Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly period ended September 30, 1998
------------------
OR
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________ to____________________________
Commission File Number: 0-22399
HARRIS FINANCIAL, INC.
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2889833
- ------------------------------- ------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
235 North Second Street PO Box 1711, Harrisburg, Pennsylvania 17105
- ------------------------------------------------------------- ---------
(Address of principal executive offices) (Zip Code)
717-236-4041
---------------------------------------------------
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
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 the number of shares outstanding of each of the Bank's classes of
common stock, as of the latest practicable date 33,703,400 shares of stock, par
value of $.01 per share, outstanding at October 31, 1998.
Page 1
<PAGE>
Part I. Financial Information.
Part 1, Item 1 Financial Statements.
(Balance of this page is left intentionally blank.)
Page 2
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Assets
- ------
Cash and cash equivalents $ 36,916 $ 24,466
Marketable securities held to maturity (Note 2) -- 96,412
Marketable securities available for sale (Note 2) 1,306,569 1,102,782
Loans receivable, net 975,317 890,484
Loans held for sale, net 23,082 14,886
Loan servicing rights 12,825 11,830
Real estate investments 7,555 6,698
Premises and equipment, net of accumulated
depreciation of $16,666 and $15,393 20,209 18,722
Accrued interest receivable 16,795 13,538
Income taxes receivable -- 5,757
Intangible assets 17,537 19,396
Other assets 3,631 2,088
---------- ----------
Total assets $2,420,436 $2,207,059
========== ==========
Liabilities and Stockholders' Equity
- ------------------------------------
Deposits $1,113,475 $1,146,238
Escrow 3,400 8,552
Accrued interest payable 13,437 4,297
Postretirement benefit obligation 2,907 2,297
Other borrowings (Note 3) 1,079,296 853,978
Deferred tax liability 5,414 8,279
Income taxes payable 3,153 --
Other liabilities 7,430 4,384
---------- ----------
Total liabilities 2,228,512 2,028,025
---------- ----------
Common stock, $.01 par value, authorized 100,000,000 shares
33,992,200 shares issued and 33,931,900 outstanding at September 30, 1998,
33,790,400 shares issued and outstanding at December 31, 1997
(Notes 7 and 8) 340 338
Paid in capital 29,560 28,016
Retained earnings 154,740 141,043
Net unrealized gain on marketable securities 9,189 10,732
Employee stock ownership plan (421) (529)
Recognition and retention plans (481) (566)
Treasury Stock, 60,300 shares (Note 4) (1,003) --
---------- ----------
Total stockholders' equity 191,924 179,034
---------- ----------
Total liabilities and stockholders' equity $2,420,436 $2,207,059
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
Page 3
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(in thousands, except for per share data)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30, Three Months Ended September 30,
------------------------------- ---------------------------------
Interest Income: 1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Loans receivable:
First mortgage loans $ 36,165 $ 34,515 $ 11,780 $ 11,634
Commercial 7,966 4,364 3,163 1,628
Consumer and other loans 14,867 14,785 5,099 5,209
Taxable investments 22,942 15,149 8,363 5,127
Taxfree investments 4,588 4,225 1,526 1,505
Dividends 6,839 5,683 2,288 2,088
Mortgage backed securities 28,488 24,807 9,170 10,164
Money market securities 56 150 13 21
--------- --------- --------- ---------
Total interest income 121,911 103,678 41,402 37,376
--------- --------- --------- ---------
Interest Expense:
Deposits 37,926 40,883 12,324 13,685
Borrowed funds (Note 3) 41,573 26,202 14,859 11,138
Escrow 72 101 37 32
--------- --------- --------- ---------
Total interest expense 79,571 67,186 27,220 24,855
--------- --------- --------- ---------
Net interest income 42,340 36,492 14,182 12,521
Provision for loan losses 1,970 457 570 153
--------- --------- --------- ---------
Net int. inc. after provision for loan losses 40,370 36,035 13,612 12,368
--------- --------- --------- ---------
Non-interest Income:
Service charges on deposits 1,976 1,187 740 461
ATM fees 1,079 443 342 177
Other svc. charges/commissions/fees 563 605 221 194
Net servicing income 195 1,616 15 530
Gain on sale of securities, net 4,276 3,905 1,306 712
Gain on sale of loans, net 3,549 1,544 1,481 739
Other 540 1,728 93 1,497
--------- --------- --------- ---------
Total non-interest income 12,178 11,028 4,198 4,310
--------- --------- --------- ---------
Non-interest Expense:
Salaries and benefits 16,531 12,685 5,835 4,553
Equipment expense 2,331 1,472 838 561
Occupancy expense 2,201 2,163 758 712
Advertising and public relations 1,484 1,466 407 494
FDIC insurance 532 567 175 186
Director fees 234 206 79 65
Income from real estate operations (498) (518) (130) (185)
Amortization of intangibles 1,860 1,787 627 600
Other 6,403 4,902 2,267 1,852
--------- --------- --------- ---------
Total non-interest expense 31,078 24,730 10,856 8,838
--------- --------- --------- ---------
Income before income taxes 21,470 22,333 6,954 7,840
Income tax expense 6,332 7,301 2,040 2,582
--------- --------- --------- ---------
Net Income $ 15,138 $ 15,032 $ 4,914 $ 5,258
========= ========= ========= =========
Basic earnings per share (Note 7) $ 0.45 $ 0.45 $ 0.14 $ 0.16
========= ========= ========= =========
Diluted earnings per share (Note 7) $ 0.44 $ 0.44 $ 0.14 $ 0.15
========= ========= ========= =========
Dividends per share $ 0.165 $ 0.145 $ 0.055 $ 0.048
========= ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
All share and per share data have been restated to give effect for a 3 for
1 stock split on November 18, 1997.
Page 4
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Net
Unrealized
Common Paid in Retained Gain/(Loss)
Stock Capital Earnings on Securities
-----------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at January 1, 1997 $ 336 $25,678 $124,812 $ 3,615
Net income 17,771
Dividends paid at $.20 per share (1,540)
Exercised stock options 2 480
Change in unrealized gain (loss) on marketable
securities, net of tax effect of $4,658 7,117
ESOP stock committed for release
Earned portion of RRP plan
Excess of fair value above cost of ESOP stock
committed for release 1,139
Excess of fair value above cost of earned portion
of RRP stock 492
Tax benefit of RRP shares awarded and options
exercised 227
-----------------------------------------------------------
Balance at December 31, 1997 $ 338 $28,016 $141,043 $10,732
Net income 15,138
Dividends paid at $.055 per share (1,441)
Exercised stock options 2 727
Change in unrealized gain on available-for-sale
securities, net of tax effect of ($1,077) (1,543)
ESOP stock committed for release
Earned portion of RRP plan
Excess of fair value above cost of ESOP stock
committed for release 559
Excess of fair value above cost of earned portion
of RRP stock 258
Treasury stock purchased 60,300 shares
-----------------------------------------------------------
Balance at September 30, 1998 $ 340 $29,560 $154,740 $ 9,189
===========================================================
</TABLE>
<TABLE>
<CAPTION>
Employee Recognition
Stock And
Ownership Retention Treasury
Plan Plan Stock Total
------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at January 1, 1997 $ (1,024) $ (665) $ -- $152,752
Net income 17,771
Dividends paid at $.20 per share (1,540)
Exercised stock options 482
Change in unrealized gain (loss) on marketable
securities, net of tax effect of $4,658 7,117
ESOP stock committed for release 495 495
Earned portion of RRP plan 99 99
Excess of fair value above cost of ESOP stock
committed for release 1,139
Excess of fair value above cost of earned portion
of RRP stock
Tax benefit of RRP shares awarded and options 492
exercised 227
------------------------------------------------------
Balance at December 31, 1997 $ (529) $ (566) $ -- $179,034
Net income 15,138
Dividends paid at $.055 per share (1,441)
Exercised stock options 729
Change in unrealized gain on available-for-sale
securities, net of tax effect of ($1,077) (1,543)
ESOP stock committed for release 108 108
Earned portion of RRP plan 85 85
Excess of fair value above cost of ESOP stock 559
committed for release
Excess of fair value above cost of earned portion
of RRP stock 258
Treasury stock purchased 60,300 shares (1,003) (1,003)
------------------------------------------------------
Balance at September 30, 1998 $ (421) $ (481) $(1,003) $191,924
======================================================
</TABLE>
See accompanying notes to consolidated financial statements.
All share and per share data have been restated to give effect for the 3 for 1
stock split on November 18, 1997.
Page 5
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1998 1997
----------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net Income $ 15,138 $ 15,032
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 1,970 457
Net depreciation, amortization, and accretion 5,530 2,330
Increase in loans held for sale (5,741) (1,031)
Net gain on sales of interest earning assets (7,825) (5,449)
Gain on sale of foreclosed real estate (5) (24)
Equity (income)/losses from joint ventures (110) 57
Increase in accrued interest receivable (3,257) (2,613)
Increase in accrued interest payable 9,140 6,722
Amortization of intangibles 1,860 1,787
Earned ESOP shares 667 921
Earned RRP shares 343 352
Provision for deferred income taxes (1,786) 239
Decrease in income taxes receivable 8,910 4,677
Other, net 1,181 (4,810)
--------- ---------
Net cash provided by operating activities 26,015 18,647
--------- ---------
Cash flows from investing activities:
Proceeds from maturities and principal reductions of marketable
securities:
Held to maturity 1,032 10,750
Available-for-sale 298,116 20,485
Proceeds from sales of marketable securities available for sale 444,207 495,432
Purchase of marketable securities available for sale (846,570) (756,253)
Loans sold 95,594 49,824
Net increase in loan originations less principal payments on
loans (187,319) (109,119)
Purchase of loan servicing rights (2,101) (781)
Investment in real estate held for investment (169) 45
Proceeds from payments on real estate held for investment 235 182
Purchases of premises and equipment (3,183) (4,390)
Cash proceeds received from the sale of foreclosed real
estate 905 759
Payments for holding company formation -- (92)
--------- ---------
Net cash used in investing activities $(199,253) $(293,158)
--------- ---------
</TABLE>
See accompanying notes to the consolidated financial statements.
Page 6
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
(continued)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1998 1997
--------- ---------
<S> <C> <C>
Cash flows from financing activities:
Net decrease in deposits $ (32,763) $(45,232)
Net increase in other borrowings 225,318 365,678
Net decrease in escrow (5,152) (3,910)
Cash dividends (1,441) (1,110)
Payments to acquire treasury stock (1,003) --
Proceeds from the exercise of stock options 729 442
--------- --------
Net cash provided by financing operations 185,688 315,868
--------- --------
Net increase in cash and cash equivalents 12,450 41,357
Cash and cash equivalents at beginning of period 24,466 29,693
--------- --------
Cash and cash equivalents at end of period $ 36,916 $ 71,050
========= ========
Supplemental disclosures:
Cash paid during the years for:
Interest on deposits, advances and other borrowings
(includes interest credited to deposit accounts) $ 66,305 $52,663
Income taxes 3,106 7,638
Cash received during the years for:
Income tax refunds $ 3,984 $ --
Non-cash investing activities:
Transfer from loans to foreclosed real estate $ 1,316 $ 516
</TABLE>
See accompanying notes to consolidated financial statements.
Page 7
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables are in thousands)
(Unaudited)
(1) Accounting Policies
The Consolidated Financial Statements include the accounts of Harris
Financial, Inc. (the "Registrant" or "HFI") and its wholly-owned subsidiary
Harris Savings Bank (the "Bank"). In turn, the Bank is comprised of the
following subsidiaries: Avstar Mortgage Corporation, Harris Delaware
Corporation, H. S. Service Corporation, First Harrisburg Service Corporation and
C.B.L. Service Corporation. All intercompany balances have been eliminated in
consolidation.
The accompanying interim financial statements have been prepared in
accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, they do not include all the information and footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management all adjustments, consisting of normal recurring
accruals, necessary for a fair presentation of the results of interim periods
have been made. Operating results for the nine month period ended September 30,
1998, are not necessarily indicative of the results that may be expected for the
year ended December 31, 1998, or any other interim period.
The accounting policies followed in the presentation of interim financial
results are consistent with those followed on an annual basis. These policies
are presented on pages 36 through 38 of the 1997 Annual Report to Stockholders.
(2) Marketable Securities
Marketable Securities consist of the following as of the date
indicated:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
-------------- ------------
<S> <C> <C>
Held-to-maturity, at amortized cost $ -- $ 96,412
---------- ----------
Available-for-sale, at amortized cost 1,291,621 1,085,214
Available-for-sale, net unrealized gain 14,948 17,568
---------- ----------
Available-for-sale, at fair value 1,306,569 1,102,782
---------- ----------
Total marketable securities $1,306,569 $1,199,194
========== ==========
</TABLE>
In January 1998, the remaining held-to-maturity portfolio with a book value of
$96.4 million was transferred to the available-for-sale segment of the portfolio
and $63.0 million of the amount transferred was subsequently sold for a gain of
$1.4 million. The market value of these securities at time of transfer was $97.5
million. The sale of these securities was executed in order to improve the
Registrant's interest rate risk profile and to align the portfolio with the
Registrant's current investment strategies. Under generally accepted accounting
principles, the sale of these securities eliminated the Registrant's ability to
use the held-to-maturity classification of securities for a period of at least
two years.
Page 8
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables are in thousands)
(Unaudited)
(3) Other Borrowings
The following table presents the composition of the Registrant's other
borrowings as of the dates indicated.
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
FHLB advances $ 720,643 $575,440
Repurchase agreements 358,158 277,548
ESOP loan 495 990
---------- --------
Total other borrowings $1,079,296 $853,978
========== ========
</TABLE>
(4) Treasury Stock Repurchase Program
On February 27, 1998, the Registrant received authorization from the
Pennsylvania Department of Banking to repurchase 450,000 shares of its
outstanding common stock at the prevailing market price at time of repurchase.
Repurchase of shares must be completed within one year of the program's
authorization date. The approval may be extended for one year if a written
request for extension is received by the Pennsylvania Department of Banking
before February 29, 1999. As of September 30, 1998, 60,300 shares have been
repurchased under this program at a cost of $1,003,000.
Page 9
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables are in thousands)
(Unaudited)
(5) New Accounting Standards
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position No. 98-1 (SOP 98-1) "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1
defines the characteristics of internal-use software and sets guidance regarding
the classification of internal-use software costs based on the type of cost
incurred and the stage of the software implementation. SOP 98-1 is effective for
financial statements for fiscal years beginning after December 15, 1998.
Management does not expect the adoption of SOP 98-1 to have a material effect on
the financial condition or results of operations of the Registrant.
In April 1998, the AICPA issued Statement of Position No. 98-5 (SOP 98-5),
"Reporting on the Costs of Start Up Activities." This statement is effective for
financial statements for fiscal years beginning after December 15, 1998. SOP
98-5 sets forth criteria for defining start up costs and requires that all such
costs be expensed as incurred. The adoption of SOP 98-5 will require the
write-off of previously capitalized start-up costs, which should be reported as
the cumulative effect of a change in accounting principle in the period of the
statement's adoption. Management believes that the adoption of this statement
will not have a material effect on the Registrant's financial condition or
results of operation.
During June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative
Instruments and Hedging Activities." The Statement establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. SFAS
133 requires that changes in the derivative's fair value be recognized currently
in earnings unless specific hedge criteria are met. Special accounting for
qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that a company
must formally document, designate and assess the effectiveness of transactions
that receive hedge accounting treatment.
SFAS 133 is effective for fiscal years beginning after June 15, 1999. A
company may also implement the Statement as of the beginning of any fiscal
quarter after issuance. The Statement cannot be applied retroactively.
Management has not yet quantified the impact of adopting SFAS 133 on the
financial statements and has not determined the timing of or method of adoption
of the Statement. However, the application of the Statement could increase
volatility in earnings and comprehensive income.
(6) Commitments and Contingent Liabilities
In the ordinary course of business, the Registrant makes commitments to
extend letters of credit to its customers. On September 30, 1998, and December
31, 1997, standby letters of credit issued and outstanding amounted to
$4,210,000 and $2,281,000 respectively. These letters of credit are not
reflected in the accompanying financial statements. Management does not
anticipate any significant losses as a result of these transactions.
At September 30, 1998, the Registrant has $79,584,000 in unused line of
credit commitments extended to its customers, $45,005,000 of undistributed funds
on construction loans and $71,160,000 of loan origination commitments.
Page 10
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables are in thousands)
(Unaudited)
(7) Earnings per share
On October 21, 1997, the Board of Directors of the Registrant declared a 3
for 1 stock split to be effected in the form of a dividend to stockholders of
record as of November 4, 1997, and payable on November 18, 1997. All share and
per share information in this report has been restated to reflect the stock
split as if it had been in effect during all periods presented.
The following table shows the reconciliation of earnings per share to basic
earnings per share and diluted earnings per share.
(The balance of this page is left intentionally blank.)
Page 11
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables are in thousands)
(Unaudited)
(7) Earnings per share (continued)
<TABLE>
<CAPTION>
Income Shares Per Share
For the nine months ended September 30, 1998 Amount
-------------------------------------
<S> <C> <C> <C>
Basic earnings per share
Income available to common shareholders $15,138,000 33,945,961 $0.45
-------------------------------------
Options held by management and directors 300,360
Diluted earnings per share -------------------------------------
Income available to common shareholders
plus assumed conversion $15,138,000 34,246,321 $0.44
For the nine months ended September 30, 1997 =====================================
Basic earnings per share
Income available to common shareholders $15,032,000 33,735,660 $0.45
-------------------------------------
Options held by management and directors 296,682
-------------------------------------
Diluted earnings per share
Income available to common shareholders
plus assumed conversion $15,032,000 34,032,342 $0.44
=====================================
<CAPTION>
Income Shares Per Share
Amount
For the three months ended September 30, 1998 -------------------------------------
<S> <C> <C> <C>
Basic earnings per share
Income available to common shareholders $ 4,914,000 33,977,091 $0.14
-------------------------------------
Options held by management and directors 286,482
-------------------------------------
Diluted earnings per share
Income available to common shareholders
plus assumed conversion $ 4,914,000 34,263,573 $0.14
=====================================
For the three months ended September 30, 1997
Basic earnings per share
Income available to common shareholders $ 5,258,000 33,806,430 $0.16
-------------------------------------
Options held by management and directors 351,612
-------------------------------------
Diluted earnings per share
Income available to common shareholders
plus assumed conversion $ 5,258,000 34,158,042 $0.15
=====================================
</TABLE>
Page 12
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables are in thousands)
(Unaudited)
(8) Reorganization
On September 17, 1997, the Bank and its existing mutual holding company
parent, Harris Financial, MHC (the "Mutual Company"), reorganized into a
two-tier mutual holding company structure (the "Two-Tier Reorganization"), with
the establishment of the Registrant as the parent of the Bank. Under the terms
of this reorganization, each share of Harris Savings Bank stock was exchanged
for one share of Harris Financial, Inc. stock.
The reorganization was accounted for in a manner similar to a pooling of
interest. Accordingly, the prior period consolidated financial statements of
Harris Financial, Inc. are identical to the prior period consolidated financial
statements of the Bank.
Prior to the consummation of this reorganization, the Registrant received
the approval of the Federal Reserve, the Pennsylvania Department of Banking, and
the FDIC.
(9) Comprehensive Income
On January 1, 1998, the Registrant adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). SFAS
130 establishes standards for reporting and displaying comprehensive income and
its components. Comprehensive income, as defined by SFAS 130, is the total of
net income and all other nonowner changes in equity. Total comprehensive income
for the nine months ended September 30, 1998, and 1997 was $13.6 million and
$19.7 million, respectively. Total comprehensive income for the three months
ended September 30, 1998, and 1997 was $4.4 million and $8.7 million,
respectively. The difference between net income and comprehensive income for the
above periods is due to unrealized gains and losses on available for sale
securities.
(10) Planned Stock Offering
On June 30, 1998, the Registrant filed a Registration Statement on Form S-3
with the SEC to register its planned sale of 2,000,000 shares of its common
stock ("the Offering"). The Registrant is a majority-owned subsidiary of the
Mutual Company, a Pennsylvania-chartered mutual holding company, which as of
June 30, 1998, owned 25,500,000 shares or 75.1% of the 33,964,950 outstanding
shares of common stock. At the conclusion of the Offering, the Mutual Company
will contribute to the Registrant 2,000,000 shares of common stock, and the
total number of shares of common stock owned by the Mutual Company will decrease
to 23,500,000, or 69.2% of the June 30, 1998 outstanding shares. The Registrant
will cancel the contributed shares and issue 2,000,000 shares of common stock.
Accordingly, the Offering will not result in a change in the number of issued
and outstanding shares of common stock. At the conclusion of the Offering, if
consummated, the total number of shares sold in the Offering (and contributed to
the Registrant by the Mutual Company) may be increased by up to 15%, at the
discretion of the Registrant and the Mutual Company. On September 4, 1998, the
Registrant suspended the Offering and re-instituted its stock repurchase program
which had been suspended until after the conclusion of the Offering. This
decision was predicated on recent volatility in the financial markets and its
impact on the Registrant's stock price. The Registrant will continue to position
itself to gain regulatory approval for a future offering. The decision to pursue
this option will be based on future market conditions, financial factors, and
the Registrant's strategic direction.
Page 13
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables are in thousands)
(Unaudited)
(11) Dividend Waivers by the Mutual Holding Company
The Mutual Company has generally waived the receipt of dividends declared
by the Bank, or, subsequent to the Two-Tier Reorganization, dividends paid by
the Registrant. The Mutual Company has not been required to obtain approval of
the Federal Reserve Bank (the "FRB" ) prior to any such waiver, and through the
date hereof has not sought or received FRB approval of any such waiver. In
connection with the FRB and Federal Deposit Insurance Corporation (the "FDIC")
approvals of the Bank's acquisition of First Harrisburg Bancor, Inc. and its
wholly owned subsidiary, First Federal Savings and Loan Association of
Harrisburg ("First Federal"), the Bank and the Mutual Company made several
commitments to the FDIC and the FRB regarding the waiver of dividends by the
Mutual Company. These commitments include the following: (i) Any dividends
waived by the Mutual Company shall be taken into account in any valuation of the
Bank and the Mutual Company, and factored into the calculation used in
establishing a fair and reasonable basis for exchanging Bank shares for holding
company shares in any subsequent conversion of the Mutual Company to stock form;
(ii) Dividends waived by the Mutual Company shall not be available for payment
to or the value thereof transferred to Minority Stockholders by any means
including through dividend payments or at liquidation; (iii) Beginning five
years after April 19, 1996, the date of consummation of the Bank's acquisition
of First Federal, the Mutual Company will make prior application to and shall
receive the approval of the FRB prior to waiving any dividends declared on the
capital stock of the Bank, and the FRB shall have the authority to approve or
deny any dividend waiver request in its discretion, and after such date such
application may be made on an annual basis with respect to any year in which the
Mutual Company intends to waive dividends paid by the Bank; (iv) After April 19,
1996, the date of consummation of the Bank's acquisition of First Federal, the
amount of waived dividends that are identified as belonging to the Mutual
Company shall not be available for payment to, or the value transferred to,
Minority Stockholders, either through dividend payments, upon the conversion of
the Mutual Company to stock form, upon the redemption of shares of the Bank,
upon the Bank's issuance of additional shares, at liquidation, or by any other
means; (v) The Mutual Company shall notify the FRB of all such transactions and
will make available to the FRB such information as the FRB determines to be
appropriate; (vi) The Bank will take into account when setting its dividend rate
the declaration rate in relation to net income and the rate's effect on the
Bank's ability to issue capital; and (vii) The dividend rate will be reasonable
and sustainable upon a full conversion to stock form of the Mutual Company;
(viii) In the event that the FRB adopts regulations regarding dividends waivers
by mutual holding companies, the Mutual Company will comply with the applicable
requirements of such regulations. After the completion of the two-tier
reorganization, the commitments became applicable to dividends paid by the
Registrant that are waived by the Mutual Company. If the Mutual Company decides
that it is in its best interest to waive the right to receive a particular
dividend to be paid by the Registrant, and, if necessary, the FRB approves such
waiver, then the Registrant pays such dividend only to Minority Stockholders,
and the amount of the dividend waived by the Mutual Company is treated in the
manner described above. The Mutual Company's decision as to whether or not to
waive a particular dividend depends on a number of factors, including the Mutual
Company's capital needs, the investment alternatives available to the Mutual
Company as compared to those available to the Registrant, and the receipt of
required regulatory approvals. There can be no assurance that (i) after the
Offering the Mutual Company will waive dividends paid by the Registrant, (ii)
the FRB will approve any dividend waivers by the Mutual Company after April
2001, or (iii) the terms that may be imposed by the FRB on any dividend waiver
will be favorable to Minority Stockholders. As of the date hereof, the Mutual
Company has waived the right to receive all dividends paid by the Bank and the
Registrant. As of April 19, 1996, the Mutual Company had waived $9.1 million of
dividends declared by the Bank, and through September 30, 1998, had waived a
total of $20.9 million of dividends paid by the Bank and the Registrant.
Page 14
<PAGE>
Item 2 Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following is management's discussion and analysis of the significant
changes in the results of operations, capital resources and liquidity presented
in its accompanying interim consolidated financial statements for Harris
Financial, Inc. (the "Registrant" or "HFI"), the holding company for Harris
Savings Bank (the "Bank"). This discussion should be read in conjunction with
the 1997 Annual Report. Current performance does not guarantee, and may not be
indicative of similar performance in the future.
In addition to historical information, this Quarterly Report on Form 10-Q
contains forward-looking statements, as such term is defined in the Securities
and Exchange Act of 1934 and the regulations thereunder. The forward-looking
statements contained herein are subject to certain risks and uncertainties that
could cause actual results to differ materially from those projected in the
forward-looking statements. Important factors that might cause such a difference
include, but are not limited to, those discussed in the section entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations". Readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect management's analysis only as of the
date hereof. The Registrant undertakes no obligation to publicly revise or
update these forward-looking statements to reflect events or circumstances that
arise after the date hereof.
(a) Results of Operations
Net Income or Loss The net income for the nine month period ending
September 30, 1998, was $15,138,000. This represented an increase of
$106,000 or .7% from the $15,032,000 net income figure reported during the
comparable nine month period ending September 30, 1997. For the three month
period ending September 30, 1998, net income was $4,914,000 which was
$344,000 or 6.5% less than the net income figure of $5,258,000 for the
comparable period in 1997.
Net Interest Income HFI's primary source of revenue is net interest income,
which represents the difference between interest income generated by
earning assets and the interest expense of deposits and external funding
sources. Furthermore, net interest income is significantly dependent on the
volume and composition of earning assets and interest earning liabilities
as well as the yield/cost of interest earning assets/liabiltiies.
Net interest income, on a tax equivalent basis, totaled $44,811,000 for the
nine months ended September 30, 1998, which represents an increase of
$6,129,000 or 15.8%, from the $38,682,000 of net interest income recorded
in the nine month period ended September 30, 1997. The primary factor for
the increase is a $360.1 million increase in total average earning assets
to $2.234 billion during the year to date period ending September 30, 1998,
as compared to $1.874 billion recorded during the same period ending
September 30, 1997.
For the nine months ended September 30, 1998, the yield on interest earning
assets stood at 7.42%. This represents an 11 basis point decrease from the
7.53% yield reported for the nine month period ended September 30, 1997.
During this same period, the cost of funds dropped 13 basis points to 5.04%
for the period ending September 30, 1998, versus 5.17% for the nine months
ended September 30, 1997. Consequently, the interest spread (difference
between the yield on assets minus the cost of funds) increased 2 basis
points to 2.38% for the nine period ending September 30, 1998, versus 2.36%
for the comparable period ending September 30, 1997. Part of this
improvement is attributable to higher yields on the mortgage loan portfolio
which reflect the effect of higher prepayments that accelerated the
recognition of deferred loan fees and will temporarily boost mortgage
yields. The second factor contributing to the increased spread is the
recognition of higher yields on the commercial loan portfolio. These trends
helped offset the decline in market rates that impacted the remaining yield
on interest earning assets.
Net interest income (on a tax equivalent basis) was $15,004,000 for the
three months ended September 30, 1998.
Page 15
<PAGE>
This figure represents an increase of $1,697,000, or 12.8%, from the
$13,307,000 of net interest income recorded in the three month period ended
September 30, 1997. This increase primarily reflects the impact of a $278.4
million increase in total average earning assets to $2.301 billion during
the three month period ended September 30, 1998, as compared to $2.023
billion recorded during the same quarter ending September 30, 1997. The
changes in balance sheet mix and developments in the financial market which
occurred during the three month period ending September 30, 1998, were
generally consistent with those described for the nine month period ended
September 30, 1998.
The Registrant continues to use wholesale funding sources to support an
investment leveraging strategy and mitigate the impact of the decline of
time deposits. During the nine month period ending September 30, 1998,
total deposits declined $32.8 million while other borrowings increased by
$225.3 million. The strategy relies on wholesale funding to support a
redeployment of capital generated from ongoing operations (leveraging) into
an interest earning capacity, via the investment portfolio. The objective
of this strategy is to increase the absolute dollar amount of interest
income. However, this strategy also serves to decrease the Registrant's net
interest margins. There are higher marginal cost of funds associated with
external borrowings than with core deposits. These factors are reflected in
the net interest margin decline of 8 basis points to the 2.67% yield for
the nine months ending September 30, 1998, versus the 2.75% yield for the
comparable period ending September 30, 1997. In addition, the previously
mentioned factors contributed to the 2 basis point decline in the net
interest margin to 2.61% for the three months ending September 30, 1998,
versus 2.63% for the comparable period ending September 30, 1997.
The following table summarizes the impact of the leveraging strategy on the
Return on Average Assets (ROAA) and Net Interest Margin (NIM) for the nine
month and three month periods ending September 30, 1998, and September 30,
1997, respectively.
Comparison of Financial Performance
with and without a Capital Leveraging Strategy
(All figures in 000's)
<TABLE>
<CAPTION>
With Without Difference in
Nine month period ending September 30, 1998 Leveraging Leveraging Basis Points
- ------------------------------------------- ---------- ---------- -------------
<S> <C> <C> <C>
Return on Average Assets 0.87% 0.77% 10
Net Interest Margin 2.67% 3.46% (79)
Three month period ending September 30,1998
- -------------------------------------------
Return on Average Assets 0.82% 0.67% 15
Net Interest Margin 2.61% 3.37% (76)
Nine month period ending September 30,1997
- ------------------------------------------
Return on Average Assets 1.03% 1.03% --
Net Interest Margin 2.75% 3.35% (60)
Three month period ending September 30, 1997
- --------------------------------------------
Return on Average Assets 1.01% 1.03% (2)
Net Interest Margin 2.63% 3.28% (65)
</TABLE>
Table 1 on the following pages presents the Registrant's average asset and
liability balances, interest rates, interest income, and interest expense for
the nine month periods and three month periods ended
Page 16
<PAGE>
September 30, 1998, and September 30, 1997, respectively.
For information on qualitative and quantitative disclosures regarding market
risk, refer to Management's Discussion and Analysis included in the 1997 Annual
Report to Stockholders. There have been no significant changes in the
Registrant's market risk profile nor in the Registrant's risk management
procedures, in the current year.
Page 17
<PAGE>
TABLE 1 - Average Balance Sheets, Rate, and Interest Income and Expense Summary
(All figures In 000's)
<TABLE>
<CAPTION>
For the nine months ended,
-------------------------------------------------------------------------------
September 30, 1998 September 30, 1997
-------------------------------------------------------------------------------
Average (1)(2) Average Average (1)(2) Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
---------------------------------------- -------------------------------------
(Dollar amounts in thousands)
<S> <C> <C> <C> <C> <C> <C>
Assets:
Interest Bearing assets:
Mortgage Loans, net (1) $ 572,775 $ 36,165 8.42% $ 558,887 $ 34,515 8.23%
Commercial loans 123,113 7,966 8.63% 73,070 4,364 7.96%
Direct consumer loans 157,101 8,947 7.59% 153,884 8,972 7.77%
Indirect consumer loans 85,931 5,920 9.19% 83,155 5,813 9.32%
Marketable Securities - Taxable 1,148,568 56,833 6.60% 871,035 44,793 6.86%
Marketable Securities - Taxfree (2) 113,860 7,058 8.27% 100,932 6,258 8.27%
Other interest earning assets 32,703 1,493 6.09% 33,032 1,153 4.65%
----------- -------- ---------- --------
Total interest-earning assets 2,234,051 124,382 7.42% 1.873,995 105,868 7.53%
-------- --------
Noninterest-earning assets 80,057 63,428
---------- ----------
Total assets $2,314,108 $1,937,423
========== ==========
Liabilities and stockholders' equity
Interest bearing liabilities: -
Savings deposits $ 149,931 $ 2,573 2.29% $ 146,971 3,024 2.74%
Time deposits 723,361 30,032 5.54% 791,717 33,021 5.56%
NOW and money market deposits 251,655 5,321 2.82% 191,814 4,838 3.36%
Escrow 10,266 72 0.94% 8,454 101 1.59%
Borrowed Funds 968,342 41,573 5.72% 593,324 26,202 5.89%
---------- -------- ---------- --------
Total interest bearing liabilities $2,103,555 79,571 5.04% $1,732,280 67,186 5.17%
-------- --------
Non interest bearing liabilities 25,504 45,567
---------- ----------
Total liabilities 2,129,059 1,777,847
Stockholders' equity 185,049 159,576
---------- ----------
Total liabilities and stockholder equity $2,314,108 $1,937,423
========== ==========
Net interest income
before provision for loan loss $ 44,811 $ 38,682
======== ========
Interest rate spread (3) 2.38% 2.36%
Net interest-earning assets $ 130,496 $ 141,715
========== ==========
Net interest margin (4) 2.67% 2.75%
Ratio of interest earning assets to
interest bearing liabilities 1.06 1.08
========== ==========
</TABLE>
(1) Includes income recognized on deferred loan fees of $2,001,000 and $805,000
for the 1998 and 1997 periods, respectively
(2) Interest income and yields are shown on a tax equivalent basis using an
effective tax rate of 35%.
(3) Represents the difference between the average yield on interest-earning
assets and the average cost on interest bearing liabilities.
(4) Represents the annualized net interest income before the provision for loan
losses divided by average interest earning assets.
Page 18
<PAGE>
TABLE 1 - Average Balance Sheets, Rate, and Interest Income and Expense Summary
(All figures In 000's)
<TABLE>
<CAPTION>
For the quarter ended,
-------------------------------------------------------------------------------
September 30, 1998 September 30, 1997
-------------------------------------------------------------------------------
Average (1)(2) Average Average (1)(2) Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
---------------------------------------- -------------------------------------
(Dollar amounts in thousands)
<S> <C> <C> <C> <C> <C> <C>
Assets:
Interest Bearing assets:
Mortgage Loans, net (1) $ 578,206 $11,780 8.15% $ 565,994 $11,619 8.21%
Commercial loans 152,961 3,163 8.27% 83,876 1,628 7.76%
Direct consumer loans 160,516 3,086 7.69% 155,594 3,192 8.21%
Indirect consumer loans 82,949 2,014 9.71% 86,061 2,017 9.37%
Marketable Securities - Taxable 1,190,582 19,526 6.56% 988,455 17,035 6.89%
Marketable Securities - Taxfree (2) 114,548 2,347 8.20% 108,745 2,242 8.25%
Other interest earning assets 21,562 308 5.71% 34,151 429 5.02%
---------- ------- ---------- -------
Total interest-earning assets 2,301,324 42,224 7.34% 2,022,876 38,162 7.55%
------- -------
Noninterest-earning assets 84,424 64,301
---------- ----------
Total assets $2 385,748 $2,087,177
========== ==========
Liabilities and stockholders' equity
Interest bearing liabilities:
Savings deposits $ 147,024 $ 692 1.88% $ 146,770 $ 1,020 2.78%
Time deposits 706,804 9,848 5.57% 777,281 10,979 5.65%
NOW and money market deposits 264,476 1,784 2.70% 196,042 1,686 3.44%
Escrow 8,865 37 1.67% 8,003 32 1.60%
Borrowed Funds - 1,042,519 14,859 5.70% 746,981 11,138 5.96%
---------- ------- ---------- -------
Total interest bearing liabilities 2,169,688 27,220 5.02% 1,875,077 24,855 5.30%
------- -------
Non interest bearing liabilities - 26,239 45,878
---------- ----------
Total liabilities 2,195,927 1,920,955
Stockholders' equity - 189,821 166,222
---------- ----------
Total liabilities and shareholders' equity $2,385,748 $2,087,177
========== ==========
Net interest income before
provision for loan losses $15,004 $13,307
======= =======
Interest rate spread (3) 2.32% 2.25%
Net interest-earning assets $ 131,636 $ 147,799
========== =========
Net interest margin (4) 2.61% 2.63%
Ratio of interest earning assets to
interest-bearing liabilities 1.06 1.08
========== =========
</TABLE>
(1) Includes income recognized on deferred loan fees of $418,000 and $311,000
for the 1998 and 1997 periods, respectively.
(2) Interest income and yields are shown on a tax-equivalent basis using an
effective tax rate of 35%.
(3) Represents the difference between the average yield on interest earning
assets and the average cost on interest bearing liabilities.
(4) Represents the annualized net interest income before provision for loan
loss divided by average interest earning assets.
Page 19
<PAGE>
Provision for Loan Losses The Registrant recognized a provision for loan loss of
$1,970,000 for the nine months ended September 30, 1998. This represents an
increase of $1,513,000 over the provision recorded for the nine months ending
September 30, 1997. The increase in the provision has resulted from a
significant increase in the Registrant's commercial loan portfolio over the past
year and which has lead to a significant increase in charge-off activity in the
portfolio. The Registrant has determined the necessary reserve by analyzing
specifically identified problem loans and assigning a reserve and considering
the impact of increased charge-off activity on the realizable asset value of the
existing loan portfolio.
Noninterest Income Noninterest income totaled $12,178,000 for the nine months
ending September 30, 1998. This represents an increase of $1,150,000, or 10.4%,
from the $11,028,000 recorded in the nine months ended September 30, 1997. This
increase is predicated on several different factors. The primary reason was a
$3,549,000 net gain on the sale of loans in the nine months ending September 30,
1998. The gain is a $2,005,000 increase over the $1,544,000 gain reported in the
comparable nine month period ending in 1997. This income recognition was
triggered by favorable market rates and opportunities to reposition segments of
the balance sheet to meet HFI's Asset Liability Management (ALM) objectives.
Secondly, service charges on deposits generated $1,976,000, or a $789,000
increase over the prior nine month period ending September 30, 1997, figure of
$1,187,000. This trend is attributable to the Registrant's strategy of
emphasizing growth in transaction accounts and the associated fees for
transaction accounts. Third, ATM Fees registered $1,079,000 for the nine months
ending September 30, 1998. This was a $636,000 increase over the $443,000
reported for the nine months ending September 30, 1997. This increase reflects
the impact of an expanding ATM network, higher transaction levels and the
inception of surcharging. Offsetting these increases was a $1,421,000 decline in
net servicing income to the year to date September 30, 1998, figure of $195,000
from the year to date September 30, 1997, figure of $1,616,000. This decrease is
caused by the prepayment of loan balances and the corresponding acceleration of
the amortization of the loan servicing rights carried on the Registrant's
balance sheet. This expense is an offset to the income stream generated by loan
servicing. The income stream is also impacted by prepayments which reduce the
total amount of fee income paid by FNMA and Freddie Mac to the Registrant. For
the nine months ending September 30, 1998, gross servicing income equalled
$2,618,000 which was offset by $2,423,000 for the amortization of loan servicing
rights. This produced a net servicing income figure of $195,000. For the nine
months ending September 30, 1997, gross servicing income totalled $2,711,000,
while the amortization of loan servicing rights created a $1,095,000 offset. The
final result is net servicing income equalling $1,616,000 for the nine month
time period. Finally, other income was $540,000 for the nine months ending
September 30, 1998. This figure was $1,188,000 less than the $1,728,000 reported
for the nine month period ending September 30, 1997. In the third quarter of
1997, the Registrant recorded a $1,556,000 pretax recovery from a $4,205,000
fraud loss associated with a mortgage brokerage company. The loss was recorded
in the second quarter of 1996.
Noninterest income equalled $4,198,000 for the three months ending September 30,
1998. This is a $112,000 or 2.6% decrease from the $4,310,000 reported in the
comparable period ending September 30, 1997. The explanation for this decrease
is the partial recovery of a mortgage brokerage company loss. During the three
months ending September 30, 1998, gross servicing income equalled $908,000 which
was offset by $893,000 for the amortization of loan servicing rights. This
produced a net servicing income figure of $15,000. The reasons for the increase
in the amortization of loan servicing rights for the three month period ending
September 30, 1998, were also specified in the preceding paragraph. For the
three month period ending September 30, 1997, gross servicing income totalled
$910,000, while the amortization of loan servicing rights produced a $380,000
reduction to gross servicing income. The final result is net servicing income
equalling $530,000 for the three month period ending September 30, 1997.
However, these decreases were offset by the following developments. Gains on the
sale of loans, net
Page 20
<PAGE>
produced a $742,000 increase ($1,481,000 versus $739,000) for the three month
period ending September 30, 1998, over September 30, 1997. In addition, gain on
the sale of securities, net increased $594,000 ($1,306,000 versus $712,000).
These trends are attributable to the ALM strategy detailed in the preceding
paragraph. Finally, service charges on deposits totalled $740,000 for the
quarter ended September 30, 1998, a $279,000 increase from the $461,000 reported
for the comparable quarter ended September 30, 1997. This change reflects the
Registrant's increased emphasis on generating transaction accounts and the
corresponding fee income from these accounts.
Noninterest Expense Noninterest expense totaled $31,078,000 for the nine month
period ending September 30, 1998. This is an increase of $6,348,000, or 25.7%,
from the $24,730,000 reported for the nine month period ending September 30,
1997. The increase in noninterest expense was caused, primarily, by a $3,846,000
increase in salary and benefit expense ($16,531,000 for the nine months ending
September 30, 1998, versus $12,685,000 for the nine months ending September 30,
1997). This increase represents salary expenditures for the acquisition of staff
to support the Registrant's transition to a full service community bank. In
addition, the Registrant recognized other expenses of $6,403,000 for the nine
month period ending September 30, 1998; representing a $1,501,000 increase in
other expenses over the $4,902,000 incurred during the nine month period ending
September 30, 1997. A significant portion of the increase represents additional
loan and deposit support activity and consulting costs incurred in the three
month period ending March 31, 1998. These costs were incurred after the
conversion to the new mainframe computer system in November 1997. Equipment
expense was $2,331,000 for the nine month period ending September 30, 1998. This
represents an $859,000 increase over the $1,472,000 figure for the comparable
period ending September 30, 1997. The increase is attributable to higher
depreciation expense for the new mainframe computer system installed in November
1997. The full impact of the additional depreciation expense will not be
experienced until the end of the 1998 fiscal year .
Noninterest expense was $10,856,000 for the three month period ending September
30, 1998. This is an increase of $2,018,000, or 22.8%, from the $8,838,000
reported for the three month period ending September 30, 1997. Salary and
benefit expense was $5,835,000 for the three month period ending September 30,
1998, versus the $4,553,000 for the three month period ending September 30,
1997. The $1,282,000 increase is attributable to the staff expenditures detailed
in the preceding paragraph. Other expense was $2,267,000 for the three month
period ending September 30, 1998. This represents an increase of $415,000 from
the $1,852,000 reported for the three month period ending September 30, 1997 and
resulted primarily for the reason described in the preceding paragraph.
Additionally, equipment expense totaled $838,000 for the three month period
ending September 30, 1998, a $277,000 increase from the $561,000 figure for the
comparable period ending September 30, 1997. The reason for this increase is the
additional depreciation expense associated with the November 1997 mainframe
computer conversion.
Provision for Income Taxes Corporate income tax expense equalled $6,332,000 for
the nine month period ended September 30, 1998, generating an effective tax rate
of 29.5% on pretax income of $21,470,000. This is a decrease of $969,000 from
the $7,301,000 of corporate tax expense, resulting in an effective tax rate of
32.7% on pretax income of $22,333,000, recorded during the nine month period
ended September 30, 1997. The decrease in the effective tax rate is the result
of the Registrant's heightened focus on increasing tax exempt sources of income.
Income tax expense totaled $2,040,000 (effective tax rate of 29.3%) for the
three months ended September 30, 1998. This represents a $542,000 decrease from
the tax expense of $2,582,000 (effective tax rate of 32.9%) recorded for the
three month period ending September 30, 1997. These changes are indicative of
increases in tax exempt sources of income in the loan portfolio which reflect a
recent emphasis on providing intermediate to long term capital project financing
to local municipalities and school districts.
Page 21
<PAGE>
Stockholders' Equity Stockholders' equity totaled $191.9 million and $179.0
million at September 30, 1998, and December 31, 1997, respectively.
Stockholders' equity amounted to 7.9% of total assets equalling $ 2.420 billion
as of September 30, 1998, compared to 8.1% on total assets of $2.207 billion at
December 31, 1997.
The increase in stockholders' equity of $12.9 million or 7.2% in the nine months
ended September 30, 1998, resulted mainly from $15.1 million in net income and
$.7 million due to exercised stock options. Offsetting these increases is a $1.5
million decline in the market value, net of tax effect, of the available-
for-sale securities portfolio and $1.4 million in dividends paid. In addition,
the Registrant purchased $1.0 million in treasury shares which was partially
offset by $.8 million increase in the excess of fair value of ESOP stock
committed for release and the excess fair value of the cost of the earned
portion of the Recognition and Retention Plan (RRP) stock.
(Balance of this page is left intentionally blank.)
Page 22
<PAGE>
Regulatory Capital Compliance Risk-based capital standards are issued by bank
regulatory agencies in the United States. These capital standards link a banking
company's capital to the risk profile of its assets and provide the basis by
which all banking companies and banks are evaluated in terms of capital
adequacy. These risk-based capital standards require all banks to have Tier 1
capital of at least 4.0% and total capital, including Tier 1 capital, equal to
at least 8.0% of risk-adjusted assets. Tier 1 capital consists of common
stockholders' equity and qualifying perpetual preferred stock along with related
surpluses and retained earnings. Total capital is comprised of Tier 1 capital,
limited life preferred stock, qualifying debt instruments, and the reserves for
possible loan losses. Furthermore, the banking regulators also issue leverage
ratio requirements. The leverage ratio requirement is measured as the ratio of
Tier 1 capital to adjusted average assets. The following table provides a
comparison of the Registrant's risk-based capital ratios and leverage ratio to
the minimum regulatory requirements for the period indicated.
<TABLE>
<CAPTION>
Minimum Minimum
Requirement Requirement
for Capital to be "Well Cap-
HARRIS FINANCIAL, INC. Actual Adequacy italized"
As of September 30, 1998 Amount Ratio Amount Ratio Amount Ratio
- ------------------------- ------ ----- ------- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Total Capital
(to Risk Weighted Assets) $174,855 12.5% $111,821 8.0% $139,777 10.0%
Tier 1 Capital
(to Risk Weighted Assets) 165,199 11.8% 55,911 4.0% 83,866 6.0%
Tier 1 Capital
(to Avg. Assets) ......... 165,199 7.0% 94,301 4.0% 117,876 5.0%
As of December 31, 1997
Total Capital
(to Risk Weighted Assets) $157,520 13.7% $ 91,979 8.0% $114,973 10.0%
Tier 1 Capital
(to Risk Weighted Assets) 148,906 13.0% 45,989 4.0% 68,984 6.0%
Tier 1 Capital
(to Avg. Assets) ............ 148,906 7.5% 80,649 4.0% 100,811 5.0%
</TABLE>
Page 23
<PAGE>
The following table provides a comparison of the Bank's risk-based capital
ratios and leverage ratio to the minimum regulatory requirements for the period
indicated.
<TABLE>
<CAPTION>
Minimum Minimum
Requirement Requirement
for Capital to be "Well Cap-
HARRIS FINANCIAL, INC. Actual Adequacy italized"
As of September 30, 1998 Amount Ratio Amount Ratio Amount Ratio
- ------------------------- ------ ----- ------- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Total Capital
(to Risk Weighted Assets) $164,987 11.9% $111,242 8.0% $139,053 10.0%
Tier 1 Capital
(to Risk Weighted Assets) 155,332 11.2% 55,621 4.0% 83,432 6.0%
Tier 1 Capital
(to Avg. Assets) 155,332 6.6% 93,936 4.0% 117,419 5.0%
As of December 31, 1997
Total Capital
(to Risk Weighted Assets) $147,533 12.9% $91,474 8.0% $114,343 10.0%
Tier 1 Capital
(to Risk Weighted Assets) 138,919 12.1% 45,737 4.0% 68,606 6.0%
Tier 1 Capital
(to Avg. Assets) 138,919 7.0% 80,558 4.0% 100,697 5.0%
</TABLE>
During the month of September 1998, the Registrant adhered to the 6.5% Tier
1 minimum stipulated by the Pennsylvania Department of Banking ("Department").
This minimum threshold was a condition required by the Department for the
Treasury Stock Repurchase Program that was approved on February 27, 1998.
Page 24
<PAGE>
Marketable Securities In January 1998, the Registrant sold securities from the
held-to-maturity (HTM) portfolio. The book value of these securities totalled
$63.0 million and a gain of $1.4 million was realized from the transaction. The
sale of these securities was executed in order to improve the Registrant's
interest rate risk profile and to align the portfolio with the Registrant's
current investment strategies. Under generally accepted accounting principles,
the sale of these securities eliminated the Registrant's ability to use the
held-to-maturity classification of securities for a period of two years.
As a result, the remaining securities in the held-to-maturity portfolio were
transferred to the available-for-sale portfolio. This transfer resulted in a
$209,565 increase, net of taxes, to the net unrealized gains on marketable
securities.
Marketable securities, excluding cash, totaled $1,306.6 million and $1,199.2
million at September 30, 1998, and December 31, 1997, respectively. Total
marketable securities increased $107.4 million, or 9.0%, during the first nine
months of 1998.
Table 2 on the following page presents the composition of the Registrant's
marketable securities portfolio as of September 30, 1998, and December 31, 1997,
respectively.
(Balance of this page left intentionally blank.)
Page 25
<PAGE>
TABLE 2 - Composition of Marketable Securities Portfolios (All figures in 000's)
The following table sets forth certain information regarding the amortized cost
and fair values of the Registrant's marketable securities portfolio at September
30, 1998 and December 31, 1997.
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
-------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
-------------------------------------------------
<S> <C> <C> <C> <C>
Held-to-maturity:
U.S. Government and agencies $ -- $ -- $ 67,933 $ 68,651
Mortgage-backed securities:
FNMA PC's -- -- 4,050 4,150
Private Issue CMO's -- -- 24,429 24,744
---------- ---------- ---------- ----------
Total mortgage-backed securities -- -- 28,479 28,894
---------- ---------- ---------- ----------
Total securities held-to-maturity $ -- $ -- $ 96,412 $ 97,545
---------- ---------- ---------- ----------
Available-for-sale:
U.S. Government and agencies $ 316,126 $ 318,436 $ 184,033 $ 184,503
Corporate bonds 148,646 141,887 20,117 20,115
Municipal obligations 112,528 118,248 109,351 114,023
FHLB stock 37,290 37,290 30,027 30,027
Equities (Common and Preferred) 117,954 128,012 116,802 124,790
Asset backed securities 33,804 34,661 24,551 24,837
Mortgage-backed securities: -
FHLMC PC's 1,660 1,736 2,920 3,066
FNMA CMO's 146,652 147,753 151,067 152,433
FHLMC CMO's 98,445 98,832 272,927 274,281
Private Issue CMO's 278,516 279,714 173,419 174,707
---------- ---------- ---------- ----------
Total mortgage-backed securities 525,273 528,035 600,333 604,487
---------- ---------- ---------- ----------
Total securities available-for-sale 1,291,621 $1,306,569 $1,085,214 $1,102,782
---------- ---------- ---------- ----------
Other interest-earning securities:
FHLB daily Investment $ 8,236 $ 8,236 $ 11,840 $ 11,840
---------- ---------- ---------- ----------
Total marketable securities and
Interest bearing investments $1,299,857 $1,314,805 $1,193,466 $1,212,167
========== ========== ========== ==========
</TABLE>
Page 26
<PAGE>
Loans Loans receivable, excluding the reduction for the allowance for loan
losses, totaled $985.0 million and $899.1 million at September 30, 1998, and
December 31, 1997, respectively. The increase of $85.9 million, or 9.6%, for the
nine months ending September 30, 1998 reflects growth in commercial loans of
$86.8 million. At the same time, first mortgage loans displayed a nine month
increase of $2.5 million or .4%. However, these increases were offset by an
decline of $3.3 million in consumer and other loans, for the nine month period
ending September 30, 1998. These trends are the results of a strategy designed
to enhance the Registrant's return on equity by repositioning the loan portfolio
into higher yielding assets and the seasonal demand for mortgage lending that
peaks in the third quarter.
Loan charge-offs, net of recoveries, totaled $929,000 for the nine month period
ended September 30, 1998, compared to $318,000 for the twelve month period ended
December 31, 1997. This difference is partially attributable to a $400,000 loss
on a participated commercial loan during February 1998. Based on management's
continuing review of the loan portfolio, and based on the increased charge-off
activity, the Registrant recorded provisions for loan losses of $1,970,000 for
the nine months ending September 30, 1998, and $610,000 for the 12 month period
ending December 31, 1997.
The Registrant considers all loans that are delinquent 90 days or more with
respect to principal and interest repayments to be in a non accrual status. Non
accrual loans were $8,318,000 and $6,938,000 at September 30, 1998, and December
31, 1997, respectively. These amounts as a percentage of total loans receivable
(including Loans held for sale, net), before deducting the Allowance for Loan
Loss, equalled .83% and .76% at September 30, 1998, and December 31, 1997,
respectively. During these time periods, the Registrant had no loans that were
more than ninety days delinquent with respect to principal and interest on
accrual status.
The Registrant conducts an external loan review to identify those loans which
are considered performing and current with respect to payments of principal and
interest but display an above normal risk of becoming non performing or
requiring restructuring in the future. This review is conducted on a quarterly
basis.
The allowance for loan losses totaled $9,655,000 and $8,614,000 at September 30,
1998, and December 31, 1997, respectively. Stated as a percentage of total loans
receivable (including Loans held for sale, net), the allowance for loan losses
amounted to .96% and .94% at September 30, 1998, and December 31, 1997,
respectively.
Table 3 on the following page depicts the trend of charge-offs, recoveries, and
provisions to the allowance for loan losses for the nine months ended September
30, 1998, and the year ended December 31, 1997, respectively. In addition, Table
4 highlights the allowance for loan losses as a percent of non accrual loans and
specifically designated problem loans for the nine months ended September 30,
1998, and the year ended December 31, 1997, respectively.
Page 27
<PAGE>
Table 3 - Analysis of the Allowance for Loan Losses (all figures in 000's)
<TABLE>
<CAPTION>
As of or for the As of or for the
Allowance for Loan Loss nine months ending twelve months ending
(All Figures in 000's) September 30, 1998 December 31, 1997
- ---------------------------------- ------------------ --------------------
<S> <C> <C>
Balance at beginning of the period $8,614 $8,322
Provision for loan losses 1,970 610
Charge Offs
Commercial 465 19
Real Estate - construction -- --
Real Estate - one to four family 403 341
Consumer loans 107 8
------ ------
Total Charge Offs 975 368
------ ------
Recoveries
Commercial 1 14
Real Estate - construction -- --
Real Estate - one to four family 34 10
Consumer loans 11 26
------ ------
Total Recoveries 46 50
------ ------
Net Charge Offs 929 318
------ ------
Balance at end of period $9,655 $8,614
====== ======
Net Charge Offs to Average Loans Outstanding 0.10% 0.04%
====== ======
</TABLE>
Table 4 - Allowance for Loan Losses Coverage Ratios
(all dollar figures in 000's)
<TABLE>
<CAPTION>
As of or for the As of or for the
nine months ending twelve months ending
September 30, 1998 December 31, 1997
------------------ --------------------
<S> <C> <C>
Allowance at the end of period $ 9,655 $ 8,614
Non accrual loans $ 8,318 $ 6,938
Problem loans $ 9,665 $12,400
Allowance/non accrual loans 116.07% 124.16%
------- -------
Allowance/problem loans 99.90% 69.47%
------- -------
</TABLE>
Page 28
<PAGE>
Asset Quality The Registrant establishes the allowance for loan losses based on
internal and external factors. The external factors include the general economic
condition of the Registrant's market area and regulatory guidelines. The
internal factors include the current composition of the portfolio, portfolio
growth trends, and the current emphasis on commercial lending as a strategic
directive. These factors are used by the Registrant to help determine the
reserve necessary to provide for probable losses within the portfolio. These
assessments are performed on a quarterly basis and the provision for loan losses
is adjusted accordingly.
The commercial loan portfolio is analyzed on an individual loan basis and a
specific reserve is developed for each known loss. In addition, the Registrant
assigns an additional reserve amount for probable losses in the loan portfolio,
using historical loss experience.
The mortgage and consumer portfolio is analyzed in pools of similar loans with
similar risk characteristics. Using historical loss experience, management
determines a specific reserve for the loan pools.
Loan charge-offs, net of recoveries, totaled $929,000 for the nine month period
ended September 30, 1998, compared to $318,000 for the twelve month period ended
December 31, 1997. Based on management's continuing review of the loan
portfolio, the Registrant recorded provision for loan losses of $1,970,000 for
the nine month period ending September 30, 1998.
The allowance for loan losses totaled $9,655,000 and $8,614,000 at September 30,
1998, and December 31, 1997, respectively. Stated as a percentage of total loans
receivable (including Loans held for sale, net), the allowance for loan losses
amounted to .96% and .94% at September 30, 1998, and December 31, 1997,
respectively.
Other Borrowings During the nine month period ended September 30, 1998, the
Registrant actively engaged in leveraging activities to deploy its capital. This
strategy relies on using external sources of funds to invest in interest earning
assets at a positive spread between the yield on interest earning assets and the
cost of the support borrowing.
Other borrowings totaled $1,079.3 million and $854.0 million at September 30,
1998 and December 31, 1997, respectively. Funding from non deposit sources
increased $225.3 million or 26.4% for the nine month period ending September 30,
1998. One component of this trend, FHLB advances registered a September 30,
1998, balance of $720.6 million. This represents an increase of $145.2 million,
or 25.2%, during the nine months ended September 30, 1998. In addition,
repurchase agreements equalled $358.2 million or an $80.6 million increase
(29.0%) for the nine month period ended September 30, 1998.
As of September 30, 1998, the Registrant had maximum FHLB lines of credit
totaling $961.7 million versus $811.7 million in available FHLB credit at
December 31, 1997. This increase of 18.5% or $150.0 million is the direct result
of the Registrant requesting the FHLB to recognize the inclusion of private
label mortgage backed securities as a component of HFI's available line of
credit base.
Liquidity The Registrant's primary sources of funds are deposits, moderate
amounts of borrowing and proceeds from principal and interest payments on loans
and mortgage-backed securities. While maturities and scheduled amortization of
loans and mortgage-backed securities are a predictable source of funds, deposit
flows and mortgage prepayments are greatly influenced by general interest rates,
economic conditions, and competition. The Registrant anticipates that it will
have sufficient funds available to meet its current commitments.
Page 29
<PAGE>
The Registrant exceeded all regulatory standards for liquidity at September 30,
1998 and December 31, 1997.
Year 2000 Compliance The efficient and reliable operation of the Registrant's
business is significantly dependent upon its computer hardware, software
programs, and operating systems (collectively "computer systems"). As a
financial services company, the Registrant relies on computer systems in
virtually all significant business operations. Management considers Year 2000
readiness to be a major business issue and has implemented a Year 2000
Compliance Effort to identify all major compliance risks.
The Registrant's Year 2000 Compliance Effort ("Y2K Project") can be broken down
into several distinct stages or phases. The first stage ("Awareness Phase")
dates from October 1996, and marks the beginning of the Y2K Project initiative.
The senior staff of HFI created a Y2K task force that represented all the major
functional areas of the Registrant. The task force started monthly meetings
during October 1997, and in July 1998 accelerated to the current bi-weekly
meeting schedule to intensify the Registrant's focus on the issue. This task
force has the commitment of the Registrant's senior management team and monthly
updates are provided to the Registrant's board of directors.
The second stage is termed the ("Inventory Phase") and covers the time period
from October 1997 to December 1997. During this phase the Registrant reviewed
all existing hardware, software and embedded technology to determine their Year
2000 Compliance profile. In December 1997, the Registrant distributed a
pamphlet to its customer base that identified the existence of Year 2000
Compliance issues and provided a high level review of the Registrant's efforts
to ensure compliance. In addition, the Registrant developed a data base to
track external vendors' responses to the Registrant's questionnaire to
determine the external vendors state of Year 2000 Compliance. The results from
the internal review and the questionnaire surveys were used as inputs to the
"Analysis Phase".
The third phase ("Analysis Phase") focused on the hardware and software
identified from the Inventory Phase that was crucial for the Registrant to
conduct its business operations. The systems were ranked "mission critical" or
"non mission critical". These two classifications were further segmented into
low, medium, or high risk ratings. Therefore, a "mission critical" system with a
high risk rating received the most testing focus. The following list details the
high priority "mission critical" systems:
(1) The AS400 mainframe hardware and operating system is certified Year 2000
Compliant by the vendor, IBM.
(2) All Alltel core systems (which include the general ledger, all major
lending and deposit applications and customer information databases), with
the exception of the mortgage servicing application, are certified Year
2000 Compliant. The mortgage system is scheduled for a November 1998
release update that will make it Year 2000 Compliant.
(3) The Registrant purchased software to test the BIOS (Basic Input Output
Systems) of all personal computers (PCs) in the local area network (LAN)
and wide area network (WAN). This testing targeted non compliant PCs that
were later replaced by the Registrant during the fourth phase of the Y2K
Project.
The subsequent fourth stage dubbed ("Testing/Renovation") phase of the Y2K
Project started in March 1998 and is scheduled for completion in December 1998.
During this phase, the Registrant's goal is to test all mission critical
systems, provide the results of those tests to the Registrant's Internal Audit
Department for review/analysis and correct non compliant mission critical
systems. In addition, the Registrant plans to test other stand alone PC
software programs. The Registrant has dedicated a separate PC, printer and
accessory environment to conduct tests in a controlled manner with the PC's
internal clock set to five specific, internally designated, Year 2000 dates.
The testing procedure
Page 30
<PAGE>
is approved by the Registrant's Internal Audit Department and the results of the
tests will be provided to the Registrant's Internal Audit Department for review
and analysis. At this point, the results of internal testing and the
identification and ensuing risk assessment of external vendors and significant
customers will be combined into an overall risk assessment for the Registrant's
Year 2000 Compliance profile. The ensuing profile will serve as the basis for a
contingency plan to address the most reasonably likely worst case scenario
facing the Registrant. The Registrant estimates that it will take approximately
$6,000 in staff time to complete this risk assessment. The first draft of the
contingency plan is scheduled for November 1998.
In addition to the Y2K Project, the Registrant installed new mainframe hardware,
operating systems and application software that was described in the preceding
paragraphs. This conversion commenced in April 1997, and replaced a prior system
that was not capable of supporting the Registrant's strategic transition to a
commercial bank as well as lacking Year 2000 Compliance certification. The costs
of that conversion consist of capitalized costs of approximately $4,083,000 for
hardware and software replacements and teller platform upgrades. In addition,
another $632,000 in operating expenses were incurred for consulting fees,
training, travel, communication and other associated conversion costs.
Page 31
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
None.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other information.
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27 Financial Data Schedule
Page 32
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HARRIS FINANCIAL, INC.
(Registrant)
By /s/ Charles C. Pearson, Jr.
---------------------------
Charles C . Pearson, Jr., President
and Chief Executive Officer
By /s/ James L. Durrell
--------------------
James L. Durrell, Executive Vice President
and Chief Financial Officer
Dated: November 4, 1998
Page 33
<PAGE>
EXHIBIT INDEX
Exhibit Number
- --------------
Exhibit 27 Financial Data Schedule
Page 34
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1998
<CASH> 36,916
<INT-BEARING-DEPOSITS> 8,236
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1,306,569
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 1,008,054
<ALLOWANCE> 9,655
<TOTAL-ASSETS> 2,420,436
<DEPOSITS> 1,113,475
<SHORT-TERM> 155,796
<LIABILITIES-OTHER> 35,741
<LONG-TERM> 923,500
0
0
<COMMON> 340
<OTHER-SE> 191,584
<TOTAL-LIABILITIES-AND-EQUITY> 2,420,436
<INTEREST-LOAN> 58,998
<INTEREST-INVEST> 62,913
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 121,911
<INTEREST-DEPOSIT> 37,926
<INTEREST-EXPENSE> 79,571
<INTEREST-INCOME-NET> 42,340
<LOAN-LOSSES> 1,970
<SECURITIES-GAINS> 4,276
<EXPENSE-OTHER> 31,078
<INCOME-PRETAX> 21,470
<INCOME-PRE-EXTRAORDINARY> 21,470
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 15,138
<EPS-PRIMARY> .45
<EPS-DILUTED> .44
<YIELD-ACTUAL> 7.42
<LOANS-NON> 8,318
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 9,665
<ALLOWANCE-OPEN> 9,264
<CHARGE-OFFS> 172
<RECOVERIES> (7)
<ALLOWANCE-CLOSE> 9,655
<ALLOWANCE-DOMESTIC> 6,228
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 3,427
</TABLE>
