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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
COMMISSION FILE NUMBER 1-13805
HARRIS PREFERRED CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
MARYLAND # 36-4183096
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
111 WEST MONROE STREET, CHICAGO, ILLINOIS 60603
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(312) 461-2121
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
------------------- ------------------------
7 3/8% Noncumulative Exchangeable Preferred Stock,
Series A, par value $1.00 per share New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether this registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company ( as
defined in Rule 12b-2 of the Act).
Yes [ ] No [X]
The number of shares of Common Stock, $1.00 par value, outstanding on May
12, 2006 was 1,000. No common equity is held by nonaffiliates.
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--------------------------------------------------------------------------------
HARRIS PREFERRED CAPITAL CORPORATION
TABLE OF CONTENTS
Part I FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets................................. 2
Consolidated Statements of Income and Comprehensive
Income...................................................... 3
Consolidated Statements of Changes in Stockholders'
Equity...................................................... 4
Consolidated Statements of Cash Flows....................... 5
Notes to Consolidated Financial Statements.................. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 6
Item 3. Quantitative and Qualitative Disclosures about Market
Risk........................................................ 19
Item 4. Controls and Procedures..................................... 19
Part II OTHER INFORMATION
Item 6. Exhibits.................................................... 19
Signatures................................................................... 20
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31, MARCH 31,
2006 2005 2005
----------- ------------ -----------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Cash on deposit with Harris N.A........................... $ 403 $ 700 $ 444
Securities purchased from Harris N.A. under agreement to
resell.................................................. 23,525 20,500 11,000
Notes receivable from Harris N.A.......................... 7,832 8,684 11,036
Securities available-for-sale:
Mortgage-backed...................................... 353,866 373,584 440,613
U.S. Treasury........................................ 89,962 74,946 24,990
Securing mortgage collections due from Harris N.A......... -- -- 106
Other assets.............................................. 1,391 1,461 1,723
-------- -------- --------
TOTAL ASSETS....................................... $476,979 $479,875 $489,912
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Broker payable -- securities purchased.................... $ -- $ -- $ 7,331
Accrued expenses.......................................... 118 129 103
-------- -------- --------
TOTAL LIABILITIES.................................. 118 129 7,434
Commitments and contingencies............................. -- -- --
STOCKHOLDERS' EQUITY
7 3/8% Noncumulative Exchangeable Preferred Stock, Series
A ($1 par value); liquidation value of $250,000,000;
20,000,000 shares authorized, 10,000,000 shares issued
and outstanding......................................... 250,000 250,000 250,000
Common stock ($1 par value); 1,000 shares authorized,
issued and outstanding.................................. 1 1 1
Additional paid-in capital................................ 240,733 240,733 240,733
Earnings in excess of (less than) distributions........... 403 (2) (550)
Accumulated other comprehensive loss -- net unrealized
losses on available-for-sale securities................. (14,276) (10,986) (7,706)
-------- -------- --------
TOTAL STOCKHOLDERS' EQUITY......................... 476,861 479,746 482,478
-------- -------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY......... $476,979 $479,875 $489,912
======== ======== ========
The accompanying notes are an integral part of these financial statements.
2
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(UNAUDITED)
QUARTER ENDED
MARCH 31
---------------------
2006 2005
--------- ---------
(IN THOUSANDS, EXCEPT
SHARE DATA)
INTEREST INCOME:
Securities purchased from Harris N.A. under agreement to
resell................................................. $ 1,014 $ 200
Notes receivable from Harris N.A. ........................ 131 184
Securities available-for-sale:
Mortgage-backed........................................ 3,894 4,372
U.S. Treasury.......................................... 98 19
------- -------
Total interest income................................ 5,137 4,775
OPERATING EXPENSES:
Loan servicing fees paid to Harris N.A. .................. 6 8
Advisory fees paid to Harris N.A. ........................ 32 24
General and administrative................................ 85 102
------- -------
Total operating expenses............................. 123 134
------- -------
Net income.................................................. 5,014 4,641
Preferred dividends......................................... 4,609 4,609
------- -------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER.................. $ 405 $ 32
======= =======
Basic and diluted earnings per common share................. $405.00 $ 32.00
======= =======
Net income.................................................. $ 5,014 $ 4,641
Other comprehensive loss -- net change in unrealized losses
on available-for-sale securities.......................... (3,290) (6,442)
------- -------
Comprehensive income (loss)................................. $ 1,724 $(1,801)
======= =======
The accompanying notes are an integral part of these financial statements.
3
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
QUARTER ENDED
MARCH 31,
-----------------------
2006 2005
---------- ----------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
Balance at January 1........................................ $479,746 $488,888
Net income................................................ 5,014 4,641
Other comprehensive loss.................................. (3,290) (6,442)
Dividends (preferred stock $0.4609 per share)............. (4,609) (4,609)
-------- --------
Balance at March 31......................................... $476,861 $482,478
======== ========
The accompanying notes are an integral part of these financial statements.
4
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
QUARTER ENDED
MARCH 31,
-------------------
2006 2005
-------- --------
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net Income................................................ $ 5,014 $ 4,641
Adjustments to reconcile net income to net cash provided
by operating activities:
Net decrease (increase) in other assets................... 26 (130)
Net decrease in accrued expenses.......................... (11) (11)
-------- --------
Net cash provided by operating activities.............. 5,029 4,500
-------- --------
INVESTING ACTIVITIES:
Net decrease in securities purchased from Harris N.A.
under agreement to resell.............................. (3,025) (500)
Repayments of notes receivable from Harris N.A. .......... 852 1,093
Increase in securing mortgage collections due from Harris
N.A. .................................................. -- (28)
Purchases of securities available-for-sale................ (89,901) (65,946)
Proceeds from maturities of securities
available-for-sale..................................... 91,357 65,527
-------- --------
Net cash (used) provided by investing activities....... (717) 146
-------- --------
FINANCING ACTIVITIES:
Cash dividends paid on preferred stock.................... (4,609) (4,609)
-------- --------
Net (decrease) increase in cash on deposit with Harris
N.A. .................................................. (297) 37
Cash on deposit with Harris N.A. at beginning of period... 700 407
-------- --------
Cash on deposit with Harris N.A. at end of period......... $ 403 $ 444
======== ========
NON CASH TRANSACTION
Unsettled security purchase............................... $ -- $ 7,331
======== ========
The accompanying notes are an integral part of these financial statements.
5
HARRIS PREFERRED CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
Harris Preferred Capital Corporation (the "Company") is a Maryland
corporation whose principal business objective is to acquire, hold, finance and
manage qualifying real estate investment trust ("REIT") assets (the "Mortgage
Assets"), consisting of a limited recourse note or notes (the "Notes") issued by
Harris N.A. (the "Bank") secured by real estate mortgage assets (the "Securing
Mortgage Loans") and other obligations secured by real property, as well as
certain other qualifying REIT assets, primarily U.S. treasury securities and
securities collateralized with real estate mortgages. The Company holds its
assets through a Maryland real estate investment trust subsidiary, Harris
Preferred Capital Trust. Harris Capital Holdings, Inc., owns 100% of the
Company's common stock. The Bank owns all common stock outstanding issued by
Harris Capital Holdings, Inc.
The accompanying consolidated financial statements have been prepared by
management from the books and records of the Company. These statements reflect
all adjustments and disclosures which are, in the opinion of management,
necessary for a fair statement of the results for the interim periods presented
and should be read in conjunction with the notes to financial statements
included in the Company's 2005 Form 10-K. Certain reclassifications were made to
conform prior years' financial statements to the current year's presentation.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America, have been condensed or omitted pursuant to the
rules and regulations of the Securities and Exchange Commission.
2. COMMITMENTS AND CONTINGENCIES
Legal proceedings in which the Company is a defendant may arise in the
normal course of business. There is no pending litigation against the Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING INFORMATION
The statements contained in this Report on Form 10-Q that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, including statements regarding the Company's expectation, intentions,
beliefs or strategies regarding the future. Forward-looking statements include
the Company's statements regarding tax treatment as a real estate investment
trust, liquidity, provision for loan losses, capital resources and investment
activities. In addition, in those and other portions of this document, the words
"anticipate," "believe," "estimate," "expect," "intend" and other similar
expressions, as they relate to the Company or the Company's management, are
intended to identify forward-looking statements. Such statements reflect the
current views of the Company with respect to future events and are subject to
certain risks, uncertainties and assumptions. It is important to note that the
Company's actual results could differ materially from those described herein as
anticipated, believed, estimated or expected. Among the factors that could cause
the results to differ materially are the risks discussed in Item 1A. "Risk
Factors" in the Company's 2005 Form 10-K and in the "Risk Factors" section
included in the Company's Registration Statement on Form S-11 (File No.
333-40257), with respect to the Preferred Shares declared effective by the
Securities and Exchange Commission on February 5, 1998. The Company assumes no
obligation to update any such forward-looking statement.
RESULTS OF OPERATIONS
FIRST QUARTER 2006 COMPARED WITH FIRST QUARTER 2005
The Company's net income for the first quarter of 2006 was $5.0 million, an
8% increase from the first quarter 2005 net income of $4.6 million. Earnings
increased primarily because of increased interest income on earning assets.
6
HARRIS PREFERRED CAPITAL CORPORATION
Interest income on securities purchased under agreement to resell for the
first quarter of 2006 was $1.0 million, on an ending balance of $23.5 million,
with an average rate of 4.2%. During the same period in 2005, the interest
income on securities purchased under agreement to resell was $200 thousand on an
ending balance of $11 million, with an average rate of 2.1%. First quarter 2006
interest income on the Notes totaled $131 thousand and yielded 6.4% on $8.2
million of average principal outstanding for the quarter compared to $184
thousand and a 6.4% yield on $11.5 million average principal outstanding for
first quarter 2005. The decrease in income was attributable to a reduction in
the Notes balance because of principal paydowns by customers in the Securing
Mortgage Loans. Interest income on securities available-for-sale for the current
quarter was $4.0 million resulting in a yield of 4.3% on an average balance of
$371 million, compared to $4.4 million with a yield of 4.2% on an average
balance of $436 million for the same period a year ago. The decrease in the
interest income is primarily attributable to the decrease in the investment
portfolio of mortgage-backed securities.
There were no Company borrowings during first quarter 2006 or 2005.
First quarter 2006 operating expenses totaled $123 thousand, a decrease of
$11 thousand or 8% from the first quarter of 2005. Loan servicing expenses
totaled $6 thousand, a decrease of $2 thousand from a year ago. This decrease is
attributable to the reduction in the principal balance of the Notes, thereby
reducing servicing fees payable to the Bank. Advisory fees for the first quarter
2006 were $32 thousand compared to $24 thousand a year earlier, due to higher
internal processing, record-keeping and overhead costs. General and
administrative expenses totaled $85 thousand, a decrease of $17 thousand over
the same period in 2005 primarily as a result of reduced expert service fees.
At March 31, 2006 and 2005, there were no Securing Mortgage Loans on
nonaccrual status.
On March 30, 2006, the Company paid a cash dividend of $0.46094 per share
on outstanding Preferred Shares to the stockholders of record on March 15, 2006
as declared on March 2, 2006. On March 30, 2005, the Company paid a cash
dividend of $0.46094 per share on outstanding Preferred Shares to the
stockholders of record on March 15, 2005, as declared on March 2, 2005.
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's equity. At March 31, 2006, net unrealized losses on
available-for-sale securities were $14.3 million compared to $7.7 million of
unrealized losses on March 31, 2005 and $11.0 million of unrealized losses at
December 31, 2005. The unrealized loss positions at March 31, 2006 and 2005 and
December 31, 2005 were attributed to changes in interest rates and not to
lowered credit quality of individual securities; therefore management believes
these losses are temporary.
LIQUIDITY RISK MANAGEMENT
The objective of liquidity management is to ensure the availability of
sufficient cash flows to meet all of the Company's financial commitments. In
managing liquidity, the Company takes into account various legal limitations
placed on a REIT.
The Company's principal asset management requirements are to maintain the
current earning asset portfolio size through the acquisition of additional Notes
or other qualifying assets in order to pay dividends to its stockholders after
satisfying obligations to creditors. The acquisition of additional Notes or
other qualifying assets is funded with the proceeds obtained as a result of
repayment of principal balances of individual Securing Mortgage Loans or
maturities or sales of securities. The payment of dividends on the Preferred
Shares is made from legally available funds, arising from operating activities
of the Company. The Company's cash flows from operating activities principally
consist of the collection of interest on the Notes, mortgage-backed securities
and other earning assets. The Company does not have and does not anticipate
having any material capital expenditures.
In order to remain qualified as a REIT, the Company must distribute
annually at least 90% of its adjusted REIT ordinary taxable income, as provided
for under the Internal Revenue Code, to its common and preferred
7
HARRIS PREFERRED CAPITAL CORPORATION
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 treasury securities will provide
adequate liquidity for its operating, investing and financing needs including
the capacity to continue preferred dividend payments on an uninterrupted basis.
As presented in the accompanying Consolidated Statements of Cash Flows, the
primary sources of funds in addition to $5.0 million provided from operations
during the three months ended March 31, 2006 were $852 thousand provided by
principal repayments on the Notes and $91.4 million from the maturities of
securities available-for-sale. In the prior period ended March 31, 2005, the
primary sources of funds other than $4.5 million from operations were $1.1
million provided by principal repayments on the Notes and $65.5 million from the
maturities of securities available-for-sale. The primary uses of funds for the
three months ended March 31, 2006 were $89.9 million for purchases of securities
available-for-sale and $4.6 million in preferred stock dividends paid. For the
prior year's quarter ended March 31, 2005, the primary uses of funds were $65.9
million for purchases of securities available-for-sale and $4.6 million in
preferred stock dividends paid.
MARKET RISK MANAGEMENT
The Company's market risk is composed primarily of interest rate risk.
There have been no material changes in market risk or the manner in which the
Company manages market risk since December 31, 2005.
OTHER MATTERS
As of March 31, 2006, the Company believes that it is in full compliance
with the REIT tax rules, and expects to qualify as a non-taxable REIT under the
provisions of the Internal Revenue Code. The Company expects to meet all REIT
requirements regarding the ownership of its stock and anticipates meeting the
annual distribution requirements.
FINANCIAL STATEMENTS OF HARRIS N.A.
The following unaudited financial information for the Bank is included
because the Company's Preferred Shares are automatically exchangeable for a new
series of preferred stock of the Bank upon the occurrence of certain events.
8
HARRIS N.A. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
(UNAUDITED)
MARCH 31 DECEMBER 31 MARCH 31
2006 2005 2005
----------- ----------- -----------
(IN THOUSANDS EXCEPT SHARE DATA)
ASSETS
Cash and demand balances due from banks............... $ 1,056,547 $ 1,321,202 $ 820,204
Money market assets:
Interest-bearing deposits at banks.................. 1,277,109 1,007,411 735,222
Federal funds sold.................................. 188,927 303,130 389,777
Securities available-for-sale (including $4.32
billion, $3.79 billion, and $4.12 billion of
securities pledged as collateral for repurchase
agreements at March 31, 2006, December 31, 2005 and
March 31, 2005, respectively)....................... 6,954,748 6,513,873 7,463,473
Trading account assets................................ 130,124 181,121 122,605
Loans................................................. 24,557,105 23,783,547 21,771,709
Allowance for loan losses............................. (322,029) (324,080) (314,949)
----------- ----------- -----------
Net loans........................................... 24,235,076 23,459,467 21,456,760
Premises and equipment................................ 440,711 436,609 427,338
Bank-owned insurance.................................. 1,125,756 1,115,172 1,082,906
Loans held for sale................................... 30,718 32,364 18,437
Goodwill and other intangible assets.................. 349,302 353,439 323,507
Other assets.......................................... 684,097 805,575 734,767
----------- ----------- -----------
TOTAL ASSETS..................................... $36,473,115 $35,529,363 $33,574,996
=========== =========== ===========
LIABILITIES
Deposits in domestic offices -- noninterest-bearing... $ 6,404,872 $ 6,278,823 $ 5,811,312
-- interest-bearing..... 17,518,203 17,471,141 17,240,355
Deposits in foreign offices -- interest-bearing...... 1,725,092 1,270,741 1,278,247
----------- ----------- -----------
Total deposits................................... 25,648,167 25,020,705 24,329,914
Federal funds purchased and securities sold under
agreement to repurchase............................. 3,427,941 3,413,640 3,753,270
Short-term borrowings................................. 1,836,254 2,041,715 785,230
Short-term senior notes............................... 835,000 800,000 750,000
Accrued interest, taxes and other expenses............ 248,239 253,141 230,511
Other liabilities..................................... 728,708 261,065 384,450
Minority interest -- preferred stock of subsidiary.... 250,000 250,000 250,000
Preferred stock issued to Harris Bankcorp, Inc. ...... -- -- 5,000
Long-term notes -- senior............................. 250,000 250,000 --
Long-term notes -- subordinated....................... 292,750 292,750 292,750
----------- ----------- -----------
TOTAL LIABILITIES..................................... 33,517,059 32,583,016 30,781,125
----------- ----------- -----------
STOCKHOLDER'S EQUITY
Common stock ($10 par value); authorized 40,000,000
shares; issued and outstanding 13,618,513,
13,618,513 and 13,557,257 shares at March 31, 2006,
December 31, 2005 and March 31, 2005,
respectively........................................ 136,185 136,185 135,573
Surplus............................................... 1,207,543 1,204,450 1,153,340
Retained earnings..................................... 1,686,951 1,675,571 1,561,650
Accumulated other comprehensive loss.................. (74,623) (69,859) (56,692)
----------- ----------- -----------
TOTAL STOCKHOLDER'S EQUITY............................ 2,956,056 2,946,347 2,793,871
----------- ----------- -----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY............ $36,473,115 $35,529,363 $33,574,996
=========== =========== ===========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
9
HARRIS N.A. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
QUARTER ENDED
MARCH 31
-------------------
2006 2005
-------- --------
(IN THOUSANDS)
INTEREST INCOME
Loans....................................................... $359,504 $276,329
Money market assets:
Deposits at banks......................................... 2,982 1,545
Federal funds sold........................................ 3,276 2,206
Trading accounts............................................ 1,664 1,129
Securities available-for-sale:
U.S. Treasury and federal agency.......................... 51,445 33,779
State and municipal....................................... 5,280 4,597
Other..................................................... 5,060 4,026
-------- --------
Total interest income..................................... 429,211 323,611
-------- --------
INTEREST EXPENSE
Deposits.................................................... 149,782 90,184
Short-term borrowings....................................... 55,890 27,330
Short-term senior notes..................................... 7,771 1,741
Minority interest-dividends on preferred stock of
subsidiary................................................ 4,609 4,609
Long-term notes -- senior................................... 3,470 0
Long-term notes -- subordinated............................. 3,546 2,190
-------- --------
Total interest expense.................................... 225,068 126,054
-------- --------
NET INTEREST INCOME......................................... 204,143 197,557
Provision for loan losses................................... 5,646 2,974
-------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES......... 198,497 194,583
-------- --------
NONINTEREST INCOME
Trust and investment management fees........................ 15,324 23,470
Money market and bond trading............................... 1,551 2,590
Foreign exchange............................................ 1,200 1,215
Service charges and fees.................................... 32,430 30,145
Net securities losses....................................... (103) (237)
Bank-owned insurance........................................ 10,584 10,246
Letter of credit fees....................................... 4,937 5,568
Syndication fees............................................ 1,698 2,692
Other....................................................... 16,338 27,673
-------- --------
Total noninterest income.................................. 83,959 103,362
-------- --------
NONINTEREST EXPENSES
Salaries and other compensation............................. 84,530 91,779
Pension, profit sharing and other employee benefits......... 30,333 26,981
Net occupancy............................................... 18,659 16,988
Equipment................................................... 15,195 13,829
Marketing................................................... 10,458 8,586
Communication and delivery.................................. 6,014 6,190
Expert services............................................. 9,473 6,203
Contract programming........................................ 7,590 7,468
Intercompany services....................................... 14,977 10,813
Other....................................................... 24,813 24,123
-------- --------
222,042 212,960
Amortization of intangibles................................. 5,024 5,053
-------- --------
Total noninterest expenses................................ 227,066 218,013
-------- --------
Income before income taxes.................................. 55,390 79,932
Applicable income taxes..................................... 14,010 25,290
-------- --------
NET INCOME.................................................. $ 41,380 $ 54,642
======== ========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
10
HARRIS N.A. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
QUARTER ENDED MARCH 31
----------------------
2006 2005
-------- ---------
(IN THOUSANDS)
Net income.................................................. $41,380 $ 54,642
Other comprehensive loss:
Cash flow hedges:
Net unrealized loss on derivative instruments, net of
tax benefit of $703 in 2006 and $5,429 in 2005........ (1,198) (9,244)
Less reclassification adjustment for realized losses
included in net income, net of tax benefit of $1,072
in 2006 and $97 in 2005............................... 1,824 164
Unrealized losses on available-for-sale securities:
Unrealized holding gains arising during the period, net
of tax benefit of $2,927 in 2006 and $994 in 2005..... (5,453) (3,325)
Less reclassification adjustment for realized losses
included in net income, net of tax benefit of $40 in
2006 and $92 in 2005.................................. 63 145
------- --------
Other comprehensive loss.................................. (4,764) (12,260)
------- --------
Comprehensive income........................................ $36,616 $ 42,382
======= ========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
11
HARRIS N.A. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
(UNAUDITED)
2006 2005
---------- ----------
(IN THOUSANDS)
Balance at January 1........................................ $2,946,347 $2,774,752
Net income................................................ 41,380 54,642
Stock option exercise..................................... 2,222 1,782
Capital contribution...................................... 871 --
Dividends -- preferred stock.............................. -- (45)
Dividends -- common stock................................. (30,000) (25,000)
Other comprehensive loss.................................. (4,764) (12,260)
---------- ----------
Balance at March 31......................................... $2,956,056 $2,793,871
========== ==========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
12
HARRIS N.A. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
QUARTER ENDED MARCH 31
-------------------------
2006 2005
----------- -----------
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net Income.................................................. $ 41,380 $ 54,642
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses................................. 5,646 2,974
Depreciation and amortization, including intangibles...... 18,831 19,186
Deferred tax expense...................................... 8,533 3,175
Net loss on sales of securities........................... 103 237
Increase in bank-owned insurance.......................... (10,584) (10,246)
Trading account net cash sales (purchases)................ 536,357 (33,157)
Net increase in interest receivable....................... (1,693) (9,340)
Net (decrease) increase in interest payable............... (128) 5,663
Net decrease in loans held for sale....................... 1,646 24,986
Other, net................................................ 3,869 25,946
----------- -----------
Net cash provided by operating activities.............. 603,960 84,066
----------- -----------
INVESTING ACTIVITIES:
Net increase in interest-bearing deposits at banks........ (272,834) (72,656)
Net decrease (increase) in Federal funds sold and
securities purchased under agreement to resell......... 114,203 (294,827)
Proceeds from sales of securities available-for-sale...... 257 18,068
Proceeds from maturities of securities
available-for-sale..................................... 774,053 1,148,999
Purchases of securities available-for-sale................ (1,220,982) (1,306,361)
Net increase in loans..................................... (787,389) (838,265)
Net (purchases) sales of premises and equipment........... (17,909) 90,486
----------- -----------
Net cash used in investing activities.................. (1,410,601) (1,254,556)
----------- -----------
FINANCING ACTIVITIES:
Net increase in deposits.................................. 728,146 670,756
Net increase (decrease) in Federal funds purchased and
securities sold under agreement to repurchase.......... 14,301 (738,426)
Net (decrease) increase in other short-term borrowings.... (205,461) 571,085
Proceeds from issuance of senior notes.................... 845,000 750,000
Repayment of senior notes................................. (810,000) (200,000)
Cash dividends paid on common stock....................... (30,000) (25,000)
----------- -----------
Net cash provided by financing activities.............. 541,986 1,028,415
----------- -----------
NET DECREASE IN CASH AND DEMAND BALANCES DUE FROM
BANKS................................................. (264,655) (142,075)
CASH AND DEMAND BALANCES DUE FROM BANKS AT JANUARY 1... 1,321,202 962,279
----------- -----------
CASH AND DEMAND BALANCES DUE FROM BANKS AT MARCH 31.... $ 1,056,547 $ 820,204
=========== ===========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
13
HARRIS N.A. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
Harris N.A. (the "Bank") is a wholly-owned subsidiary of Harris Bankcorp,
Inc. ("Bankcorp"), a wholly-owned subsidiary of Harris Financial Corp., a
wholly-owned U.S. subsidiary of Bank of Montreal. The consolidated financial
statements of the Bank include the accounts of the Bank and its wholly-owned
subsidiaries. Significant intercompany accounts and transactions have been
eliminated. Certain reclassifications were made to conform prior year's
financial statements to the current year's presentation.
On February 17, 2006 Bankcorp merged one of its bank subsidiaries, NLSB
Bank, with and into Harris N.A. This transaction was recorded at its carrying
value and prior year financial statements have been restated.
The consolidated financial statements have been prepared by management from
the books and records of the Bank, without audit by independent certified public
accountants. However, these statements reflect all adjustments and disclosures
which are, in the opinion of management, necessary for a fair presentation of
the results for the interim periods presented.
Because the results of operations are so closely related to and responsive
to changes in economic conditions, the results for any interim period are not
necessarily indicative of the results that can be expected for the entire year.
2. LEGAL PROCEEDINGS
The Bank and certain of its subsidiaries are defendants in various legal
proceedings arising in the normal course of business. In the opinion of
management, based on the advice of legal counsel, the ultimate resolution of
these matters will not have a material adverse effect on the Bank's consolidated
financial position.
3. CASH FLOWS
For purposes of the Bank's Consolidated Statements of Cash Flows, cash and
cash equivalents is defined to include cash and demand balances due from banks.
Cash interest payments for the three months ended March 31 totaled $225.2
million and $120.4 million in 2006 and 2005, respectively. Cash income tax
payments over the same periods totaled $30.2 million and $11.2 million,
respectively.
4. STOCK-BASED COMPENSATION PLANS
The Bank adopted the Financial Accounting Standards Board ("FASB")
Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004),
"Share-Based Payment," on January 1, 2006 using the modified prospective
transition method. SFAS No. 123R 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. Under SFAS No.
123R, expense is recognized based on the estimated number of shares for which
service is expected to be rendered and over the period during which employees
are required to provide service in exchange for the shares. Prior to January 1,
2006, the Bank used the fair value based method of accounting for its share-
based compensation plans, as defined in SFAS No. 123, "Accounting for
Stock-Based Compensation."
The Bank has three types of share-based compensation plans: a stock option
program, a mid-term incentive plan and an employee share purchase plan.
STOCK OPTION PROGRAM
The Stock Option Program was established under the Bank of Montreal ("BMO")
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.
14
HARRIS N.A. AND SUBSIDIARIES
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 at a rate of 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 fair value
of stock options granted is estimated using a trinomial option pricing model.
Weighted-average assumptions of risk-free interest rate, expected term, expected
volatility and dividend growth are used to determine the fair value of options
on grant date.
Historical forfeitures of the stock option awards have not been material.
Accordingly, the expense recorded for this program in the quarter ended March
31, 2006 was not adjusted for estimated forfeitures. Stock options were not
granted during the quarter ended March 31, 2006, so the expense recorded for
this program in the quarter ended March 31, 2006 was not adjusted for employees
eligible to retire. In accordance with SFAS No. 123R, stock-based compensation
granted to retirement-eligible employees is expensed in entirety at the time of
grant. Per SFAS No. 123R, cash flows resulting from realized tax deductions in
excess of recognized compensation cost are financing cash flows.
The compensation expense related to this program totaled $0.4 million and
$0.8 million in the first quarter of 2006 and 2005, respectively. The related
tax benefits recognized for the quarters ended March 31, 2006 and March 31, 2005
were $0.2 million and $0.3 million, respectively. As of March 31, 2006, the
total unrecognized compensation cost related to nonvested stock option awards
was $4.1 million and the weighted average period over which it is expected to be
recognized is approximately 3.1 years.
No stock options were granted during the quarters ended March 31, 2006 and
2005, respectively. The total intrinsic value of stock options exercised during
the quarters ended March 31, 2006 and 2005 was $12.4 million and $4.2 million,
respectively. Cash proceeds from options exercised under the plan totaled $13.1
million and $4.9 million for the quarters ended March 31, 2006 and 2005,
respectively. The excess tax benefits realized during the quarters ended March
31, 2006 and 2005 were $1.8 million and $1.1 million, respectively.
The following table summarizes the stock option activity for the first
quarter of 2006 and provides details of stock options outstanding at March 31,
2006:
THREE MONTHS ENDED MARCH 31, 2006
-------------------------------------------------------------
AGGREGATE
INTRINSIC WTD. AVG.
WTD. AVG. VALUE REMAINING
OPTIONS SHARES EXERCISE PRICE (IN MILLIONS) CONTRACTUAL LIFE
------- --------- -------------- ------------- ----------------
Outstanding at beginning of year... 3,967,370 $32.67
Granted............................ -- --
Exercised.......................... (441,913) 29.39
Forfeited, cancelled............... -- --
Transferred........................ -- --
Expired............................ -- --
---------
Outstanding at March 31, 2006...... 3,525,457 33.03 $76.3 5.38 years
=========
Options exercisable at March 31,
2006............................. 2,916,064 $29.99 $70.6 4.74
Weighted-average fair value of
options granted during the
year............................. N/A
---------------
N/A -- There were no stock options granted during first quarter 2006.
Note: The opening balance of options outstanding at the beginning of the year
was originally reported as 3,471,719. The balance in the above table reflects
adjustments for prior years' stock splits and options exercised not previously
reported. This had no material impact on current or prior period earnings.
15
HARRIS N.A. AND SUBSIDIARIES
The following table summarizes the nonvested stock option activity for the
first quarter of 2006:
WTD. AVG.
GRANT DATE
FAIR VALUE
OPTIONS SHARES PER SHARE
------- ------- ----------
Nonvested at beginning of year.............................. 609,393 $8.05
Granted..................................................... -- --
Vested...................................................... -- --
Forfeited, cancelled........................................ -- --
-------
Nonvested at March 31, 2006................................. 609,393 $8.05
=======
MID-TERM INCENTIVE PLANS
The Bank maintains mid-term incentive plans in order 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.
The mid-term incentive plans have a three year performance cycle. The right
to receive distributions under the plans depends on the achievement of specific
performance criteria that are set at the grant date such as the current market
value of BMO's common shares and BMO's total shareholder return compared with
that of its competitors. Distribution rights are subject to either cliff vesting
at the end of the three year period or graded vesting of one-third per year over
the three year period. Depending on the plan, participants receive either a
single cash payment at the end of the three year period or three annual cash
payments over the three year period.
The Bank is party to agreements made between BMO and third parties to
assume the majority of the Bank's obligations related to the incentive plans in
exchange for fixed cash payments. Amounts paid by the Bank under these
agreements were capitalized and will be recognized as compensation expense over
the performance cycles of the plans on a straight-line basis. Any future
obligations to participants required under these plans will be the
responsibility of the third parties.
For the remaining obligations relating to the plans for which BMO has not
entered into agreements with third parties, the amount of compensation expense
is amortized over the service period to reflect the current market value of
BMO's common shares and BMO's total shareholder return compared with that of its
competitors. Adjustments for changes in estimates of ultimate payments to
participants are recognized in current and future periods.
Historical forfeitures of the mid-term incentive plan awards have been
material. Accordingly, the expense recorded for the plans in the quarter ended
March 31, 2006 was reduced by $1.9 million ($1.2 million after-tax) attributable
to estimated forfeitures. Mid-term incentive plan awards were not granted during
the quarter ended March 31, 2006, so the expense recorded for the plans in the
quarter ended March 31, 2006 was not adjusted for employees eligible to retire.
No mid-term incentive awards were granted or distributed during the
quarters ended March 31, 2006 and March 31, 2005.
The compensation expense related to the plans totaled $2.6 million and $4.6
million in the first quarter of 2006 and 2005, respectively. The related tax
benefits recognized for the quarters ended March 31, 2006 and March 31, 2005
were $1.0 million and $1.7 million, respectively. As of March 31, 2006, the
total unrecognized compensation cost related to nonvested awards was $15.0
million and the weighted average period over which it is expected to be
recognized is approximately 1.7 years.
16
HARRIS N.A. AND SUBSIDIARIES
EMPLOYEE SHARE PURCHASE PLAN
The Bank of Montreal 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 $0.2 million and $0.1 million for the
quarter ended March 31, 2006 and March 31, 2005, respectively.
17
HARRIS N.A. AND SUBSIDIARIES
FINANCIAL REVIEW
FIRST QUARTER 2006 COMPARED WITH FIRST QUARTER 2005
SUMMARY
The Bank had first quarter 2006 net income of $41.4 million, a decrease of
$13.3 million or 24 percent from first quarter 2005. Return on equity was 5.69
percent in the current quarter, compared to 7.94 percent from last year's first
quarter. Return on assets was 0.47 percent compared to 0.68 percent a year ago.
First quarter net interest income on a fully taxable equivalent basis was
$210.5 million, up $8.3 million or 4 percent from $202.2 million in 2005's first
quarter. Average earning assets increased 10 percent to $32.38 billion from
$29.53 billion in 2005, due in part to an increase of $3.1 billion in average
loans. Net interest margin decreased to 2.62 percent in the current quarter from
2.76 percent in the year-ago quarter, primarily reflecting a flat yield curve
depressing spreads and the impact of greater reliance on higher-cost wholesale
funding sources. This was somewhat offset by strong loan growth, particularly in
the retail loan portfolio.
The first quarter 2006 provision for loan losses was $5.6 million compared
to $3.0 million in the first quarter of 2005. Net charge-offs decreased to $7.8
million from $9.0 million in the prior year. The credit profile of the loan
portfolio is expected to remain solid with moderate increases in default and
loss experiences in late 2006. The increase in the provision in the first
quarter of 2006 reflected charge-off activity and slightly higher levels of
non-performing loans.
Noninterest income was $84.0 million, a decrease of $19.4 million or 19
percent from the same quarter last year. This was primarily attributable to a
$8.1 million decrease in trust and investment management fees, a $3.2 million
decrease in loan sales income, a $1.8 million decrease in indirect loan fees, a
$1.2 million decline in mortgage origination fees and a $1.0 million decrease in
money market and bond trading income.
First quarter 2006 noninterest expenses of $227.1 million increased $9.1
million from the year ago quarter. The increase was attributable to intercompany
service costs rising by $4.2 million, a $3.3 million increase in expert service
expenses, higher marketing expenses of $1.9 million, increased credit expenses
of $1.4 million and a $1.4 million increase in equipment expenditures. The
increases were partially offset by reduced salaries and other compensation
expenses. Income tax expense decreased $11.3 million, reflecting lower pretax
income from year ago results.
Nonperforming assets at March 31, 2006 were $169 million or 0.69 percent of
total loans, up from $133 million or 0.58 percent at December 31, 2005, and $151
million or 0.72 percent a year ago. At March 31, 2006, the allowance for
possible loan losses was $322 million, equal to 1.34 percent of loans
outstanding, compared to $315 million or 1.45 percent of loans outstanding at
the end of first quarter 2005. As a result, the ratio of the allowance for
possible loan losses to nonperforming assets decreased from 209 percent at March
31, 2005 to 191 percent at March 31, 2006.
At March 31, 2006, Tier 1 capital of the Bank amounted to $2.93 billion, up
from $2.76 billion one year earlier. The regulatory leverage capital ratio was
8.26 percent for the first quarter of 2006 compared to 8.50 percent in the same
quarter of 2005. The Bank's capital ratio exceeds the prescribed regulatory
minimum for banks. The Bank's March 31, 2006 Tier 1 and total risk-based capital
ratios were 9.41 percent and 11.39 percent compared to respective ratios of 9.79
percent and 11.95 percent at March 31, 2005.
18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Liquidity Risk Management" and "Market Risk Management" under
Management's Discussion and Analysis of Financial Condition and Results of
Operations on page 7.
ITEM 4. CONTROLS AND PROCEDURES
As of March 31, 2006, Paul R. Skubic, the Chairman of the Board, Chief
Executive Officer and President of the Company, and Janine Mulhall, the Chief
Financial Officer of the Company, evaluated the effectiveness of the disclosure
controls and procedures of the Company and concluded that these disclosure
controls and procedures are effective to ensure that material information
required to be included in this Report has been recorded, processed, summarized
and made known to them in a timely fashion, as appropriate to allow timely
decisions regarding disclosures. There was no change in the Company's internal
control over financial reporting identified in connection with such evaluations
that occurred during the quarter ended March 31, 2006 that has materially
affected or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II. OTHER INFORMATION
ITEMS 1, 1A, 2, 3, 4 AND 5 ARE BEING OMITTED FROM THIS REPORT BECAUSE SUCH ITEMS
ARE NOT APPLICABLE TO THE REPORTING PERIOD.
ITEM 6. EXHIBITS
10.1 COMPENSATION OF INDEPENDENT DIRECTORS (FILED AS EXHIBIT 10.1 TO THE
COMPANY'S CURRENT REPORT ON FORM 8-K FOR MARCH 2, 2006 AND INCORPORATED
BY REFERENCE HEREIN)
31.1 CERTIFICATION OF JANINE MULHALL PURSUANT TO RULE 13a-14(a)
31.2 CERTIFICATION OF PAUL R. SKUBIC PURSUANT TO RULE 13a-14(a)
32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, Harris
Preferred Capital Corporation has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized on the 12th day of May
2006.
/s/ PAUL R. SKUBIC
--------------------------------------
Paul R. Skubic
Chairman of the Board and President
/s/ JANINE MULHALL
--------------------------------------
Janine Mulhall
Chief Financial Officer
20