2004, and the results of its operations and its cash flows for the
year then ended, in conformity with U.S. generally accepted accounting
principles.

/S/ KPMG LLP

March 2, 2005
Chicago, Illinois

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors
of Harris Preferred Capital Corporation

In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations and comprehensive income, of changes in
stockholders' equity and of cash flows present fairly, in all material respects,
the financial position of Harris Preferred Capital Corporation (the "Company")
and its subsidiary at December 31, 2003, and the results of their operations and
their cash flows for each of the two years in the period ended December 31, 2003
in conformity with accounting principles generally accepted in the United States
of America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

February 23, 2004
Chicago, Illinois

HARRIS PREFERRED CAPITAL CORPORATION

CONSOLIDATED BALANCE SHEETS

DECEMBER 31
---------------------
2004 2003
--------- ---------
(IN THOUSANDS, EXCEPT
SHARE DATA)

ASSETS
Cash on deposit with Harris Trust and Savings Bank.......... $ 407 $ 926
Securities purchased from Harris Trust and Savings Bank
under agreement to resell................................. 10,500 11,500
Notes receivable from Harris Trust and Savings Bank......... 12,129 16,547
Securities available-for-sale:
Mortgage-backed........................................... 419,315 233,857
U.S. Treasury............................................. 44,993 229,995
Securing mortgage collections due from Harris Trust and
Savings Bank.............................................. 78 414
Other assets................................................ 1,600 1,079
-------- --------
TOTAL ASSETS.............................................. $489,022 $494,318
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses............................................ $ 134 $ 84
-------- --------
Commitments and contingencies............................... -- --

STOCKHOLDERS' EQUITY
7 3/8% Noncumulative Exchangeable Preferred Stock, Series A
($1 par value); liquidation value of $250,000; 20,000,000
shares authorized, 10,000,000 shares issued and
outstanding............................................... 250,000 250,000
Common stock ($1 par value); 1,000 shares authorized, issued
and outstanding........................................... 1 1
Additional paid-in capital.................................. 240,733 240,733
(Distributions in excess of earnings) earnings in excess of
distributions............................................. (582) 1,230
Accumulated other comprehensive income -- net unrealized
gains/(losses) on available-for-sale securities........... (1,264) 2,270
-------- --------
TOTAL STOCKHOLDERS' EQUITY................................ 488,888 494,234
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................ $489,022 $494,318
======== ========

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

HARRIS PREFERRED CAPITAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31
---------------------------------
2004 2003 2002
--------- --------- ---------
(IN THOUSANDS, EXCEPT SHARE DATA)

INTEREST INCOME:
Securities purchased from Harris Trust and Savings Bank
under agreement to resell.............................. $ 1,060 $ 1,266 $ 2,063
Notes receivable from Harris Trust and Savings Bank....... 907 1,508 2,776
Securities available-for-sale:
Mortgage-backed........................................ 14,973 14,791 14,693
U.S. Treasury.......................................... 58 113 402
------- ------- -------
Total interest income................................ 16,998 17,678 19,934
NON-INTEREST INCOME:
Gain on sale of securities................................ 1,062 4,158 2,677
------- ------- -------
1,062 4,158 2,677
OPERATING EXPENSES:
Loan servicing fees paid to Harris Trust and Savings
Bank................................................... 44 70 131
Advisory fees paid to Harris Trust and Savings Bank....... 124 56 43
General and administrative................................ 362 362 314
------- ------- -------
Total operating expenses............................. 530 488 488
------- ------- -------
Net income.................................................. 17,530 21,348 22,123
Preferred stock dividends................................... 18,438 18,438 18,438
------- ------- -------
NET INCOME AVAILABLE (LOSS ALLOCATED) TO COMMON
STOCKHOLDER............................................... $ (908) $ 2,910 $ 3,685
======= ======= =======
Basic and diluted earnings (loss) per common share.......... $ (908) $ 2,910 $ 3,685
======= ======= =======
Net income.................................................. $17,530 $21,348 $22,123
Other comprehensive income/(loss) -- net unrealized
gains/(losses) on available-for-sale securities........... (3,534) (8,092) 12,239
------- ------- -------
Comprehensive income........................................ $13,996 $13,256 $34,362
======= ======= =======

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

HARRIS PREFERRED CAPITAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

(DISTRIBUTIONS IN ACCUMULATED
EXCESS OF OTHER
ADDITIONAL EARNINGS) EARNINGS COMPREHENSIVE TOTAL
PREFERRED COMMON PAID-IN IN EXCESS OF INCOME STOCKHOLDERS'
STOCK STOCK CAPITAL DISTRIBUTIONS (LOSS) EQUITY
--------- ------ ---------- ------------------ ------------- -------------
(IN THOUSANDS EXCEPT PER SHARE DATA)

BALANCE AT DECEMBER 31, 2001... $250,000 $ 1 $240,733 $ 385 $(1,877) $489,242
Net income................... -- -- -- 22,123 -- 22,123
Other comprehensive income... -- -- -- -- 12,239 12,239
Dividends declared on common
stock ($3,220.00 per
share)..................... -- -- -- (3,220) -- (3,220)
Dividends declared on
preferred stock ($1.8438
per share)................. -- -- -- (18,438) -- (18,438)
-------- ----- -------- -------- ------- --------
BALANCE AT DECEMBER 31, 2002... $250,000 $ 1 $240,733 $ 850 $10,362 $501,946
======== ===== ======== ======== ======= ========
Net income................... -- -- -- 21,348 -- 21,348
Other comprehensive loss..... -- -- -- -- (8,092) (8,092)
Dividends declared on common
stock ($2,530.00 per
share)..................... -- -- -- (2,530) -- (2,530)
Dividends declared on
preferred stock ($1.8438
per share)................. -- -- -- (18,438) -- (18,438)
-------- ----- -------- -------- ------- --------
BALANCE AT DECEMBER 31, 2003... $250,000 $ 1 $240,733 $ 1,230 $ 2,270 $494,234
======== ===== ======== ======== ======= ========
Net income................... -- -- -- 17,530 -- 17,530
Other comprehensive loss..... -- -- -- -- (3,534) (3,534)
Dividends declared on common
stock ($904 per share)..... -- -- -- (904) -- (904)
Dividends declared on
preferred stock ($1.8438
per share)................. -- -- -- (18,438) -- (18,438)
-------- ----- -------- -------- ------- --------
BALANCE AT DECEMBER 31, 2004... $250,000 $ 1 $240,733 $ (582) $(1,264) $488,888
======== ===== ======== ======== ======= ========

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

HARRIS PREFERRED CAPITAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31
---------------------------------
2004 2003 2002
--------- --------- ---------
(IN THOUSANDS)

OPERATING ACTIVITIES:
Net income.............................................. $ 17,530 $ 21,348 $ 22,123
Adjustments to reconcile net income to net cash provided
by operating activities:
Gain on sale of securities........................... (1,062) (4,158) (2,677)
Net (increase) decrease in other assets.............. (521) 868 (2)
Net increase (decrease) in accrued expenses.......... 50 (12) (4)
--------- --------- ---------
Net cash provided by operating activities.......... 15,997 18,046 19,440
--------- --------- ---------
INVESTING ACTIVITIES:
Net decrease in securities purchased from Harris Trust
and Savings Bank under agreement to resell........... 1,000 8,500 1,000
Repayments of notes receivable from Harris Trust and
Savings Bank......................................... 4,418 14,531 24,884
Decrease in securing mortgage collections due from
Harris Trust and Savings Bank........................ 336 2,516 2,423
Purchases of securities available-for-sale.............. (676,706) (765,405) (848,215)
Proceeds from sales of securities available-for-sale.... 51,458 99,756 181,510
Proceeds from maturities of securities
available-for-sale................................... 622,320 643,222 640,838
--------- --------- ---------
Net cash provided by investing activities.......... 2,826 3,120 2,440
--------- --------- ---------
FINANCING ACTIVITIES:
Cash dividends paid on preferred stock.................. (18,438) (18,438) (18,438)
Cash dividends paid on common stock..................... (904) (2,530) (3,220)
--------- --------- ---------
Net cash used by financing activities.............. (19,342) (20,968) (21,658)
--------- --------- ---------
Net (decrease) increase in cash on deposit with Harris
Trust and Savings Bank............................... (519) 198 222
Cash on deposit with Harris Trust and Savings Bank at
beginning of period.................................. 926 728 506
--------- --------- ---------
Cash on deposit with Harris Trust and Savings Bank at
end of period........................................ $ 407 $ 926 $ 728
========= ========= =========

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

HARRIS PREFERRED CAPITAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND BASIS OF PRESENTATION

Harris Preferred Capital Corporation (the "Company") is a Maryland
corporation whose principal business objective is to acquire, hold, finance and
manage qualifying real estate investment trust ("REIT") assets (the "Mortgage
Assets"), consisting of a limited recourse note or notes (the "Notes") issued by
Harris Trust and Savings Bank (the "Bank") secured by real estate mortgage
assets (the "Securing Mortgage Loans") and other obligations secured by real
property, as well as certain other qualifying REIT assets. The Company holds its
assets through a Maryland real estate investment trust subsidiary, Harris
Preferred Capital Trust. The Company has elected to be a REIT under sections 856
through 860 of the Internal Revenue Code of 1986, as amended (the "Code"), and
will generally not be subject to Federal income tax to the extent that it meets
all of the REIT requirements in the Code Sections 856-860. All of the 1,000
shares of the Company's common stock, par value $1.00 per share (the "Common
Stock"), are owned by Harris Capital Holdings, Inc. ("HCH"), a wholly-owned
subsidiary of the Bank. On December 30, 1998, the Bank transferred its ownership
of the common stock of the Company to HCH. The Bank is required to maintain
direct or indirect ownership of at least 80% of the outstanding Common Stock of
the Company for as long as any 7 3/8% Noncumulative Exchangeable Preferred
Stock, Series A (the "Preferred Shares"), $1.00 par value, is outstanding. The
Company was formed by the Bank to provide the opportunity to invest in
residential mortgages and other real estate assets and to provide the Bank with
a cost-effective means of raising capital for federal regulatory purposes.

On February 11, 1998, the Company completed an initial public offering (the
"Offering") of 10,000,000 shares of the Company's Preferred Shares, receiving
proceeds of $242,125,000, net of underwriting fees. The Preferred Shares are
traded on the New York Stock Exchange. Concurrent with the issuance of the
Preferred Shares, the Bank contributed additional capital of $250 million to the
Company.

The Company used the proceeds raised from the initial public offering of
the Preferred Shares and the additional capital contributed by the Bank to
purchase $356 million of Notes from the Bank and $135 million of mortgage-backed
securities at their estimated fair value.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

CASH AND CASH EQUIVALENTS

Cash and cash equivalents include cash on deposit with the Bank.

ALLOWANCE FOR POSSIBLE LOAN LOSSES

The allowance for possible loan losses is maintained at a level considered
adequate to provide for potential loan losses. The allowance is increased by
provisions charged to operating expense and reduced by net charge-offs. Known
losses of principal on impaired loans are charged off. The provision for loan
losses is based on past loss experience, management's evaluation of the loan
portfolio securing the Mortgage Assets under current economic conditions and
management's estimate of anticipated, but as yet not specifically identified,
loan losses. Such estimates are reviewed periodically and adjustments, if
necessary, are recorded during the periods in which they become known. At
December 31, 2004 and 2003, no allowance for possible loan losses was recorded
under this policy.

INCOME TAXES

The Company has elected to be taxed as a REIT commencing with its taxable
year ended December 31, 1998 and intends to comply with the provisions of the
Code with respect thereto. The Company does not expect to be subject to Federal
income tax because assets, income distribution and stock ownership tests in Code
Sections 856-860 are met. Accordingly, no provision for income taxes is included
in the accompanying financial statements.
26

The REIT Modernization Act, which took effect on January 1, 2001, modified
certain provisions of the Code with respect to the taxation of REITs. A key
provision of this tax law change reduced the required level of distributions by
a REIT from 95% to 90% of ordinary taxable income.

SECURITIES

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.

Interest income on securities, including amortization of discount or
premium, is included in earnings. Realized gains and losses, as a result of
securities sales, are included in gain on sale of securities in the consolidated
statement of operations, with the cost of securities sold determined on the
specific identification basis.

The Company purchases U.S. Treasury and Federal agency securities from the
Bank under agreements to resell identical securities. The amounts advanced under
these agreements represent short-term loans and are reflected as securities
purchased under agreement to resell in the balance sheet. Securities purchased
under agreement to resell totaled $10.5 million at December 31, 2004 compared to
$11.5 million at December 31, 2003. The securities underlying the agreements are
book-entry securities. Securities are transferred by appropriate entry into the
Company's account with the Bank under a written custodial agreement with the
Bank that explicitly recognizes the Company's interest in these securities.

The Company's investment securities are exposed to various risks such as
interest rate, market and credit. Due to the level of risk associated with
certain investment securities and the level of uncertainty related to changes in
the value of investment securities, it is at least reasonably possible that
changes in risks in the near term would materially affect the carrying value of
investments in securities available-for-sale currently reported in the balance
sheet.

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

NEW ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards ("SFAS") No. 123 (revised 2004), "Share-Based Payments" in
2004. The Statement replaces SFAS No. 123, "Accounting for Stock-Based
Compensation," and supersedes Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees." SFAS 123(R) applies primarily to
accounting for transactions where an entity obtains employee services in
share-based payment transactions using the fair value based method of
accounting. The Statement is effective as of the beginning of the first interim
or annual reporting period that begins after June 15, 2005. The Company does not
expect the implementation of this Statement to have a material effect on its
financial position or results of operations.

MANAGEMENT'S ESTIMATES

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.

3. NOTES RECEIVABLE FROM THE BANK

On February 11, 1998, proceeds received from the Offering were used in part
to purchase $356 million of Notes at a rate of 6.4%. The Notes are secured by
mortgage loans originated by the Bank. The principal amount of the Notes equals
approximately 80% of the aggregate outstanding principal amount of the Mortgage
Loans. During 2004, the Company received repayments on the Notes of $4.4 million
compared to 2003 repayments of $14.5 million. For years ended December 31, 2004,
2003 and 2002, the Bank paid interest on the Notes in the amount of $907
thousand, $1.5 million and $2.8 million, respectively, to the Company.

The Notes are recourse only to the Securing Mortgage Loans that are secured
by real property. The Notes mature on October 1, 2027. Payments of principal and
interest on the Notes are recorded monthly from payments received on the
Securing Mortgage Loans. The Company has a security interest in the real
property securing the underlying mortgage loans and is entitled to enforce
payment on the Securing Mortgage Loans in its own name if a mortgagor should
default. In the event of default, the Company has the same rights as the
original mortgagee to foreclose the mortgaged property and satisfy the
obligations of the Bank out of the proceeds. The Securing Mortgage Loans are
serviced by the Bank, as agent of the Company.

The Company intends that each mortgage loan securing the Notes will
represent a first lien position and will be originated in the ordinary course of
the Bank's real estate lending activities based on the underwriting standards
generally applied (at the time of origination) for the Bank's own account. The
Company also intends that all Mortgage Assets held by the Company will meet
market standards, and servicing guidelines promulgated by the Company, and
Federal National Mortgage Association ("Fannie Mae") and Federal Home Loan
Mortgage Corporation ("FHLMC") guidelines and procedures.

The balance of Securing Mortgage Loans at December 31, 2004 and 2003 was
$15 million and $21 million, respectively. The weighted average interest rate on
those loans at December 31, 2004 and 2003 was 5.862% and 5.996%, respectively.

None of the Securing Mortgage Loans collateralizing the Notes were on
nonaccrual status at December 31, 2004 or 2003.

A majority of the collateral securing the underlying mortgage loans is
located in Illinois. The financial viability of customers in this state is, in
part, dependent on the state's economy. The Company's maximum risk of accounting
loss, should all customers in Illinois fail to perform according to contract
terms and all collateral prove to be worthless, was approximately $11 million at
December 31, 2004 and $12 million as of December 31, 2003.

4. SECURITIES

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

DECEMBER 31, 2004 DECEMBER 31, 2003
---------------------------------------------- ----------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
--------- ---------- ---------- -------- --------- ---------- ---------- --------
(IN THOUSANDS)

AVAILABLE-FOR-SALE
SECURITIES
Mortgage-backed............ $420,583 $971 $2,239 $419,315 $231,587 $2,665 $395 $233,857
U.S. Treasury.............. 44,989 4 -- 44,993 229,995 -- -- 229,995
-------- ---- ------ -------- -------- ------ ---- --------
Total Securities........... $465,572 $975 $2,239 $464,308 $461,582 $2,665 $395 $463,852
======== ==== ====== ======== ======== ====== ==== ========

The following table summarizes mortgage-backed securities with unrealized
losses as of December 31, 2004, the amount of the unrealized loss and the
related fair value of the securities with unrealized losses. The unrealized
losses have been further segregated by mortgage-backed securities that have been
in a continuous unrealized loss position for less than 12 months and those that
have been and those that been in a continuous unrealized loss position for 12 or
more months. Management believes that all of the unrealized losses are
temporary.

LENGTH OF CONTINUOUS UNREALIZED LOSS POSITION
--------------------------------------------------------------------
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
--------------------- -------------------- ---------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
-------- ---------- ------- ---------- -------- ----------
(IN THOUSAND)

Mortgage-backed........ $236,138 $1,866 $37,692 $373 $273,830 $2,239
======== ====== ======= ==== ======== ======

The amortized cost and estimated fair value of total available-for-sale
securities at December 31, 2004, by contractual maturity, are shown below.
Expected maturities can differ from contractual maturities since borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties. The U.S. Treasury Bills held at December 31, 2004 mature within the
next month.

DECEMBER 31, 2004
--------------------
AMORTIZED FAIR
COST VALUE
--------- --------

Maturities:
Within 1 year............................................. $ 44,993 $ 44,997
1 to 5 years.............................................. 131,776 132,011
5 to 10 years............................................. 98,626 97,327
Over 10 years............................................. 190,177 189,973
-------- --------
Total Securities............................................ $465,572 $464,308
======== ========

5. COMMON AND PREFERRED STOCK

On February 11, 1998, the Company issued 10,000,000 Preferred Shares,
Series A, at a price of $25 per share pursuant to its Registration Statement on
Form S-11. Proceeds from this issuance, net of underwriting fees, totaled
$242,125,000. The liquidation value of each Preferred Share is $25 plus any
authorized, declared and unpaid dividends. The Preferred Shares are redeemable
at the option of the Company, in whole or in part, at the liquidation preference
thereof, plus the quarterly accrued and unpaid dividends, if any, to the date of
redemption. The Company may not redeem the Preferred Shares without prior
approval from the Board of Governors of the Federal Reserve System or the
appropriate successor federal regulatory agency. Except under certain limited
circumstances, as defined, the holders of the Preferred Shares have no voting
rights. The Preferred Shares are automatically exchangeable for a new series of
preferred stock of the Bank upon the occurrence of certain events.

Holders of Preferred Shares are entitled to receive, if declared by the
Board of Directors of the Company, noncumulative dividends at a rate of 7 3/8%
per annum of the $25 per share liquidation preference (an amount equivalent to
$1.84375 per share per annum). Dividends on the Preferred Shares, if authorized
and declared, are payable quarterly in arrears on March 30, June 30, September
30, and December 30 each year. Dividends paid to the holders of the Preferred
Shares for the years ended December 31, 2004 and 2003 were $18,438,000 in both
years. The allocations of the distributions declared and paid for income tax
purposes for the years ended December 31, 2004 and 2003 were 87.7% of ordinary
income, 7.4% of capital gain and 4.9% of return of capital and 92% of ordinary
income and 8% of capital gain, respectively.

On December 30, 1998, the Bank contributed the Common Stock of the Company
to HCH. The Bank is required to maintain direct or indirect ownership of at
least 80% of the outstanding Common Stock of the Company for as long as any
Preferred Shares are outstanding. Dividends on Common Stock are paid if and when
authorized and declared by the Board of Directors out of funds legally available
after all preferred

dividends have been paid. A Common Stock dividend of $2,000 per common share was
declared on December 2, 2003, to the stockholder of record on December 15, 2003
and paid on December 31, 2003. In addition, on September 13, 2004 and September
12, 2003, the Company paid a cash dividend of $904 thousand and $530 thousand,
respectively, on the outstanding common shares. These dividends completed the
2003 and 2002 REIT tax compliance requirements.

6. TRANSACTIONS WITH AFFILIATES

The Company entered into an advisory agreement (the "Advisory Agreement")
with the Bank pursuant to which the Bank administers the day-to-day operations
of the Company. The Bank is responsible for (i) monitoring the credit quality of
Mortgage Assets held by the Company; (ii) advising the Company with respect to
the reinvestment of income from and payments on, and with respect to, the
acquisition, management, financing, and disposition of the Mortgage Assets held
by the Company; and (iii) monitoring the Company's compliance with the
requirements necessary to qualify as a REIT.

The Advisory Agreement in effect for 2004, 2003 and 2002 entitled the Bank
to receive advisory fees of $124,000, $56,000, and $43,000, respectively for
processing, recordkeeping, legal, management and other services.

The Securing Mortgage Loans are serviced by the Bank pursuant to the terms
of a servicing agreement (the "Servicing Agreement"). The Bank receives a fee
equal to 0.25% per annum on the principal balances of the loans serviced. The
Servicing Agreement requires the Bank to service the mortgage loans in a manner
generally consistent with accepted secondary market practices, and servicing
guidelines promulgated by the Company and with Fannie Mae and FHLMC guidelines
and procedures. In 2004, 2003, and 2002 the Bank received payments of $44
thousand, $70 thousand and $131 thousand, respectively.

The Company purchases U.S. Treasury and Federal agency securities from the
Bank under agreements to resell identical securities. At December 31, 2004, the
Company held $10.5 million of such assets and had earned $1.0 million of
interest from the Bank during 2004. At December 31, 2003 the Company held $11.5
million of such assets and earned $1.3 million of interest for 2003. At December
31, 2002 the Company held $20 million of such assets and earned $2.1 million of
interest for 2002. The Company receives rates on these assets comparable to the
rates that the Bank offers to unrelated counterparties under similar
circumstances.

7. OPERATING SEGMENT

The Company's operations consist of monitoring and evaluating the
investments in Mortgage Assets. Accordingly, the Company operates in only one
segment. The Company has no external customers and transacts most of its
business with the Bank.

8. COMMITMENTS AND CONTINGENCIES

Legal proceedings in which the Company is a defendant may arise in the
normal course of business. At December 31, 2004 and 2003, there was no pending
litigation against the Company.

9. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

The following table sets forth selected quarterly financial data for the
Company:

YEAR ENDED DECEMBER 31, 2004 YEAR ENDED DECEMBER 31, 2003
--------------------------------------- ----------------------------------------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
-------- -------- ------- ------- --------- ------- -------- -------
(IN THOUSANDS EXCEPT PER SHARE DATA)

Total interest
income............... $ 3,383 $ 3,847 $ 4,805 $ 4,963 $ 5,293 $4,779 $ 3,856 $ 3,750
Total noninterest
income............... 398 -- 464 200 2,463 -- 687 1,008
Total operating
expenses............. 137 137 94 162 130 99 80 179
-------- -------- ------- ------- --------- ------ -------- -------
Net income............. 3,644 3,710 5,175 5,001 7,626 4,680 4,463 4,569
Preferred dividends.... 4,609 4,609 4,609 4,611 4,609 4,609 4,609 4,611
-------- -------- ------- ------- --------- ------ -------- -------
Net income available
(loss allocated) to
common stockholder... (965) (899) 566 390 3,017 71 (146) (32)
======== ======== ======= ======= ========= ====== ======== =======
Basic and diluted
(loss) income per
common share......... $(965.00) $(899.00) $566.00 $390.00 $3,017.00 $71.00 $(146.00) $(32.00)
======== ======== ======= ======= ========= ====== ======== =======

FINANCIAL STATEMENTS OF HARRIS TRUST AND SAVINGS BANK

The following unaudited financial information and audited financial
statements for Harris Trust and Savings Bank are included because the Preferred
Shares are automatically exchangeable for a new series of preferred stock of the
Bank upon the occurrence of certain events.

HARRIS TRUST AND SAVINGS BANK

CERTAIN INFORMATION REGARDING HARRIS TRUST AND SAVINGS BANK

Harris Trust and Savings Bank ("the Bank") is an Illinois banking operation
located at 111 West Monroe Street, Chicago, Illinois 60603. The Bank is a
wholly-owned subsidiary of Harris Bankcorp, Inc., a multibank holding company
incorporated under the laws of the State of Delaware and headquartered in
Chicago and registered under the Bank Holding Company Act of 1956, as amended.
Harris Bankcorp, Inc. is a wholly-owned subsidiary of Harris Financial Corp.
("HFC") (formerly known as Bankmont Financial Corp.). Harris Bankcorp, Inc. also
owns 29 other banks, 27 in the counties surrounding Chicago, one with locations
in Arizona, Florida and Washington and one with locations in northwest Indiana.
HFC is a wholly-owned subsidiary of Bank of Montreal. At December 31, 2004,
Harris Bankcorp's assets amounted to $34.12 billion, with the Bank representing
approximately 62 percent of that total.

The Bank, an Illinois state-chartered bank, has its principal office, 56
domestic branch offices and 128 automated teller machines located in the Chicago
area. The Bank also has offices in Atlanta, Los Angeles and San Francisco and a
foreign branch office in Nassau. At December 31, 2004, the Bank had total assets
of $21.22 billion, total deposits of $13.85 billion, total loans of $11.48
billion and equity capital of $1.64 billion.

The Bank provides a broad range of banking and financial services to
individuals and corporations domestically and abroad, including corporate
banking, personal financial services, personal trust services and investment
services. The Bank also offers (i) demand and time deposit accounts; (ii)
various types of loans (including term, real estate, revolving credit facilities
and lines of credit); (iii) sales and purchases of foreign currencies; (iv)
interest rate management products (including swaps, forward rate agreements and
interest rate guarantees); (v) cash management services; (vi) underwriting of
municipal bonds; (vii) financial consulting; and (viii) a wide variety of
personal trust and trust-related services.

Competitors of the Bank include commercial banks, savings and loan
associations, consumer and commercial finance companies, credit unions and other
financial services companies. Based on legislation passed in 1986 that allows
Illinois banks to be acquired by banks or holding companies in states with a
reciprocal law in effect, together with the Federal Interstate Banking
Efficiency Act of 1994 that allows for both interstate banking and interstate
branching in certain circumstances, the Bank believes that the level of
competition will increase in the future.

The Bank is subject to regulation by the Board of Governors of the Federal
Reserve System and the Federal Deposit Insurance Corporation. As a
state-chartered bank, it is also regulated by the Illinois Office of Banks and
Real Estate. These regulatory bodies examine the Bank and supervise numerous
aspects of its business. The Federal Reserve System regulates money and credit
conditions and interest rates in order to influence general economic conditions,
primarily through open market operations in U.S. Government securities, varying
the discount rate on bank borrowings, setting reserve requirements against
financial institution deposits and prescribing minimum capital requirements for
member banks. These policies have a significant influence on overall growth and
distribution of bank loans, investments and deposits, and affect interest rates
charged on loans and earned on investments or paid for time, savings and other
deposits. Board of Governors monetary policies have had a significant effect on
the operating results of commercial banks in the past and this is expected to
continue.

On June 4, 2004, Harris Bankcorp, Inc. announced its plan to consolidate
twenty-six of its existing bank charters, including the Bank, into one national
bank charter, Harris N.A. This transaction is expected to be completed in May
2005. The combination will be recorded at historical carrying value and, where
applicable, prior years' financial statements will be restated.

Although primarily focusing on U.S. domestic customers, identifiable
foreign assets accounted for 4 percent of the Bank's total consolidated assets
at December 31, 2004 and foreign net loss was $31.8 million in 2004. Foreign
activities result from three primary sources: (i) lending to foreign banks and
other financial institutions; (ii) time deposits held or issued to foreign
banks; and (iii) foreign exchange trading profits of approximately $5.9 million.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

2004 COMPARED TO 2003

SUMMARY

The Bank's 2004 net income was $141.1 million, up $23.2 million from 2003.
A significantly lower provision for loan losses was the primary reason for this
improvement. This was partially offset by lower noninterest income. Return on
average common equity ("ROE") for 2004 was 8.71 percent and 7.43 percent in
2003. Return on average assets ("ROA") was 0.69 percent in 2004 and 0.61 percent
in 2003.

Earnings before amortization of valuation intangibles ("cash earnings")
were $147.3 million in 2004, a 19 percent increase compared to 2003. Cash return
on average common stockholder's equity ("cash ROE") represents net income
applicable to common stock plus after-tax amortization expense of intangibles,
divided by average common stockholder's equity less average intangible assets.
Cash ROE, excluding the impact of unrealized securities gains and losses on
equity, was 10.08 percent in 2004 compared to 9.06 percent in 2003.

For 2004, net interest income on a fully taxable equivalent basis of $442.2
million was down 1 percent from 2003. Net interest margin declined from 2.70
percent to 2.49 percent in 2004, reflecting the impact of lower yields in the
investment securities portfolio and higher funding costs for certain borrowings.
Average earning assets increased $1.20 billion or 7 percent to $17.79 billion in
the current year, largely due to an increase of $884 million in average loans.

Noninterest income decreased $58.4 million to $456.3 million for 2004.
Gains on sales of mortgage loans decreased $9.2 million, net fees from providing
service to related corporate entities decreased $28.9 million, syndication fee
income decreased $10.1 million and service fees and charges decreased $12.4
million. Trust and investment management fees increased $8.5 million and the
Bank realized a $7.1 million gain on the sale of assets received in an earlier
troubled debt restructuring. A gain of $7.7 million was realized on the
termination of a swap.

Total noninterest expenses were $683.6 million, down $7.1 million or 1
percent from 2003. Total direct compensation costs declined by 8 percent in 2004
although this was somewhat offset by charges for outsourced services. Income
taxes were $58.7 million, up $19.4 million from 2003, reflecting higher pretax
income in 2004.

The provision for loan losses was $7.2 million in 2004 compared to $103.6
million in 2003. Net loan charge-offs during the current year were $23.5 million
compared to $75.8 million in 2003 reflecting lower write-offs in the commercial
loan portfolio. The decrease in provision was based on management's estimate of
potentially lower loan losses due to continued declines in non-performing loan
levels as well as reduced charge-offs.

Nonperforming assets totaled $125 million or 1.09 percent of total loans
compared to $172 million or 1.79 percent a year earlier. At December 31, 2004,
the allowance for loan losses was $220 million or 1.91 percent of total loans
outstanding compared to $235 million or 2.45 percent of loans at the end of
2003. As a result, the ratio of the allowance for loan losses to nonperforming
assets increased from a multiple of 1.4 at December 31, 2003 to 1.8 at December
31, 2004.

At December 31, 2004, the Bank's equity capital amounted to $1.64 billion,
up from $1.60 billion at December 31, 2003. The Bank paid cash and non-cash
dividends totaling $70.5 million in 2004. Unrealized securities losses, net of
tax benefit, were $21.3 million at December 31, 2004 compared to net of tax
unrealized securities gains of $31.0 million at December 31, 2003. In February
1998, Harris Preferred Capital Corporation, a subsidiary of the Bank, issued
$250 million of noncumulative preferred stock in a public offering (see Note 18
to Financial Statements). The preferred stock qualifies as Tier 1 capital for
U.S. banking regulatory purposes.

The Bank's regulatory capital leverage ratio was 8.33 percent compared to
8.52 percent one year earlier. Regulators require most banking institutions to
maintain capital leverage ratios of not less than 4.0 percent. At
33

December 31, 2004, the Bank's Tier 1 and total risk-based capital ratios were
9.49 percent and 11.75 percent, respectively, compared to respective ratios of
10.20 percent and 12.25 percent at December 31, 2003. The 2004 year-end
risk-based capital ratios substantially exceeded minimum required regulatory
ratios of 4.0 percent and 8.0 percent, respectively.

2003 COMPARED TO 2002

SUMMARY

The Bank's 2003 net income was $117.9 million, down $54.0 million from
2002. Declines in gains from sales of portfolio securities, a higher provision
for loan losses and increased pension costs more than offset increased
noninterest revenue excluding security sales. Return on average common equity
("ROE") for 2003 was 7.43 percent and 11.02 percent in 2002. Return on average
assets ("ROA") was 0.61 percent in 2003 and 0.95 percent in 2002.

Earnings before amortization of goodwill and other valuation intangibles
("cash earnings") were $124.0 million in 2003, a 30 percent decrease compared to
2002. Cash return on average common stockholder's equity ("cash ROE") represents
net income applicable to common stock plus after-tax amortization expense of
goodwill and other valuation intangibles, divided by average common
stockholder's equity less average intangible assets. Cash ROE was 8.76 percent
in 2003 compared to 12.85 percent in 2002.

For 2003, net interest income on a fully taxable equivalent basis of $447.9
million was down 4 percent from 2002. Net interest margin declined from 2.99
percent to 2.70 percent in 2003, reflecting the impact of lower yields in the
investment securities portfolio. Average earning assets increased $1.01 billion
or 6 percent to $16.59 billion in the current year, attributable to an increase
of $990 million in investment securities.

Noninterest income increased $2.2 million to $514.7 million for 2003. Gains
on sales of mortgage loans increased $8.9 million and fees from providing
service to related corporate entities rose $28.5 million. Net gains from sales
of investment securities decreased $35.3 million.

Total noninterest expenses were $690.7 million, up $34.4 million or 5
percent from 2002. Income taxes were $39.3 million, down $28.0 million from
2002, reflecting lower pretax income in 2003.

The provision for loan losses was $103.6 million in 2003 compared to $71.2
million in 2002. Net loan charge-offs during the current year were $75.8 million
compared to $91.6 million in 2002 reflecting lower write-offs in the commercial
loan portfolio.

Nonperforming assets totaled $172 million or 1.79 percent of total loans at
both December 31, 2003 and December 31, 2002. At December 31, 2003, the
allowance for possible loan losses was $235 million or 2.45 percent of total
loans outstanding compared to $207 million or 2.15 percent of loans at the end
of 2002. As a result, the ratio of the allowance for possible loan losses to
nonperforming assets increased from a multiple of 1.2 at December 31, 2002 to
1.4 at December 31, 2003.

At December 31, 2003, the Bank's equity capital amounted to $1.60 billion,
up slightly from $1.58 billion at December 31, 2002. Unrealized securities
gains, net of tax, were $31.0 million at December 31, 2003 compared to $73.0
million at December 31, 2002. In February 1998, Harris Preferred Capital
Corporation, a subsidiary of the Bank, issued $250 million of noncumulative
preferred stock in a public offering (see Note 18 to Financial Statements). The
preferred stock qualifies as Tier 1 capital for U.S. banking regulatory
purposes.

The Bank's regulatory capital leverage ratio was 8.52 percent compared to
8.64 percent one year earlier. Regulators require most banking institutions to
maintain capital leverage ratios of not less than 4.0 percent. At December 31,
2003, the Bank's Tier 1 and total risk-based capital ratios were 10.20 percent
and 12.25 percent, respectively, compared to respective ratios of 10.19 percent
and 12.50 percent at December 31, 2002. The 2003 year-end risk-based capital
ratios substantially exceeded minimum required regulatory ratios of 4.0 percent
and 8.0 percent, respectively.

INDEPENDENT AUDITORS' REPORT

To the Stockholder and Board
of Directors of Harris Trust and Savings Bank

We have audited the accompanying consolidated statements of condition of
Harris Trust and Savings Bank (an indirect wholly-owned subsidiary of Bank of
Montreal) and subsidiaries as of December 31, 2004 and 2003, and the related
consolidated statements of income, comprehensive income, changes in
stockholder's equity and cash flows for each of the years in the three year
period ended December 31, 2004. These consolidated financial statements are the
responsibility of Harris Trust and Savings Bank's management. Our responsibility
is to express an opinion on these consolidated financial statements based on our
audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Harris Trust
and Savings Bank and subsidiaries as of December 31, 2004 and 2003, and the
results of their operations and their cash flows for each of the years in the
three year period ended December 31, 2004 in conformity with United States of
America generally accepted accounting principles.

/S/ KPMG LLP

Chicago, Illinois
March 16, 2005

HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CONDITION

DECEMBER 31
---------------------------------
2004 2003
--------------- ---------------
(IN THOUSANDS EXCEPT SHARE DATA)

ASSETS
Cash and demand balances due from banks..................... $ 887,827 $ 823,615
Money market assets:
Interest-bearing deposits at banks........................ 662,366 424,459
Federal funds sold........................................ 541,300 409,425
Securities available-for-sale (including $3.36 billion and
$4.07 billion of securities pledged as collateral for
repurchase agreements at December 31, 2004 and December
31, 2003, respectively)................................... 5,784,417 6,624,280
Trading account assets...................................... 90,130 59,467
Loans....................................................... 11,484,948 9,573,452
Allowance for loan losses................................... (219,740) (234,798)
----------- -----------
Net loans.............................................. 11,265,208 9,338,654
Premises and equipment...................................... 309,415 302,975
Bank-owned insurance........................................ 1,072,660 1,035,239
Loans held for sale......................................... 43,423 168,904
Goodwill and other intangible assets........................ 155,596 165,978
Other assets................................................ 412,305 566,494
----------- -----------
TOTAL ASSETS........................................... $21,224,647 $19,919,490
=========== ===========

LIABILITIES
Deposits in domestic offices -- noninterest-bearing......... $ 4,019,416 $ 4,231,540
-- interest-bearing........... 8,149,640 7,844,596
Deposits in foreign offices -- noninterest-bearing.......... -- 49,016
-- interest-bearing.............. 1,677,428 616,889
----------- -----------
Total deposits......................................... 13,846,484 12,742,041
Federal funds purchased..................................... 1,267,850 1,190,839
Securities sold under agreement to repurchase............... 3,299,029 3,452,567
Short-term borrowings....................................... 88,070 10,841
Short-term senior notes..................................... 200,000 --
Accrued interest, taxes and other expenses.................. 165,618 171,422
Other liabilities........................................... 264,134 275,151
Minority interest -- preferred stock of subsidiary.......... 250,000 250,000
Preferred stock issued to Harris Bankcorp, Inc. ............ 5,000 5,000
Long-term notes -- subordinated............................. 200,000 225,000
----------- -----------
TOTAL LIABILITIES...................................... 19,586,185 18,322,861
----------- -----------
STOCKHOLDER'S EQUITY
Common stock ($10 par value); 10,100,000 and 10,000,000
shares authorized, issued and outstanding at December 31,
2004 and December 31, 2003, respectively.................. 101,000 100,000
Surplus..................................................... 647,365 634,944
Retained earnings........................................... 941,767 860,674
Accumulated other comprehensive (loss) income............... (51,670) 1,011
----------- -----------
TOTAL STOCKHOLDER'S EQUITY............................. 1,638,462 1,596,629
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY............. $21,224,647 $19,919,490
=========== ===========

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

HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31
---------------------------------
2004 2003 2002
--------- --------- ---------
(IN THOUSANDS EXCEPT SHARE DATA)

INTEREST INCOME
Loans....................................................... $535,018 $470,500 $512,946
Money market assets:
Deposits at banks......................................... 5,417 3,061 2,066
Federal funds sold and securities purchased under
agreement to resell.................................... 8,638 3,655 7,938
Trading accounts............................................ 2,396 1,672 2,031
Securities available-for-sale:
U.S. Treasury and federal agency.......................... 110,007 163,593 195,336
State and municipal....................................... 1,140 302 24
Other..................................................... 10,431 2,178 2,243
-------- -------- --------
Total interest income.................................. 673,047 644,961 722,584
-------- -------- --------
INTEREST EXPENSE
Deposits.................................................... 155,868 125,102 162,267
Short-term borrowings....................................... 54,573 50,458 64,262
Senior notes................................................ 3,238 3,722 12,144
Minority interest -- dividends on preferred stock of
subsidiary................................................ 18,438 18,438 18,438
Long-term notes............................................. 6,601 10,452 11,257
-------- -------- --------
Total interest expense................................. 238,718 208,172 268,368
-------- -------- --------
NET INTEREST INCOME......................................... 434,329 436,789 454,216
Provision for loan losses................................... 7,177 103,604 71,220
-------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES......... 427,152 333,185 382,996
-------- -------- --------
NONINTEREST INCOME
Trust and investment management fees........................ 93,043 84,586 82,829
Money market and bond trading............................... 11,994 9,343 9,347
Foreign exchange............................................ 5,850 5,076 7,155
Service charges and fees.................................... 100,310 112,683 118,635
Net securities gains........................................ 26,180 25,953 61,272
Bank-owned insurance........................................ 40,355 43,712 50,713
Gains from loan restructuring............................... 7,131 -- --
Letter of credit fees....................................... 22,922 26,349 24,399
Syndication fees............................................ 4,063 14,168 6,289
Other....................................................... 144,450 192,856 151,869
-------- -------- --------
Total noninterest income............................... 456,298 514,726 512,508
-------- -------- --------
NONINTEREST EXPENSES
Salaries and other compensation............................. 293,896 321,170 310,116
Pension, profit sharing and other employee benefits......... 83,552 76,572 61,279
Net occupancy............................................... 43,905 41,964 41,727
Equipment................................................... 52,236 54,586 53,531
Marketing................................................... 34,772 31,217 29,165
Communication and delivery.................................. 22,230 22,963 22,593
Expert services............................................. 22,650 26,733 28,328
Contract programming........................................ 31,137 28,930 29,105
Other....................................................... 88,873 76,337 70,369
-------- -------- --------
673,251 680,472 646,213
Amortization of intangibles................................. 10,382 10,267 10,151
-------- -------- --------
Total noninterest expenses............................. 683,633 690,739 656,364
-------- -------- --------
Income before income taxes.................................. 199,817 157,172 239,140
Applicable income taxes..................................... 58,726 39,301 67,306
-------- -------- --------
NET INCOME.................................................. $141,091 $117,871 $171,834
======== ======== ========

The accompanying notes to consolidated financial statements are an integral part
of these statements.
37

HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31
---------------------------------
2004 2003 2002
--------- --------- ---------
(IN THOUSANDS)

NET INCOME.................................................. $141,091 $117,871 $171,834
Other comprehensive (loss) income:
Cash flow hedges:
Net unrealized (loss) gain on derivative instruments,
net of tax (benefit) expense of ($3,077) in 2004, $21
in 2003 and zero in 2002............................. (5,309) 35 --
Minimum pension liability adjustment net of tax expense
(benefit) of $6,210 in 2004, ($3,161) in 2003 and
($16,618) in 2002...................................... 4,864 (4,792) (25,194)
Unrealized (losses) gains on available-for-sale
securities:
Unrealized holding (losses) gains arising during
period, net of tax (benefit) expense of ($21,105) in
2004, ($18,194) in 2003 and $58,702 in 2002.......... (36,909) (26,140) 90,296
Less reclassification adjustment for gains included in
net income, net of tax expense of $10,185 in 2004,
$10,096 in 2003 and $23,835 in 2002.................. (15,995) (15,857) (37,437)
-------- -------- --------
Other comprehensive (loss) income......................... (53,349) (46,754) 27,665
-------- -------- --------
Comprehensive income........................................ $ 87,742 $ 71,117 $199,499
======== ======== ========

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

HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES

STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY

ACCUMULATED
OTHER
COMPREHENSIVE TOTAL
COMMON RETAINED INCOME STOCKHOLDER'S
STOCK SURPLUS EARNINGS (LOSS) EQUITY
-------- -------- --------- ------------- -------------
(IN THOUSANDS EXCEPT PER SHARE DATA)

BALANCE AT DECEMBER 31, 2001....... $100,000 $620,586 $ 819,991 $ 20,100 $1,560,677
Contribution to capital
surplus....................... -- 5,591 -- -- 5,591
Tax benefit from stock option
exercise...................... -- 463 -- -- 463
Net income....................... -- -- 171,834 -- 171,834
Dividends -- ($18.80 per common
share)........................ -- -- (188,000) -- (188,000)
Dividends -- ($0.115 per
preferred share).............. -- -- (576) -- (576)
Other comprehensive income....... -- -- -- 27,665 27,665
-------- -------- --------- -------- ----------
BALANCE AT DECEMBER 31, 2002....... 100,000 626,640 803,249 47,765 1,577,654
Contribution to capital
surplus....................... -- 6,086 -- -- 6,086
Tax benefit from stock option
exercise...................... -- 2,218 -- -- 2,218
Net income....................... -- -- 117,871 -- 117,871
Dividends -- ($6.00 per common
share)........................ -- -- (60,000) -- (60,000)
Dividends -- ($0.089 per
preferred share).............. -- -- (446) -- (446)
Other comprehensive loss......... -- -- -- (46,754) (46,754)
-------- -------- --------- -------- ----------
BALANCE AT DECEMBER 31, 2003....... 100,000 634,944 860,674 1,011 1,596,629
Contribution to capital
surplus....................... -- 4,423 -- -- 4,423
Tax benefit from stock option
exercise...................... -- 4,398 -- -- 4,398
Contribution of parent's banking
assets........................ 1,000 3,600 9,716 668 14,984
Net income....................... -- -- 141,091 -- 141,091
Dividends -- ($6.50 per common
share)........................ -- -- (65,000) -- (65,000)
Dividends -- ($0.025 per
preferred share).............. -- -- (124) -- (124)
Adjustment of prior quarters'
preferred dividends........... -- -- 767 -- 767
Non-cash dividend of
subsidiary.................... -- -- (5,357) -- (5,357)
Other comprehensive loss......... -- -- -- (53,349) (53,349)
-------- -------- --------- -------- ----------
BALANCE AT DECEMBER 31, 2004....... $101,000 $647,365 $ 941,767 $(51,670) $1,638,462
======== ======== ========= ======== ==========

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

HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31
---------------------------------------
2004 2003 2002
----------- ----------- -----------
(IN THOUSANDS)

OPERATING ACTIVITIES:
Net Income.......................................... $ 141,091 $ 117,871 $ 171,834
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses........................ 7,177 103,604 71,220
Depreciation and amortization, including
intangibles.................................... 68,413 67,207 61,892
Deferred tax expense............................. 1,264 9,487 6,035
Net gain on sales of securities.................. (26,180) (25,953) (61,272)
Increase in bank-owned insurance................. (39,560) (43,054) (47,105)
Trading account net cash purchases............... (27,550) (14,712) (21,486)
(Increase) decrease in interest receivable....... (9) 4,839 19,811
Increase (decrease) in interest payable.......... (107) 7,331 (22,155)
Decrease (increase) in loans held for sale....... 125,481 (19,593) (27,723)
Other, net....................................... 113,044 74,257 14,234
----------- ----------- -----------
Net cash provided by operating activities...... 363,064 281,284 165,285
----------- ----------- -----------
INVESTING ACTIVITIES:
Net increase in interest-bearing deposits at
banks.......................................... (237,907) (7,253) (221,483)
Net (increase) decrease in Federal funds sold and
securities purchased under agreement to
resell......................................... (125,753) (171,475) 341,800
Proceeds from sales of securities
available-for-sale............................. 2,610,520 1,539,979 2,678,763
Proceeds from maturities of securities
available-for-sale............................. 3,099,331 4,526,559 7,453,346
Purchases of securities available-for-sale....... (4,920,853) (7,031,858) (9,992,242)
Net (increase) decrease in loans................. (1,826,595) (53,809) 246,595
Net purchases of premises and equipment.......... (56,211) (53,744) (56,753)
Other, net....................................... 2,139 152 5,145
----------- ----------- -----------
Net cash (used) provided by investing
activities.................................. (1,455,329) (1,251,449) 455,171
----------- ----------- -----------
FINANCING ACTIVITIES:
Cash received in contribution of parent's banking
assets......................................... 3,379 -- --
Net increase (decrease) in deposits.............. 1,056,472 1,703,757 (152,576)
Net (decrease) increase in Federal funds
purchased and securities sold under agreement
to repurchase.................................. (85,527) (417,378) 637,433
Net increase (decrease) in other short-term
borrowings..................................... 77,229 (289,853) (404,005)
Proceeds from issuance of senior notes........... 2,380,000 2,590,000 750,000
Repayment of senior notes........................ (2,180,000) (2,790,000) (1,410,000)
Proceeds from issuance of long-term notes........ 200,000 -- --
Repayment of long-term notes..................... (225,000) -- --
Cash dividends paid on common stock.............. (65,000) (60,000) (188,000)
Cash portion of dividend of non-bank
subsidiary..................................... (5,076) -- --
----------- ----------- -----------
Net cash provided (used) by financing
activities.................................. 1,156,477 736,526 (767,148)
----------- ----------- -----------
Net increase (decrease) in cash and demand
balances due from banks........................ 64,212 (233,639) (146,692)
Cash and demand balances due from banks at
January 1...................................... 823,615 1,057,254 1,203,946
----------- ----------- -----------
Cash and demand balances due from banks at
December 31.................................... $ 887,827 $ 823,615 $ 1,057,254
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest....................................... $ 238,826 $ 200,841 $ 290,524
Income taxes................................... $ 43,651 $ 21,263 $ 67,056

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

HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION AND NATURE OF OPERATIONS

Harris Trust and Savings Bank is a wholly-owned subsidiary of Harris
Bankcorp, Inc. ("Bankcorp"), a Delaware corporation which is a wholly-owned
subsidiary of Harris Financial Corp. ("HFC"), a Delaware corporation which is a
wholly-owned subsidiary of Bank of Montreal ("BMO"). Throughout these Notes to
Consolidated Financial Statements, the term "Bank" refers to Harris Trust and
Savings Bank and subsidiaries.

The consolidated financial statements 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 years' financial statements to the current year's presentation.
See Note 23 to the Consolidated Financial Statements for additional information
on business combinations and Note 24 for additional information on related party
transactions.

The Bank provides banking, trust and other services domestically and
internationally through the main banking facility and 5 active nonbank
subsidiaries. The Bank provides a variety of financial services to commercial
and industrial companies, financial institutions, governmental units,
not-for-profit organizations and individuals throughout the U.S., primarily the
Midwest, and abroad. Services rendered and products sold to customers include
demand and time deposit accounts and certificates; various types of loans; sales
and purchases of foreign currencies; interest rate management products; cash
management services; underwriting of municipal bonds; and financial consulting.

BASIS OF ACCOUNTING

The accompanying consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America and conform to practices within the banking industry.

FOREIGN CURRENCY AND FOREIGN EXCHANGE CONTRACTS

Assets and liabilities denominated in foreign currencies have been
translated into United States dollars at respective year-end rates of exchange.
Monthly translation gains or losses are computed at rates prevailing at
month-end. There were no material translation gains or losses during any of the
years presented. Foreign exchange trading positions including spot, forwards,
option contracts and swaps are revalued monthly using prevailing market rates.
Exchange adjustments are included with noninterest income in the Consolidated
Statements of Income.

DERIVATIVE FINANCIAL INSTRUMENTS

The Bank uses various interest rate, foreign exchange, equity and commodity
derivative contracts in the management of its risk strategy or as part of its
dealer and trading activities. Interest rate contracts may include futures,
forwards, forward rate agreements, option contracts, caps, floors, collars and
swaps. Foreign exchange contracts may include spot, forwards, futures, option
contracts and swaps. Equity contracts and commodity contracts may include option
contracts and swaps.

All derivative instruments are recognized at fair value in the Consolidated
Statements of Condition as other assets or other liabilities. All derivative
instruments are designated either as hedges or as held for trading or
non-hedging purposes.

Derivative instruments that are used in the management of the Bank's risk
strategy may qualify for hedge accounting if the derivatives are designated as
hedges and applicable hedge criteria are met. On the date that the Bank enters
into a derivative contract, it designates the derivative as a hedge of the fair
value of a recognized asset or liability or an unrecognized firm commitment, a
hedge of a forecasted transaction or the
41

variability of cash flows that are to be received or paid in connection with a
recognized asset or liability, a foreign currency fair value or cash flow hedge.
Changes in the fair value of a derivative that is highly effective (as defined)
and qualifies as a fair value hedge, along with changes in the fair value of the
underlying hedged item, are recorded in current period earnings. Changes in the
fair value of a derivative that is highly effective (as defined) and qualifies
as a cash flow hedge, to the extent that the hedge is effective, are recorded in
other comprehensive income until earnings are impacted by the underlying hedged
item. Net gains or losses resulting from hedge ineffectiveness are recorded in
current period earnings. Changes in the fair value of a derivative that is
highly effective (as defined) and qualifies as a foreign currency hedge are
recorded in either current period earnings or other comprehensive income
depending on whether the hedging relationship meets the criteria for a fair
value or cash flow hedge.

The Bank formally documents all hedging relationships at inception of hedge
transactions. The process includes documenting the risk management objective and
strategy for undertaking the hedge transaction and identifying the specific
derivative instrument and the specific underlying asset, liability, firm
commitment or forecasted transaction. The Bank formally assesses, both at
inception and on an ongoing quarterly basis, whether the derivative hedging
instruments have been highly effective in offsetting changes in the fair value
or cash flows of the hedged items and whether the derivatives are expected to
remain highly effective in future periods.

Hedge accounting is discontinued prospectively when the Bank determines
that the hedge is no longer highly effective, the derivative instrument expires
or is sold, terminated or exercised, it is no longer probable that the
forecasted transaction will occur, the hedged firm commitment no longer meets
the definition of a firm commitment, or the designation of the derivative as a
hedging instrument is no longer appropriate.

When hedge accounting is discontinued because a fair value hedge is no
longer highly effective, the derivative instrument will continue to be recorded
on the balance sheet at fair value but the hedged item will no longer be
adjusted for changes in fair value that are attributable to the hedged risk.
When hedge accounting is discontinued because the hedged item in a fair value
hedge no longer meets the definition of a firm commitment, the derivative
instrument will continue to be recorded on the balance sheet at fair value and
any asset or liability that was recorded to recognize the firm commitment will
be removed from the balance sheet and recognized as a gain or loss in current
period earnings. When hedge accounting is discontinued because a cash flow hedge
is no longer highly effective, the gain or loss on the derivative that is in
accumulated other comprehensive income ("AOCI") will remain there until earnings
are impacted by the hedged item and the derivative instrument will be marked to
market through earnings. When hedge accounting is discontinued because it is no
longer probable that the forecasted transaction in a cash flow hedge will occur,
the gain or loss on the derivative that was in AOCI will be recognized
immediately in earnings and the derivative instrument will be marked to market
through earnings. When hedge accounting is discontinued and the derivative
remains outstanding, the derivative may be redesignated as a hedging instrument
as long as the applicable hedge criteria are met under the terms of the new
contract.

Derivative instruments that are entered into for risk management purposes
and do not otherwise qualify for hedge accounting are marked to market and the
resulting unrealized gains and losses are recognized in noninterest income in
the period of change.

Derivative instruments that are used as part of the Bank's dealer and
trading activities are marked to market and the resulting unrealized gains and
losses are recognized in noninterest income in the period of change.

IMPACT OF NEW ACCOUNTING STANDARDS

The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards ("SFAS") No. 123 (revised 2004), "Share-Based
Payment," in 2004. The Statement replaces SFAS No. 123, "Accounting for
Stock-Based Compensation," and supersedes Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS 123(R) applies
primarily to accounting for transactions where an entity obtains employee
services in share-based payment transactions using the fair value based method
of accounting. The Statement is effective as of the beginning of the first
42

annual reporting period that begins after December 15, 2005. The Bank uses the
fair value based method of accounting for its stock-based compensation plans and
does not expect the implementation of this Statement to have a material effect
on its financial position or results of operations.

The American Institute of Certified Public Accountants ("AICPA") issued
Statement of Position ("SOP") 03-3, "Accounting for Certain Loans or Debt
Securities Acquired in a Transfer," in December 2003. The SOP applies to the
purchase of a loan, a group of loans, and loans acquired in a purchase business
combination. It does not apply to loans originated by the Bank. The SOP
addresses accounting for differences, attributable to credit quality, between
contractual and expected cash flows from the initial investment in loans
acquired in a transfer. It prohibits the acquirer from carrying over or
establishing an allowance for loan losses in the initial accounting for loans
acquired in a transfer. This SOP is effective for loans acquired in fiscal years
beginning after December 15, 2004.

SECURITIES

The Bank classifies securities as either trading account assets or
available-for-sale. Trading account assets include securities acquired as part
of trading activities and are typically purchased with the expectation of
near-term profit. These assets consist primarily of municipal bonds and U.S.
government securities. All other securities are classified as
available-for-sale, even if the Bank has no current plans to divest.

Trading account assets are reported at fair value with unrealized gains and
losses included in trading account income, which also includes realized gains
and losses from closing such positions. Available-for-sale securities are
reported at fair value with unrealized gains and losses included, on an
after-tax basis, in a separate component of stockholder's equity. Purchase
premiums and discounts are recognized in interest income using the interest
method over the terms of the securities. Realized gains and losses, as a result
of securities sales, are included in securities gains, with the cost of
securities sold determined on the specific identification basis.

In making a determination of temporary vs. other-than-temporary impairment
of an investment, a major consideration of management is whether the Bank 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.

LOANS, LOAN FEES AND COMMITMENT FEES

Loans not held for sale are recorded at the principal amount outstanding,
net of unearned income, deferred fees and origination costs. For fair value
hedges that are highly effective, loans designated as the underlying hedged
items are recorded net of changes in fair value attributable to the hedged
risks. Origination fees collected and origination costs incurred on commercial
loans, loan commitments, mortgage loans and standby letters of credit (except
loans held for sale) are generally deferred and amortized over the life of the
related facility. Other loan-related fees that are not the equivalent of yield
adjustments are recognized as income when received or earned. At December 31,
2004 and 2003, the Bank's Consolidated Statements of Condition included
approximately $8 million and $12 million, respectively, of deferred loan-related
fees net of deferred origination costs.

In conjunction with its mortgage and commercial banking activities, the
Bank will originate loans with the intention of selling them in the secondary
market. These loans are classified as held for sale and are included in "Loans
held for sale" on the Bank's Consolidated Statements of Condition. The loans are
carried at the lower of allocated cost or current market value, on a portfolio
basis. Deferred origination fees and costs associated with these loans are not
amortized and are included as part of the basis of the loan at time of sale.
Realized gains and unrealized losses are included with other noninterest income.

The Bank engages in the servicing of mortgage loans and acquires mortgage
servicing rights by purchasing or originating mortgage loans and then selling
those loans with servicing rights retained. The rights to service mortgage loans
for others are recognized as separate assets by allocating the total cost of the
mortgage loans to the mortgage servicing rights and the loans (without the
mortgage servicing rights) based on their relative fair values. The capitalized
mortgage servicing rights are amortized in proportion to and over the period of
estimated net servicing income. The capitalized mortgage servicing rights are
periodically evaluated for impairment based on the fair value of those rights.
Fair values are estimated using discounted cash flow analyses. The risk
characteristics of the underlying loans used to stratify capitalized mortgage
servicing rights for purposes of measuring impairment are market interest rates,
loan type and repricing interval.

Commercial and real estate loans are placed on nonaccrual status when the
collection of interest is doubtful or when principal or interest is 90 days past
due, unless the credit is adequately collateralized and the loan is in process
of collection. When a loan is placed on nonaccrual status, all interest accrued
but not yet collected which is deemed uncollectible is charged against interest
income in the current year. Interest on nonaccrual loans is recognized as income
only when cash is received and the Bank expects to collect the entire principal
balance of the loan. Loans are returned to accrual status when all the principal
and interest amounts contractually due are brought current and future payments
are reasonably assured. Interest income on restructured loans is accrued
according to the most recently agreed upon contractual terms.

Commercial and real estate loans are charged off when, in management's
opinion, the loan is deemed uncollectible. Consumer installment loans are
charged off when 120 days past due. Consumer revolving loans are charged off
when 180 days past due. Accrued interest on these loans is recorded to interest
income. Such loans are not normally placed on nonaccrual status.

Commercial loan commitments and letters of credit are executory contracts
and the notional balances are not reflected on the Bank's Consolidated
Statements of Condition. Fees collected are generally deferred and recognized
over the life of the facility.

Impaired loans (primarily commercial credits) are measured based on the
present value of expected future cash flows (discounted at the loan's effective
interest rate) or, alternatively, at the loan's observable market price or the
fair value of supporting collateral. Impaired loans are defined as those where
it is probable that amounts due for principal or interest according to
contractual terms will not be collected. Nonaccrual and certain restructured
loans meet this definition. Large groups of smaller-balance, homogeneous loans,
primarily residential real estate and consumer installment loans, are excluded
from this definition of impairment. The Bank determines loan impairment when
assessing the adequacy of the allowance for loan losses.

ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is maintained at a level considered adequate
to provide for probable loan losses. The allowance is increased by provisions
charged to operating expense and reduced by net charge-offs. Known losses of
principal on impaired loans are charged off. 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. Such estimates are reviewed periodically and adjustments, if
necessary, are recorded during the periods in which they become known.

PREMISES AND EQUIPMENT

Premises and equipment are stated at cost less accumulated depreciation and
amortization. Interest costs associated with long-term construction projects are
capitalized and then amortized over the life of the related asset after the
project is completed. For financial reporting purposes, the provision for
depreciation and amortization is computed on the straight-line basis over the
estimated useful lives of the assets. Estimated useful lives range from 3 years
to 39 years.

BANK-OWNED INSURANCE

The Bank has purchased life insurance coverage for certain officers. The
one-time premiums paid for the policies, which coincide with the initial cash
surrender value, are recorded as assets on the Consolidated Statements of
Condition. Increases or decreases in cash surrender value (other than proceeds
from death benefits) are recorded as other income or other expense. Proceeds
from death benefits first reduce the cash surrender value attributable to the
individual policy and any additional proceeds are recorded as other income.

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 that originated prior to July 1, 2001 was amortized on a
straight-line basis through 2001 year-end but discontinued effective January 1,
2002 in connection with the adoption of SFAS No. 142. Goodwill arising
subsequent to July 1, 2001 is not amortized. Goodwill is periodically assessed
for impairment, at least annually. The excess of carrying value over fair value,
if any, is recorded as an impairment loss. Intangible assets with finite lives
are amortized on either an accelerated or straight-line basis depending on the
character of the acquired asset. Original lives range from 3 to 15 years.
Intangible assets subject to amortization are reviewed for impairment when
events or future assessments of profitability indicate that the carrying value
may not be recoverable. If the carrying value is not expected to be recovered
and the carrying value exceeds fair value, an impairment loss is recognized.
Intangible assets with indefinite useful lives are not amortized and are
reviewed for impairment annually or more frequently if events indicate
impairment. The excess of carrying value over fair value, if any, is recorded as
an impairment loss.

OTHER ASSETS

Property or other assets received in satisfaction of debt are included in
"Other Assets" on the Bank's Consolidated Statements of Condition and are
recorded at the lower of remaining cost or fair value. Fair values for other
real estate owned generally are reduced by estimated costs to sell. Losses
arising from subsequent write-downs to fair value are charged directly to
noninterest expense.

RETIREMENT AND OTHER POSTEMPLOYMENT BENEFITS

The Bank has noncontributory defined benefit pension plans covering
virtually all its employees. For its primary plan, the policy of the Bank is to,
at a minimum, fund annually an amount necessary to satisfy the requirements
under the Employee Retirement Income Security Act ("ERISA"), without regard to
prior years' contributions in excess of the minimum. The Bank generally
contributes the maximum allowable under the U.S. Internal Revenue Code.

The Bank provides medical care benefits for retirees meeting certain age
and service requirements. The Bank contributes to the cost of coverage based on
employees' length of service.

Postemployment benefits provided to former or inactive employees after
employment but before retirement are accrued if they meet the conditions for
accrual of compensated absences. Otherwise, postemployment benefits are recorded
when expenses are incurred.

INCOME TAXES

Deferred tax assets and liabilities, as determined by the temporary
differences between financial reporting and tax bases of assets and liabilities,
are computed using enacted tax rates and laws. The effect on deferred tax assets
and liabilities of a change in tax rates or law is recognized as income or
expense in the period including the enactment date.

The Bank is included in the consolidated Federal income tax return of HFC.
Income tax return liabilities or benefits for all the consolidated entities are
not materially different than they would have been if computed on a separate
return basis.

MANAGEMENT'S ESTIMATES

The preparation of 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 financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. The areas requiring significant management judgment include provision
and allowance for loan losses, income taxes, pension cost, postemployment
benefits, valuation of intangible assets, fair values and temporary vs.
other-than-temporary impairment.

RECLASSIFICATIONS

Certain reclassifications were made to conform prior years' financial
statements to the current year's presentation.

2. SECURITIES

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

DECEMBER 31, 2004 DECEMBER 31, 2003
------------------------------------------------- -------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE COST GAINS LOSSES FAIR VALUE
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
(IN THOUSANDS)

U.S. Treasury......... $1,108,221 $ 4 $ 5,746 $1,102,479 $2,820,111 $35,934 $4,306 $2,851,739
Federal agency........ 3,892,537 1,044 21,022 3,872,559 3,663,043 5,886 959 3,667,970
Mortgage-backed....... 37,004 1,161 126 38,039 43,385 1,073 228 44,230
State and municipal... 42,002 634 74 42,562 28,592 364 -- 28,956
Non-mortgage asset
backed.............. 706,099 -- 10,267 695,832 -- -- -- --
Other................. 31,286 1,660 -- 32,946 31,260 125 -- 31,385
---------- ------ ------- ---------- ---------- ------- ------ ----------
Total securities...... $5,817,149 $4,503 $37,235 $5,784,417 $6,586,391 $43,382 $5,493 $6,624,280
========== ====== ======= ========== ========== ======= ====== ==========

The following table summarizes, for available-for-sale securities with
unrealized losses as of December 31, 2004, the amount of the unrealized loss and
the related fair value of the securities with unrealized losses. The unrealized
losses have been further segregated by investment securities that have been in a
continuous unrealized loss position for less than 12 months and those that have
been in a continuous unrealized loss position for 12 or more months. The
majority of unrealized losses are attributable to rising interest rates in 2004.
Management believes that all of the unrealized losses are temporary.

LENGTH OF CONTINUOUS UNREALIZED LOSS POSITION
---------------------------------------------------------------------------
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
----------------------- ----------------------- -----------------------
UNREALIZED UNREALIZED UNREALIZED
FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES
---------- ---------- ---------- ---------- ---------- ----------
(IN THOUSANDS)

U.S. Treasury.................. $ 759,506 $ 4,153 $ 297,980 $1,593 $1,057,486 $ 5,746
Federal agency................. 2,616,190 16,958 1,015,681 4,064 3,631,871 21,022
Mortgage-backed................ -- -- 11,978 126 11,978 126
State and municipal............ 8,705 53 3,007 21 11,712 74
Non-mortgage asset backed...... 695,832 10,267 -- -- 695,832 10,267
Other.......................... -- -- -- -- -- --
---------- ------- ---------- ------ ---------- -------
Temporarily impaired
securities -- available-for-sale.. $4,080,233 $31,431 $1,328,646 $5,804 $5,408,879 $37,235
========== ======= ========== ====== ========== =======

At December 31, 2004 and 2003, available-for-sale and trading account
securities having a carrying amount of $3.36 billion and $4.07 billion,
respectively, were pledged as collateral for certain liabilities, securities
sold under agreement to repurchase, public and trust deposits, trading account
activities and for other purposes where permitted or required by law. The Bank
maintains effective control over the securities sold under agreement to
repurchase and accounts for the transactions as secured borrowings.

The amortized cost and estimated fair value of available-for-sale
securities at December 31, 2004, by contractual maturity, are shown below.
Expected maturities can differ from contractual maturities since borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties.

DECEMBER 31, 2004
-----------------------
AMORTIZED FAIR
COST VALUE
---------- ----------
(IN THOUSANDS)

Maturities:
Within 1 year............................................. $3,759,912 $3,740,561
1 to 5 years.............................................. 1,669,097 1,654,113
5 to 10 years............................................. 122,252 121,220
Over 10 years............................................. 197,598 197,538
Mortgage-backed........................................... 37,004 38,039
Other securities without stated maturity.................... 31,286 32,946
---------- ----------
Total securities....................................... $5,817,149 $5,784,417
========== ==========

In 2004, 2003 and 2002, proceeds from the sale of securities
available-for-sale amounted to $2.61 billion, $1.54 billion and $2.68 billion,
respectively. Gross gains of $26.5 million and gross losses of $0.3 million were
realized on these sales in 2004, gross gains of $26.5 million and gross losses
of $0.5 million were realized on these sales in 2003 and gross gains of $63.0
million and gross losses of $1.7 million were realized on these sales in 2002.
Net unrealized holding gains on trading securities decreased during 2004 from an
unrealized gain of $1.1 million at December 31, 2003 to an unrealized gain of
$0.7 million at December 31, 2004. The decrease of $0.4 million has been
included in 2004 earnings.

3. LOANS

The following table summarizes loan balances by category:

DECEMBER 31
------------------------
2004 2003
----------- ----------
(IN THOUSANDS)

Domestic loans:
Commercial, financial, agricultural, brokers and
dealers................................................ $ 5,677,305 $5,043,936
Real estate construction.................................. 220,430 289,364
Real estate mortgages..................................... 3,629,480 3,260,731
Installment............................................... 1,868,108 930,644
Foreign loans:
Banks and other financial institutions.................... -- 29,223
Other, primarily commercial and industrial................ 89,625 19,554
----------- ----------
Total loans............................................ 11,484,948 9,573,452
Less allowance for loan losses.............................. 219,740 234,798
----------- ----------
Loans, net of allowance for loan losses.............. $11,265,208 $9,338,654
=========== ==========

Nonaccrual loans, restructured loans and other nonperforming assets are
summarized below:

YEARS ENDED DECEMBER 31
------------------------------
2004 2003 2002
-------- -------- --------
(IN THOUSANDS)

Nonaccrual loans..................................... $125,214 $171,226 $169,588
Restructured loans................................... -- -- --
-------- -------- --------
Total nonperforming loans............................ 125,214 171,226 169,588
Other assets received in satisfaction of debt........ 220 450 1,975
-------- -------- --------
Total nonperforming assets...................... $125,434 $171,676 $171,563
======== ======== ========
Gross amount of interest income that would have been
recorded if year-end nonperforming loans had been
accruing interest at their original terms.......... $ 7,976 $ 12,380 $ 8,496
Interest income actually recognized.................. -- -- --
-------- -------- --------
Interest shortfall................................. $ 7,976 $ 12,380 $ 8,496
======== ======== ========
90-day past due loans, still accruing interest (all
domestic).......................................... $ 48,236 $ 14,865 $ 12,478
======== ======== ========

At December 31, 2004 and 2003, the Bank had no aggregate public and private
sector outstandings to any single country experiencing a liquidity problem which
exceeded one percent of the Bank's consolidated assets. At December 31, 2004 and
2003 commercial loans with a carrying value of $2.9 billion and $4.78 billion,
respectively, were pledged to secure potential borrowings with the Federal
Reserve.

4. ALLOWANCE FOR LOAN LOSSES

The changes in the allowance for loan losses are as follows:

YEARS ENDED DECEMBER 31
-------------------------------
2004 2003 2002
-------- -------- ---------
(IN THOUSANDS)

Balance, beginning of year.......................... $234,798 $206,999 $ 227,374
-------- -------- ---------
Charge-offs......................................... (47,820) (88,244) (106,650)
Recoveries.......................................... 24,360 12,439 15,055
-------- -------- ---------
Net charge-offs................................... (23,460) (75,805) (91,595)
Provisions charged to operations.................... 7,176 103,604 71,220
Acquired reserve.................................... 1,226 -- --
-------- -------- ---------
Balance, end of year................................ $219,740 $234,798 $ 206,999
======== ======== =========

Details on impaired loans and related allowance are as follows:

IMPAIRED LOANS IMPAIRED LOANS
FOR WHICH THERE FOR WHICH THERE TOTAL
IS A RELATED IS NO RELATED IMPAIRED
ALLOWANCE ALLOWANCE LOANS
--------------- --------------- --------
(IN THOUSANDS)

December 31, 2004
Balance...................................... $ 79,303 $45,911 $125,214
Related allowance............................ 34,441 -- 34,441
-------- ------- --------
Balance, net of allowance.................... $ 44,862 $45,911 $ 90,773
======== ======= ========
December 31, 2003
Balance...................................... $144,064 $27,162 $171,226
Related allowance............................ 76,913 -- 76,913
-------- ------- --------
Balance, net of allowance.................... $ 67,151 $27,162 $ 94,313
======== ======= ========

YEARS ENDED DECEMBER 31
------------------------------
2004 2003 2002
-------- -------- --------
(IN THOUSANDS)

Average impaired loans............................... $142,156 $181,900 $191,493
======== ======== ========
Total interest income on impaired loans recorded on a
cash basis......................................... $ -- $ -- $ --
======== ======== ========

5. PREMISES AND EQUIPMENT

Premises and equipment are stated at cost less accumulated depreciation and
amortization. A summary of these accounts is set forth below:

DECEMBER 31
-------------------
2004 2003
-------- --------
(IN THOUSANDS)

Land........................................................ $ 28,336 $ 22,855
Premises.................................................... 222,334 209,877
Equipment................................................... 403,707 410,674
Leasehold improvements...................................... 47,062 47,175
-------- --------
Total..................................................... 701,439 690,581
Accumulated depreciation and amortization................... 392,024 387,606
-------- --------
Premises and equipment.................................... $309,415 $302,975
======== ========

Depreciation and amortization expense was $48.7 million in 2004, $49.4
million in 2003 and $46.3 million in 2002.

On December 17, 2001, the Bank closed on the sale of its fifteen story
operations center containing approximately 415,000 gross square feet located at
311 West Monroe Street, Chicago, Illinois, and leased back approximately 259,000
rentable square feet. The lease ends on December 31, 2011. The Bank has rights
of first offering to lease additional space and options to extend to December
31, 2026. The remainder of the building was occupied by third-party tenants. The
sale resulted in a realized gain of $1 million and a deferred gain, which is
being amortized in to income over the remaining life of the lease, of $12.2
million and $14.0 million as of December 31, 2004 and 2003, respectively.

In addition, the Bank owns or leases premises at other locations to conduct
branch banking activities.

6. GOODWILL AND OTHER INTANGIBLE ASSETS

The Bank adopted SFAS No. 142, "Goodwill and Other Intangible Assets," on
January 1, 2002. Under this standard, goodwill and other intangible assets that
have indefinite useful lives are not subject to amortization while intangible
assets with finite lives are amortized. Goodwill is periodically assessed for
impairment, at least annually. Upon adoption of SFAS No. 142, the Bank had no
goodwill.

The Bank adopted SFAS No. 147, "Acquisitions of Certain Financial
Institutions -- an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9," on October 1, 2002. Under this standard, most
acquisitions of financial institutions are removed from the scope of SFAS No. 72
and Interpretation 9 and are accounted for in accordance with SFAS No. 141,
"Business Combinations," and SFAS No. 142. As such, unidentifiable intangible
assets recognized and amortized in accordance with SFAS No. 72, "Accounting for
Certain Acquisitions of Banking or Thrift Institutions," represent goodwill that
will be accounted for under SFAS No. 142. At adoption date, the Bank had an
unidentifiable intangible asset that, in accordance with SFAS No. 72, was
excluded from the scope of SFAS No. 142 and continued to be amortized through
third quarter 2002. Upon adoption of the Statement, the unidentifiable
intangible asset was reclassified to goodwill and no longer amortized starting
in fourth quarter 2002. Under the transitional requirements of the Statement,
the first three quarters of 2002 were restated to reflect the reversal of
previously amortized goodwill in those quarters. The earnings impact for each of
these three quarters was $2.35 million pretax ($1.4 million after tax).

The Bank's goodwill was subject to the annual impairment test in the fourth
quarter of 2004. The fair value of the reporting unit was estimated using a
valuation technique based on discounted cash flow analyses. The test did not
identify potential impairment and no impairment loss was recognized in 2004.

The carrying value of the Bank's goodwill was $89.3 million at December 31,
2004 and 2003.

Besides goodwill, the Bank did not have any intangible assets not subject
to amortization as of December 31, 2004 and 2003.

As of December 31, 2004, the gross carrying amount and accumulated
amortization of the Bank's amortizable intangible assets are included in the
following table:

DECEMBER 31,
---------------------------
DECEMBER 31, 2004 2004 2003
----------------------------- ------------ ------------
GROSS CARRYING ACCUMULATED NET CARRYING NET CARRYING
AMOUNT AMORTIZATION VALUE VALUE
-------------- ------------ ------------ ------------
(IN THOUSANDS)

Branch network..................... $145,000 $(82,167) $62,833 $72,500
Other.............................. 5,724 (2,284) 3,440 4,155
-------- -------- ------- -------
Total finite life intangibles.... $150,724 $(84,451) $66,273 $76,655
-------- -------- ------- -------

Total amortization expense for the Bank's intangible assets was $10.4
million in 2004, $10.3 million in 2003 and $10.2 million in 2002.

Estimated intangible asset amortization expense is $10.4 million for each
of the years ending December 31, 2005, 2006, 2007 and 2008 and $9.9 million for
the year ending December 31, 2009.

MORTGAGE SERVICING RIGHTS

The carrying amount of mortgage servicing rights ("MSR") was $17.9 million
and $16.3 million at December 31, 2004 and 2003, respectively. The fair value of
those rights equaled the carrying amount at both December 31, 2004 and December
31, 2003. MSR, included in other assets, of $5.2 million and $11.2 million were
capitalized during 2004 and 2003, respectively. Amortization expense associated
with MSR was $8.7 million and $7.7 million in 2004 and 2003, respectively. The
carrying amount of the MSR valuation allowance was $0.9 million and $6.0 million
at December 31, 2004 and 2003, respectively. There were no direct write-downs in
2004 or 2003.

The Corporation accounts for MSR at the lower of cost or fair value, in
accordance with SFAS No. 140. Fair value of MSR is estimated using discounted
cash flow analyses. The analyses consider portfolio characteristics, servicing
fees, prepayment assumptions, delinquency rates, late charges, other ancillary
revenues, costs to service and other economic factors. The estimated fair value
of MSR is sensitive to changes in interest rates, including their effect on
prepayment speeds. The Corporation stratifies its portfolio on the basis of
market interest rates, loan type and repricing interval. MSR impairment is
considered temporary and recognized as an expense through a valuation allowance
to the extent that the carrying value exceeds estimated fair value.

7. DEPOSITS

The following table summarizes deposit balances by category:

INCREASE (DECREASE)
DECEMBER 31 2004 VS. 2003
------------------------- --------------------
2004 2003 AMOUNT %
----------- ----------- ------------ -----
(DOLLARS IN THOUSANDS)

Demand deposits.......................... $ 4,019,416 $ 4,231,540 $ (212,124) (5)
Interest-bearing checking deposits....... 129,408 146,441 (17,033) (12)
Money market accounts.................... 2,369,938 2,094,733 275,205 13
Statement savings accounts............... 1,693,152 1,799,684 (106,532) (6)
Savings certificates..................... 1,481,071 1,477,743 3,328 --
Other time deposits...................... 2,476,071 2,325,995 150,076 6
Deposits in foreign offices.............. 1,677,428 665,905 1,011,523 152
----------- ----------- ----------
Total deposits......................... $13,846,484 $12,742,041 $1,104,443 9
=========== =========== ==========

Certificates of deposit in denominations of $100,000 or more issued by
domestic offices totaled $2.94 billion and $2.73 billion at December 31, 2004
and 2003, respectively. All time deposits in foreign offices were in
denominations of $100,000 or more.

8. SECURITIES PURCHASED UNDER AGREEMENT TO RESELL AND SECURITIES SOLD UNDER
AGREEMENT TO REPURCHASE

At various times the Bank enters into purchases of U.S. Treasury and
Federal agency securities under agreements to resell identical securities. The
amounts advanced under these agreements represent short-term loans and are
reflected as receivables in the Consolidated Statements of Condition. There were
no securities purchased under agreement to resell outstanding at December 31,
2004 and December 31, 2003. The securities underlying the agreements are
book-entry securities. Securities are transferred by appropriate entry into the
Bank's account with Bank of New York through the Federal Reserve Bank of New
York under a written custodial agreement with Bank of New York that explicitly
recognizes the Bank's interest in these securities.

The Bank also enters into sales of U.S. Treasury and Federal agency
securities under agreements to repurchase identical securities. The amounts
received under these agreements represent short-term borrowings and are
reflected as liabilities in the Consolidated Statements of Condition. Securities
sold under agreement to repurchase totaled $3.30 billion and $3.45 billion at
December 31, 2004 and 2003, respectively. Securities sold under agreement to
repurchase are transferred via book-entry to the counterparty, if transacted
with a financial institution or a broker-dealer, or are delivered to customer
safekeeping accounts. The Bank monitors the market value of these securities and
adjusts the level of collateral for repurchase agreements, as appropriate. The
Bank maintains effective control over the securities sold under agreement to
repurchase and accounts for the transactions as secured borrowings.

SECURITIES PURCHASED UNDER AGREEMENT TO RESELL

2004 2003
---------- ----------
(DOLLARS IN THOUSANDS)

Amount outstanding at end of year........................... $ -- $ --
Highest amount outstanding as of any month-end during the
year...................................................... $553,250 $350,375
Daily average amount outstanding during the year............ $107,401 $ 65,847
Daily average annualized rate of interest................... 0.89% 0.53%

SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE

2004 2003
---------- ----------
(DOLLARS IN THOUSANDS)

Amount outstanding at end of year........................... $3,299,028 $3,452,567
Highest amount outstanding as of any month-end during the
year...................................................... $3,802,636 $4,821,309
Daily average amount outstanding during the year............ $3,215,071 $4,164,402
Daily average annualized rate of interest................... 1.22% 1.04%

9. SENIOR NOTES AND LONG-TERM NOTES

The following table summarizes the Bank's long-term notes:

DECEMBER 31
-------------------
2004 2003
-------- --------
(IN THOUSANDS)

Floating rate subordinated note to Bankcorp due March 31,
2005...................................................... $ -- $ 50,000
Floating rate subordinated note to Bankcorp due December 1,
2006...................................................... -- 50,000
Fixed rate 6.5% subordinated note to Bankcorp due December
27, 2007.................................................. -- 60,000
Fixed rate 7.63% subordinated note to Bankcorp due June 27,
2008...................................................... -- 15,000
Fixed rate 7.13% subordinated note to Bankcorp due June 30,
2009...................................................... -- 50,000
Floating rate subordinated note to Bankcorp due May 31,
2014...................................................... 100,000 --
Floating rate subordinated note to Bankcorp due May 31,
2016...................................................... 100,000 --
-------- --------
Total..................................................... $200,000 $225,000
======== ========

All of the Bank notes are unsecured obligations, ranking on a parity with
all unsecured and subordinated indebtedness of the Bank and are not subject to
redemption prior to maturity at the election of the debtholders. The interest
rate on the floating rate note due May 31, 2014 reprices quarterly and floats at
35 basis points above 90 day London Interbank Offering Rate ("LIBOR"). The
interest rate on the floating rate note due May 31, 2016 reprices quarterly and
floats at 37.5 basis points above 90 day LIBOR. At year-end 2004, 90 day LIBOR
was 2.56 percent.

There are no scheduled principal payments on long-term notes during the
years 2005 through 2009. In 2010 and beyond, scheduled principal payments on
long-term notes are $200 million.

The Bank offers to institutional investors from time to time, unsecured
short-term and medium-term bank notes in an aggregate principal amount of up to
$1.50 billion outstanding at any time. The term of each note could range from 14
days to 15 years. These senior notes are subordinated to deposits and rank pari
passu with all other unsecured senior indebtedness of the Bank. As of December
31, 2004, a $200 million senior short-term note was outstanding with an original
maturity of 32 days (remaining maturity of 28 days) and stated interest rate of
2.34 percent. There were no senior short-term notes outstanding as of December
31, 2003.

10. FAIR VALUE OF FINANCIAL INSTRUMENTS

Generally accepted accounting principles require the disclosure of
estimated fair values for both on and off-balance-sheet financial instruments.
The Bank's fair values are based on quoted market prices when available. For
financial instruments not actively traded, such as certain loans, deposits,
off-balance-sheet transactions and long-term borrowings, fair values have been
estimated using various valuation methods and assumptions. Although management
used its best judgment in estimating these values, there are inherent
limitations in any estimation methodology. In addition, accounting
pronouncements require that fair values be estimated on an item-by-item basis,
thereby ignoring the impact a large sale would have on a thin market and
intangible values imbedded in established lines of business. Therefore, the fair
value estimates presented herein are not necessarily indicative of the amounts
the Bank could realize in an actual transaction. The fair value estimation
methodologies employed by the Bank were as follows:

The carrying amounts for cash and demand balances due from banks along with
short-term money market assets and liabilities (including Federal funds sold,
Federal funds purchased, securities purchased under agreement to resell and
securities sold under agreement to repurchase) reported on the Bank's
Consolidated Statements of Condition were considered to be the best estimates of
fair value for these financial instruments. Fair values of trading account
assets and available-for-sale securities were based on quoted market prices.

A variety of methods were used to estimate the fair value of loans. Changes
in estimated fair value of loans reflect changes in credit risk and general
interest rates which have occurred since the loans were originated. Fair values
of floating rate loans, including commercial, broker dealer, financial
institution, construction, charge card, consumer and home equity, were assumed
to be the same as carrying value since the loans' interest rates automatically
reprice to market. Fair values of residential mortgages were based on current
prices for securities backed by similar loans. For long-term fixed rate loans,
including consumer installment and commercial mortgage loans, fair values were
estimated based on the present value of future cash flows with current market
rates as discount rates. Additionally, management considered appraisal values of
collateral when nonperforming loans were secured by real estate.

The fair values of accrued interest receivable and payable approximate
carrying values due to the short-term nature of these assets and liabilities.

The fair value of loans held for sale is based on future mortgage-backed
security prices corresponding to the mortgage loan pools.

The fair values of bank-owned insurance approximate carrying value, because
upon liquidation of these investments the Bank would receive the cash surrender
value which equals carrying value.

The fair values of demand deposits, savings accounts, interest-bearing
checking deposits and money market accounts were the amounts payable on demand
at the reporting date, or the carrying amounts. The fair value of time deposits
was estimated using a discounted cash flow calculation with current market rates
offered by the Bank as discount rates.

The fair value of short-term borrowings and short-term senior notes
approximates carrying value because the average maturity on these notes is less
than one year.

The fair value of minority interest -- preferred stock of subsidiary
(Harris Preferred Capital Corporation) approximates carrying value as the
preferred stock has a liquidation preference that equals book value.

In 2004 the fair value of floating rate long-term notes were assumed to be
the same as carrying value since the notes' interest rates automatically reprice
to market. In 2003 the fair value of the fixed rate long-term notes was
determined using a discounted cash flow calculation with current rates available
to the Bank for similar debt as discount rates.

The fair value of credit facilities approximates their carrying value (i.e.
deferred income) or estimated cost that would be incurred to induce third
parties to assume these commitments.

The estimated fair values of the Bank's financial instruments at December
31, 2004 and 2003 are presented in the following table. See Note 11 to
Consolidated Financial Statements for additional information regarding fair
values of off-balance-sheet financial instruments.

DECEMBER 31
-----------------------------------------------------
2004 2003
------------------------- -------------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
----------- ----------- ----------- -----------
(IN THOUSANDS)

ASSETS
Cash and demand balances due from
banks.................................. $ 887,827 $ 887,827 $ 823,615 $ 823,615
Money market assets:
Interest-bearing deposits at banks..... 662,366 662,366 424,459 424,459
Federal funds sold and securities
purchased under agreement to
resell.............................. 541,300 541,300 409,425 409,425
Securities available-for-sale............ 5,784,417 5,784,417 6,624,280 6,624,280
Trading account assets................... 90,130 90,130 59,467 59,467
Loans, net of unearned income and
allowance for loan losses.............. 11,265,208 11,260,262 9,338,654 9,364,083
Accrued interest receivable.............. 72,627 72,627 71,811 71,811
Loans held for sale...................... 43,423 43,916 168,904 168,904
Bank-owned insurance..................... 1,072,660 1,072,660 1,035,239 1,035,239
----------- ----------- ----------- -----------
Total on-balance-sheet financial
assets......................... $20,419,958 $20,415,505 $18,955,854 $18,981,283
=========== =========== =========== ===========

LIABILITIES
Deposits:
Demand deposits........................ $ 8,188,806 $ 8,188,806 $ 8,301,415 $ 8,301,415
Time deposits.......................... 5,657,678 5,661,138 4,440,626 4,455,398
Federal funds purchased.................. 1,267,850 1,267,850 1,190,839 1,190,839
Securities sold under agreement to
repurchase............................. 3,299,029 3,299,029 3,452,567 3,452,567
Short-term borrowings.................... 88,070 88,070 10,841 10,841
Accrued interest payable................. 23,306 23,306 23,251 23,251
Short-term notes -- senior............... 200,000 200,000 -- --
Minority interest -- preferred stock of
subsidiary............................. 250,000 250,000 250,000 250,000
Preferred stock issued to Harris
Bankcorp, Inc.......................... 5,000 5,000 5,000 5,000
Long-term notes -- subordinated.......... 200,000 200,000 225,000 243,571
----------- ----------- ----------- -----------
Total on-balance-sheet financial
liabilities.................... $19,179,739 $19,183,199 $17,899,539 $17,932,882
=========== =========== =========== ===========
OFF-BALANCE-SHEET CREDIT FACILITIES
(POSITIVE POSITIONS/(OBLIGATIONS))
Loan commitments......................... $ (6,694) $ (6,694) $ (11,239) $ (11,239)
Standby letters of credit................ (1,313) (1,313) (1,126) (1,126)
----------- ----------- ----------- -----------
Total off-balance-sheet credit
facilities..................... $ (8,007) $ (8,007) $ (12,365) $ (12,365)
=========== =========== =========== ===========

11. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

The Bank utilizes various financial instruments with off-balance-sheet risk
in the normal course of business to meet its customers' financing and risk
management needs. The Bank's major categories of financial

instruments with off-balance-sheet risk include credit facilities, financial
guarantees and various securities-related activities.

CREDIT FACILITIES

Credit facilities with off-balance-sheet risk include commitments to extend
credit and commercial letters of credit.

Commitments to extend credit are contractual agreements to lend to a
customer as long as contract terms have been met. They generally require payment
of a fee and have fixed expiration dates. The Bank's commitments serve both
business and individual customer needs, and include commercial loan commitments,
home equity lines, commercial real estate loan commitments and mortgage loan
commitments. The maximum potential amount of undiscounted future payments the
Bank could be required to make is represented by the total contractual amount of
commitments, which was $9.6 billion and $8.3 billion at December 31, 2004 and
2003, respectively. Since only a portion of commitments will ultimately be drawn
down, the Bank does not expect to provide funds for the total contractual
amount. Risks associated with certain commitments are reduced by participations
to third parties, which at December 31, 2004, totaled $970 million and at
December 31, 2003, totaled $944 million.

Commercial letters of credit are commitments to make payments on behalf of
customers when letter of credit terms have been met. Maximum risk of accounting
loss is represented by total commercial letters of credit outstanding of $30
million at December 31, 2004 and $46 million at December 31, 2003.

Credit risks associated with all of these facilities are mitigated by
reviewing customers' creditworthiness on a case-by-case basis, obtaining
collateral, limiting loans to individual borrowers, setting restrictions on
long-duration maturities and establishing stringent covenant terms outlining
performance expectations which, if not met, may cause the Bank to terminate the
contract. Credit risks are further mitigated by monitoring and maintaining
portfolios that are well-diversified.

Collateral is required to support certain of these credit facilities when
they are drawn down and may include equity and debt securities, commodities,
inventories, receivables, certificates of deposit, savings instruments, fixed
assets, real estate, life insurance policies and memberships on national or
regional stock and commodity exchanges. Requirements are based upon the risk
inherent in the credit and are more stringent for firms and individuals with
greater default risks. The Bank monitors collateral values and appropriately
perfects its security interest. Periodic evaluations of collateral adequacy are
performed by Bank personnel.

The fair value of credit facilities (i.e. deferred income) is approximately
equal to their carrying value of $8.0 million at December 31, 2004 and $12.4
million at December 31, 2003.

FINANCIAL GUARANTEES

Financial guarantees with off-balance-sheet risk include standby letters of
credit, loans sold with recourse and written put options.

Standby letters of credit are unconditional commitments that guarantee the
obligation of a customer to a third party should that customer default. They are
issued to support financial and performance-related obligations including
brokers' margin maintenance, industrial revenue bond repayment, debt repayment,
construction contract performance and trade agreement performance. The Bank's
maximum risk of accounting loss for these items is represented by the total
commitments outstanding of $2.89 billion at December 31, 2004 and $2.76 billion
at December 31, 2003. Risks associated with standby letters of credit are
reduced by participations to third parties which totaled $1.06 billion at
December 31, 2004 and $948 million at December 31, 2003. In most cases, these
commitments expire within three years without being drawn upon.

The Bank has sold mortgage loans with limited recourse. The recourse
provisions require the Bank to reimburse the buyer, based on pre-determined
rates, upon the occurrence of certain credit-related events. The maximum amount
payable under the recourse provisions is $7.0 million at December 31, 2004 and
2003. The

carrying amount of the recourse liability is $0.5 million at December 31, 2004
and $1.3 million at December 31, 2003.

Written put options are contracts that provide the buyer the right (but not
the obligation) to sell a financial instrument at a specified price, either
within a specified period of time or on a certain date. The Bank writes put
options, providing the buyer the right to require the Bank to buy the specified
assets per the contract terms. The maximum amount payable for the written put
options is equal to their notional amount of $930 million and $865 million at
December 31, 2004 and 2003, respectively. The fair value of the related
derivative liability is $4.7 million at December 31, 2004 and $4.3 million at
December 31, 2003.

SECURITIES ACTIVITIES

The Bank's securities activities that have off-balance-sheet risk include
municipal bond underwriting and short selling of securities.

Through its municipal bond underwriting activities, the Bank commits to buy
and offer for resale newly issued bonds. The Bank is exposed to market risk
because it may be unable to resell its inventory of bonds profitably as a result
of unfavorable market conditions. In syndicate arrangements, the Bank is
obligated to fulfill syndicate members' commitments should they default. The
syndicates of which the Bank was a member had underwriting commitments totaling
$59 million at December 31, 2004 and $47 million at December 31, 2003.

Security short selling, defined as selling of securities not yet owned,
exposes the Bank to off-balance-sheet market risk because the Bank may be
required to buy securities at higher prevailing market prices to cover its short
positions. The Bank had a short position of $0.1 million at December 31, 2004
and no position at December 31, 2003.

12. DERIVATIVE FINANCIAL INSTRUMENTS

The Bank utilizes various derivative financial instruments in the normal
course of business to a) meet its customers' financing and risk management
needs, b) reduce its own risk exposure, and c) produce fee income and trading
profits. Fair values of derivative financial instruments are based on market
prices of comparable instruments, pricing models using year-end rates and
counterparty credit ratings.

All derivative instruments are recognized at fair value in the Consolidated
Statements of Condition. All derivative instruments are designated either as
hedges or held for trading or non-hedging purposes.

The Bank uses various interest rate, foreign exchange, equity, and
commodity derivative contracts as part of its dealer and trading activities or
in the management of its risk strategy. Interest rate contracts may include
futures, forwards, forward rate agreements, option contracts, caps, floors,
collars and swaps. Foreign exchange contracts may include spot, futures,
forwards, option contracts and swaps. Equity contracts and commodity contracts
may include options and swaps. The Bank enters into derivative contracts with
BMO to facilitate a more efficient use of combined resources and to better serve
customers. See Note 24 for additional information on related party transactions.

At December 31, 2004, the Bank recorded, for dealer and trading activities
and for risk management activities that do not otherwise qualify for hedge
accounting, the fair value of derivative instrument assets of $174 million in
other assets and derivative instrument liabilities of $173 million in other
liabilities. At December 31, 2003, the Bank recorded the fair value of
derivative instrument assets of $112 million in other assets and derivative
instrument liabilities of $93 million in other liabilities. These amounts
reflect the netting of certain derivative instrument assets and liabilities when
the conditions in FASB Interpretation ("FIN") No. 39, "Offsetting of Amounts
Related to Certain Contracts," have been met.

DEALER AND TRADING ACTIVITY

Interest Rate Contracts

As dealer, the Bank serves customers seeking to manage interest rate risk
by entering into contracts as counterparty to their (customer) transactions. In
its trading activities, the Bank uses interest rate contracts to profit from
expected future market movements.

These contracts may create exposure to both credit and market risk.
Replacement risk, the primary component of credit risk, is the risk of loss
should a counterparty default following unfavorable market movements and is
measured as the Bank's cost of replacing contracts at current market rates. The
Bank manages credit risk by establishing credit limits for customers and
products through an independent corporate-wide credit review process and by
continually monitoring exposure against those limits to ensure they are not
exceeded. Credit risk is, in many cases, further mitigated by the existence of
netting agreements that provide for netting of contractual receivables and
payables in the event of default or bankruptcy. Netting agreements apply to
situations where the Bank is engaged in more than one outstanding derivative
transaction with the same counterparty and also has a legally enforceable master
netting agreement with that counterparty.

Market risk is the potential for loss arising from potential adverse
changes in underlying market factors, including interest and foreign exchange
rates. The Bank manages market risk through the imposition of integrated
value-at-risk limits and an active, independent monitoring process.

Value-at-risk methodology is used for measuring the market risk of the
Bank's trading positions. This statistical methodology uses recent market
volatility to estimate the maximum daily trading loss that the Bank would expect
to incur, on average, 99 percent of the time. The model also measures the effect
of correlation among the various trading instruments to determine how much risk
is eliminated by offsetting positions.

Futures and forward contracts are agreements in which the Bank is obligated
to make or take delivery, at a specified future date, of a specified instrument,
at a specified price or yield. Futures contracts are exchange traded and,
because of exchange requirements that gains and losses be settled daily, create
negligible exposure to credit risk.

Forward rate agreements are arrangements between two parties to exchange
amounts, at a specified future date, based on the difference between an agreed
upon interest rate and reference rate applied to a notional principal amount.
These agreements enable purchasers and sellers to fix interest costs and
returns.

Options are contracts that provide the buyer the right (but not the
obligation) to purchase or sell a financial instrument, at a specified price,
either within a specified period of time or on a certain date. Interest rate
guarantees (caps, floors and collars) are agreements between two parties that,
in general, establish for the purchaser a maximum level of interest expense or a
minimum level of interest revenue based on a notional principal amount for a
specified term. Options and interest rate guarantees written create exposure to
market risk. As a writer of interest rate options and guarantees, the Bank
receives a premium at the outset of the agreement and bears the risk of an
unfavorable change in the price of the financial instrument underlying the
option or interest rate guarantee. Options and interest rate guarantees
purchased create exposure to credit risk and, to the extent of the premium paid
or unrealized gain recognized, market risk.

Interest rate swaps are contracts involving the exchange of interest
payments based on a notional amount for a specified period. Most of the Bank's
activity in swaps is as intermediary in the exchange of interest payments
between customers, although the Bank also uses swaps to manage its own interest
rate exposure (see discussion of risk management activity).

Foreign Exchange Contracts

The Bank is a dealer in foreign exchange ("FX") contracts. FX contracts may
create exposure to market and credit risk, including replacement risk and
settlement risk. Credit risk is managed by establishing limits for customers
through an independent corporate-wide credit approval process and continually
monitoring exposure against those limits. In addition, both settlement and
replacement risk are reduced through netting
57

by novation, agreements with counterparties to offset certain related
obligations. Market risk is managed through establishing exposure limits by
currency and monitoring actual exposure against those limits, entering into
offsetting positions, and closely monitoring price behavior.

The Bank and BMO combine their U.S. FX revenues. Under this arrangement, FX
net profit is shared by the Bank and BMO in accordance with a specific formula
set forth in the agreement. This agreement expires on October 31, 2005, but may
be extended at that time. Either party may terminate the arrangement at its
option. FX revenues are reported net of expenses. Net gains (losses) from
dealer/trading foreign exchange contracts, for the years ended December 31, 2004
and December 31, 2003, totaled $5.9 million and $5.1 million, respectively, of
net profit under the aforementioned agreement with BMO.

At December 31, 2004, approximately 98 percent of the Bank's gross notional
positions in foreign currency contracts are represented by seven currencies:
Eurodollar, Canadian dollar, British pound, Australian dollar, Swedish krona,
Japanese yen and the Mexican peso.

Foreign exchange contracts include spot, futures, forwards, options and
swaps that enable customers to manage their foreign exchange risk. Spot, future
and forward contracts are agreements to exchange currencies at a future date, at
a specified rate of exchange. Foreign exchange option contracts give the buyer
the right and the seller an obligation (if the buyer asserts his right) to
exchange currencies during a specified period (or on a certain date in the case
of "European" options) at a specified exchange rate. Cross currency swap
contracts are agreements to exchange principal denominated in two different
currencies at the spot rate and to repay the principal at a specified future
date and exchange rate.

Equity Contracts

The Bank enters into equity contracts that enable customers to manage the
risk associated with equity price fluctuations. Equity contracts include options
and swaps.

Commodity Contracts

The Bank enters into commodity contracts that enable customers to manage
the risk associated with commodity price fluctuations. Commodity contracts
include options and swaps.

RISK MANAGEMENT ACTIVITY

In addition to its dealer and trading activities, the Bank uses interest
rate contracts, primarily swaps, and foreign exchange contracts to reduce the
level of financial risk inherent in mismatches between the interest rate
sensitivities and foreign currency exchange rate fluctuations of certain assets
and liabilities. For non-trading risks, market risk is controlled by actively
managing the asset and liability mix, either directly through the balance sheet
or with off-balance sheet derivative instruments. Measures also focus on
interest rate exposure gaps and sensitivity to rate changes.

The Bank has an interest rate risk management strategy that incorporates
the use of derivative instruments to minimize significant unplanned fluctuations
in earnings that may be caused by interest rate volatility. The Bank manages
interest rate sensitivity by modifying the repricing or maturity characteristics
of certain fixed rate assets so that net interest margin is not adversely
affected, on a material basis, by movements in interest rates. As a result of
interest rate fluctuations, fixed rate assets will appreciate or depreciate in
market value. The effect of the unrealized appreciation or depreciation will
generally be offset by the gains or losses on the derivative instruments.

The Bank has a foreign currency risk management strategy that incorporates
the use of derivative instruments to minimize significant unplanned fluctuations
in earnings that may be caused by foreign currency exchange rate fluctuations.
Certain assets and liabilities are denominated in foreign currency, creating
exposure to changes in exchange rates. The Bank uses cross currency interest
rate swaps and foreign exchange forward contracts to hedge the risk.

Risk management activities include the following derivative transactions
that qualify for hedge accounting.

Fair Value Hedges

The Bank uses interest rate swaps to alter the character of 1) revenue
earned on certain long-term, fixed rate loans and available-for-sale securities
and 2) interest paid on certain long-term, fixed rate deposits. Interest rate
swaps convert the loans, securities and deposits from fixed rate to variable
rate. Interest rate swap contracts generally involve the exchange of fixed and
variable rate interest payments between two parties, based on a common notional
amount and maturity date.

For fair value hedges, as of December 31, 2004 the Bank recorded the fair
value of derivative instrument liabilities of $38.0 million in other
liabilities. For fair value hedges, as of December 31, 2003 the Bank recorded
the fair value of derivative instrument assets and liabilities of $10.7 million
and $23.9 million, respectively, in other assets and other liabilities. No hedge
ineffectiveness was recorded to earning for the year ended December 31, 2004.
Net losses recorded for the year-to-date period ended December 31, 2003
representing the ineffective portion of the fair value hedges were not material
to the consolidated financial statements of the Bank. Gains or losses resulting
from hedge ineffectiveness are recorded in noninterest income.

Cash Flow Hedges

The Bank uses interest rate swaps to reduce the variability associated with
future interest payments on floating-rate, prime-based loans. Interest rate
swaps convert the expected cash flows on the loans from variable to fixed.
Changes in the fair value of the swaps that are effective hedges are recorded in
other comprehensive income.

For cash flow hedges, as of December 31, 2004 the Bank recorded the fair
value of derivative instrument liabilities of $8.6 million in other liabilities.
No hedge ineffectiveness was recorded to earnings for the year ended December
31, 2004. The unrealized gains (losses) in accumulated other comprehensive
income ("AOCI") related to the interest rate swaps are reclassified to earnings
in the same period that the interest on the floating-rate loans affects
earnings. Approximately $2.0 million is expected to be reclassified to earnings
over the next twelve months. As of September 30, 2004 certain swaps were
dedesignated as hedges in order to comply with FAS 133 Implementation Issue No.
G25, "Cash Flow Hedges: Using the First-Payments-Received Technique in Hedging
the Variable Interest Payments on a Group of Non-Benchmark-Rate-Based Loans."
Losses from the hedge dedesignation were reclassified from AOCI and recorded in
noninterest income for the year ended December 31, 2004 but were not material to
the consolidated financial statements of the Bank.

For cash flow hedges, as of December 31, 2003 the fair value of the
derivative instrument asset was recorded in other assets and was not material to
the consolidated financial statements of the Bank. No hedge ineffectiveness was
recorded to earnings for the year ended December 31, 2003.

Risk management activities also include the following derivative
transactions that do not otherwise qualify for hedge accounting.

Foreign exchange contracts are used to stabilize any currency exchange rate
fluctuation for certain senior notes and certain loans. The derivative
instruments, primarily cross currency interest rate swaps and to a lesser extent
forward contracts, do not qualify for hedge accounting and are accounted for at
fair value.

The Bank has qualifying mortgage loan commitments that are intended to be
sold in the secondary market. These loan commitments are derivatives and are
recorded as liabilities at fair value. The Bank enters into forward sales of
mortgage-backed securities to minimize its exposure to interest rate volatility.
These forward sales of mortgage-backed securities are also derivatives and are
accounted for at fair value.

Interest rate swaps are used to modify exposure to variability in cash
flows for certain syndication arrangements, where the Bank is agent. The
derivative instruments do not qualify for hedge accounting and are accounted for
at fair value.

13. CONCENTRATIONS OF CREDIT RISK IN FINANCIAL INSTRUMENTS

The Bank had one major concentration of credit risk arising from financial
instruments at December 31, 2004 and 2003. This concentration was the Midwest
geographic area. This concentration exceeded 10 percent of the Bank's total
credit exposure, which is the total potential accounting loss should all
customers fail to perform according to contract terms and all collateral prove
to be worthless.

MIDWESTERN GEOGRAPHIC AREA

A majority of the Bank's customers are located in the Midwestern region of
the United States, defined here to include Illinois, Indiana, Iowa, Michigan,
Minnesota, Missouri, Ohio and Wisconsin. The Bank provides credit to these
customers through a broad array of banking and trade financing products
including commercial loans, commercial loan commitments, commercial real estate
loans, consumer installment loans, mortgage loans, home equity loans and lines,
standby and commercial letters of credit and banker's acceptances. The financial
viability of customers in the Midwest is, in part, dependent on the region's
economy. The Bank's maximum risk of accounting loss, should all customers making
up the Midwestern concentration fail to perform according to contract terms and
all collateral prove to be worthless, was approximately $16.9 billion or 55
percent of the Bank's total credit exposure at December 31, 2004 and $14.0
billion or 50 percent of the Bank's total credit exposure at December 31, 2003.

The Bank manages this exposure by continually reviewing local market
conditions and customers, adjusting individual and industry exposure limits
within the region and by obtaining or closely monitoring collateral values. See
Note 11 to Financial Statements for information on collateral supporting credit
facilities.

14. EMPLOYEE BENEFIT PLANS

The Bank has noncontributory defined benefit pension plans covering
virtually all its employees as of December 31, 2004. Most of the employees
participating in retirement plans were included in one primary plan ("primary
plan") during the three-year period ended December 31, 2004. The plan is a
multiple-employer plan covering the Bank's employees as well as persons employed
by certain affiliated entities.

Certain employees participating in the primary plan are also covered by a
supplemental unfunded retirement plan. The purpose of this plan is to extend
full retirement benefits to individuals without regard to statutory limitations
for qualified funded plans.

Effective January 1, 2002, the plan's benefit formula for new employees was
changed to an account-based formula from a final average pay formula. The
account-based benefit formula is based upon eligible pay, age and length of
service. Prior to January 1, 2002, the plan's benefit formula was a final
average pay formula, based upon length of service and an employee's highest
qualifying compensation during five consecutive years of active employment less
an estimated Social Security benefit. For employees who were employed as of
December 31, 2001 and leave the Corporation on or after January 1, 2002,
benefits are initially calculated two ways: under the account-based formula for
service beginning January 1, 2002 and under the final average pay formula for
all service. This latter group of employees will receive that retirement benefit
which yields the highest return.

The policy for this plan is to have the participating entities, at a
minimum, fund annually an amount necessary to satisfy the requirements under
ERISA, without regard to prior years' contributions in excess of the minimum.
The Bank generally contributes the maximum allowable under the U.S. Internal
Revenue Code. For 2004, 2003 and 2002, cumulative contributions were less than
the amounts recorded as primary plan pension expense for financial reporting
purposes. For 2005 (plan year 2004), the estimated pension contribution is
approximately $17 million. The total consolidated pension expense of the Bank,
including the supplemental unfunded retirement plan (excluding settlement losses
and curtailment gains), for 2004, 2003,

and 2002 was $30.2 million, $22.2 million and $11.7 million, respectively. The
qualified pension accumulated benefit obligation as of December 31, 2004, 2003,
and 2002 was $288.8 million, $263.6 million and $233.3 million, respectively.

For the supplemental unfunded retirement plan, no settlement losses were
recorded in 2004 or 2002 and a $2.6 million settlement loss was recognized in
2003.

In addition to pension benefits, the Bank provides medical care benefits
for retirees (and their dependents) who have attained age 55 and have at least
10 years of service. The Bank also provides medical care benefits for disabled
employees and widows of former employees (and their dependents). The Bank
provides these medical care benefits through a self-insured plan. Under the
terms of the plan, the Bank contributes to the cost of coverage based on
employees' length of service. Cost sharing with plan participants is
accomplished through deductibles, coinsurance and out-of-pocket limits. Funding
for the plan largely comes from the general assets of the Bank supplemented by
contributions to a trust fund created under Internal Revenue Code Section
401(h).

Effective July 1, 2004 the Bank adopted FASB Staff Position No. 106-2,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement, and Modernization Act of 2003." The Bank elected retroactive
application to December 31, 2003. Under the Act, an employer is eligible for a
federal subsidy if the prescription drug benefit available under its
postretirement medical plan is "actuarially equivalent" to the Medicare Part D
benefit. In 2004, the Bank recorded a reduction to postretirement medical
expense in the amount of $0.5 million, as determined by the Bank's actuarial
consultants. Based on their analysis, the Bank's postretirement benefit medical
plan would pass the test for actuarial equivalence and would qualify for the
subsidy.

The following tables set forth the change in benefit obligation and plan
assets for the pension and postretirement medical care benefit plans for the
Bank:

PENSION BENEFITS POSTRETIREMENT MEDICAL BENEFITS
--------------------------------- --------------------------------
2004** 2003** 2002** 2004** 2003** 2002**
--------- --------- --------- -------- --------- ---------
(IN THOUSANDS)

CHANGE IN BENEFIT
OBLIGATION*
Benefit obligation at
beginning of year......... $ 340,935 $ 311,566 $ 248,377 $54,169 $ 44,361 $ 38,389
Service cost................ 16,969 13,867 10,871 1,876 1,569 1,259
Interest cost............... 19,400 19,239 18,451 2,944 2,917 2,799
Plan Amendments............. -- -- 1,585 -- -- --
Acquisitions/transfers...... 40 -- -- -- -- --
Medicare drug legislation... -- -- -- (9,157) -- --
Benefits paid (net of
participant
contributions)............ (31,500) (42,600) (19,065) (2,265) (2,227) (2,863)
Actuarial (gain) or loss.... 4,551 38,863 51,347 (1,700) 7,549 4,777
--------- --------- --------- ------- -------- --------
Benefit obligation at end of
year...................... $ 350,395 $ 340,935 $ 311,566 $45,867 $ 54,169 $ 44,361
========= ========= ========= ======= ======== ========

CHANGE IN PLAN ASSETS
Fair value of plan assets at
beginning of year......... $ 215,285 $ 210,844 $ 236,956 $31,407 $ 24,406 $ 25,962
Actual return on plan
assets.................... 32,317 38,180 (14,316) 5,010 7,001 (3,579)
Acquisitions/transfers...... 358 -- -- -- -- --
Employer contribution....... 13,626 8,861 7,269 -- -- 2,023
Benefits paid............... (31,500) (42,600) (19,065) -- -- --
--------- --------- --------- ------- -------- --------
Fair value of plan assets at
end of year***............ $ 230,086 $ 215,285 $ 210,844 $36,417 $ 31,407 $ 24,406
========= ========= ========= ======= ======== ========
Funded Status............... $(120,309) $(125,650) $(100,722) $(9,450) $(22,762) $(19,955)
Contributions made between
measurement date
(September 30) and end of
year...................... -- -- -- -- -- --
Unrecognized actuarial
(gain) or loss............ 110,839 131,102 117,006 (5,842) 7,506 5,079
Unrecognized transition
(asset) or obligation..... -- -- -- 13,890 15,641 17,392
Unrecognized prior service
cost...................... 3,116 2,836 2,556 846 1,015 1,184
--------- --------- --------- ------- -------- --------
Net amount at year-end...... $ (6,354) $ 8,288 $ 18,840 $ (556) $ 1,400 $ 3,700
========= ========= ========= ======= ======== ========
AMOUNTS RECOGNIZED IN THE
STATEMENT OF CONDITION
CONSIST OF:
Prepaid benefit cost........ $ -- $ -- $ -- $ -- $ 1,400 $ 3,700
Accrued benefit liability... (48,117) (44,313) (25,528) (556) -- --
Intangible asset............ 3,114 2,836 2,556 -- -- --
Accumulated other
comprehensive income
(gross of tax)............ 38,649 49,765 41,812 -- -- --
--------- --------- --------- ------- -------- --------
Net amount recognized at
year-end.................. $ (6,354) $ 8,288 $ 18,840 $ (556) $ 1,400 $ 3,700
========= ========= ========= ======= ======== ========
Other comprehensive income
attributable to change in
additional minimum
liability (gross of
tax)...................... $ (11,116) $ 7,953 $ 41,812 $ -- $ -- $ --

COMPONENTS OF NET PERIODIC
BENEFIT COST
Service cost................ $ 16,969 $ 13,867 $ 10,871 $ 1,876 $ 1,569 $ 1,259
Interest cost............... 19,400 19,239 18,451 2,944 2,917 2,799
Expected return on plan
assets.................... (15,073) (17,591) (21,778) (2,513) (1,953) (2,077)
Amortization of prior
service cost.............. (279) (279) (280) 169 169 169
Amortization of transition
(asset) or obligation..... -- -- (85) 1,751 1,751 1,751
Amortization of actuarial
(gain) or loss............ 7,283 4,638 -- (6) -- (233)
--------- --------- --------- ------- -------- --------
Net periodic benefit cost... $ 28,300 $ 19,874 $ 7,179 $ 4,221 $ 4,453 $ 3,668
========= ========= ========= ======= ======== ========

---------------

* Benefit obligation is projected for Pension Benefits and accumulated for
Postretirement Medical Benefits.

** Plan assets and obligation measured as of September 30.

*** The actual allocation of plan assets by category are as follows:

2004 2003 2002
---- ---- ----

Pension:
Equity securities........................................... 72% 73% 67%
Fixed income securities..................................... 28% 27% 33%
Postretirement Medical:
Equity securities........................................... 72% 73% 66%
Fixed income securities..................................... 28% 27% 34%

At December 31, 2004 over one-half of the plan assets consisted of
investments in mutual funds administered by Harris Investment Management,
Inc., a subsidiary of Bankcorp.

Investment objectives include the achievement of a total account return
(net of fees) which meets or exceeds over a long time horizon the expected
return on plan assets, the inflation rate as measured by the Consumer Price
Index, and the median performance in a comparable manager universe. The
return on asset assumption is based upon management's review of the current
rate environment, historical trend analysis and the mix of asset categories
represented in the Plan's portfolio. The performance benchmark includes the
asset classes of equities and fixed income securities. Plan asset and
liability studies are presented to the Investment Committee periodically.
The current portfolio target allocation is as follows:

Equity securities........................................... 70%
Fixed income securities..................................... 30%

POSTRETIREMENT
PENSION BENEFITS MEDICAL BENEFITS
--------------------- ------------------
2004 2003 2002 2004 2003 2002
----- ----- ----- ---- ---- ----

WEIGHTED-AVERAGE ASSUMPTIONS USED TO
DETERMINE BENEFIT OBLIGATIONS AS OF
DECEMBER 31
Discount rate.......................... 6.00% 6.00% 6.75% 6.00% 6.00% 6.75%
Rate of compensation increase.......... 3.80% 4.20% 5.50% N/A N/A N/A
WEIGHTED-AVERAGE ASSUMPTIONS USED TO
DETERMINE NET BENEFIT COST FOR YEARS
ENDED DECEMBER 31
Discount rate.......................... 6.00% 6.75% 7.50% 6.00% 6.75% 7.50%
Expected return on plan assets......... 8.00% 8.00% 9.00% 8.00% 8.00% 8.00%
Rate of compensation increase.......... 3.80% 4.20% 5.50% N/A N/A N/A

For measurement purposes, a 9 percent annual rate of increase for pre 65
and an 11 percent annual rate of increase for post 65 in the per capita cost of
covered health care benefits was assumed for 2004. The rate will be graded down
to 5.0 percent for pre 65 and 5.5 percent for post 65 in 2013 and 2012,
respectively, and remain level thereafter.

Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A one-percentage-point change in
assumed health care cost trend rates would have the following effects:

1-PERCENTAGE 1-PERCENTAGE
POINT INCREASE POINT DECREASE
-------------- --------------
(IN THOUSANDS)

Effect on total of service and interest cost components... $ 882 $ (694)
Effect on postretirement benefit obligation............... $6,653 $(5,387)

The following table sets forth the status of the supplemental unfunded
retirement plan:

SUPPLEMENTAL UNFUNDED
RETIREMENT BENEFITS
------------------------------
2004 2003 2002
-------- -------- --------
(IN THOUSANDS)

CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year.............. $ 13,951 $ 25,544 $ 23,750
Service cost......................................... 1,234 1,132 2,273
Interest cost........................................ 635 1,075 1,398
Settlement (gain) or loss............................ -- 1,546 --
Plan amendments/merger............................... -- -- --
Benefits paid (net of participant contributions)..... (3,784) (180) (239)
Settlement payments.................................. -- (10,872) --
Actuarial (gain) or loss............................. 2,454 (4,294) (1,638)
-------- -------- --------
Benefit obligation at end of year.................... $ 14,490 $ 13,951 $ 25,544
======== ======== ========
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year....... $ -- $ -- $ --
Actual return on plan assets......................... -- -- --
Employer contribution................................ 3,784 11,052 239
Benefits paid........................................ (3,784) (11,052) (239)
-------- -------- --------
Fair value of plan assets at end of year............. $ -- $ -- $ --
======== ======== ========

SUPPLEMENTAL UNFUNDED
RETIREMENT BENEFITS
------------------------------
2004 2003 2002
-------- -------- --------
(IN THOUSANDS)

Funded Status........................................ $(14,490) $(13,951) $(25,544)
Contributions made between measurement date
(September 30) and end of year..................... 28 916 --
Unrecognized actuarial (gain) or loss................ 5,101 3,325 8,020
Unrecognized transition (asset) or obligation........ -- -- 12
Unrecognized prior service cost...................... (3,001) (2,978) (2,880)
-------- -------- --------
Prepaid (accrued) benefit cost....................... $(12,362) $(12,688) $(20,392)
======== ======== ========
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost......................................... $ 1,234 $ 1,132 $ 2,273
Interest cost........................................ 635 1,075 1,398
Expected return on plan assets....................... -- -- --
Amortization of prior service cost................... 23 97 170
Amortization of transition (asset) or obligation..... -- 13 10
Amortization of actuarial (gain) or loss............. 15 53 664
-------- -------- --------
Net periodic benefit cost............................ $ 1,907 $ 2,370 $ 4,515
======== ======== ========
Additional (gain) or loss recognized due to:
Settlement......................................... $ -- $ 2,597 $ --
WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE
BENEFIT OBLIGATIONS AS OF DECEMBER 31
Discount rate........................................ 5.25% 5.25% 5.50%
Rate of compensation increase........................ 3.80% 4.20% 5.50%
WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE NET
BENEFIT COST FOR YEARS ENDED DECEMBER 31
Discount rate........................................ 5.25% 5.50% 6.00%
Rate of compensation increase........................ 3.80% 4.20% 5.50%

The benefits expected to be paid in each of next five years and the
aggregate for the five years thereafter are as follows:

POSTRETIREMENT SUPPLEMENTAL UNFUNDED
YEAR PENSION BENEFITS MEDICAL BENEFITS RETIREMENT BENEFITS
---- ---------------- ---------------- ---------------------
(IN THOUSANDS)

2005................................ $ 18,758 $ 2,929 $ 889
2006................................ 19,799 2,875 1,129
2007................................ 21,662 2,923 1,346
2008................................ 23,625 2,971 1,614
2009................................ 24,643 3,016 2,090
2010-2014........................... 146,201 15,916 15,116

The Bank has a defined contribution plan that is available to virtually all
employees. Effective January 1, 2002, the Bank amended the plan to enhance the
401(k) matching contribution and discontinue the profit sharing contribution.
The matching contribution is based on the amount of eligible employee
contributions. The profit sharing contribution was based on the annual financial
performance of the Bank relative to predefined targets. The Bank's total expense
for this plan was $9.8 million, $9.4 million and $9.3 million in 2004, 2003 and
2002, respectively.

15. STOCK OPTIONS

The Bank has three stock-based compensation plans: an options program, a
performance incentive plan and an employee share purchase plan. The option plans
are accounted for under the fair value based method of accounting and are
described below.

STOCK OPTION PROGRAM

The Stock Option Program was established under the Bank of Montreal Stock
Option Plan for certain designated executives and other employees of the Bank
and affiliated companies in order to provide incentive to attain long-term
strategic goals and to attract and retain services of key employees.

The Bank has two types of option plans. The Fixed Stock Option Plan
consists of standard stock options with a ten-year term which are exercisable
only during the second five years of their term, assuming cumulative performance
goals are met. The Performance Based Option Plan consists of standard and
performance conditioned stock options with a ten-year term and a four-year
vesting period, which are exercisable twenty-five percent per annum. The
standard options may be exercised at any time once vested. The
performance-conditioned options may be exercised provided the BMO shares trade
at fifty percent over the price of the stock at date of grant for twenty
consecutive days, after the vesting date. The stock options are exercisable for
BMO common stock equal to the market price on the date of grant. The
compensation expense related to this program totaled $4.0 million, $5.8 million
and $5.6 million in 2004, 2003 and 2002, respectively.

The following table summarizes the stock option activity for 2004, 2003 and
2002 and provides details of stock options outstanding at December 31, 2004:

2004 2003 2002
-------------------------- -------------------------- --------------------------
WTD. AVG. WTD. AVG. WTD. AVG.
OPTIONS SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
------- --------- -------------- --------- -------------- --------- --------------

Outstanding at beginning of
year..................... 3,422,184 $33.40 3,994,491 $33.32 3,609,059 $34.30
Granted.................... 379,700 44.08 -- -- 425,300 26.18
Exercised.................. (520,475) 36.10 (470,448) 34.25 (76,115) 30.44
Forfeited, cancelled....... -- -- -- -- -- --
Transferred................ 8,200 37.01 (101,859) 26.18 36,247 13.15
Expired.................... -- -- -- -- -- --
--------- --------- ---------
Outstanding at end of
year..................... 3,289,609 34.22 3,422,184 33.40 3,994,491 33.32
========= ========= =========
Options exercisable at
year-end................. 2,526,266 $34.66 2,432,304 $35.70 1,552,213 $35.51
Weighted-average fair value
of options granted during
the year................. $ 8.57 N/A $ 5.27

---------------

N/A -- There were no stock options granted during fiscal 2003.

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------------- ----------------------------------
NUMBER WTD. AVG. NUMBER
RANGE OF OUTSTANDING REMAINING WTD. AVG. EXERCISABLE WTD. AVG.
EXERCISE PRICES DECEMBER 31, 2004 CONTRACTUAL LIFE EXERCISE PRICE DECEMBER 31, 2004 EXERCISE PRICE
--------------- ----------------- ---------------- -------------- ----------------- --------------

$22-30............... 1,508,845 6.84 years $23.68 1,073,302 $23.56
34-42............... 969,998 5.39 38.11 814,298 37.41
46-54............... 810,766 6.47 49.17 638,666 49.80
--------- ---------
22-54............... 3,289,609 6.32 34.22 2,526,266 34.66
========= =========

The fair value of the stock options granted has been estimated using a
trinomial option pricing model. The weighted-average fair value of options
granted during the years ended December 31, 2004 and

December 31, 2002 was $8.57 and $5.27, respectively. No stock options were
granted during the year ended December 31, 2003. The following weighted-average
assumptions were used to determine the fair value of options on the date of
grant:

2004 2003 2002
----- ---- -----

Risk-free interest rate..................................... 4.51% N/A 4.80%
Expected life, in years..................................... 7.0 N/A 7.0
Expected volatility......................................... 23.06% N/A 23.44%
Compound annual dividend growth............................. 9.45% N/A 8.39%

MID-TERM INCENTIVE PLAN

The Bank maintains the Mid-Term Incentive Plan which was established in
January 2000. The plan is intended to enhance the Bank's ability to attract and
retain high quality employees and to provide a strong incentive to employees to
achieve BMO's governing objective of maximizing value for its shareholders.

During 2004 the Bank was party to an agreement made between BMO and a third
party to assume the obligation related to the 2004 Mid-Term Incentive Plan. The
Bank's share of the payment was $12.4 million. A similar agreement was entered
into in 2003 and 2002 related to the 2003 and 2002 Mid-Term Incentive Plans for
a payment of $14.7 million and $8.0 million, respectively. These amounts will be
recorded as compensation expense over the three year performance cycle of the
plan on a straight-line basis. Any future payments required under these plans
will be the responsibility of the third party.

Payouts under the plan to participants depend on the achievement of
specific performance criteria that are set at the grant date. The right to
receive distributions under the plan vest and are paid out after three years
based on various factors including the BMO share price. Compensation expense for
this plan totaled $11.4 million, $20.5 million and $10.6 million in 2004, 2003
and 2002, respectively.

EMPLOYEE SHARE PURCHASE PLAN

The Bank of Montreal ("BMO") Employee Share Purchase Plan offers employees
the opportunity to purchase BMO common shares at a discount of 15 percent from
market value. Full-time and part-time employees of the Bank are eligible to
participate in the plan. Employees can elect to contribute up to 15 percent of
their salary toward the purchase of BMO common shares. The Bank contributes the
difference between the employee cost and the market price. The shares in the
plan are purchased on the open market and the plan reinvests all cash dividends
in additional common shares. The Bank's contribution is recorded as compensation
expense over each three-month offering period. Compensation expense for the
employee share purchase plan totaled $0.4 million, $0.3 million and $0.1 million
in 2004, 2003 and 2002, respectively.

16. LEASE EXPENSE AND OBLIGATIONS

Rental expense for all operating leases was $16.5 million in 2004, $16.6
million in 2003, and $15.9 million in 2002. These amounts include real estate
taxes, maintenance and other rental-related operating costs of $6.1 million,
$6.2 million, and $6.6 million for 2004, 2003, and 2002, respectively, paid
under net lease arrangements. Lease commitments are primarily for office space.

Minimum rental commitments as of December 31, 2004 for all noncancelable
operating leases are as follows:

(IN THOUSANDS)

2005........................................................ $10,351
2006........................................................ 9,904
2007........................................................ 8,750
2008........................................................ 6,577
2009........................................................ 6,431
2010 and thereafter......................................... 15,825
-------
Total minimum future rentals.............................. $57,838
=======

Occupancy expenses for 2004, 2003, and 2002 have been reduced by $18
million, $17 million, and $17 million, respectively, for rental income from
leased premises.

17. INCOME TAXES

The 2004, 2003 and 2002 applicable income tax expense (benefit) were as
follows:

FEDERAL STATE TOTAL
------- ------- -------
(IN THOUSANDS)

2004: Current........................................... $53,328 $ 4,134 $57,462
Deferred.......................................... 2,036 (772) 1,264
------- ------- -------
Total......................................... $55,364 $ 3,362 $58,726
======= ======= =======
2003: Current........................................... $31,116 $(1,302) $29,814
Deferred.......................................... 8,374 1,113 9,487
------- ------- -------
Total......................................... $39,490 $ (189) $39,301
======= ======= =======
2002: Current........................................... $58,791 $ 2,480 $61,271
Deferred.......................................... 5,247 788 6,035
------- ------- -------
Total......................................... $64,038 $ 3,268 $67,306
======= ======= =======

Deferred tax assets (liabilities) are comprised of the following at
December 31, 2004, 2003 and 2002:

DECEMBER 31
------------------------------
2004 2003 2002
-------- -------- --------
(IN THOUSANDS)

Deferred tax assets:
Allowance for loan losses.......................... $ 87,384 $ 91,977 $ 83,194
Deferred expense and prepaid income................ 13,588 13,155 13,554
Deferred employee compensation..................... 19,621 19,110 16,605
Other assets....................................... 261 882 16,697
-------- -------- --------
Gross deferred tax assets....................... 120,854 125,124 130,050
-------- -------- --------
Deferred tax liabilities:
Depreciable assets................................. (37,595) (40,650) (43,608)
Amortizable intangibles............................ (12,306) (8,937) (5,676)
Other liabilities.................................. (5,282) (9,747) (5,489)
-------- -------- --------
Gross deferred tax liabilities.................. (55,183) (59,334) (54,773)
-------- -------- --------
Deferred tax assets................................ 65,671 65,790 75,277
The tax effect of fair value adjustments on
available-for-sale securities, minimum pension
liabilities and hedging transactions recorded
directly to stockholder's equity................... 28,080 (76) (31,507)
-------- -------- --------
Net deferred tax assets.............................. $ 93,751 $ 65,714 $ 43,770
-------- -------- --------

At December 31, 2004 and 2003, the respective deferred tax assets of $65.6
million and $65.8 million included $58.3 million and $59.3 million for Federal
taxes and $7.3 million and $6.5 million for state taxes, respectively.
Management believes that the realization of the recognized net deferred tax
asset is more likely than not based on existing carryback ability and
expectations as to future taxable income.

Total income tax expense of $58.7 million for 2004, $39.3 million for 2003
and $67.3 million for 2002 reflects effective tax rates of 29.4 percent, 25.0
percent and 28.2 percent, respectively. The reconciliation between actual tax
expense and the amount determined by applying the federal statutory rate of 35
percent to income before income taxes were as follows:

YEARS ENDED DECEMBER 31
---------------------------------------------------------------------
2004 2003 2002
--------------------- --------------------- ---------------------
PERCENT OF PERCENT OF PERCENT OF
PRETAX PRETAX PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
-------- ---------- -------- ---------- -------- ----------
(DOLLARS IN THOUSANDS)

Computed tax expense........... $ 69,936 35.0% $ 55,010 35.0% $ 83,699 35.0%
Increase (reduction) in income
tax expense due to:
Tax-exempt income from loans
and investments net of
municipal interest expense
disallowance.............. (1,108) (0.6) (563) (0.4) (567) (0.2)
Bank-owned insurance......... (14,082) (7.0) (15,253) (9.7) (17,709) (7.4)
State income taxes........... 2,185 1.1 (123) (0.1) 2,124 0.9
Other, net................... 1,795 0.9 230 0.2 (241) (0.1)
-------- ---- -------- ---- -------- ----
Actual tax expense............. $ 58,726 29.4% $ 39,301 25.0% $ 67,306 28.2%
======== ==== ======== ==== ======== ====

18. REGULATORY CAPITAL

The Bank, as a state-member bank, must adhere to the capital adequacy
guidelines of the Federal Reserve Board ("the Board"), which are not
significantly different than those published by other U.S. banking regulators.
The guidelines specify minimum ratios for Tier 1 capital to risk-weighted assets
of 4 percent and total regulatory capital to risk-weighted assets of 8 percent.

Risk-based capital guidelines define total capital to consist primarily of
Tier 1 (core) and Tier 2 (supplementary) capital. In general, Tier 1 capital is
comprised of stockholder's equity, including certain types of preferred stock,
less goodwill and certain other intangibles. Core capital must comprise at least
50 percent of total capital. Tier 2 capital basically includes subordinated debt
(less a discount factor during the five years prior to maturity), other types of
preferred stock and the allowance for loan losses. The portion of the allowance
for loan losses includable in Tier 2 capital is limited to 1.25 percent of
risk-weighted assets.

The Board also requires an additional measure of capital adequacy, the Tier
1 leverage ratio, which is evaluated in conjunction with risk-based capital
ratios. The Tier 1 leverage ratio is computed by dividing period-end Tier 1
capital by adjusted quarterly average assets. The Board established a minimum
ratio of 3 percent applicable only to the strongest banking organizations
having, among other things, excellent asset quality, high liquidity, good
earnings and no undue interest rate risk exposure. Other institutions are
expected to maintain a minimum ratio of 4 percent.

The Federal Deposit Insurance Corporation Improvement Act of 1991 contains
prompt corrective action provisions that established five capital categories for
all Federal Deposit Insurance Corporation ("FDIC")-insured institutions ranging
from "well capitalized" to "critically undercapitalized." Classification within
a category is based primarily on the three capital adequacy measures. An
institution is considered "well capitalized" if its capital level significantly
exceeds the required minimum levels, "adequately capitalized" if it meets the
minimum levels, "undercapitalized" if it fails to meet the minimum levels,
"significantly undercapitalized" if it is significantly below the minimum levels
and "critically undercapitalized" if it has a ratio of tangible equity to total
assets of 2 percent or less.

Noncompliance with minimum capital requirements may result in regulatory
corrective actions that could have a material effect on the Bank's financial
statements. Depending on the level of noncompliance, regulatory corrective
actions may include the following: requiring a plan for restoring the
institution to an acceptable capital category, restricting or prohibiting
certain activities and appointing a receiver or conservator for the institution.

As of December 31, 2004, the most recent notification from the FDIC
categorized the Bank as "well capitalized" under the regulatory framework for
prompt corrective action. Management is not aware of any conditions or events
since December 31, 2004 that have changed the capital category of the Bank.

At December 31, 2004 the Bank had $255 million of minority interest in
preferred stock of subsidiaries including $250 million noncumulative,
exchangeable Series A preferred stock with dividends payable at the rate of
7 3/8% per annum. The Bank also had a total of $5 million of preferred stock
with cumulative dividends payable at the rate of LIBOR plus 100 basis points
adjusted as of the first business day of the calendar quarter that the record
date falls. During both 2004 and 2003, $18 million of dividends were paid on the
preferred stock. All issues of preferred stock qualify as Tier 1 capital for the
Bank under U.S. banking regulatory guidelines.

The following table summarizes the Bank's risk-based capital ratios and
Tier 1 leverage ratio for the past two years as well as the minimum amounts and
ratios as per capital adequacy guidelines and FDIC prompt corrective action
provisions.

TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
-------------------- --------------------- -----------------------
CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
---------- ------- ----------- ------- ------------ --------
(IN THOUSANDS)

As of December 31, 2004:
Total Capital to Risk-
Weighted Assets......... $2,185,086 11.75% $$1,487,718 $8.00% $$1,859,648 $10.00%
Tier 1 Capital to Risk-
Weighted Assets......... $1,764,599 9.49% $$ 743,772 $4.00% $$1,115,658 $ 6.00%
Tier 1 Capital to Average
Assets.................. $1,764,599 8.33% $$ 847,346 $4.00% $$1,059,183 $ 5.00%
As of December 31, 2003:
Total Capital to Risk-
Weighted Assets......... $1,980,042 12.25% $$1,293,089 $8.00% $$1,616,361 $10.00%
Tier 1 Capital to Risk-
Weighted Assets......... $1,649,198 10.20% $$ 646,744 $4.00% $$ 970,116 $ 6.00%
Tier 1 Capital to Average
Assets.................. $1,649,198 8.52% $$ 774,271 $4.00% $$ 967,839 $ 5.00%

19. INVESTMENTS IN SUBSIDIARIES AND STATUTORY RESTRICTIONS

Harris Trust and Savings Bank's investment in the combined net assets of
its wholly-owned subsidiaries was $777 million and $792 million at December 31,
2004 and 2003, respectively.

Provisions of both Illinois and Federal banking laws place restrictions
upon the amount of dividends that can be paid to Bankcorp by its bank
subsidiaries. Illinois law requires that no dividends may be paid in an amount
greater than the net profits then on hand, reduced by certain loan losses (as
defined). In addition to these restrictions, Federal Reserve member banking
subsidiaries require prior approval of Federal banking authorities if dividends
declared by a subsidiary bank, in any calendar year, will exceed its net profits
(as defined in the applicable statute) for that year, combined with its retained
net profits, as so defined, for the preceding two years. Based on these and
certain other prescribed regulatory limitations, the Bank could have declared,
without regulatory approval, $183 million of dividends at December 31, 2004.
Actual dividends paid, however, would be subject to prudent capital maintenance.
Cash and non-cash dividends paid to Bankcorp by the Bank amounted to $70 million
and $60 million in 2004 and 2003, respectively.

The Bank is required by the Federal Reserve Act to maintain reserves
against certain of their deposits. Reserves are held either in the form of vault
cash or balances maintained with the Federal Reserve Bank. Required reserves are
essentially a function of daily average deposit balances and statutory reserve
ratios prescribed by type of deposit. During 2004 and 2003, daily average
reserve balances of $263 million and $279 million, respectively, were required
for the Bank. At year-end 2004 and 2003, balances on deposit at the Federal
Reserve Bank totaled $213 million and $164 million, respectively.

20. CONTINGENT LIABILITIES

Harris Trust and Savings Bank and certain 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 financial position or results of operations.

21. OTHER COMPREHENSIVE INCOME

The following table summarizes the components of other comprehensive income
(loss) shown in stockholder's equity:

TOTAL
UNREALIZED GAINS MINIMUM UNREALIZED ACCUMULATED
(LOSSES) ON PENSION GAIN ON OTHER
AVAILABLE-FOR-SALE LIABILITY DERIVATIVE COMPREHENSIVE
SECURITIES ADJUSTMENT INSTRUMENTS INCOME
------------------ ---------- ----------- -------------
(IN THOUSANDS)

Balance at December 31, 2002...... $ 72,959 $(25,194) $ -- $ 47,765
======== ======== ======= ========
Balance at December 31, 2003...... $ 30,962 $(29,986) $ 35 $ 1,011
======== ======== ======= ========
Balance at December 31, 2004...... $(21,274) $(25,122) $(5,274) $(51,670)
======== ======== ======= ========

22. FOREIGN ACTIVITIES (BY DOMICILE OF CUSTOMER)

Income and expenses identifiable with foreign and domestic operations are
summarized in the table below:

FOREIGN DOMESTIC CONSOLIDATED
-------- ----------- ------------
(IN THOUSANDS)

2004
Total operating income.......................... $ 15,772 $ 1,113,573 $ 1,129,345
Total expenses.................................. 68,483 861,045 929,528
-------- ----------- -----------
(Loss) income before taxes...................... (52,711) 252,528 199,817
Applicable income taxes......................... (20,950) 79,676 58,726
-------- ----------- -----------
Net (loss) income............................... $(31,761) $ 172,852 $ 141,091
======== =========== ===========
Identifiable assets at year-end................. $756,654 $20,467,993 $21,224,647
======== =========== ===========
2003
Total operating income.......................... $ 17,790 $ 1,141,897 $ 1,159,687
Total expenses.................................. 27,425 975,090 1,002,515
-------- ----------- -----------
(Loss) income before taxes...................... (9,635) 166,807 157,172
Applicable income taxes......................... (3,829) 43,130 39,301
-------- ----------- -----------
Net (loss) income............................... $ (5,806) $ 123,677 $ 117,871
======== =========== ===========
Identifiable assets at year-end................. $523,206 $19,396,284 $19,919,490
======== =========== ===========
2002
Total operating income.......................... $ 18,305 $ 1,216,787 $ 1,235,092
Total expenses.................................. 2,978 992,974 995,952
-------- ----------- -----------
Income before taxes............................. 15,327 223,813 239,140
Applicable income taxes......................... 6,092 61,214 67,306
-------- ----------- -----------
Net income...................................... $ 9,235 $ 162,599 $ 171,834
======== =========== ===========
Identifiable assets at year-end................. $559,259 $18,467,759 $19,027,018
======== =========== ===========

Determination of rates for foreign funds generated or used are based on the
actual external costs of specific interest-bearing sources or uses of funds for
the periods. Internal allocations for certain unidentifiable income and expenses
were distributed to foreign operations based on the percentage of identifiable
foreign

income to total income. As of December 31, 2004, 2003 and 2002, identifiable
foreign assets accounted for 4 percent, 3 percent and 3 percent, respectively,
of total consolidated assets.

23. BUSINESS COMBINATIONS

At December 31, 2004 and 2003, intangible assets, including goodwill
resulting from business combinations, amounted to $156 million and $166 million,
respectively. Amortization of these intangibles amounted to $10.4 million in
2004, $10.3 million in 2003 and $10.2 million in 2002.

In June 2004, Harris Bank Round Lake, a wholly-owned subsidiary of Harris
Bankcorp Inc., was merged with and into the Bank. At that time, Harris Bank
Round Lake total assets were $167 million and total deposits were $151 million.
The impact to the Bank's stockholder's equity was an increase of $15.0 million.
The combination was recorded using historical carrying values for Harris Bank
Round Lake. In consideration of this contribution to its capital, the Bank
issued 100,000 shares of common stock to Bankcorp.

ACTUAL PROFORMA
DECEMBER 31, 2004 COMBINED
BALANCES FOR BALANCES OF
HARRIS TRUST AND HARRIS N.A. AT
SAVINGS BANK DECEMBER 31, 2004
----------------- -----------------
(IN MILLIONS)

Assets.............................................. $23,199 $33,267
Deposits............................................ 12,172 21,022
Equity.............................................. 1,643 2,620

24. RELATED PARTY TRANSACTIONS

During 2004, 2003 and 2002, the Bank engaged in various transactions with
BMO and its subsidiaries. These transactions included the payment and receipt of
service fees and occupancy expenses; purchasing and selling Federal funds;
repurchase and reverse repurchase agreements; short-term borrowings; time
deposit issuance; interest rate and foreign exchange rate contracts. The purpose
of these transactions was to facilitate a more efficient use of combined
resources and to better serve customers. Fees for these services were determined
in accordance with applicable banking regulations. During 2004, 2003 and 2002,
the Bank received from BMO approximately $14.0 million, $17.3 million and $20.8
million, respectively, primarily for trust services, data processing and other
operations support provided by the Bank. Excluding interest expense payments
disclosed below, the Bank made payments to BMO of approximately $47.5 million,
$30.4 million and $24.9 million in 2004, 2003 and 2002, respectively.

At December 31, 2004, derivative contracts with BMO represent $37.6 million
and $45.5 million of unrealized gains and unrealized losses, respectively. At
December 31, 2003, derivative contracts with BMO represented $49.4 million and
$102.1 million of unrealized gains and unrealized losses, respectively.

The Bank and BMO combine their U.S. foreign exchange activities. Under this
arrangement, the Bank and BMO share FX net profit in accordance with a specific
formula set forth in the agreement. This agreement expires in October 2005 but
may be extended at that time. Either party may terminate the arrangement at its
option. FX revenues are reported net of expenses. 2004, 2003 and 2002 foreign
exchange revenues included $5.9 million, $5.1 million and $7.2 million of net
profit, respectively, under this agreement.

On June 18, 2004, the Bank issued a dividend to Harris Bankcorp, Inc.
consisting of a wholly-owned U.S. subsidiary, Harris Bank International Corp.
("HBIC"). At the time of the dividend, HBIC had assets of $7.1 million and
equity of $5.4 million.

On July 3, 2003, the Bank issued a $1.0 billion certificate of deposit
("CD") to a subsidiary of BMO, BMO (Barbados) Limited. The certificate matures
June 30, 2008 and bears a 2.84 percent fixed rate of interest, payable
quarterly. On August 28, 2003, the Bank issued a $427.7 million CD to BMO
(Barbados) Limited. The certificate matures March 31, 2009 and bears a 4.30
percent fixed rate of interest, payable semi-annually. On September 22, 2003,
the Bank issued a $570 million CD to BMO (Barbados) Limited. The certificate
matures September 24, 2007 and bears a 3.28 percent fixed rate of interest,
payable quarterly. Interest expense recognized on these CD's in 2004 and 2003
was $66.6 million and $25.4 million, respectively.

On June 29, 1999, the Bank borrowed (Canadian) $109.0 million from BMO (US)
Finance, LLC ("FINCO"), a Delaware limited liability company and an indirect
subsidiary of BMO. The Bank entered into a currency and interest rate swap
agreement to exchange the C$109.0 million for U.S. $73.7 million and made
monthly interest payments on the swap. This debt was paid off July 29, 2004.

On June 28, 1999, the Bank borrowed (Canadian) $100.2 million from FINCO.
The Bank entered into a currency swap agreement to exchange the C$100.2 million
for U.S. $74.5 million and made monthly interest payments on the swap. This debt
was paid off July 29, 2004.

The Bank has loans outstanding to certain executive officers and directors.
These loans totaled $5.6 million and $8.8 million at December 31, 2004 and 2003,
respectively.