<PAGE>
Selected Consolidated Financial Data
---------------------------------------------------
All dollar amounts presented in the tables, except for per share amounts, are in
thousands.
Set forth below are selected financial data of Harris Financial, Inc. (HFI).
This information is derived in part from and should be read in conjunction with
the Consolidated Financial Statements of Harris Financial, Inc. and Notes which
are presented later in this report.
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------------------------------
At Year End: 1997 1996 1995 1994 1993
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total Assets ............................... $2,207,059 $ 1,768,122 $1,255,864 $1,058,088 $1,087,006
Loans receivable, net ...................... 890,484 823,916 651,605 574,794 566,550
Loans held-for-sale, net ................... 14,886 9,053 0 0 0
Marketable securities ...................... 1,199,194 828,910 524,932 409,123 424,181
Deposits ................................... 1,146,238 1,173,423 1,073,710 910,576 937,903
Escrow ..................................... 8,552 8,203 4,649 5,116 11,643
Advances from FHLB-Pittsburgh and
other borrowed funds .................... 852,988 419,146 17,200 0 0
Other Borrowings ........................... 990 1,485 1,980 2,475 0
Retained earning, (partially restricted) (1) 141,043 124,812 125,244 117,292 107,886
Paid in capital and common stock ........... 28,354 26,014 25,434 24,656 0
Unearned ESOP and RRP shares ............... (1,095) (1,689) (2,339) (3,007) 0
Net unrealized gain (loss) on
marketable securities ................... 10,732 3,615 3,120 (3,905) 0
</TABLE>
(1) Retained earnings are partially restricted in connection with regulations
related to the insurance of savings accounts which require HFI to maintain
certain statutory reserves.
<TABLE>
<CAPTION>
Years ended December 31,
-----------------------------------------------------------
For the Years: 1997 1996 1995 1994 1993
-----------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest income ............................ $ 141,067 $ 107,988 $ 80,625 $ 73,932 $ 81,020
Interest expense ........................... 93,085 67,326 47,696 38,241 41,409
-----------------------------------------------------------
Net interest income ..................... 47,982 40,662 32,929 35,691 39,611
Provision for loan losses ............. 610 1,957 0 0 800
-----------------------------------------------------------
Net interest income after provision
for loan losses ...................... 47,372 38,705 32,929 35,691 38,811
Non-interest income ........................ 14,559 3,996 2,564 2,503 4,563
Non-interest expense ....................... 35,848 42,187 20,776 20,793 17,966
-----------------------------------------------------------
Income before income taxes and
cumulative effect of accounting
changes ................................. 26,083 514 14,717 17,401 25,408
Income taxes ............................... 8,312 (517) 5,503 7,348 9,170
-----------------------------------------------------------
Income after taxes and before
cumulative effect of accounting changes 17,771 1,031 9,214 10,053 16,238
Cumulative effect of accounting changes .... 0 0 0 0 1,420
-----------------------------------------------------------
Net income .............................. $ 17,771 $ 1,031 $ 9,214 $ 10,053 $ 17,658
===========================================================
</TABLE>
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------
Financial Ratios: 1997 1996 1995 1994 1993
----------------------------------------------
<S> <C> <C> <C> <C> <C>
Return on average assets ............ 0.88% 0.07% 0.81% 0.93% 1.67%
Return on average equity ............ 10.73% 0.68% 6.34% 7.59% 17.75%
Average equity to average assets .... 8.21% 9.88% 12.83% 12.27% 9.42%
Per Share Data (2):
Combined pre- and post-reorganization
earnings per share ............... $0.53 $ 0.03 $ 0.28 $0.31
Basic earnings per share ............ $0.53 $ 0.03 $ 0.28 $0.28
Fully diluted earnings per share .... $0.52 $ 0.03 $ 0.28 $0.28
Dividends per share ................. $0.20 $ 0.19 $ 0.17 $0.09
Book value per share ................ $5.29 $ 4.54 $ 4.50 $4.03
Dividend payout ratio ............... 8.67% 141.90% 13.70% 6.44%
</TABLE>
(2) All per share values have been adjusted to reflect the 1997 three for one
stock split.
Harris Financial, Inc. 1997 Annual Report 1
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
This section presents Management's discussion and analysis of the financial
condition and results of operations of Harris Financial, Inc. (HFI) and its
Subsidiaries. This discussion and analysis should be read in conjunction with
the consolidated financial statements and notes which appear later in this
report.
Forward-looking Statements
In addition to historical information, this Annual Report contains
forward-looking statements. The forward-looking statements contained in the
following sections 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 shouldn't place undue reliance on these forward-looking
statements, as they reflect management's analysis as of the date of this report.
HFI has no obligation to update or revise these forward-looking statements to
reflect events or circumstances that occur after the date of this report.
Readers should carefully review the risk factors described in other documents
HFI files from time to time with the Securities and Exchange Commission,
including Quarterly 10-Q reports and reports filed on Form 8-K.
Summary
Harris Financial, Inc. (HFI) began providing financial services as a state
chartered mutual savings and loan association in 1886. HFI continued to operate
under this charter until 1991, when Harris Savings Association converted its
charter to a state chartered mutual savings bank. On January 25, 1994, with its
conversion to a state chartered stock savings bank, Harris Savings (the Bank)
became for the first time a publicly traded stock bank. As an integral part of
this conversion, the Bank completed a successful stock issuance that raised net
proceeds of $23.7 million. On September 17, 1997, the Bank reorganized the
existing mutual holding company into a two-tier holding company with the
establishment of a state chartered corporation as the stock holding company
parent of the Bank. The deposits of HFI are insured by Federal Deposit Insurance
Corporation (FDIC) under the Savings Association Insurance Fund (SAIF). HFI has
been a member of the Federal Home Loan Bank System since 1941. HFI presently
operates 33 full service offices, an operations center and a business center and
serves depositors primarily in the five central Pennsylvania counties of
Dauphin, Cumberland, York, Lancaster, and Lebanon and in the northern Maryland
county of Washington. It serves small business borrowers in the same area.
Residential mortgages are written in Pennsylvania plus four other states through
the mortgage banking subsidiary in Blue Bell, Pennsylvania. Mobile home loans
are originated throughout most of the eastern United States.
At December 31, 1997, HFI had total assets of $2.2 billion with deposits of
$1.1 billion and stockholders' equity of $179 million.
HFI's primary lending activities continue to be the origination of loans
secured by first mortgages on owner-occupied one-to-four family residences. At
December 31, 1997, such loans totaled $539.2 million or 60.4% of total loans.
HFI began originating commercial loans in 1996 and its portfolio totaled $81.3
million at December 31, 1997.
The net income of HFI is dependent to a substantial extent on net interest
income, which represents the difference between interest income earned on loans
and investments and interest expense incurred on deposit accounts and
borrowings. Interest income is derived from the average interest yield earned on
average interest earning assets, while interest expense represents the average
interest cost incurred on average interest-bearing liabilities. Because of this
reliance on net interest income, Harris Financial, Inc. is affected by changes
in the overall level of interest rates and prevailing economic conditions.
Generally, as interest rates rise, the percentage of net interest income of HFI
will tend to fall and conversely, when interest rates fall, the percentage of
net interest income will tend to rise. This condition is often referred to as
"interest rate risk". Financial institutions which accept and manage substantial
degrees of interest rate risk are generally susceptible to larger net interest
income fluctuations when compared to peer institutions which accept less
interest rate risk. Accordingly, successful management of interest rate risk is
a primary determinant of HFI's return on equity.
During most of 1997, interest rates remained relatively stable with swings in
interest rates moving within a narrow range, primarily due to low inflation and
a relatively stable economy. Therefore, there was not a lot of fluctuation in
the net interest margin percentages. HFI aggressively leveraged the balance
sheet in order to utilize its excess capital in 1997. The leveraging exercise
added absolute dollars to net income but at reduced margins. This had the effect
of reducing the overall net interest margin percentage. Many of the investments
were tax reduced or tax free investments, actually contributing to the overall
net interest margin percentage on a tax-equivalent basis. However, the net
interest margin percentage decreased in total to 2.66% for the year ended
December 31, 1997 compared to 2.87% for the year ended December 31, 1996.
Another major risk normally undertaken by financial institutions is "credit
risk". This is the risk that a borrower will not repay a loan and that the
underlying collateral will be insufficient to prevent a significant loss. Credit
losses in 1997, 1996, and 1995 were considered to be immaterial and consistent
with HFI's long history of being among the top performers in the industry in
asset quality. In 1996, HFI began to underwrite commercial loans on businesses
and as such, it began to take on more credit risk and become more like a full
service community bank. This is part of a planned restructuring to place less
reliance on interest rate risk and to diversify the assets of HFI.
HFI has historically practiced expense control. As it continued the
transition to a community bank, additional expenditures, both of a capital and
periodic expense nature, were incurred during the year ended December 31, 1997
compared to the year ended December 31, 1996. Increased expenditures were
primarily due to $5.0 million for the upgrade of the information systems
infrastructure to accommodate the overall transition to a community savings
bank.
The pages that follow present detailed discussion and analysis of the
matters discussed in the summary as well as other significant components of
HFI's financial condition and results of operations.
Harris Financial, Inc. 1997 Annual Report 9
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
- - ---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Results of Operations
Net Interest Income During 1997, 1996, and 1995, Harris Financial, Inc. ("HFI"
or "the Corporation") derived most of its earnings from net interest income.
Virtually all of this net interest income was earned by HFI's subsidiary Harris
Savings Bank ("the Bank"). Net interest income is the excess of interest income
earned on average interest-earning assets above interest expense incurred on
average interest-bearing liabilities. Net interest income, before provision for
loan losses, on a taxable equivalent basis, was $51.1 million in 1997, an
increase of $9.0 million, or 21.4% from $42.1 million in 1996. Net interest
income in 1996 increased $9.2 million, or 28.0%, from $32.9 million in 1995.
Table 1 presents the average asset and liability balances, interest rates,
interest income and interest expense for each of the years in the three year
period ended December 31, 1997.
Table 1 Average Balance Sheets, Rates and Interest Income and Expense Summary
<TABLE>
<CAPTION>
For the Years Ended December 31,
----------------------------------------------------------------------------------------------------
1997(6) 1996(6) 1995
----------------------------------------------------------------------------------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest(7) Cost Balance Interest(7) Cost Balance Interest(7) Cost
----------------------------------------------------------------------------------------------------
Assets:
Interest Earning Assets:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage Loans, net (1)(8). $ 556,995 $ 45,808 8.22% $ 601,299 $ 48,453 8.06% $ 454,057 $ 36,577 8.06%
Commercial Loans .......... 78,567 6,767 8.61% 68,262 5,413 7.93% 49,256 4,276 8.68%
Other loans, net (8) ...... 243,975 19,442 7.97% 188,409 15,759 8.36% 103,671 8,857 8.54%
Marketable securities --
taxable, net (2) ......... 916,265 61,561 6.72% 530,557 33,983 6.41% 458,804 28,711 6.26%
Marketable securities--
tax free, net (2) ........ 103,708 8,839 8.52% 46,055 4,005 8.70% 0 0 0.00%
Other interest-earning
assets (3) ............... 20,524 1,744 8.49% 28,567 1,777 6.22% 33,587 2,204 6.56%
----------------------------------------------------------------------------------------------------
Total interest-earning assets 1,920,034 144,161 7.51% 1,463,149 109,390 7.48% 1,099,375 80,625 7.33%
----------------------------------------------------------------------------------------------------
Non-interest earning assets 75,123 64,318 34,095
----------------------------------------------------------------------------------------------------
Total Assets $1,995,157 $1,527,467 $1,133,470
====================================================================================================
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Savings Deposits ......... $ 147,738 $4,072 2.76% $146,929 $4,171 2.84% $ 151,085 $ 4,679 3.10%
Time Deposits ............ 782,578 43,760 5.59% 814,658 45,668 5.61% 677,211 37,928 5.60%
NOW and money
market accounts ......... 220,557 6,551 2.97% 171,004 5,965 3.49% 118,275 4,098 3.46%
Escrow/stock subscriptions 7,444 116 1.55% 8,182 130 1.59% 5,435 128 2.36%
Borrowed Funds ........... 654,447 38,586 5.90% 196,672 11,392 5.79% 14,458 863 5.97%
----------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities .............. 1,812,764 93,085 5.13% 1,337,445 67,326 5.03% 966,464 47,696 4.94%
----------------------------------------------------------------------------------------------------
Non-interest bearing
liabilities .............. 17,853 39,039 21,592
----------------------------------------------------------------------------------------------------
Total liabilities .......... 1,830,617 1,376,484 988,056
----------------------------------------------------------------------------------------------------
Stockholders' Equity ....... 164,540 150,983 145,414
----------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $1,995,157 $1,527,467 $1,133,470
====================================================================================================
Net Interest Income $ 51,076 $ 42,064 $32,929
====================================================================================================
Interest rate spread (4) 2.38% 2.45% 2.39%
====================================================================================================
Net interest-earning assets $ 107,270 $ 125,704 $ 132,911
====================================================================================================
Net interest margin (5) 2.66% 2.87% 3.00%
====================================================================================================
Ratio of Interest-earning assets
to interest-bearing liabilities 1.06 1.09 1.14
====================================================================================================
</TABLE>
(1) Includes mortgage loans held-for-sale.
(2) Includes available for sale.
(3) Includes interest-earning deposits in the FHLB-Pittsburgh, federal funds
sold and FHLB-Pittsburgh stock.
(4) Interest rate spread represents the difference between the average rate on
interest-earning assets and the average cost of interest-bearing
liabilities.
(5) Net interest margin represents net interest income before provision for
loan loss divided by average interest-earning assets.
(6) Amounts presented on a tax-equivalent basis using an effective tax rate of
35%.
(7) Includes income recognized on deferred loan fees of $1,283,000, $1,423,000,
$1,199,000 in 1997, 1996 and 1995, respectively.
(8) Includes non-accrual loans.
10 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Results of Operations (continued)
Net Interest Income (continued) In addition to absolute levels of net interest
income, the volatility of net interest income, or its sensitivity to key
variables, is of significant interest to financial institution constituents. The
key variables that determine the volatility of net interest income are changes
in average account balances (volume), changes in interest rates, and the mix of
interest-earning assets and interest-bearing liabilities. A lag exists between
the time changes occur in market interest rates and when such changes are
reflected in the performance of the Corporation's interest-earning asset and
interest-bearing liability portfolios. The average yield on average
interest-earning assets is influenced by the rate of repayments and prepayments,
purchases and sales, and the mix of asset maturities as well as current market
rates. Similarly, the average cost of average interest-bearing liabilities is
influenced by redemptions, early withdrawals, deposit purchases, deposit raising
activities, borrowed funds activity and the mix of liability maturities as well
as current market rates.
Table 2 presents an analysis of the changes in tax equivalent net interest
income attributable to changes in the volume and rate components of net interest
income. During 1997, there was an increase in net interest income of $5.1
million due to changes in volume and an increase of $3.9 million due to changes
in rates. During 1996, there was an increase in net interest income of $8.8
million due to changes in volume and an increase of $.4 million due to changes
in rates. Table 1 indicates that the average balance of total earning assets in
1997 increased $456.9 million from 1996 and the average balance of total
interest bearing liabilities increased $475.3 million from 1996. Also, the
average balance of total earning assets in 1996 increased $363.8 million from
1995 and the average balance of total interest bearing liabilities increased
$371.0 million from 1995.
Table 2 Rate/Volume Analysis of Changes in Net Interest Income
<TABLE>
<CAPTION>
Year Ended December 31, 1997 Year Ended December 31, 1996
Compared to Compared to
Year Ended December 31, 1996 Year Ended December 31, 1995
Increase (Decrease) Increase (Decrease)
-------------------------------------------------------------------------
Volume Rate Net Volume Rate Net
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Mortgage loans, net ................. $(3,619) $ 974 $(2,645) $11,885 $ (9) $11,876
Commercial loans .................... 862 492 1,354 1,533 (396) 1,137
Other loans, net .................... 4,451 (768) 3,683 7,088 (186) 6,902
Marketable securities - Taxable ..... 25,865 1,713 27,578 4,591 681 5,272
Marketable securities - Tax-free .... 4,917 (83) 4,834 4,005 0 4,005
Other interest-earning assets ....... (579) 546 (33) (317) (110) (427)
-------------------------------------------------------------------------
Total interest-earning assets .... 31,897 2,874 34,771 28,785 (20) 28,765
-------------------------------------------------------------------------
Interest-bearing liabilities:
Savings deposits .................... 23 (122) (99) (125) (383) (508)
Time deposits ....................... (1,763) (145) (1,908) 7,701 39 7,740
NOW and money market deposits ....... 1,561 (975) 586 1,833 34 1,867
Escrow and stock subscriptions ...... (11) (3) (14) 52 (50) 2
Borrowed funds ...................... 26,980 214 27,194 10,555 (26) 10,529
-------------------------------------------------------------------------
Total interest-bearing liabilities 26,790 (1,031) 25,759 20,016 (386) 19,630
-------------------------------------------------------------------------
Net change in interest income ....... $ 5,107 $ 3,905 $ 9,012 $ 8,769 $ 366 $ 9,135
=========================================================================
</TABLE>
Note: Changes in interest income and interest expense arising from the
combination of rate and volume variances are prorated across rate and volume
variances.
Net interest income increased substantially in 1997 from increased volume
in the marketable securities portfolio, resulting from HFI's continued reliance
upon a wholesale leverage strategy to deploy surplus capital to generate
significant additional earnings. This leverage strategy refers to HFI's ongoing
use of wholesale borrowings to fund the acquisition of investment-grade
marketable securities to generate additional return on equity. Surplus capital
available for financing the Corporation's wholesale leveraging operations refers
to leverage capital in excess of 6.75% at the Corporation level and in excess of
6.5% at the Bank level. Average other loans increased in 1997 primarily due to
the effect of having First Harrisburg Bancor consolidated into the Bank for a
full year. Although not apparent in Table 2, the commercial loan mix changed in
1997 to include a larger composition of non-real estate loans. Management
attributes the increased volume in non-real estate commercial loan balances to
the continuing success achieved by the Corporation's Business Banking Group,
which began operations early in 1996. The primary sources of the increases in
assets in 1996 were the acquisition of First Harrisburg Bancor and reliance on
the wholesale leverage strategy described above.
Virtually all of the increase of $475.3 million in average interest-bearing
liabilities in 1997 was due to increases in borrowed funds to support the Bank's
leveraged investment strategy. This same source of funding also contributed
$182.2 million of the $371.0 million increase in average interest-bearing
liabilities in 1996, with the remaining increase resulting primarily from the
acquisition of First Harrisburg Bancor. Average deposit balances were
essentially stable in 1997 and 1996.
Harris Financial, Inc. 1997 Annual Report 11
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
- - ---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Results of Operations (continued)
Net Interest Income (continued) In recognition of the margin compression
experienced by the Bank and the thrift industry during the last few years,
management has implemented a number of initiatives to accelerate the Bank's
operational conversion to a full-service financial institution. An area of
primary importance in this strategy is the Bank's Business Banking Group, a
function management expects to significantly expand in 1998 to provide high-
quality commercial financial products and services to a profitable niche of
small business customers. Beginning in 1998, management also expects to alter
its marketing and retailing strategies to leverage the Bank's extensive branch
presence and its recent major technology investments to deliver high-quality,
high-margin products to its retail markets. Management believes this change in
its strategic focus is essential to improving HFI's long-term return to its
shareholders and it is committed to success in this endeavor. During 1998,
management will also accelerate the shift in the Bank's competitive focus away
from "thrift-style", or low-margin, pricing and toward the marketing and
delivery of value-added products and services to more profitable customer
segments. Management does not underestimate the magnitude of this task; however,
the continued rapid consolidation of the financial services industry has
profoundly affected, and will continue to affect, many competitors of HFI in a
manner that presents vast opportunities for aggressive community financial
institutions. In 1998 and beyond, HFI will be focused upon exploiting the most
profitable market niches created within the rapidly-shifting financial services
landscape. Management cannot reasonably estimate the effect on earnings in 1998
or future years from these endeavors.
Provision for Loan Losses HFI maintains an allowance for loan losses to provide
for possible future losses in its loan portfolio. During 1997, HFI recorded
provisions for loan losses of $.6 million, versus $2.0 million in 1996 and none
in 1995. Management provisioned heavily in 1996 because of actual loan growth in
the commercial loan portfolio. Management provisioned for loan losses at a
reduced level in 1997 to match actual growth trends achieved in HFI's commercial
and other loan portfolios.
Management reviews loan delinquencies continuously and performs an analysis
of loan quality quarterly, classifying assets to determine the adequacy of its
allowance for loan losses. The Bank will continue to provide for possible loan
losses when deemed appropriate. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Bank's
allowance for loan losses and valuation of foreclosed real estate. Such agencies
may require the Bank to recognize additional provision for loan losses based on
their judgment about information available to them at the time of their
examination. A detailed discussion of the Allowance for Loan Losses is presented
in the "Asset Quality" section which appears later in this report.
During 1998, management expects to provision at a more accelerated rate than
was experienced in 1997 in anticipation of significant volume increases in the
commercial and consumer loan portfolios. This increased provisioning is intended
to build strong loan loss reserves at the Bank and it is not a reflection of any
deterioration in actual credit quality or loosening of credit underwriting
standards. The Bank continues to experience exceptional loan quality and low
delinquency levels relative to its financial institution peers. Management
believes that the long-term financial strength and profitability of the Bank is
greatly dependent upon its ability to continue differentiating itself from its
peers in this manner.
Non-Interest Income Table 3 presents a summary of the changes in non-interest
income for the two-year period ended December 31, 1997.
Table 3 Non-Interest Income
<TABLE>
<CAPTION>
1997/1996 1996/1995
-------------------------------------------------------------------------------
Increase (Decrease) Increase (Decrease)
-------------------------------------------------------------------------------
1997 Amount % 1996 Amount % 1995
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Service charges on deposits .......... $ 2,156 $ 1,224 131.3 $ 932 $ 157 20.3 $ 775
Other service charges/commissions/fees 1,355 498 58.1 857 226 35.8 631
Net servicing income ................. 2,183 861 65.1 1,322 290 28.1 1,032
Gain (loss) on sale of
mortgage-backed securities, net ... 3,576 4,797 392.9 (1,221) (1,331) (1.210.0) 110
Gain on sale of other securities, net 481 444 1,200.0 37 37 N/A 0
Gain (loss) on sale of loans, net .... 2,472 609 32.7 1,863 1,931 2,839.7 (68)
Other ................................ 2,336 2,130 1,034.0 206 122 145.2 84
-------------------------------------------------------------------------------
Total ............................. $14,559 $10,563 264.3 $ 3,996 $1,432 55.9 $ 2,564
===============================================================================
</TABLE>
Non-interest income totaled $14.6 million in 1997, which represents an
increase of $10.6 million, or 264.3%, from the $4.0 million recorded in 1996.
Gains on sales of marketable securities and loans accounted for $5.9 million of
the increase, with total net gains of $4.1 million resulting from asset
portfolio management, including sales as market opportunities warranted. An
additional $1.6 million of the increase in non-interest income in 1997 resulted
from a one-time partial recovery of fraud losses recorded in 1996 in association
with the Bank's 1996 acquisition of First Harrisburg Bancor. The Bank also
recorded an increase of $1.7 million in its combined service charges and fee
income during 1997. This increase in service charge and fee income resulted
primarily from the expansion of the Bank's Automated Teller Machine (ATM)
network and from growth associated with the Bank's "High Performance Checking"
program. The major thrust of this checking program is delivering a high-quality,
profitable line of checking deposit products to a much larger share of the
Bank's market than had been achieved before 1996. Net loan servicing income also
increased substantially, contributing $.9 million to the total increase in
non-interest income in 1997.
Non-interest income totaled $4.0 million in 1996, which represents an
increase of $1.4 million, or 55.9%, from the $2.6 million of total non-interest
income recorded in 1995. The 1996 increase can be attributed primarily to the
acquisition of First Harrisburg Bancor including its subsidiary Avstar Mortgage
Corporation and an increase in net revenue from purchased loan servicing. The
increase in the loss on sale of mortgage-backed securities of $1.3 million was
due to the restructuring of the securities portfolio in 1996. All other
non-interest income flows were considered stable during 1996 as compared to
1995.
12 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
- - ---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Results of Operations (continued)
None-Interest Income (continued) HFI's strategic initiatives include continued
focus on growing non-interest revenue streams and the relative contribution of
non-interest income to HFI's earnings. Management cautions the reader that
capital market opportunities such as those experienced in 1997 may not
materialize in 1998 and years beyond; however, HFI's future strategies will
include continued professional, but sound investment portfolio management.
Management does expect increasing contributions of non-interest income in 1998
from its ATM network, which is targeted to increase from 22 machines at present
to 33 machines in 1998, maturity of the existing network, and from increased
surcharging of non-Harris customers using Harris ATMs. In 1998, management also
expects continued significant growth in, and increasing service charge and
product cross-selling revenue from, its High Performance Checking program. In
addition, the Bank continues to grow its loan servicing portfolio and to gain
scale economies in its loan servicing operations, a result of which is
anticipated increased net loan servicing revenue in 1998. Finally, HFI will also
expand its offerings in 1998 to an under-served sector of the fiduciary services
market and, to a lesser extent in 1998, will expand its efforts in securities
and insurance product sales through various delivery channels. Management does
not anticipate a material contribution to earnings in 1998 from fiduciary
services, securities sales, or insurance sales.
Non-Interest Expense Table 4 presents a summary of the changes in non-interest
expense for the two year period ended December 31, 1997.
Table 4 Non-Interest Expense
<TABLE>
<CAPTION>
1997/1996 1996/1995
--------------------------------------------------------------------------
Increase (Decrease) Increase (Decrease)
--------------------------------------------------------------------------
1997 Amount % 1996 Amount % 1995
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Salaries and benefits (1) ...... $19,006 $4,296 29.2 $14,710 $3,323 29.2 $11,387
Equipment expense .............. 2,183 536 32.5 1,647 544 49.3 1,103
Occupancy expense .............. 2,886 419 17.0 2,467 646 35.5 1,821
Advertising and public relations 2,091 546 35.3 1,545 903 140.7 642
FDIC insurance ................. 751 (8,554) (91.9) 9,305 7,190 340.0 2,115
Trustee fees ................... 333 26 8.5 307 (4) (1.3) 311
(Income) loss from real estate
operations ................... (770) (415) 116.9 (355) 187 (34.5) (542)
Amortization and write-off of
intangibles .................. 2,393 286 13.6 2,107 1,733 463.4 374
Non-operational loss ........... 0 (4,305) N/A 4,305 4,305 0.0 0
Other .......................... 6,975 826 13.4 6,149 2,584 72.5 3,565
--------------------------------------------------------------------------
Total ....................... $35,848 $(6,339) (15.0) $42,187 $21,411 103.1 $20,776
==========================================================================
</TABLE>
(1) Full-time equivalent employees totaled 532, 481, and 362 at December 31,
1997, 1996, and 1995, respectively. The actual number of employees,
including part-time employees, totaled 550, 543, and 403 at December 31,
1997, 1996, and 1995, respectively.
During 1997, HFI recorded non-interest expense of $35.8 million. This
represents a decrease of $6.3 million, or 15.0%, from $42.2 million of
non-interest expense recorded in 1996. During 1996, two significant one-time
charges were recorded, including a $7.0 million expense for the Bank's portion
of the Savings Association Insurance Fund ("SAIF") recapitalization and a $4.3
million fraud loss in connection with the acquisition of First Harrisburg.
Offsetting the decrease in total non-interest expense in 1997 was an increase of
$4.3 million in salaries and benefits expense. This increase in salaries and
benefits expense was comprised of a $2.6 million increase in salaries and wages,
a $1.1 million increase in stock compensation expense, and a $.6 million
increase in benefits expense. Within the salaries and wages category,
approximately $1.0 million reflected one-time compensation settlements effected
with the change in the Chief Executive Officer position in the fourth quarter of
1997. Also, the $1.1 million increase in stock compensation expense was due to
the increase in market value of HFI's common stock during 1997. HFI also
recorded an additional $1.0 million in equipment expense and other costs
associated with its major 1997 investments in information technology.
During 1996, HFI recorded total non-interest expense of $42.2 million. This
represented an increase of $21.4 million, or 103.1%, from $20.8 million in 1995.
This increase was primarily due to the one-time $7.0 million expense associated
with the SAIF recapitalization. In addition, the Bank incurred a $4.3 million
fraud loss in connection with the acquisition of First Harrisburg. Intangible
asset amortization also increased by $1.7 million due to $.6 million of goodwill
amortization from the First Harrisburg acquisition and a $1.1 million increase
in deposit premium expense from the 1995 acquisition of two branches in
Hagerstown, Maryland. The remainder of the increase in non-interest expense was
primarily due to the ongoing expenses associated with the acquisition of First
Harrisburg in 1996.
Management expects HFI to begin experiencing efficiency and productivity
increases in 1998 as Harris employees exploit the Corporation's new information
systems. During the fourth quarter of 1997, substantially all of the
Corporation's core information systems were replaced with new leading edge
information systems whose capabilities are much more aligned with HFI's
strategic objectives. Management is confident that the Harris workforce, now
equipped with and trained upon these information systems, will be able to
compete with the most innovative and sophisticated financial service competitors
in the Corporation's markets.
Provision for Income Taxes Income tax provisions totaled $8.3 million in
1997, which represents an increase of $8.8 million from the $.5 million of
income tax benefit recorded in 1996. Income tax provisions for 1997 resulted in
an effective tax rate of 31.8% on income before taxes of $26.1 million. HFI's
1997 effective tax rate was lower than the statutory rate, primarily due to
HFI's significant investment in tax-advantaged marketable securities including
municipal bonds and certain preferred equities. Management expects to continue
the aggressive use of tax-advantaged investments and other tax saving strategies
in 1998 to protect earnings.
Harris Financial, Inc. 1997 Annual Report 13
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
- - ---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Results of Operations (continued)
Provision for Income Taxes (continued) Income tax provisions totaled $(.5)
million in 1996, which represents a decrease of $6.0 million, or 109.4%, from
the $5.5 million of income tax expense recorded in 1995. Income tax provisions
for 1996 resulted in an effective tax rate of (100.0)% on income before taxes of
$.5 million. Income tax provisions for 1995 resulted in an effective tax rate of
37.4% on income before taxes of $14.8 million. The reduction of 137.4% in the
Bank's effective tax rate in 1996 as compared to 1995 can be attributed
primarily to a one time SAIF assessment and fraud loss discussed in the previous
section of this report.
Discussion of Market Risk The financial condition and results of operation of
HFI are subject to three primary market risk factors: interest rate risk, credit
risk, and concentration risk. These risk factors are discussed below in order of
potential impact to the Bank's earnings and capital, from most critical to least
critical.
Interest Rate Risk HFI's primary component of market risk currently is
interest rate volatility. Virtually all of HFI's interest rate risk exposure
lies with the Bank because all of HFI's interest-bearing liabilities and
virtually all of its interest-earning assets currently are located at the Bank
level. Fluctuations in market interest rates will impact both the level of net
interest income recorded on a large portion of HFI's assets and liabilities and
the market value of virtually all of HFI's assets and liabilities. In addition
to interest rate risk associated with loans and deposits, HFI manages interest
rate risk associated with the Bank's significant leverage portfolios. The Bank's
leverage portfolios include large investments in marketable securities, which
are funded through wholesale borrowings and are almost all matched funded.
Management employs an Asset/Liability Committee (ALCO), which meets at
least once each month, to manage its interest rate risk exposure. HFI primarily
employs dynamic GAP analysis and Net Interest Income Volatility analysis to
assist in the management of interest rate risk. In the context of this
discussion, dynamic GAP refers to the Bank's refinement of standard repricing
analysis procedures to include anticipated prepayments, option calls, and other
factors not normally employed in static GAP analysis. HFI's standard ALCO
procedures include a review of monthly GAP results. Table 6 of the later section
titled "Financial Condition" presents the Bank's GAP position at December 31,
1997. As of this date, the Bank's cumulative one-year GAP and three-year GAP
ratios were modestly asset-sensitive at 4.94% and 8.24%, respectively.
Management attributes this modest asset-sensitivity primarily to the effect of
assumed option calls on certain marketable securities and assumed accelerated
prepayments on mortgage loans and mortgage-backed securities. These assumptions
reflect the historically low long-term interest rates existing in the market at
December 31, 1997.
Net Interest Income (NII) volatility analysis is employed to measure the
probable effect of significant changes in market interest rates upon HFI's
projected Net Interest Income. Management considers one- and two-year
projections for NII volatility to be the most relevant for managing HFI's
interest rate risk exposure. HFI's standard ALCO procedures include a review of
monthly analysis results for NII volatility. Using HFI's asset and liability
portfolios as of December 31, 1997, management projects Net Interest Income
during 1998 to fluctuate $.1 million, or .13%, if market rates decrease 200
basis points over the next twelve months and to fluctuate $(1.3) million, or
(2.18%), if market rates increase 200 basis points over the next twelve months.
These NII volatility values are well within thresholds established by the Board
of Directors for market rate shocks required by the Bank's regulators.
<TABLE>
<CAPTION>
Rate Scenarios -200 bp -100 bp 0 bp +100 bp +200 bp
<S> <C> <C> <C> <C> <C>
Absolute Change in NII 77 (540) 0 240 (1,284)
Relative Change in NII .13 % (.92)% 0 .41 % ( 2.18)%
Board of Directors Limit (%) (20)% ( 10)% 0 (10)% ( 20)%
</TABLE>
Credit Risk Virtually all of HFI's credit risk lies with the Bank, which
holds all of HFI's loan assets and virtually all of its marketable securities.
Due to prudent underwriting activities and strong credit and collections
management, the Bank's experience in credit losses continues to rank among the
best in the financial services industry. As part of its conversion from a
savings institution, the Bank created a Business Banking Group to offer
commercial financial products and services to small businesses in the Bank's
primary market area. This expansion beyond traditional thrift lending such as
residential mortgage lending and real estate secured consumer lending has the
effect of increasing the Bank's credit risk exposure. To accommodate this credit
risk exposure, management has hired skilled and experienced commercial lending
professionals to manage its Business Banking Group. In addition, the Bank has
adopted commercial bank underwriting, credit management, and loan loss
provisioning techniques. With regard to its marketable securities portfolio, at
December 31, 1997 and 1996, over 95% of the marketable securities in HFI's
portfolio were rated "AAA", with the remainder rated "AA" or "A". Management is
confident in the Bank's abilities to manage its ongoing credit risk exposure.
14 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Results of Operations (continued)
Discussion of Market Risk (continued)
Concentration Risk -- Geographic HFI's primary market area includes the five
central Pennsylvania counties of Dauphin, Cumberland, York, Lancaster, and
Lebanon and the northern Maryland county of Washington. With the exception of
the Bank's manufactured home loan portfolio and a small investment in loans by
its subsidiary Avstar Mortgage Corporation, virtually all of the Bank's loans
and deposits are dependent on this primary market area. The southcentral
Pennsylvania and northern Maryland area has enjoyed a strong, well-diversified,
and stable economy for many years relative to the general economic conditions
experienced in the northeastern United States and the nation as a whole.
Currently, the Bank's primary market area does not appear to be exhibiting signs
of economic deterioration. Should such economic stress become evident, however,
the Bank's loan and deposit portfolios and operations could be adversely
impacted. Management believes its strong product diversity adequately mitigates
its geographic concentration risk.
Concentration Risk -- Major Creditor The Bank relies heavily on wholesale
borrowings to support its leveraged investment strategies. As discussed in
previous sections of this report, these strategies have significantly enhanced
the Corporation's return to our shareholders. As presented in detail in the
"Borrowings" section of this report, a significant portion of the Bank's
wholesale borrowings are placed with the Federal Home Loan Bank of Pittsburgh
(the "FHLB"). If the Bank's maximum borrowing capacity with the FHLB were to be
encumbered in the future, through statutory restrictions that do not exist at
this time or through other means, the Bank's leveraged investment strategies
would be impacted to some degree. However, given the quality of the Bank's
assets pledged as collateral to support wholesale borrowings, management
believes the Bank would be able to expand its placement of borrowings with other
primary borrowing sources. Management anticipates that such a shift in borrowing
sources would result in, at worst, only modest potential decreases in net
interest income from wholesale leveraging activities. Management is not aware of
any contemplated regulatory actions that indicate the Bank's borrowing capacity
at the FHLB might become restricted to less than the maximum capacity disclosed
in the section titled "Borrowings" which appears later in this report.
Year 2000 -- The efficient and reliable operation of the Corporation's
business is significantly dependent upon its computer hardware, software
programs, and operating systems (collectively "computer systems"). As a
financial services company, HFI 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 Plan to successfully
address all related risks.
The Corporation is currently evaluating all of HFI's computer systems for
Year 2000 readiness, including its systems that do not involve business
information processing. In addition, management is communicating with vendors,
business partners, commercial banking customers, and others to coordinate full
Year 2000 conversion. Management expects all business-critical systems to be
Year 2000 compliant by December 31, 1998 to allow a full year for adequate
integrated testing and completion of any remaining corrective action. HFI
anticipates that all of its computer systems will be completely tested and made
fully Year 2000 compliant during 1999.
During 1997, HFI made substantial progress toward Year 2000 compliance by
replacing its core banking hardware and software systems. HFI manages its
information systems internally, using computer systems acquired from
nationally-recognized vendors. HFI does not operate any legacy, or
internally-developed, computer systems. The Corporation's core banking hardware
consists of a mainframe system, a number of stand-alone and network servers, and
certain microcomputers. As of this time, virtually all of the Corporation's core
banking hardware and operating systems are Year 2000 compliant. The
Corporation's core banking software is not fully Year 2000 compliant at this
time; however, a substantial portion of the business-critical programs are Year
2000 ready. Because HFI has already replaced its core banking computer systems
with Year 2000 compliant systems, management expects ongoing remaining expenses
for Year 2000 preparation to be immaterial to HFI's earnings in 1998 and beyond.
Harris Financial, Inc. 1997 Annual Report 15
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
- - ---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Financial Condition
Sources and Uses of Funds HFI's operating activities generated cash totaling
$16.6 million in 1997. In addition to cash flows from operations, HFI generates
and uses cash in its investing and financing activities. During 1997, HFI's cash
flows from investing activities resulted in a net use of cash of $427.3 million,
which included a net use of cash in securities transactions totaling $355.0
million and a net use of cash from loan transactions totaling $67.8 million.
During 1997, HFI's financing activities provided net cash of $405.5 million,
including a net decrease in deposits totaling $27.2 million and an increase from
borrowing activities totaling $433.3 million.
HFI's operating activities generated cash totaling $14.9 million in 1996.
In addition to cash flows from operations, HFI generates and uses cash in its
investing and financing activities. During 1996, HFI's cash flows from investing
activities resulted in a net use of cash of $276.0 million, which included a net
use of cash in securities transactions totaling $67.0 million and a net use of
cash from loan transactions totaling $177.2 million. During 1996, the HFI's
financing activities provided net cash of $255.3 million, including a net
decrease in deposits totaling $71.2 million and an increase from borrowing
activities totaling $329.5 million.
Capital Resources HFI is subject to minimum capital standards at both the
Corporation level and at the Bank level. Table 5 presents the regulatory capital
positions and ratios for HFI and the Bank as of December 31, 1997 and 1996. At
December 31, 1997 and 1996, HFI and the Bank exceeded all regulatory minimum
capital requirements for well-capitalized institutions. Also, during 1997 and
1996, the excess capital positions of HFI and the Bank were maintained within
parameters established by HFI's Board of Directors.
Table 5 Capital Analysis
<TABLE>
<CAPTION>
Harris Financial, Inc. (HFI)
At December 31,
------------------------
1997 1996
------------------------
<S> <C> <C>
Capital:
Tier 1 capital ....................... $148,906 $126,217
Tier 2 capital ....................... 8,614 8,322
------------------------
Total capital ........................ $157,520 $134,539
========================
Total risk-weighted assets ........... $1,149,733 $914,383
========================
Ratios:
Tier 1 capital to risk-weighted assets 13.0% 13.8%
Tier 2 capital to risk-weighted assets 0.7% 0.9%
------------------------
Total capital to risk-weighted assets 13.7% 14.7%
========================
Leverage ratio ....................... 6.8% 7.3%
========================
</TABLE>
Harris Savings Bank (HSB)
<TABLE>
<CAPTION>
At December 31,
------------------------
1997 1996
------------------------
Capital:
<S> <C> <C>
Tier 1 capital ....................... $138,919 $126,217
Tier 2 capital ....................... 8,614 8,322
------------------------
Total capital ........................ $147,533 $134,539
========================
Total risk-weighted assets ........... $1,143,429 $914,383
========================
Ratios:
Tier 1 capital to risk-weighted assets 12.1% 13.8%
Tier 2 capital to risk-weighted assets 0.8% 0.9%
------------------------
Total capital to risk-weighted assets 12.9% 14.7%
========================
Leverage ratio ....................... 6.4% 7.3%
========================
</TABLE>
Under FDIC capital definitions, leverage capital is composed of equity
capital reduced by goodwill and other intangible assets. The leverage ratio
equals leverage capital divided by total assets. Under FDIC capital definitions,
risk-based capital is composed of Tier 1 and Tier 2 capital. Tier 1 capital
equates to leverage capital and Tier 2 capital includes the allowance for loan
losses and qualifying debt obligations. The risk-based capital ratio equals the
total of Tier 1 and Tier 2 capital divided by total risk-weighted assets. HFI
and the Bank, as FDIC-insured institutions and HSB (a state chartered savings
bank) must maintain minimum levels of capital under regulations of the FDIC and
the Pennsylvania Department of Banking ("the Department").
Shareholders' equity increased $26.3 million, or 17.2%, in 1997. This
increase included capital additions of $17.8 million from net income,
$7.1 million from a net increase in the market value, net of tax effect, of the
available-for-sale securities portfolio, $.5 million from the exercise of stock
options and $2.4 million from earned ESOP and RRP shares. Offsetting these
capital additions in 1997 were $1.5 million of dividends declared to
stockholders. For the year 1997, the ratio of average equity to average assets
was 8.2%.
Shareholders equity increased $1.3 million, or .86%, in 1996. This increase
included capital additions of $1.0 million from net income, $.5 million from a
net increase in the market value, net of tax effect, of the available-for-sale
securities portfolio, $1.2 million from earned ESOP and RRP shares. Offsetting
these capital additions in 1996 were $1.5 million of dividends declared to
stockholders. For the year 1996, the ratio of average equity to average assets
was 9.9%.
Interest Rate Sensitivity The largest component of HFI's net income is net
interest income, which HFI attempts to maximize by properly managing a variety
of risks, including interest rate risk, credit risk, liquidity risk, and various
other market risks. HFI's market risk exposure was discussed in summary fashion
in a previous section of this report titled "Discussion of Market Risks".
This section discusses in detail HFI's exposure to, and management of, its
interest rate risk. As mentioned previously, virtually all of HFI's interest
rate risk exposure lies at the Bank level and the Bank manages this exposure
primarily through its Asset/Liability Management Committee ("ALCO"). ALCO
generally meets monthly to review the Bank's current and projected interest rate
risk position; monitor current asset and liability products, risks and rates;
and communicate to the Bank's Board of Directors concerning the Bank's interest
rate risk exposure. ALCO primarily uses three tools to measure the Bank's
interest rate risk exposure including a modified form of standard repricing
analysis ("GAP"), net interest income analysis ("NII") and to a lesser extent
market value of portfolio equity analysis ("MVPE"). Of the three measures, the
Bank places the greatest emphasis on NII volatility simulation. The Bank
maintains an interest rate risk policy, which establishes acceptable limits and
ranges for the GAP, NII and MVPE positions. ALCO monitors the Bank's various
interest rate risk measures in light of current and expected market conditions
and approves desired asset and liability transactions and offerings accordingly.
The Bank also sells a significant portion of its conforming mortgage loan
originations to mitigate its interest rate risk exposure. In addition, the
Bank's investment and borrowing activities are managed to mitigate the Bank's
overall interest rate risk profile.
16 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Financial Condition (continued)
Interest Rate Sensitivity (continued) Table 6 sets forth in detail the amounts
of the Bank's interest-earning assets and interest-bearing liabilities at
December 31, 1997, which are anticipated by the Bank to reprice or mature in
each of the future time periods shown.
Table 6 GAP Analysis
<TABLE>
<CAPTION>
At December 31, 1997
------------------------------------------------------------------------------
More Than More Than
One Year One Year to Three Years to More Than
or Less Three Years Five Years Five Years
------------------------------------------------------------------------------
Balance Rate Balance Rate Balance Rate Balance Rate
------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Real Estate, Commercial & Consumer Loans:
Fixed (2) .................................... $136,791 8.31% $193,939 8.29% $132,862 8.27% $223,768 8.44%
Variable (2) ................................. 152,521 8.33 48,364 8.26 5,810 8.60 14,506 8.60
Marketable Securities
and Overnight Investments:
Fixed ........................................ 301,935 7.34 143,611 7.18 165,366 8.17 126,142 7.40
Variable ..................................... 457,925 6.66 0 0.00 0 0.00 0 0.00
------------------------------------------------------------------------------
Total interest-earning assets ............... $1,049,172 7.31% $385,914 7.87% $304,038 8.22% $364,416 8.09%
------------------------------------------------------------------------------
Interest-bearing liabilities
Savings Accounts ............................... $1,263 2.25% $0 0.00% $0 0.00% $147,455 2.77%
NOW Accounts (1) ............................... 0 0.00 0 0.00 0 0.00 53,963 2.00
Money Market Accounts (Variable) ............... 128,165 4.27 0 0.00 0 0.00 0 0.00
Time Deposits:
Fixed ........................................ 418,637 5.16 262,232 5.97 39,797 6.05 7,907 3.18
Variable ..................................... 40,165 5.38 0 0.00 0 0.00 0 0.00
Escrow ......................................... 0 0.00 0 0.00 0 0.00 8,552 1.75
Other Borrowings:
Fixed ........................................ 148,362 5.88 50,850 6.31 450,300 5.74 990 5.75
Variable ..................................... 203,476 5.50 0 0.00 0 0.00 0 0.00
------------------------------------------------------------------------------
Total interest-bearing Liabilities .......... $940,068 5.23% $313,082 6.03% $490,097 5.77% $218,867 2.57%
------------------------------------------------------------------------------
Interest sensitivity gap per period ............ $109,104 $72,832 $(186,059) $145,549
------------------------------------------------------------------------------
Cumulative interest sensitivity gap ............ $109,104 $181,936 $ (4,123) $141,426
------------------------------------------------------------------------------
Cumulative interest sensitivity gap
as a percentage of total assets 4.94% 8.24% (0.19)% 6.41%
------------------------------------------------------------------------------
Cumulative net interest-earning assets
as a percentage of net interest-bearing liabilities 111.61% 114.52% 99.76% 107.21%
------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
--------------------
Total
--------------------
Balance Rate
--------------------
Interest-earning assets:
Real Estate, Commercial & Consumer Loans:
<S> <C> <C>
Fixed (2) .................................... $687,360 8.34%
Variable (2) ................................. 221,201 8.34
Marketable Securities
and Overnight Investments:
Fixed ........................................ 737,054 7.51
Variable ..................................... 457,925 6.66
--------------------
Total interest-earning assets ............... $2,103,540 7.68%
--------------------
Interest-bearing liabilities
Savings Accounts ............................... $148,718 2.76%
NOW Accounts (1) ............................... 53,963 2.00
Money Market Accounts (Variable) ............... 128,165 4.27
Time Deposits:
Fixed ........................................ 728,573 5.48
Variable ..................................... 40,165 5.38
Escrow ......................................... 8,552 1.75
Other Borrowings:
Fixed ........................................ 650,502 5.82
Variable ..................................... 203,476 5.50
--------------------
Total interest-bearing Liabilities .......... $1,962,114 5.20%
--------------------
Interest sensitivity gap per period ............ $141,426
--------------------
Cumulative interest sensitivity gap ............
--------------------
Cumulative interest sensitivity gap
as a percentage of total assets................
--------------------
Cumulative net interest-earning assets
as a percentage of net interest-bearing
liabilities....................................
--------------------
</TABLE>
(1) Excludes non-interest bearing accounts
(2) Excludes deferred loan costs and fees
Generally, the amount of assets and liabilities shown in Table 6 were
determined in accordance with the contractual terms of the underlying financial
instruments. However, certain instruments have been presented based on the
estimated effects of general repricing and prepayment assumptions. In the
current economic environment, refinancing activity is expected to be well above
historical norms; therefore, accelerated prepayment speeds have been assumed for
both mortgage loans and mortgage-backed securities. Also, marketable securities
exhibiting a high probability of being called prior to maturity have been
assumed to be called at the first call date. Also, certain preferred equities
and municipal bonds are assumed to reprice on their first call date. Consumer
loans are also assumed to prepay at above-average speeds. Time deposits, money
market accounts, and escrow accounts reflect the contractual maturities of the
underlying deposits. Remaining transaction accounts, all checking accounts, and
most of the Bank's short-term savings accounts are considered not to be interest
rate sensitive, and are assumed to mature beyond five years.
Marketable Securities HFI maintains its marketable securities portfolio to
manage risks, leverage capital to provide additional earnings, invest excess
cash, and provide liquidity. Management considers the marketable securities
portfolio to be a critical tool for integrated risk management of the entire
Corporation. HFI's investment policy currently provides for held-to-maturity,
available-for-sale, and trading portfolios as defined by Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" (SFAS 115), however, the Bank currently does not engage in
trading portfolio activities and intends to discontinue the use of the
held-to-maturity portfolio during 1998. HFI recorded net unrealized after-tax
investment gains of $10.7 million and $3.6 million as of December 31, 1997 and
1996, respectively.
The fair market value of the investment portfolio was $1,212.2 million at
December 31, 1997, up $377.5 million, or 45.2 %, from $834.7 million at December
31, 1996. This growth was accomplished primarily through the continuation of
HFI's aggressive "leverage" strategy as described in the "Results of Operations"
section of this report. Leveraged investments grew $474.5 million, or 225.8%, to
$684.6 million at December 31, 1997 from $210.1 million at December 31, 1996.
The fair market value of the investment portfolio was $834.7 million at
December 31, 1996, up $288.0 million, or 52.7%, from $546.7 million at December
31, 1995. This growth was primarily accomplished through the securitization and
sale of mortgage loans, the proceeds from which were reinvested in securities
more consistent with the goals of the portfolio. Adding to this growth was a
significant increase in leveraged investments. Leveraged investments grew $193.0
million to $210.2 million at December 31, 1996 from $17.2 million at
December 31, 1995.
Harris Financial, Inc. 1997 Annual Report 17
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
- - ---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Financial Condition (continued)
Marketable Securities (continued) During 1997 and 1996, HFI aggressively used
tax-advantaged investments to protect its earnings. The fair market value of
tax-advantaged investments was $114.0 million, or 9.5% of total investments at
December 31, 1997. At December 31, 1996, tax-advantaged investments totaled
$90.2 million, or 10.8% of total investments. On a nontaxable equivalent basis,
the weighted average yield on the portfolio was 6.59% at December 31, 1997
compared to 6.81% at December 31, 1996. Also, management continues to emphasize
flexibility and liquidity in its investment management as evidenced by the
expanded use of the available-for-sale portfolio. The available-for-sale
portfolio represented 92% of HFI's investment portfolio at December 31, 1997, up
from 87% at December 31, 1996. Additionally, management uses the Harris Delaware
Corp. and Harris Financial Inc. portfolios to facilitate the prudent management
of risks and after-tax returns.
Management believes HFI's marketable securities portfolios are properly
structured at December 31, 1997 to limit exposure to interest rate risk, credit
risk, and liquidity risk, while achieving an acceptable investment yield.
Relative to peer financial institution portfolios, HFI's investment portfolio is
well-diversified and includes only high-quality instruments. At December 31,
1997 and 1996, over 95% of the marketable securities in the HFI portfolio were
rated "AAA", with the remainder rated "AA" or "A". Also, fixed rate investments
comprised 64.6% and 60.3% of the total investment portfolio at December 31, 1997
and 1996, respectively. Table 7 presents the marketable securities portfolios
maturity stratification as of December 31, 1997. Following Table 7 is Table 8,
which presents a summary of HFI's marketable securities portfolios as of
December 31, 1997, 1996, and 1995.
Table 7 Analysis of Investments
The table below sets forth certain information regarding the carrying
value, weighted average yields and maturities of Harris Financial, Inc.'s
marketable securities, including available-for-sale, at December 31, 1997. The
stratification of balances is based on expected maturities which may differ from
contractual maturities.
<TABLE>
<CAPTION>
At December 31, 1997
--------------------------------------------------------------------------------
One Year After One Through After Five Through
or Less Five Years Ten Years
--------------------------------------------------------------------------------
Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield
--------------------------------------------------------------------------------
Held-to-maturity:
<S> <C> <C> <C> <C> <C> <C>
U.S. government and agency obligations ...... $9,999 5.84% $57,434 6.57% $ 500 6.34%
Mortgage-backed securities (3):
FNMA PCs .................................. 516 8.73% 3,534 7.44% 0 0%
Private issue CMOs ........................ 0 0% 0 0% 0 0%
--------------------------------------------------------------------------------
Total mortgage-backed securities ............ $ 516 8.73% $3,534 7.44% 0 0%
--------------------------------------------------------------------------------
Total securities held-to-maturity ........... $ 10,515 5.98% $60,968 6.62% $ 500 6.34%
--------------------------------------------------------------------------------
Available-for-sale:
U.S. government
and agency obligations .................... $128,486 7.40% $25,785 7.41% $25,038 7.69%
Corporate bonds ............................. 0 0% 19,117 6.53% 0 0%
SBAs ........................................ 0 0% 0 0% 0 0%
Municipal securities ........................ 1,325 4.98% 64,595 5.39% 43,431 5.62%
Equity (1)(2) ............................... 11,907 6.72% 92,629 6.34% 0 0%
Asset-backed securities ..................... 0 0% 0 0% 0 0%
Mortgage-backed securities:
FNMA PCs .................................. 0 0% 0 0% 0 0%
FHLMC PCs ................................. 0 0% 2 7.00% 80 8.33%
GNMA PCs .................................. 0 0% 0 0% 0 0%
Private issue PCs ......................... 0 0% 0 0% 0 0%
FNMA CMOs ................................. 0 0% 44,758 7.01% 6,439 6.55%
FHLMC CMOs ................................ 0 0% 90,372 7.17% 4,899 6.52%
Private issue CMOs ........................ 0 0% 7,557 6.73% 20,631 6.60%
--------------------------------------------------------------------------------
Total mortgage-backed securities ............ 0 0% 142,689 7.10% 32,049 6.58%
--------------------------------------------------------------------------------
Total securities-available-for-sale ......... 141,718 7.32% 344,815 6.57% 100,518 6.45%
--------------------------------------------------------------------------------
Total marketable securities.................. $ 152,233 7.23% $405,783 6.58% $101,018 6.45%
================================================================================
---------------------------------------------------------
Over Ten Years Total
---------------------------------------------------------
Weighted Weighted
Amortized Average Amortized Market Average
Cost Yield Cost Value Yield
---------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Held-to-maturity:
U.S. government and agency obligations ..... $ 0 0% $67,933 $68,651 6.46%
Mortgage-backed securities (3):
FNMA PCs .................................. 0 0% 4,050 4,150 7.60%
Private issue CMOs ........................ 24,429 7.37% 24,429 24,744 7.37%
---------------------------------------------------------
Total mortgage-backed securities ............ $24,429 7.37% $28,479 $28,894 7.41%
---------------------------------------------------------
Total securities held-to-maturity ........... $24,429 7.37% $96,412 $97,545 6.74%
---------------------------------------------------------
Available-for-sale:
U.S. government
and agency obligations .................... $4,724 8.00% $184,033 $184,503 7.45%
Corporate bonds ............................. 1,000 5.70% 20,117 20,115 6.49%
SBAs ........................................ 0 0% 0 0 0%
Municipal securities ........................ 0 0% 109,351 114,023 5.48%
Equity (1)(2) ............................... 42,293 6.10% 146,829 154,817 6.30%
Asset-backed securities ..................... 24,551 7.41% 24,551 24,837 7.41%
Mortgage-backed securities:
FNMA PCs .................................. 0 0% 0 0 0%
FHLMC PCs ................................. 2,838 8.25% 2,920 3,066 8.25%
GNMA PCs .................................. 0 0% 0 0 0%
Private issue PCs ......................... 0 0% 0 0 0%
FNMA CMOs ................................. 99,870 6.77% 151,067 152,433 6.83%
FHLMC CMOs ................................ 177,656 7.28% 272,927 274,281 7.23%
Private issue CMOs ........................ 145,231 6.96% 173,419 174,707 6.91%
---------------------------------------------------------
Total mortgage-backed securities ............ 425,595 7.03% 600,333 604,487 7.02%
---------------------------------------------------------
Total securities-available-for-sale ......... 498,163 6.98% 1,085,214 1,102,782 6.84%
---------------------------------------------------------
Total marketable securities.................. $522,592 7.00% $1,181,626 $1,200,327 6.84%
=========================================================
</TABLE>
(1) Includes FHLMC, FNMA and FHLB stocks.
(2) The yield on the equities has not been computed on a tax equivalent basis.
(3) Based on current prepayment trends, $608.3 million of mortgage-backed
securities are anticipated to prepay or reprice within three years.
18 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Financial Condition (continued)
Marketable Securities (continued)
Table 8 Composition of Marketable Securities Portfolios
The following table sets forth certain information regarding the amortized cost
and fair values of Harris Financial, Inc.'s marketable securities portfolio at
December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
1997 1996 1995
----------------------------------------------------------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Held-to-maturity:
U.S. Government and agencies ...... $ 67,933 $ 68,651 $ 72,513 $ 72,783 $ 77,578 $ 79,422
FHLB certificates of deposit ...... 0 0 0 0 700 700
Mortgage-backed securities:
FNMA PCs ....................... 4,050 4,150 4,780 4,901 5,574 5,848
FHLMC PCs ...................... 0 0 0 0 2,997 2,975
FNMA CMOs ...................... 0 0 0 0 7,193 7,164
FHLMC CMOs ..................... 0 0 0 0 17,557 17,522
Private Issue CMOs ............. 24,429 24,744 32,124 32,228 38,064 38,750
----------------------------------------------------------------------
Total mortgage-backed securities .. 28,479 28,894 36,904 37,129 71,385 72,259
----------------------------------------------------------------------
Total securities held-to-maturity . $ 96,412 $ 97,545 $ 109,417 $ 109,912 $ 149,663 $ 152,381
----------------------------------------------------------------------
Available-for-sale:
U.S. Government and agencies ...... $ 184,033 $ 184,503 $ 143,370 $ 142,721 $ 44,018 $ 44,639
Corporate bonds ................... 20,117 20,115 17,000 16,660 0 0
SBAs .............................. 0 0 31,522 31,705 0 0
Municipal Securities .............. 109,351 114,023 89,840 90,155 0 0
Equity ............................ 146,829 154,817 102,887 107,808 23,019 25,846
Asset-backed securities ........... 24,551 24,837 2,756 2,758 0 0
Mortgage-backed securities:
FNMA PCs ....................... 0 0 10,040 10,077 13,908 13,758
FHLMC PCs ...................... 2,920 3,066 70,942 71,858 125,721 128,244
GNMA PCs ....................... 0 0 1,565 1,593 0 0
Private Issue PCs .............. 0 0 36,598 36,749 49,741 49,658
FNMA CMOs ...................... 151,067 152,433 62,597 62,698 65,423 64,943
FHLMC CMOs ..................... 272,927 274,281 122,851 122,866 48,439 48,181
Private issue CMOs ............. 173,419 174,707 21,732 21,845 0 0
----------------------------------------------------------------------
Total mortgage-backed securities .. 600,333 604,487 326,325 327,686 303,232 304,784
----------------------------------------------------------------------
Total securities available-for-sale $1,085,214 $1,102,782 $ 713,700 $ 719,493 $ 370,269 $ 375,269
----------------------------------------------------------------------
Other interest-earning securities:
FHLB daily investment ............. $ 11,840 $ 11,840 $ 5,265 $ 5,265 $ 19,036 $ 19,036
----------------------------------------------------------------------
Total marketable securities and
interest-bearing investments .. $1,193,466 $1,212,167 $ 828,382 $ 834,670 $ 538,968 $ 546,686
======================================================================
</TABLE>
HFI maintains a significant investment in mortgage-backed securities,
including primarily floating-rate and fixed-rate collateralized mortgage
obligations ("CMOs"). Most of these mortgage-backed securities are directly
insured or guaranteed by the FHLMC and FNMA; however, HFI does maintain a
substantial investment in private label (non-agency) CMOs. At their acquisition
date, all of HFI's CMOs passed established Federal Financial Institution
Examination Council standards ("the FFIEC test") for investment by regulated
financial institutions. At December 31, 1997, a limited number of CMO
instruments held by HFI did not pass the FFIEC test in the low interest rate
environment existing at that time. Management continues to monitor these
securities but is confident that their performance has not been impaired.
Table 9 presents selected financial information related to HFI's
held-to-maturity and available-for-sale portfolios at, or for the years ended,
December 31, 1997, 1996, and 1995.
Harris Financial, Inc. 1997 Annual Report 19
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
- - ---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Financial Condition (continued)
Marketable Securities (continued)
Table 9 Marketable Securities Classification
1997 1996 1995
----------------------------
(dollar amounts in millions)
Held-to-maturity portfolio:
Year-end amortized cost ...... $96.4 $109.4 $149.7
Percent of total assets ...... 4.37% 6.19% 11.92%
Year-end portfolio yields .... 6.73% 6.73% 6.49%
Year-end net unrealized gains $1.1 0.5 $2.7
Available-for-sale portfolio:
Year-end amortized cost ...... $1,085.2 713.7 $370.3
Percent of total assets ...... 49.17% 40.37% 29.48%
Year-end portfolio yields .... 6.50% 6.82% 6.36%
Pre-tax profit (loss) on sales $4.06 $(1.18) $0.10
Volume of sales .............. $495.6 $422.8 2.6
Year-end net unrealized gains $17.6 $ 5.8 5.0
At December 31, 1997, the Bank had no involvement with derivative financial
instruments that meet the definition of SFAS 119. During 1998, management may
take selective derivative positions for the purpose of managing its interest
rate risk.
Loans As previously discussed in the "Results of Operations" section of this
report, HFI was engaged during 1997 and 1996 in converting from a savings bank
to a full-service financial institution. All of HFI's lending operations reside
at the Bank level. As a savings bank, Harris primarily originated and invested
in residential mortgage loans and real estate-secured consumer loans. As part of
its strategic conversion, HFI has increased its focus on originating and
investing in commercial loans. During 1997 and 1996, the Bank continued to rank
as a top residential mortgage originator in its primary market area but
decreased its investment in residential mortgage loan assets as a percent of
total assets. The Bank also emphasized consumer loans, including home equity
lines of credit and second mortgage loans, as well as multi-family residential
mortgage loans and commercial real estate mortgage loans. The Bank offers its
loan products with fixed and adjustable interest rates and a wide variety of
repayment terms. With the increase in emphasis on commercial lending, the Bank's
ongoing credit risk exposure has increased relative to years before 1996. The
"Asset Quality" discussion that follows this section presents a detailed
discussion of the Bank's credit risk exposure. Also, the Bank's loan portfolios
include primarily loans to borrowers within the Central Pennsylvania region. The
Bank's geographic concentration risk was discussed in a prior section titled
"Discussion of Market Risks".
The Bank increased its total loan origination activity in 1997 as compared
to 1996. During 1997, the Bank originated mortgage loans totaling $276.1
million, commercial loans totaling $48.9 million, and consumer loans totaling
$61.4 million. During 1996, the Bank originated mortgage loans totaling $300.3
million, commercial loans totaling $24.3 million, and consumer loans totaling
$111.7 million. Management attributes the continued high volume of mortgage loan
originations in 1997 to a combination of aggressive mortgage loan marketing by
the Bank and its mortgage banking subsidiary Avstar, as well as a favorable
interest rate environment. The increase in commercial loans in 1997 was due
primarily to expansion of the Business Banking operation and related marketing
efforts. The decrease in consumer loan originations in 1997 can be attributed
primarily to the Bank's decision to reduce its risk exposure in mobile home
lending. Consumer loan originations also came under increased competitive
pressure in 1997 from first-lien mortgage products in the Bank's primary market
area.
Table 10 presents the composition of the Bank's mortgage, commercial,
consumer and other loan portfolios as of December 31, 1997, 1996, 1995, 1994,
and 1993, respectively.
20 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Financial Condition (continued)
Loans (continued)
Table 10 Loan Composition
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
-----------------------------------------------------------------------------------------------
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage Loans:
One-to-four family................. $539,248 60.35% $514,694 62.31% $472,998 71.54% $433,206 73.87% $439,230 75.77%
Construction (1)................... 35,209 3.94% 25,647 3.11% 23,415 3.54% 8,642 1.47% 5,915 1.02%
Other.............................. 1,605 0.18% 21,777 2.63% 23,015 3.48% 22,299 3.80% 25,257 4.36%
-----------------------------------------------------------------------------------------------
Total mortgage loans............ 576,062 64.47% 562,118 68.05% 519,428 78.56% 464,147 79.14% 470,402 81.15%
-----------------------------------------------------------------------------------------------
Commercial Loans:
Residential real estate
(multi-family)................... 15,635 1.75% 21,299 2.58% 27,171 4.11% 27,443 4.68% 27,004 4.66%
Commercial......................... 65,620 7.34% 17,636 2.13% 2,240 0.34% 1,884 0.32% 880 0.15%
----------------------------------------------------------------------------------------------
Total commercial loans.......... 81,255 9.09% 38,935 4.71% 29,411 4.45% 29,327 5.00% 27,884 4.81%
-----------------------------------------------------------------------------------------------
Consumer and other loans:
Mobile home........................ 71,356 7.98% 65,794 7.97% 20,991 3.18% 10,767 1.84% 7,196 1.24%
Home equity and second mortgage.... 155,861 17.44% 153,464 18.58% 83,031 12.56% 74,295 12.67% 66,941 11.55%
Credit cards....................... 0 0% 0 0% 3,258 0.49% 3,765 0.64% 3,881 0.67%
Other.............................. 9,097 1.02% 5,672 0.69% 5,031 0.76% 4,196 0.71% 3,377 0.58%
-----------------------------------------------------------------------------------------------
Total consumer and other
loans......................... 236,314 26.44% 224,930 27.24% 112,311 16.99% 93,023 15.86% 81,395 14.04%
-----------------------------------------------------------------------------------------------
Loans receivable, gross......... 893,631% 100.00% 825,983 100.00% 661,150 100.00% 586,497 100.00% 579,681 100.00%
-----------------------------------------------------------------------------------------------
Plus:
Dealer Reserves.................... 14,504 13,880 4,308 2,102 1,300
Less:
Unearned discounts................. 855 (327) (220) (78) (131)
Net deferred loans origination
fees............................. 8,182 7,952 7,959 7,614 7,978
Allowance for loan losses.......... 8,614 8,322 6,114 6,269 6,584
-----------------------------------------------------------------------------------------------
17,651 15,947 13,853 13,805 14,431
-----------------------------------------------------------------------------------------------
Loans receivable, net........... $890,484 $823,916 $651,605 $574,794 $566,550
==============================================================================================
Mortgage Loans:
ARM................................ $ 90,615 15.73% $133,544 22.89% $114,185 20.89% $95,713 19.47% $ 91,010 18.30%
Fixed-rate......................... 485,447 84.27% 449,873 77.11% 432,414 79.11% 395,877 80.53% 406,396 81.70%
-----------------------------------------------------------------------------------------------
Total mortgage loans............ $576,062 100.00% $583,417 100.00% $546,599 100.00% $491,590 100.00% $497,406 100.00%
===============================================================================================
</TABLE>
(1) Net of undisbursed portion of $29,338, $27,401, $22,301, $10,802 and $9,983
at December 31, 1997, 1996, 1995, 1994 and 1993, respectively.
The Bank manages the interest rate risk exposure in its loan portfolio in
part by selling a significant portion of its residential mortgage loan
production. Such loan sales to the secondary mortgage market may take the form
of individual loan sales, flow-based sales, or swaps for mortgage-backed
securities. The Bank generally sells its mortgage loans on a "servicing
retained" basis as part of its strategy of generating net loan servicing income
to enhance its non-interest income performance. Swapped and sold mortgage loans
totaled $84.0 million in 1997 and $183.7 million in 1996.
Table 11 shows the maturity or period to repricing of the Bank's loan
portfolio at December 31, 1997. Adjustable rate loans are included as being due
in the period of scheduled rate adjustment. The table does not include
prepayments or scheduled principal amortization.
Harris Financial, Inc. 1997 Annual Report 21
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Financial Condition (continued)
Loans (continued)
Table 11 Loan Maturity and Repricing
<TABLE>
<CAPTION>
Amounts Due or Repricing at December 31, 1997
------------------------------------------------------------------------------
After One Year
-----------------------------------------------
Over One Over Three Over Five Over Ten Over Total
Within Through Through Through Through Twenty After
One Three Five Ten Twenty Years One
Year Years Years Years Years Years Year Total
------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans:
One-to-four family ................... $ 529 $ 6,876 $ 25,684 $ 71,002 $134,272 $300,885 $538,719 $539,248
Construction (1) ..................... 5,052 758 71 772 6,578 21,978 30,157 35,209
Other ................................ 515 30 3 30 160 867 1,090 1,605
------------------------------------------------------------------------------
Total mortgage loans .............. 6,096 7,664 25,758 71,804 141,010 323,730 569,966 576,062
------------------------------------------------------------------------------
Commercial loans:
Residential real estate (multi-family) 2,451 166 150 680 6,893 5,295 13,184 15,635
Other commercial ..................... 19,422 3,766 1,700 3,554 35,450 1,728 46,198 65,620
------------------------------------------------------------------------------
Total commercial loans ............ 21,873 3,932 1,850 4,234 42,343 7,023 59,382 81,255
------------------------------------------------------------------------------
Consumer and other loans:
Home equity and second mortgage ...... 38,731 10,462 17,770 48,718 40,154 26 117,130 155,861
Other ................................ 4,827 1,351 716 4,439 66,635 2,485 75,626 80,453
------------------------------------------------------------------------------
Total consumer and other loans .... 43,558 11,813 18,486 53,157 106,789 2,511 192,756 236,314
------------------------------------------------------------------------------
Loans receivable, gross ........... $ 71,527 $ 23,409 $ 46,094 $129,195 $290,142 $333,264 $822,104 $893,631
==============================================================================
</TABLE>
(1) Includes obligations to convert at contractually stated rates into
permanent mortgage loans.
Asset Quality Virtually all of HFI's credit risk lies with the Bank, which holds
all of HFI's loan assets and virtually all of its marketable securities. With
regard to its marketable securities portfolio, at December 31, 1997 and 1996,
over 95% of the marketable securities in the HFI portfolio were rated "AAA",
with the remainder rated "AA" or "A". The Bank's experience in loan credit
losses continues to rank among the best in the financial services industry due
to prudent underwriting activities. As part of its conversion from a savings
institution, the Bank created a Business Banking Group to offer commercial
financial products and services to small businesses in the Bank's primary market
area. This expansion beyond traditional thrift lending such as residential
mortgage lending and real estate secured consumer lending has had the effect of
increasing the Bank's credit risk exposure. To accommodate this credit risk
exposure, management has hired skilled and experienced commercial lending
professionals to manage its Business Banking Group. In addition, the Bank has
adopted commercial bank underwriting, credit management, and loan loss
provisioning techniques. Management is confident in the Bank's abilities to
manage its ongoing credit risk exposure.
As part of its credit risk management, the Bank follows a policy of
continuous credit loss monitoring, including assessment of the adequacy of the
allowance for loan losses. This assessment is performed by considering current
asset quality, overall trends of internal delinquency by loan category, the
balance of loans within the portfolio, anticipated external economic conditions,
and anticipated loan growth. These assessments are performed on a quarterly
basis and the provision for loan losses is adjusted accordingly.
On January 1, 1995, the Bank adopted the provisions of Statement of
Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment
of a Loan" (SFAS 114), as amended by SFAS No. 118, "Accounting by Creditors for
Impairment of a Loan - Income Recognition and Disclosure" (SFAS 118). SFAS 114
and SFAS 118 address the accounting by creditors for impairment of certain
loans. The Statements require that impaired loans that are within the scope of
SFAS 114 be measured based on the present value of expected future cash flows
discounted at the loan's effective interest rate or the loan's market price or
the fair value of the collateral if the loan is collateral dependent. SFAS 118
amended the provisions of SFAS 114 to allow a creditor to use existing methods
for recognizing interest income on an impaired loan and to require additional
disclosure on interest income recognition related to impaired loans.
When a loan is considered to be impaired, the amount of impairment is
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate or, at the loan's market price or fair value
of the collateral if the loan is collateral dependent. Management evaluates its
loans individually for impairment. The Bank excludes smaller balance,
homogeneous loans such as consumer and residential mortgage loans from the
evaluation for impairment. Impairment losses are included in the allowance for
possible loan losses. Impaired loans are charged-off when management determines
that the loan is not likely to be collectible. Interest income on impaired loans
is generally recorded as payments are collected. Interest on impaired loans that
are contractually past due at least ninety days is reserved in accordance with
regulatory requirements.
At December 31, 1997 and 1996, the Bank had no impaired loans and no
required impairment loss reserves, as all impaired loans were deemed
uncollectable and charged off as of the respective year ends. Table 12 presents
an allocation of the allowance for loan losses by category of loans as of
December 31, 1997, 1996, 1995, 1994,and 1993. The specific allocation ascribed
to each category may be different than actual experience. Accordingly, the
entire allowance is available to absorb losses in any category.
22 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
- - ---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Financial Condition (continued)
Asset Quality (continued)
Table 12 Allocation of the Allowance for Loan Losses
<TABLE>
<CAPTION>
As of December 31,
----------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------------------------------------------------------------------------------------------------
% of Total % of Total % of Total % of Total % of Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One-to-four family
mortgage loans ............ $1,072 60.35% $2,777 62.31% $1,627 71.54% $1,718 73.87% $2,121 75.77%
Commercial loans ............ 2,546 9.09% 2,720 4.71% 1,851 4.45% 904 5.00% 1,073 4.81%
Consumer and other loans .... 2,107 30.56% 1,780 32.98% 716 24.01% 1,614 21.13% 1,183 19.42%
Impaired loans .............. 0 0% 0 0% 0 0% 0 0.0% 0 0%
Unallocated ................. 2,889 N/A 1,045 N/A 1,920 N/A 2,033 N/A 2,207 N/A
----------------------------------------------------------------------------------------------------
Total .................... $8,614 100.00% $8,322 100.00% $6,114 100.00% $6,269 100.00% $6,584 100.00%
====================================================================================================
</TABLE>
Table 13 presents an analysis of activity in the Bank's allowance for loan
losses for the five year period ended December 31, 1997. Net additions to the
allowance during this five-year period totaled $4.4 million, or 51.6%, of the
$8.6 million balance in the allowance at December 31, 1997. Charged-offs of
loans, net of recoveries, amounted to $.3 million, $.8 million, $.2 million, $.3
million, and $.2 million for 1997, 1996, 1995, 1994, and 1993, respectively, and
totaled $1.8 million for the five years combined.
Table 13 Analysis of the Allowance for Loan Losses
<TABLE>
<CAPTION>
At or for the Years Ended December 31, (1)
--------------------------------------------------
1997 1996 1995 1994 1993
--------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of period ...................... $8,322 $6,114 $6,269 $6,584 $6,000
Addition due to acquisitions ........................ 0 1,074 0 0 0
Provision for loan losses ........................... 610 1,957 0 0 800
Charge-offs:
One-to-four family mortgage loans ................... (341) (649) (5) (106) (17)
Other mortgage loans ................................ (19) (35) (71) (112) (137)
Consumer and other loans ............................ (8) (176) (99) (123) (66)
--------------------------------------------------
Total charge-offs ................................... (368) (860) (175) (341) (220)
--------------------------------------------------
Recoveries:
One-to-four family mortgage loans ................... 10 19 0 0 0
Other mortgage loans ................................ 14 0 0 0 0
Consumer and other loans ............................ 26 18 20 26 4
--------------------------------------------------
Total recoveries .................................... 50 37 20 26 4
--------------------------------------------------
Balance at end of the period ........................ $8,614 $8,322 $6,114 $6,269 $6,584
==================================================
Ratio of net charge-offs to average loans outstanding 0.04% 0.10% 0.03% 0.06% 0.03%
</TABLE>
(1) During the periods noted, the Bank held no foreign loans.
During 1998, the Bank expects to increase its loan loss provision expense
relative to 1997 in anticipation of significant volume increases in the
commercial and consumer loan portfolios. This increased provisioning is intended
to sustain strong loan loss reserves at the Bank and it is not a reflection of
any deterioration in actual credit quality or loosening of credit underwriting
standards.
Table 14 reflects the Bank's non-performing asset balances as of December
31, 1997, 1996, 1995, 1994, and 1993. The Bank's policy is to discontinue the
accrual of interest on virtually all loans that become at least ninety days
delinquent. Unpaid interest is charged against income at the time a loan is
placed on non-accrual status. Foreclosed real estate, including properties that
are held for investment, are also included in non-performing assets.
Foreclosed real estate includes $6.0 million, $5.9 million, and $5.9
million as of December 31, 1997, 1996, and 1995 that represents the Bank's
carrying value of a large apartment complex located in the Bank's primary market
area. During 1997, 1996 and 1995, the Bank operated the property for investment
purposes and recorded $.8 million, $.8 million, and $.7 million of associated
net rental income during these periods, respectively. Loans which are considered
performing and are current as to payments of principal and interest but have an
above normal risk of becoming non-performing or requiring restructuring in the
future are estimated to total approximately $12.4 million at December 31, 1997.
Harris Financial, Inc. 1997 Annual Report 23
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
- - ---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Financial Condition (continued)
Asset Quality (continued)
Table 14 Non-Performing Assets
<TABLE>
<CAPTION>
At December 31,
-------------------------------------------
1997 1996 1995 1994 1993
-------------------------------------------
<S> <C> <C> <C> <C> <C>
Non-accrual mortgage loans ........................$ 5,544 $4,827 $1,907 $2,830 $2,352
Non-accrual other loans ........................... 1,394 798 40 170 75
-------------------------------------------
Total non-accrual loans(1) ..................... 6,938 5,625 1,947 3,000 2,427
Loans 90 days or more delinquent and still accruing 0 0 63 78 119
-------------------------------------------
Total non-performing loans ..................... 6,938 5,625 2,010 3,078 2,546
Total foreclosed real estate(2) ................ 6,711 7,042 6,563 6,697 6,523
-------------------------------------------
Total non-performing assets .......................$13,649 $12,667 $8,573 $9,775 $9,069
===========================================
Non-performing loans to total loans(3) ............ 0.78% 0.68% 0.31% 0.54% 0.44%
Total non-performing loans and
foreclosed real estate to total assets ......... 0.62% 0.72% 0.68% 0.92% 0.83%
</TABLE>
(1) The amounts of additional interest income that would have been recorded on
non-accrual loans, had they been current, totaled $360,000, $293,000,
$76,000, $141,000, and $148,000 for the years 1997, 1996, 1995, 1994, and
1993, respectively.
(2) Includes $5,972,000, $5,914,000, and $5,896,000 of foreclosed real estate
held-for-investment at December 31, 1997, 1996 and 1995, respectively.
(3) Total loans excludes loans held-for-sale.
The Bank's ratio of non-performing loans to total loans and its ratio of
non-performing assets to total assets continue to compare favorably to industry
peer group averages. Management believes that the long-term financial strength
and profitability of the Bank is greatly dependent upon its ability to continue
differentiating itself from its peers with exceptional asset quality.
Deposits All of HFI's deposit gathering activities are conducted through the
Bank. As of December 31, 1997, the Bank's total deposit portfolio of $1.146
billion included time deposits of $769 million, or 67.1% of total deposits, and
checking, money market, and savings deposits totaling $377 million, or 32.9% of
total deposits. This compares to total deposits of $1.173 billion at December
31, 1996, at which time the Bank held $810 million of time deposits, or 69.1% of
total deposits, and checking, money market, and savings deposits totaling $363
million, or 30.9%, of total deposits. Included in the Bank's time deposits at
December 31, 1997, were $25.0 million of brokered certificates of deposit. The
Bank held no brokered deposits as of December 31, 1996.
Table 15 provides a detailed analysis of the Bank's average deposit
balances, average cost, and interest expense for the three-year period ended
December 31, 1997.
Table 15 Average Interest-Bearing Deposits, Interest Expense
and Average Cost
<TABLE>
<CAPTION>
For the Years Ended December 31,
----------------------------------------------------------------------------------------
1997 1996 1995
----------------------------------------------------------------------------------------
Average Average Average Average Average Average
Balance Interest Cost Balance Interest Cost Balance Interest Cost
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Savings deposits ....... $ 147,738 $ 4,072 2.76% $ 146,929 $ 4,171 2.84% $151,085 $ 4,679 3.10%
Time deposits .......... 782,578 43,760 5.59% 814,658 45,668 5.61% 677,211 37,928 5.60%
NOW and money
market accounts ...... 220,557 6,551 2.97% 171,004 5,965 3.49% 118,275 4,098 3.46%
----------------------------------------------------------------------------------------
Total interest-bearing
deposits ............. $1,150,873 $54,383 4.73% $1,132,591 $55,804 4.93% $946,571 $46,705 4.93%
========================================================================================
</TABLE>
The Bank's relative mix of lower-cost deposits to total deposits has improved
in 1997 relative to 1996, primarily reflecting management's reduced emphasis on
gathering higher-cost time deposit funds and to growth associated with the
Bank's "High Performance Checking" program. The major thrust of this checking
program is delivering a high-quality, profitable line of checking deposit
products to a much larger share of the Bank's market than had been achieved
before 1996.
The Bank's total deposit balances were stable in 1997, mirroring the
experience of the financial institution industry as a whole during this period.
In 1998, management expects opportunities for deposit growth in the Bank's
market area to increase as a number of very large financial institutions based
outside of Pennsylvania complete their announced acquisitions of local
depository institutions. Such events often result in disruption to the
acquiree's operations, deterioration in its work force morale, and
dissatisfaction in its customer base. To capitalize on the associated potential
opportunities, HFI began in 1997 to aggressively market to business clients and
retail customers associated with these acquired institutions. Management expects
to devote even greater emphasis to this strategy in 1998.
24 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Financial Condition (continued)
Deposits (continued) The aggregate amount of deposits with a minimum
denomination of $100,000 was $136.9 million, $123.9 million, and $85.6 million
as of December 31, 1997, 1996, and 1995, respectively. Table 16 presents a
maturity stratification of the Bank's time deposits with minimum denominations
of $100,000 as of December 31, 1997, 1996, and 1995, respectively.
Table 16 Maturity of Time Deposits of $100,000 or More
At December 31,
-------------------------------
1997 1996 1995
-------------------------------
Three months or less ................ $12,452 $ 7,015 $ 9,482
Over three months through six
months............................. 7,149 10,561 6,919
Over six months through twelve
months............................. 11,131 16,959 8,593
Over twelve months .................. 23,532 21,211 21,860
-------------------------------
Total ............................ $54,264 $55,746 $46,854
===============================
The Bank pays deposit insurance premiums to the Savings Association Insurance
Fund ("SAIF") of the FDIC. The Bank's assessment rate was 6.4 basis points in
1997 and 23.0 basis points in 1996. The Bank paid insurance premiums to the SAIF
totaling $.8 million, $2.3 million, and $2.1 million in 1997, 1996, and 1995,
respectively. Also, the Bank paid a one-time SAIF assessment which amounted to
an additional expense of approximately $7.0 million in 1996.
On September 30, 1996, the President signed into law the Deposit Insurance
Funds Act of 1996 to recapitalize the SAIF and to provide for repayment of the
Financial Institution Collateral Obligation (FICO) bonds issued by the U.S.
Department of the Treasury. The FDIC levied a one-time special assessment on
SAIF deposits equal to 65.7 cents per $100 of the SAIF-assessable deposit base
as of March 31, 1995. During the years 1997, 1998 and 1999, the Bank Insurance
Fund ("BIF") will pay $322 million of FICO debt service, and the SAIF will pay
$458 million. Qualifying Oakar institutions, which are BIF-insured banks that
acquired SAIF deposits and continue to pay SAIF assessments on a portion of
their deposits, are entitled to reduce their SAIF assessment base by 20% for
purposes of calculating this special assessment.
During 1997, 1998 and 1999, the average regular annual deposit insurance
assessment is estimated to be about 1.29 cents per $100 of deposits for BIF
deposits and 6.44 cents per $100 of deposits for SAIF deposits. Individual
institution's assessments will continue to vary according to their capital and
management ratings. The FDIC retained the ability to raise deposit assessments
as necessary to maintain the funds at their statutorily targeted capitalization
levels. After 1999, BIF and SAIF will share the FICO costs equally. Under
current estimates, BIF and SAIF assessment bases would each be assessed at the
rate of approximately 2.43 cents per $100 of deposits. The FICO bonds will
mature in 2018-2019, ending the interest payment obligation.
The law also provides that BIF and SAIF are to merge to form the Deposit
Insurance Fund ("DIF") at the beginning of 1999, provided that there are no SAIF
institutions in existence at that time. Merger of the Funds will require state
laws to be amended in those states authorizing savings associations to eliminate
that authorization (state chartered savings banks will not be affected). This
provision reflects Congress's apparent intent to merge thrift and commercial
bank charters by January 1999; however, no law has yet been enacted to achieve
that purpose. The Act also provides regulatory relief to the financial services
industry relative to environmental risks, frequency of examinations, and the
simplification of forms and disclosures.
Other Borrowings All of HFI's other borrowings are placed at the Bank level. The
Bank relies heavily on wholesale borrowings to support its leveraged investment
strategies and, to a lesser extent, to substitute when deposit funds are
insufficient to match certain asset maturities. As discussed in previous
sections of this report, the leveraged investment strategies have significantly
enhanced the Corporation's return to its shareholders. At December 31, 1997 and
1996, the Bank had other borrowings totaling $854.0 million and $420.6 million,
respectively. Table 17 presents the composition of other borrowings as of
December 31, 1997.
Table 17 Other Borrowings Information
<TABLE>
<CAPTION>
Repurchase
FHLB Agreement ESOP Total
-------------------------------------------
<S> <C> <C> <C> <C>
Outstanding at December 31, 1997 .......... $575,440 $277,548 $990 $853,978
Weighted average rate at December 31,
1997..................................... 5.85% 5.87 5.75% 5.86%
Maximum amount outstanding at any month
end...................................... $600,702 $279,366 $990 $881,058
Average amount outstanding for the year ... $511,054 $165,371 $990 $677,415
Weighted average rate for the year ........ 5.83% 5.79 5.75% 5.82%
</TABLE>
Average non-deposit borrowings, which include other borrowings and escrow
account balances, amounted to $685.8 million, $204.9 million, and $19.9 million
in 1997, 1996, and 1995, respectively. Average non-deposit borrowings increased
$480.9 million and $185.0 million in 1997 and 1996, respectively, primarily to
fund leveraged investments and to a lesser extent to supplement deposits.
Included in non-deposit borrowings were repurchase agreements, the average
balance of which was $165.4 million, $22.9 million, and $1.6 million during
1997, 1996, and 1995, respectively. The highest month-end balance of repurchase
agreements outstanding was $279.4 million, $54.6 million and $18.6 million
during 1997, 1996, and 1995, respectively. The securities underlying the
agreements were under the Bank's control.
Harris Financial, Inc. 1997 Annual Report 25
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
- - ---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Financial Condition (continued)
Other Borrowings (continued) Table 18 presents the scheduled maturity of the
Bank's other borrowings as of December 31, 1997, 1996, and 1995. As part of the
Bank's interest rate risk management, all borrowings used to fund leveraged
investments have been matched in maturity to the associated assets.
Table 18 Maturity of Other Borrowings
At December 31,
---------------------------------
1997 1996 1995
---------------------------------
Three months or less ................ $105,512 $ 30,495 $17,695
Over three months through six
months............................. 98,895 0 0
Over six months through twelve
months............................. 122,366 137,000 0
Over twelve months .................. 527,205 253,136 1,485
---------------------------------
Total ............................ $853,978 $420,631 $19,180
=================================
As discussed in a previous section of this report under the heading
"Concentration Risk - Major Creditor", a significant portion of the Bank's
wholesale borrowings are placed with the Federal Home Loan Bank of Pittsburgh
(the "FHLB"). Pursuant to collateral agreements with the FHLB, borrowings are
fully secured by certain debt securities and qualifying first mortgage loans.
The Bank's maximum borrowing capacity totaled $811.7 million and $959.9 million
at December 31, 1997 and 1996, respectively. The decrease in the maximum
borrowing capacity at the FHLB in 1997 was due entirely to the use of qualified
assets to collateralize non-FHLB repurchase agreements. As of December 31, 1997,
the Bank had total borrowings outstanding to the FHLB of $575.4 million.
If the Bank's maximum borrowing capacity at the FHLB were to be encumbered in
the future, through statutory restrictions that do not exist at this time, the
Bank's leveraged investment strategies would be impacted to some degree.
However, given the quality of the Bank's assets pledged as collateral to support
wholesale borrowings, management believes the Bank would be able to expand its
placement of borrowings with other primary borrowing sources. Management
anticipates that such a shift in borrowing sources would result in, at worst,
only modest potential decreases in net interest income from wholesale leveraging
activities. Management is not aware of any contemplated regulatory actions that
indicate the Bank's maximum borrowing capacity at the FHLB might become
restricted to less than the maximum capacity disclosed above.
The Bank maintains a leveraged Employee Stock Ownership Plan ("ESOP") for the
benefit of its employees. The terms of the associated ESOP borrowing include
five equal annual principal installments of $495,000 beginning January 25, 1995
and on the last day of January each year thereafter until retirement of the
debt. Interest on the borrowing accrues at the rate of 5.75% per annum and is
payable monthly. ESOP borrowings totaled $1.0 million and $1.5 million at
December 31, 1997 and 1996, respectively.
Acquisitions HFI did not complete any significant whole institution, asset
portfolio, deposit portfolio, or branch acquisitions during 1997. In addition,
HFI did not execute any letters of intent in 1997 regarding contemplated future
transactions of this nature.
On April 19, 1996, the Bank acquired First Harrisburg Bancor, Inc. ("First
Harrisburg"), a local thrift institution. The acquisition was a 100% cash
purchase of all outstanding First Harrisburg common shares at $14.77 per share,
which resulted in a total cost of approximately $38 million, and was accounted
for by the Bank as a purchase transaction. As of April 19, 1996, First
Harrisburg had total assets of approximately $276.6 million and total
liabilities of approximately $252.2 million. The Bank recorded approximately
$13.8 million of goodwill upon consummation of this acquisition, which is being
amortized over a fifteen year period using the straight-line method.
Management considers an aggressive acquisition strategy to be a critical
strategic objective. Management believes that consolidation of the financial
services industry will continue to present acquisition opportunities in
geographical markets and business market niches within which Harris intends to
expand and prosper. Such markets may include non-traditional banking products
and services.
Liquidity Virtually all of HFI's liquidity exists with the Bank. During 1997 and
1996, HFI maintained substantial excess liquidity. Excess liquidity in this
context refers to the ability of HFI to generate an amount of cash over and
above its current commitments without taking any action that would diminish
earnings or capital. HFI anticipates that it will have sufficient funds
available from normal operations to meet its current commitments. At December
31, 1997, the Bank had commitments to originate loans, including funds available
on construction loans of $52.7 million. At December 31, 1997, the Bank had
commitments to purchase $56.9 million of marketable securities. The Bank also is
obligated to pay $9.2 million under its lease agreements for branch and
administrative facilities. Certificates of deposit which are scheduled to mature
in one year or less at December 31, 1997, totaled $462.3million. Based on
historical experience, management estimates that a significant portion of such
certificates of deposits will remain with the Bank.
26 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Financial Condition (continued)
Liquidity (continued) HFI's primary sources of funds are deposits, other
borrowings and proceeds from principal and interest payments on loans and
marketable securities. While maturities and scheduled amortization of loans and
marketable securities are a predictable source of funds, deposit flows and
mortgage prepayments are greatly influenced by general interest rates, economic
conditions, and competition. HFI and the Bank are required to maintain a
sufficient level of liquid assets, as determined by management and reviewed for
adequacy by the FDIC during their regular examination. The FDIC, however, does
not prescribe by regulation a minimum amount or percentage of liquid assets. The
FDIC allows any marketable security, whose sale would not impair the capital
adequacy to be eligible for liquidity. HFI's liquidity is quantified through the
use of three ratios: a standard liquidity ratio of liquid assets to short-term
borrowings plus deposits and two dependency ratios of volatile liabilities
(certificates of deposit greater than $100,000 plus short-term borrowings) less
short-term assets, to long-term assets, with the desired result being a negative
percentage. The first dependency ratio is calculated internally by HFI and
includes investments in the available-for-sale portfolio in short-term assets.
The second dependency ratio is calculated according to FDIC guidelines and
excludes the available-for-sale portfolio from short-term assets. HFI's standard
FDIC liquidity ratios were 82.0%, 63.7%, and 51.1% at December 31, 1997, 1996,
and 1995, respectively. HFI's FDIC qualified liquid assets were $1,152.6
million, $858.8 million, and $560.1 million at December 31, 1997, 1996, and
1995, respectively. HFI's internal dependency liquidity ratios, as calculated by
management, were (71.6%), (53.1%), and (16.4%) at December 31, 1997, 1996, and
1995, respectively. The FDIC's dependency liquidity ratios for the Bank were
17.4%, 13.0%, and 3.2% at December 31, 1997, 1996, and 1995, respectively. All
of these liquidity ratios indicate substantial excess liquidity.
Regulations The Bank is subject to extensive regulation, supervision and
examination by the Pennsylvania Department of Banking as its chartering
authority and by the Federal Deposit Insurance Corporation as the insurer of
deposits up to applicable limits. The Bank is also a member of the Federal Home
Loan Bank System and is subject to certain limited regulations promulgated by
the Federal Home Loan Bank. As a bank holding company, HFI is subject to
regulation and oversight by the Federal Reserve Board. Such regulation and
supervision govern the activities in which an institution and its holding
company may engage and are intended primarily for the protection of the
insurance fund and the depositors. Regulatory authorities have extensive
discretion in connection with their supervisory and enforcement activities which
are intended to strengthen the financial condition of the banking and thrift
industries, including the imposition of restrictions on the operation of an
institution, the classification of assets by the institution and the adequacy of
an institution's allowance for loan losses.
From time to time, various types of federal and state legislation have been
proposed that could result in additional regulation of, and restrictions on, the
business of HFI and the Bank. It cannot be predicted whether such legislation
will be enacted, or if enacted, how such legislation would affect the business
of HFI and the Bank. As a consequence of the extensive regulation of commercial
banking activities in the United States, HFI's and the Bank's business is
particularly susceptible to being affected by federal legislation and
regulations that may increase the costs of doing business.
Environmental Regulation There are several federal and state statutes which
regulate the obligations and liabilities of financial institutions pertaining to
environmental issues. In addition to the potential for attachment of liability
resulting from its own actions, a bank may be held liable under certain
circumstances for the actions of its borrowers, or third parties, when such
actions result in environmental problems on properties that collateralize loans
held by the bank. Further, the liability has the potential to far exceed the
original amount of the loan issued by the Bank. Currently, the Bank is not a
party to any pending legal proceeding pursuant to any environmental statute, nor
is the Bank aware of any circumstances which may give rise to liability under
any such statute.
Inflation and Changing Prices The consolidated statements in this report have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the changes in the relative purchasing
power of money due to inflation. The impact of inflation is reflected in the
increased cost of the Bank's operations. Unlike most industrial companies,
nearly all the assets and liabilities of the Bank are monetary in nature. As a
result, interest rates have a greater impact on the Bank's performance than do
the effects of general levels of inflation. Interest rates do not necessarily
move in the same direction or to the same extent as the price of goods and
services.
Corporate Reorganization On January 25, 1994, Harris Savings Bank (the Bank)
reorganized into a Pennsylvania chartered mutual holding company. The
reorganization was accomplished through the purchase and assumption of assets
and liabilities whereby the Bank: (i) incorporated a Pennsylvania capital stock
savings bank and transferred most of its assets (except $1.0 million) and all of
its liabilities, including all of its deposit liabilities, to the newly-formed
bank in exchange for all of the common stock of the Bank not sold in the
Offering; and (ii) adopted a new charter issued by the Pennsylvania Department
of Banking changing its form to that of a state chartered mutual holding
company. Each savings account of the Bank at the time of the reorganization
became a savings account in the newly-formed bank in the same amount and upon
the same terms and conditions, except the holder of each such deposit account
retained liquidation rights with respect to the holding company rather than the
Bank.
Prior to the reorganization, the Bank received the approval of the Federal
Reserve, the Pennsylvania Department of Banking and the FDIC for transactions
contemplated by the plan of reorganization. The plan of reorganization
authorized the Bank to offer stock in one or more stock offerings up to a
maximum of 49% of the issued and outstanding shares of its common stock. The
common stock was offered on a priority basis to: (i) eligible depositors as of
December 31, 1992; (ii) the employee stock ownership plan (ESOP); (iii)
officers, trustees and employees of the Bank, and the Bank's recognition and
retention plans (RRP); (iv) other depositors and borrowers as of October 29,
1993; and (v) the general public. Subscriptions received during the offering
period which ended December 29, 1993, including shares reserved for the ESOP,
exceeded the maximum offering of 7,500,000 shares ($25,000,000). As a result of
the maximum subscription, Harris Financial, MHC (mutual holding company)
received 25,500,000 shares (76.4%) of Harris Savings Bank (stock bank) stock.
Also, the ESOP received 742,500 shares and the RRP received 375,000 shares. As a
result of the stock offering, Harris Savings Bank received gross proceeds of
$25.2 million which net of expenses associated with the offering of $1.5 million
resulted in net capital additions to the Bank of $23.7 million.
Harris Financial, Inc. 1997 Annual Report 27
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
- - ---------------------------------------------------
(All dollar amounts presented in the tables are in thousands)
Financial Condition (continued)
Corporate Reorganization (continued) On September 17, 1997, Harris Savings Bank
(HSB) and its existing mutual holding company, Harris Financial, MHC,
reorganized into a two-tier mutual holding company structure with the
establishment of a state chartered holding company, Harris Financial, Inc.
(HFI), as the parent of HSB. 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
interests. Accordingly, all prior period financial information of Harris
Financial, Inc. in this annual report is identical to the prior period financial
information of Harris Savings Bank.
Prior to the consummation of this reorganization, HFI received the approval
of the Federal Reserve, the Pennsylvania Department of Banking, and the FDIC.
On October 21, 1997, the Board of Directors of Harris Financial, Inc.
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 annual report has been restated to
reflect the stock split as if it had been in effect during all periods
presented.
During 1997, 1996 and 1995, HFI's mutual holding company parent, Harris
Financial, MHC, waived all of its dividends due from Harris Financial, Inc.
These dividends, had they not been waived, would have totaled $5.1 million, $4.9
million and $4.3 million in 1997, 1996 and 1995, respectively. Recently, the
Federal Reserve Board and the FDIC have devoted attention to the issue of such
dividend waivers and their potential impact on future appraisals of FDIC-insured
institutions considering a full stock conversion. Neither HFI or Harris
Financial, MHC, is contemplating such a conversion at this time. The Federal
Reserve Board and the FDIC are also reviewing whether such dividend waivers
potentially represent a breach of fiduciary duties by directors of mutual
holding companies. Management is currently monitoring developments related to
its existing and contemplated future dividend waivers.
New Accounting Guidance In June 1997, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 130 (SFAS 130),
"Reporting Comprehensive Income", which establishes standards for reporting and
displaying comprehensive income and its components. The statement requires that
comprehensive income be reported in a financial statement and be displayed with
the same prominence as other financial information. Comprehensive income, as
defined by SFAS 130, is the total of net income and all other non-owner changes
in equity. SFAS 130 is effective for fiscal years beginning after December 15,
1997. Management believes that the adoption of this statement will not have a
material effect on HFI's financial condition or results of operations.
28 Harris Financial, Inc. 1997 Annual Report
<PAGE>
[LOGO]
MANAGEMENT REPORT
Financial Statements
Harris Financial, Inc. (HFI) is responsible for the preparation, integrity
and fair presentation of its published financial statements as of December 31,
1997, and the year then ended. The financial statements have been prepared in
accordance with generally accepted accounting principles, and as such, include
amounts, some of which are based on judgements and estimates of management.
Internal Control Structure Over Financial Reporting
Management is responsible for establishing and maintaining an effective
internal control structure over financial reporting presented in conformity with
generally accepted accounting principles and the Federal Financial Institutions
Examination Council instructions for Consolidated Reports of Condition and
Income (call report instructions). The structure contains monitoring mechanisms,
and actions are taken to correct deficiencies identified.
There are inherent limitations in the effectiveness of any internal control
structure, including the possibility of human error and the circumvention or
overriding of controls. Accordingly, even an effective internal control
structure can provide only reasonable assurance with respect to financial
statement preparation. Further, because of changes in conditions, the
effectiveness of an internal control structure may vary over time.
Management assessed HFI's internal control structure over financial reporting
presented in conformity with generally accepted accounting principles and call
report instructions as of December 31, 1997. This assessment was based on
criteria for effective internal control over financial reporting described in
"Internal Control -- Integrated Framework" issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, management
believes that, as of December 31, 1997, Harris Financial, Inc. maintained an
effective internal control structure over financial reporting presented in
conformity with generally accepted accounting principles and call report
instructions.
Compliance With Laws and Regulations
Management is also responsible for compliance with the federal and state laws
and regulations concerning dividend restrictions and federal laws and
regulations concerning loans to insiders designated by the FDIC as safety and
soundness laws and regulations.
Management assessed its compliance with the designated laws and regulations
relating to safety and soundness. Based on this assessment, management believes
that Harris Financial, Inc. complied, in all significant respects, with the
designated laws and regulations relating to safety and soundness for the year
ended December 31, 1997.
/s/ Charles C. Pearson, Jr.
---------------------------------------------
Charles C. Pearson, Jr., President and Chief Executive Officer
/s/ James L. Durrell
---------------------------------------------
James L. Durrell, Executive Vice President and Chief Financial Officer
Harris Financial, Inc. 1997 Annual Report 29
<PAGE>
INDEPENDENT AUDITORS' REPORT
Arthur Andersen LLP
To the Board of Directors of
Harris Financial, Inc.:
We have audited the accompanying consolidated balance sheet of Harris Financial,
Inc. and Subsidiaries as of December 31, 1997, and the related consolidated
statements of income, stockholders' equity, and cash flows for the year then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit. The financial statements of Harris Financial,
Inc. as of December 31, 1996, and for the years ended December 31, 1996 and
1995, were audited by other auditors whose report dated January 21, 1997,
expressed an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Harris Financial,
Inc. and Subsidiaries as of December 31, 1997, and the consolidated results of
its operations and cash flows for the year then ended in conformity with
generally accepted accounting principles.
/s/ Arthur Andersen
-------------------
Arthur Andersen LLP
Lancaster, PA
January 20, 1998
30 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Harris Financial, Inc. and Subsidiaries
Consolidated Statements of Financial Condition
--------------------------------------------------------
December 31, 1997 and 1996 (in thousands, except per share data)
<TABLE>
<CAPTION>
1997 1996
------------------------------
Assets
<S> <C> <C>
Cash and cash equivalents .................................................. $ 24,466 $ 29,693
Marketable securities held-to-maturity
(fair value of $97,545 and $109,912)
(note 4)................................................................. 96,412 109,417
Marketable securities available-for-sale
(note 4)................................................................. 1,102,782 719,493
Loans receivable, net (note 5) ............................................. 890,484 823,916
Loans held for sale, net ................................................... 14,886 9,053
Loan servicing rights (note 6) ............................................. 11,830 12,264
Real estate investments (note 7) ........................................... 6,698 7,940
Premises and equipment, net (note 8) ....................................... 18,722 14,595
Intangible assets (note 10) ................................................ 19,396 21,695
Accrued interest receivable (note 9) ....................................... 13,538 12,052
Income taxes receivable .................................................... 5,757 4,677
Other assets ............................................................... 2,088 3,317
------------------------------
Total assets ............................................................ $2,207,059 $1,768,112
==============================
Liabilities and Stockholders' Equity
Deposits (note 11) ......................................................... $1,146,238 $1,173,423
Escrow ..................................................................... 8,552 8,203
Accrued interest payable ................................................... 4,297 3,012
Other borrowings (note 12) ................................................. 853,978 420,631
Postretirement benefit obligation (note 15)................................. 2,297 2,360
Deferred tax liability, net (note 18) ...................................... 8,279 3,257
Other liabilities .......................................................... 4,384 4,474
------------------------------
Total liabilities ....................................................... 2,028,025 1,615,360
------------------------------
Commitments (notes 14 and 19)
Common Stock $.01 par value, authorized 50,000,000 shares;
33,790,400 shares issued and outstanding at December 31, 1997, and
33,649,200 shares issued and outstanding at December 31, 1996 ........... 338 336
Paid in capital ............................................................ 28,016 25,678
Retained Earnings .......................................................... 141,043 124,812
Net unrealized gain on marketable securities (note 4) ...................... 10,732 3,615
Employee stock ownership plan (note 16) .................................... (529) (1,024)
Recognition and retention plans (note 17) .................................. (566) (665)
------------------------------
Total stockholders' equity .............................................. 179,034 152,752
------------------------------
Total liabilities and stockholders' equity .............................. $2,207,059 $1,768,112
==============================
</TABLE>
30 Harris Financial, Inc. 1997 Annual Report
<PAGE>
See accompanying notes to financial statements
All share and per share data has been restated to give effect to the three for
one stock split.
Harris Financial, Inc. 1997 Annual Report 31
<PAGE>
Harris Financial, Inc. and Subsidiaries
Consolidated Statements of Income
- - --------------------------------------------------------
Years ended December 31, 1997, 1996 and 1995 (in thousands, except per
share data)
<TABLE>
<CAPTION>
1997 1996 1995
---------------------------------
Interest Income:
Loans receivable
<S> <C> <C> <C>
First mortgage loans .............................. $43,929 $46,798 $36,577
Commercial loans .................................. 6,767 5,413 4,276
Consumer and other loans .......................... 19,442 15,759 8,857
Held-for-sale ..................................... 1,879 1,655 0
Taxable investments .................................. 21,239 10,193 8,647
Tax-free investments ................................. 5,746 2,603 0
Dividends ............................................ 7,821 3,404 1,508
Mortgage-backed securities ........................... 34,075 21,856 20,726
Money market investments ............................. 169 307 34
---------------------------------
Total interest income ............................. 141,067 107,988 80,625
---------------------------------
Interest expense:
Deposits (note 11) ................................... 54,383 55,804 46,705
Borrowed funds (note 12) ............................. 38,586 11,392 863
Escrow ............................................... 116 130 128
---------------------------------
Total interest expense ............................ 93,085 67,326 47,696
---------------------------------
Net interest income ............................... 47,982 40,662 32,929
Provision for loan losses (note 5) ................... 610 1,957 0
---------------------------------
Net interest income after provision for loan
losses........................................... 47,372 38,705 32,929
---------------------------------
Non-interest income:
Service charges on deposits .......................... 2,156 932 775
Other service charges/commissions/fees ............... 1,355 857 631
Net servicing income ................................. 2,183 1,322 1,032
Gain (loss) on sale of mortgage-backed securities,
net................................................. 3,576 (1,221) 110
Gain on sale of other securities, net ................ 481 37 0
Gain (loss) on sale of loans, net .................... 2,472 1,863 (68)
Other ................................................ 2,336 206 84
---------------------------------
Total non-interest income ......................... 14,559 3,996 2,564
---------------------------------
Non-interest expense:
Salaries and benefits ................................ 19,006 14,710 11,387
Equipment expense .................................... 2,183 1,647 1,103
Occupancy expense .................................... 2,886 2,467 1,821
Advertising and public relations ..................... 2,091 1,545 642
FDIC insurance ....................................... 751 9,305 2,115
Director fees ........................................ 333 307 311
Income from real estate operations (note 7) .......... (770) (355) (542)
Amortization and write-off of intangibles (note 10) .. 2,393 2,107 374
Non-operational losses (note 5) ...................... 0 4,305 0
Other ................................................ 6,975 6,149 3,565
---------------------------------
Total non-interest expense ........................ 35,848 42,187 20,776
---------------------------------
Income before income taxes ........................... 26,083 514 14,717
Income tax expense (benefit) (note 18) ............... 8,312 (517) 5,503
---------------------------------
Net income ........................................ $17,771 $1,031 $9,214
=================================
Basic Earnings per share (notes 1 and 3) ............. $ 0.53 $ 0.03 $0.28
=================================
Fully diluted earnings per share (notes 1 and 3) ..... $ 0.52 $ 0.03 $0.28
=================================
</TABLE>
See accompanying notes to financial statements.
All share and per share data has been restated to give effect to the three for
one stock split.
32 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Harris Financial, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
--------------------------------------------------------
Years ended December 31, 1997, 1996 and 1995 (in thousands)
<TABLE>
<CAPTION>
Net Employee Recognition
Unrealized Stock And
Common Paid In Retained Gain (Loss) on Ownership Retention
Stock Capital Earnings Securities Plan Plans Total
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1995 ................... $336 $24,320 $117,292 $(3,905) $(2,014) $(993) $135,036
Net Income ................................... 9,214 9,214
Dividends paid at $.17 per share ............. (1,262) (1,262)
Exercised stock options ...................... 316 316
Change in unrealized gain (loss) on marketable
securities, net of tax effect of $4,233 ... 7,025 7,025
ESOP stock committed for release ............. 495 495
Earned portion of RRP plan ................... 173 173
Excess of fair value above cost of
ESOP stock committed for release .......... 359 359
Excess of fair value above cost of
earned portion of RRP stock ............... 103 103
-----------------------------------------------------------------------------
Balance at December 31, 1995 ................. 336 25,098 125,244 3,120 (1,519) (820) 151,459
Net Income ................................... 1,031 1,031
Dividends paid at $.19 per share ............. (1,463) (1,463)
Exercised stock options ...................... 60 60
Change in unrealized gain (loss) on marketable
securities, net of tax effect of $298 ..... 495 495
ESOP stock committed for release ............. 495 495
Earned portion of RRP plan ................... 155 155
Excess of fair value above cost of
ESOP stock committed for release .......... 342 342
Excess of fair value above cost of
earned portion of RRP stock ............... 82 82
Tax benefit of RRP shares awarded and
options exercised ......................... 96 96
-----------------------------------------------------------------------------
Balance at December 31, 1996 ................. 336 25,678 124,812 3,615 (1,024) (665) 152,752
Net Income ................................... 17,771 17,771
Dividends paid at $.20 per share ............. (1,540) (1,540)
Exercised stock options ...................... 2 480 482
Change in unrealized gain (loss) on marketable
securities, net of tax effect of $4,658 ... 7,117 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 1,139
Excess of fair value above cost of
earned portion of RRP plan ................ 492 492
Tax benefit of RRP shares awarded and
options exercised ......................... 227 227
-----------------------------------------------------------------------------
Balance at December 31, 1997 ................. $338 $28,016 $141,043 $10,732 $ (529) $(566) $179,034
=============================================================================
</TABLE>
See accompanying notes to financial statements.
All share and per share data has been restated to give effect to the three for
one stock split.
Harris Financial, Inc. 1997 Annual Report 33
<PAGE>
Harris Financial, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
- - --------------------------------------------------------
Years ended December 31, 1997, 1996 and 1995 (in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
-----------------------------------------
Cash flows from operating activities:
<S> <C> <C> <C>
Net income ...................................................................... $ 17,771 $ 1,031 $ 9,214
Adjustments to reconcile net income to net cash provided by operating activities:
Non-operational loss ......................................................... 0 4,305 0
Provision for loan losses .................................................... 610 1,957 0
Net depreciation, amortization and accretion ................................. 4,131 4,043 844
(Increase) decrease in loans held for sale ................................... (4,008) 2,313 0
Net gain on sales of interest earning assets ................................. (6,529) (679) (42)
(Gain) loss on the sale of foreclosed real estate ............................ (112) 250 (113)
Equity losses (income) from joint ventures ................................... 43 (15) 69
Increase in accrued interest receivable ...................................... (1,486) (3,773) (2,114)
Increase in accrued interest payable ......................................... 1,285 1,934 470
Amortization and write-off of intangibles .................................... 2,393 2,107 374
Earned ESOP shares ........................................................... 1,634 837 854
Earned RRP shares ............................................................ 591 237 276
Provision for deferred income taxes .......................................... (76) 1,678 836
Other, net ................................................................... 375 (1,373) (713)
-----------------------------------------
Net cash provided by operating activities .................................... 16,622 14,852 9,955
-----------------------------------------
Cash flows from investing activities:
Proceeds from maturities and principal reductions of marketable securities:
Held-to-maturity ............................................................. 13,454 40,180 60,273
Available-for-sale ........................................................... 118,079 71,532 31,476
Proceeds from sales of marketable securities available-for-sale ................. 499,633 421,605 2,701
Purchase of marketable securities:
Held-to-maturity ............................................................. (500) 0 (110,267)
Available-for-sale ........................................................... (985,709) (600,362) (76,674)
Purchase of loans ............................................................... 0 (8,474) (14,239)
Loans sold ...................................................................... 83,980 7,242 5,808
Net increase in loan originations less principal payments of loans .............. (151,771) (175,927) (80,699)
Purchase of loan servicing rights ............................................... (943) (3,708) (5,866)
Investment in real estate held for investment ................................... 45 (141) (299)
Proceeds from payments on real estate held for investment ....................... 826 12 384
Purchase of premises and equipment .............................................. (5,685) (2,852) (643)
Cash proceeds received from the sale of foreclosed real estate .................. 1,381 783 1,120
Branch Purchase ................................................................. 0 0 115,611
Bank acquisition net of cash received ........................................... 0 (25,849) 0
Payments for holding company formation .......................................... (92) 0 0
-----------------------------------------
Net cash used in investing activities ........................................ (427,302) (275,959) (71,314)
-----------------------------------------
Cash flows from financing activities:
Net (decrease) increase in deposits ............................................. (27,185) (71,218) 37,163
Net increase in other borrowings ................................................ 433,347 329,463 16,705
Net increase (decrease) in escrow ............................................... 349 (1,494) (467)
Cash dividends .................................................................. (1,540) (1,463) (1,262)
Proceeds from the exercise of stock options ..................................... 482 60 316
-----------------------------------------
Net cash provided by financing operations .................................... 405,453 255,348 52,455
-----------------------------------------
Net decrease in cash and cash equivalents .................................... (5,227) (5,759) (8,904)
Cash and cash equivalents at beginning of period ................................ 29,693 35,452 44,356
-----------------------------------------
Cash and cash equivalents at end of period ...................................... $ 24,466 $ 29,693 $ 35,452
=========================================
</TABLE>
34 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Harris Financial, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (continued)
- - --------------------------------------------------------
Years ended December 31, 1997, 1996 and 1995 (in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
------------------------------------
Supplemental disclosures:
<S> <C> <C> <C>
Cash paid during the years for:
Interest on deposits, advances and other borrowings
(includes interest credited to deposit accounts) ............ $ 74,260 $ 65,392 $47,226
Income taxes .................................................. 10,238 2,575 5,107
Non-cash investing activities:
Transfers from loans to foreclosed real estate ................... $ 862 $ 923 $ 619
Mortgage-backed securities received in exchange for mortgage
loans........................................................... 0 176,450 12,518
Bank acquisition (note 10):
Fair value of assets acquired .................................... $ 0 $276,581 $ 0
Premium paid ..................................................... 0 13,816 0
Fair value of liabilities assumed ................................ 0 252,211 0
Branch acquisition (note 10):
Fair value of assets acquired .................................... $ 0 $ 0 $115,611
Deposit premium paid ............................................. 0 0 10,360
Fair value of liabilities assumed ................................ 0 0 125,971
</TABLE>
See accompanying notes to consolidated financial statements.
Harris Financial, Inc. 1997 Annual Report 35
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- - --------------------------------------------------------
December 31, 1997, 1996 and 1995
(1) Summary of Significant Accounting Policies The accounting and reporting
policies of Harris Financial, Inc. (HFI) and its subsidiaries conform to
generally accepted accounting principles and to general practices within the
banking industry. The following is a description of the more significant of
those policies.
(a) Basis of Financial Statement Presentation The Consolidated Financial
Statements include the accounts of Harris Financial, Inc. and its wholly-owned
subsidiary Harris Savings Bank (HSB). In turn, HSB is the sole owner of the
following subsidiaries: Avstar Mortgage Corporation, Harris Delaware
Corporation, HS Service Corporation, First Harrisburg Service Corporation and
C.B.L. Service Corporation. All significant intercompany transactions and
balances are eliminated in consolidation.
HSB is primarily engaged in attracting deposits from the general public and
investing deposit funds primarily in one-to-four family residential loans,
commercial loans, consumer loans and marketable securities. Harris Delaware
Corporation was incorporated during 1995 for the purpose of managing certain
investments in marketable securities. Avstar Mortgage Corporation is a mortgage
banking company which originates and sells primarily one-to-four family
residential loans. HS Service Corporation is primarily engaged in residential
real estate investments in joint ventures. First Harrisburg Service Corporation
is mainly involved with title insurance activities and an investment in a
wholly-owned subsidiary which is primarily engaged in real estate investments in
joint ventures. CBL Service Corporation is inactive and has negligible assets
and liabilities. HFI and HSB are subject to the regulations of certain federal
agencies and undergo periodic examinations by those regulatory authorities.
In preparing the financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and revenues and expenses for
the period. Actual results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for loan losses and the valuation
of real estate acquired in connection with foreclosures or in satisfaction of
loans. In connection with the determination of the allowances for loan losses
and foreclosed real estate, management obtains independent appraisals for
significant properties.
Management believes that the allowances for losses on loans and foreclosed
real estate are adequate. While management uses available information to
recognize losses on loans and foreclosed real estate, future additions to the
allowances may be necessary based on changes in economic conditions and asset
mix.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review HFI's allowances for losses on loans
and foreclosed real estate. Such agencies may require HFI to recognize additions
to the allowances based on their judgments of information available to them at
the time of their examination.
(b) Cash and Cash Equivalents For purposes of the statement of cash flows,
HFI defines cash equivalents as demand deposits with other financial
institutions.
(c) Marketable Securities Marketable securities are classified in two
categories and accounted for as follows:
o Debt securities that HFI has the positive intent and ability to hold to
maturity are classified as held-to-maturity securities and reported at amortized
cost.
o All other debt securities and all equity securities are classified as
available-for-sale securities and reported at fair value, with unrealized gains
and losses, net of tax, excluded from earnings and reported in a separate
component of shareholders' equity.
The determination as to which portfolio to hold each security is made at the
time of purchase, based on management's intent.
Premiums and discounts are amortized or accreted over the term of the related
securities using a method that approximates the interest method, adjusted for
prepayments. Gains or losses upon sale are determined using the specific
identification method.
Federal law requires a member institution of the Federal Home Loan Bank
(FHLB) system to hold stock of its district FHLB according to a predetermined
formula. This stock is recorded at cost and may be pledged to secure FHLB
advances.
(d) Loans Receivable Loans receivable are stated at unpaid principal
balances, adjusted for the allowance for loan losses, net deferred loan
origination fees and unearned discounts and premiums.
Discounts and premiums on first mortgage loans are amortized to income using
a method that approximates the interest method over the remaining period to
contractual maturity, adjusted for prepayments. Discounts on consumer loans are
recognized over the lives of the loans using methods that approximate the
interest method.
The allowance for loan losses is increased by charges to income and decreased
by charge-offs (net of recoveries). Management's periodic evaluation of the
adequacy of the allowance is based on HFI's past loan loss experience, known and
inherent risks in the portfolio, adverse situations that may affect the
borrowers ability to repay, estimated value of any underlying collateral and
current economic conditions.
Recognition of interest income on loans is computed using the interest
method. Interest on loans that are contractually past due ninety days and over
is reserved. Loans are returned to accrual status when the collectibility of
past due principal and interest is reasonably assured.
36 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
--------------------------------------------------------
December 31, 1997, 1996 and 1995
(1) Summary of Significant Accounting Policies (continued)
(d) Loans Receivable (continued) HFI adopted the provisions of Statement of
Financial Accounting Standard No. 114, "Accounting by Creditors for Impairment
of a Loan", SFAS 114, as amended by SFAS No. 118, "Accounting by Creditors for
Impairment of a Loan - Income Recognition and Disclosure", SFAS 118, on January
1, 1995. Generally, all non-accrual loans are deemed to be impaired. In
addition, management, considering current information and events regarding the
borrowers' ability to repay their obligations, considers a loan to be impaired
when it is probable that HFI will be unable to collect all amounts due according
to the contractual terms of the loan agreement. In evaluating whether a loan is
impaired, management considers not only the amount that HFI expects to collect
but also the timing of collection. Generally, if a delay in payment is
insignificant (e.g. less than 30 days), a loan is not deemed to be impaired.
When a loan is considered to be impaired, the amount of impairment is
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate or, at the loan's market price or fair value
of the collateral if the loan is collateral dependent. Historically, the
majority of loans deemed to be impaired by management have been collateral
dependent. Loans are evaluated individually for impairment. HFI excludes smaller
balance, homogeneous loans (e.g. primarily consumer and residential mortgages)
from the evaluation for impairment. Impairment losses are excluded from the
allowance for possible loan losses. Impaired loans are charged-off when
management believes that the ultimate collectibility of a loan is not likely.
Interest income on impaired loans is generally recorded as payments are
collected. Interest on impaired loans that are contractually past due ninety
days and over is reserved in accordance with regulatory requirements.
(e) Loans Held for Sale Mortgage loans originated and intended for sale in
the secondary market are carried at the lower of cost or market, net of deferred
fees relating to the specific loans. Gains and losses on the sale of loans are
determined using the specific identification method.
(f) Real Estate Held for Investment and Foreclosed Real Estate In 1996, HFI
adopted the provisions of Financial Accounting Standard No. 121 (SFAS 121),
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of". SFAS 121 provides guidance for recognition and measurement of
impairment of long-lived assets, certain identifiable intangibles and goodwill
related to both assets to be held and used and assets to be disposed of. The
adoption of SFAS 121 did not impact HFI's financial position or results of
operations. Real estate properties acquired through loan foreclosure are
initially recorded at the lower of the carrying or fair value less estimated
costs to sell at the date of foreclosure. At the time of foreclosure the excess,
if any, of the carrying value over the estimated fair value of the property is
charged to the allowance for loan losses. Real estate properties held for
investment are carried at the lower of cost, including cost of improvements and
amenities incurred subsequent to acquisition, or estimated net realizable value.
Costs relating to development and improvement of property are capitalized,
whereas costs relating to holding property are expensed.
Valuations are periodically performed by management on both real estate held
for investment and foreclosed real estate. An allowance for losses is
established by a charge to operations if the carrying value of real estate held
for investment exceeds its estimated net realizable value, or the carrying value
of foreclosed real estate exceeds its estimated fair value.
(g) Premises and Equipment Buildings, leasehold improvements, furniture,
fixtures, and equipment are carried at cost, less accumulated depreciation and
amortization. Buildings, furniture, fixtures, and equipment are depreciated
using the straight-line method over the estimated useful lives of the assets.
The cost of leasehold improvements is being amortized using the straight-line
method over the lesser of the estimated useful lives or the terms of the related
leases.
(h) Loan Origination and Commitment Fees and Related Costs Loan fees and
certain direct loan origination costs are deferred and the net fee or cost is
recognized as an adjustment to interest income using the interest method over
the contractual life of the loans. Calculation of the interest method is done on
a loan-by-loan basis. The amortization of deferred fees and costs is
discontinued on non-performing loans.
(i) Intangible Assets Deposit premiums are amortized using the straight-line
method over the estimated benefit period (approximately 7 years). The
amortization period for deposit premiums is subject to periodic review for
reasonableness by management.
(j) Goodwill Goodwill results when, under the purchase method of accounting
for acquisitions, the amount paid for the acquired entity is greater than the
net of the fair value of the assets acquired less the fair value of the
liabilities assumed. HFI amortizes goodwill over the estimated life of the
assets acquired (15 years). The amortization period for goodwill is subject to
periodic review by management.
(k) Loan Servicing Effective January 1, 1996, HFI adopted the provisions of
Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage
Servicing Rights, an amendment of FASB Statement No. 65" (SFAS 122). SFAS 122
amended Statement 65 to require an institution to recognize as separate assets
the rights to service mortgage loans for others when a mortgage loan is sold or
securitized and servicing rights retained. On January 1, 1997, HFI adopted SFAS
No. 125 "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities", which supersedes SFAS No. 122. SFAS 125 expands
the method of accounting for loan servicing rights to apply to purchased
mortgage servicing rights. When capitalizing mortgage servicing rights, HFI
allocates the total cost of the mortgage loans (the recorded investment in the
mortgage loans including net deferred fees or costs and any purchase premium or
discount) to the mortgage servicing rights and the loans (without the mortgage
servicing rights) based on their relative fair values. Such fair value is
primarily based on observable market prices. Mortgage servicing rights
(including purchased mortgage servicing) are amortized in proportion to, and
over the period of, estimated net servicing revenue based on management's best
estimate of remaining loan lives. The effect of adoption of SFAS 122 was an
increase to income of approximately $1,896,000 in 1996.
Harris Financial, Inc. 1997 Annual Report 37
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- - --------------------------------------------------------
December 31, 1997, 1996 and 1995
(1) Summary of Significant Accounting Policies (continued)
(k) Loan Servicing (continued) HFI measures the impairment of servicing
rights based on the difference between the carrying amount of the servicing
rights and their current fair value. Impairment of servicing rights is
recognized through a valuation allowance. The amount of impairment recognized is
the amount by which the capitalized mortgage servicing rights exceed their fair
value. For the purpose of evaluating and measuring impairment of capitalized
mortgage servicing rights, HFI stratifies those rights based on the predominant
risk characteristics of the underlying loans. HFI primarily stratifies mortgage
servicing rights by loan type (for example, conventional or government
guaranteed and adjustable rate or fixed rate mortgage loans) and interest rate.
Valuation techniques for measuring fair value incorporate assumptions that
market participants use in estimating future servicing income and expense,
including assumptions about prepayment, default and interest rates.
(l) Income Taxes HFI accounts for income taxes using the asset and liability
method. The objective of the asset and liability method is to establish deferred
tax assets and liabilities for temporary differences between the financial
reporting and tax basis of HFI's assets and liabilities based on enacted tax
rates expected to be in effect when such amounts are realized or settled.
(m) Derivative Financial Instruments HFI has no material involvement with
derivative financial instruments that meet the definition of SFAS 119.
(n) Earnings Per Share Effective December 15, 1997, HFI adopted the
provisions of Statement of Financial Accounting Standards No. 128 "Earnings per
Share" (SFAS 128). SFAS 128 requires earnings per share to be reported as basic
earnings per share and fully diluted earnings per share. Basic earnings per
share is based on total weighted average shares outstanding for a given period.
Diluted earnings per share is based on total weighted average shares
outstanding, and also assumes the exercise or conversion of all potentially
dilutive instruments currently outstanding.
In addition, the earnings per share calculations retroactively reflect the
impact of a three for one stock split effected in the form of a stock dividend
to shareholders of record as of November 4, 1997. The number of shares (1996 and
1995 restated for the impact of the stock dividend) used to compute fully
diluted earnings per share were 34,076,061, 33,268,485 and 33,043,749 in 1997,
1996 and 1995, respectively.
(o) Dividends HFI may not pay dividends on or repurchase any of its common
stock if the effect thereof would reduce net worth below the level of adequate
capitalization as defined by the FDIC and the Pennsylvania Department of
Banking.
During 1997, 1996 and 1995, HFI's mutual holding company parent, Harris
Financial, MHC, waived all of its dividends due from HFI. These dividends, had
they not been waived, would have totaled $5,100,000, $4,930,000, and $4,335,000
in 1997, 1996 and 1995, respectively.
(p) Stock-Based Compensation In 1996, HFI adopted Statement of Financial
Accounting Standard No.123 (SFAS 123), "Accounting for Stock-Based
Compensation", for disclosure purposes only. SFAS 123 defines a fair value based
method of measuring stock compensation expense. The pro forma disclosure of net
income and earnings per share, assuming the adoption of the fair value method
for financial statement purposes, is included in footnote 17. HFI continues to
account for stock-based compensation under the intrinsic value based method
under APB Opinion No. 25.
(q) Reclassifications Certain amounts in prior years' financial statements
may have been reclassified to conform with the current year's classifications.
(2) Regulatory Structure HFI's primary regulators are the Pennsylvania
Department of Banking, the Federal Deposit Insurance Corporation (FDIC) and the
Federal Reserve (FRB). Both HFI and HSB are also bound by many of the provisions
of the Financial Institutions Reform, Recovery and Enforcement Act of 1989
(FIRREA).
HFI and HSB are subject to various regulatory capital requirements
administered by the federal and state banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory -- and possibly additional
discretionary -- actions by regulators that, if undertaken, could have a direct
material effect on HFI's financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, HFI must meet
specific capital guidelines that involve quantitative measures of HFI's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. HFI's capital amounts and classifications are also subject
to qualitative judgments by the regulators about components, risk weightings,
and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require HFI to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined by the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 1997, that HFI
meets all capital adequacy requirements to which it is subject.
As of June 30, 1997, the most recent notification from the Commonwealth of
Pennsylvania categorized HFI as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well capitalized, HFI must
maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios
as set forth in the table. There are no conditions or events since that
notification that management believes have changed HFI's category.
HFI's actual capital amounts and ratios are also presented in the following
table:
38 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
--------------------------------------------------------
All dollar amounts presented in the tables are in thousands
(2) Regulatory Structure (continued)
<TABLE>
<CAPTION>
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
-----------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
-----------------------------------------------------------------------------------
Harris Financial, Inc. (HFI)
As of December 31, 1997
<S> <C> <C> <C> <C> <C> <C>
is equal to or is equal to or is equal to or is equal to or
greater than greater than greater than greater than
Total Capital (to Risk Weighted Assets) .. $157,520 13.7% $ 91,979 8.0% $114,973 10.0%
is equal to or is equal to or is equal to or is equal to or
greater than greater than greater than greater than
Tier 1 Capital (to Risk Weighted
Assets) ................................ 148,906 13.0% 45,989 4.0% 68,984 6.0%
is equal to or is equal to or is equal to or is equal to or
greater than greater than greater than greater than
Tier 1 Capital (to Average Assets) ....... 148,906 7.5% 80,649 4.0% 100,811 5.0%
As of December 31, 1996
is equal to or is equal to or is equal to or is equal to or
greater than greater than greater than greater than
Total Capital (to Risk Weighted Assets) .. $134,539 14.7% $ 73,151 8.0% $91,438 10.0%
is equal to or is equal to or is equal to or is equal to or
greater than greater than greater than greater than
Tier 1 Capital (to Risk Weighted
Assets) ................................ 126,217 13.8% 36,575 4.0% 54,863 6.0%
is equal to or is equal to or is equal to or is equal to or
greater than greater than greater than greater than
Tier 1 Capital (to Average Assets) ....... 126,217 8.3% 61,099 4.0% 76,373 5.0%
Harris Savings Bank (HSB)
As of December 31, 1997
is equal to or is equal to or is equal to or is equal to or
greater than greater than greater than greater than
Total Capital (to Risk Weighted Assets) .. $147,533 12.9% $ 91,474 8.0% $114,343 10.0%
is equal to or is equal to or is equal to or is equal to or
greater than greater than greater than greater than
Tier 1 Capital (to Risk Weighted
Assets) ................................ 138,919 12.1% 45,737 4.0% 68,606 6.0%
is equal to or is equal to or is equal to or is equal to or
greater than greater than greater than greater than
Tier 1 Capital (to Average Assets) ....... 138,919 7.0% 80,558 4.0% 100,697 5.0%
As of December 31, 1996
is equal to or is equal to or is equal to or is equal to or
greater than greater than greater than greater than
Total Capital (to Risk Weighted Assets) .. $134,539 14.7% $ 73,151 8.0% $91,438 10.0%
is equal to or is equal to or is equal to or is equal to or
greater than greater than greater than greater than
Tier 1 Capital (to Risk Weighted
Assets) ................................ 126,217 13.8% 36,575 4.0% 54,863 6.0%
is equal to or is equal to or is equal to or is equal to or
greater than greater than greater than greater than
Tier 1 Capital (to Average Assets) ....... 126,217 8.3% 61,099 4.0% 76,373 5.0%
</TABLE>
The Pennsylvania Department of Banking also required minimum regulatory
leverage capital of 3% and risk-based capital of 8% as of December 31, 1997 and
December 31, 1996. Both HFI and HSB exceeded minimum regulatory capital levels
at December 31, 1997 and 1996.
(3) Corporate Reorganization and Stock Issuance On January 25, 1994, Harris
Savings Bank (HSB) reorganized into a Pennsylvania chartered mutual holding
company through a purchase and assumption of assets and liabilities whereby HSB:
(i) incorporated a Pennsylvania capital stock savings bank; (ii) transferred
most of its assets (except $1.0 million) and all of its liabilities, including
all of its deposit liabilities, to the newly-formed bank in exchange for all of
the common stock of HSB not sold in the Offering; and (iii) adopted a new
charter issued by the Pennsylvania Department of Banking changing its form to
that of a state chartered mutual holding company. Each savings account of Harris
Savings Bank at the time of the reorganization became a savings account in the
newly-formed bank in the same amount and upon the same terms and conditions,
except the holder of each such deposit account retains liquidation rights with
respect to the holding company rather than HSB.
Prior to the reorganization, HSB received the approval of the Federal
Reserve, the Department of Banking and the FDIC for transactions contemplated by
the plan of reorganization. The plan of reorganization authorized HSB to offer
stock in one or more stock offerings up to a maximum of 49% of the issued and
outstanding shares of its common stock. The common stock was offered on a
priority basis to: (i) eligible depositors as of December 31, 1992; (ii) the
employee stock ownership plan (ESOP); (iii) officers, trustees and employees of
HSB, and HSB's recognition and retention plans (RRP); (iv) other depositors and
borrowers as of October 29, 1993; and (v) the general public. Subscriptions
received during the offering period which ended December 29, 1993, including
shares reserved for the ESOP, exceeded the maximum offering of 7,500,000 shares
($25,000,000). As a result of the maximum subscription, Harris Financial, MHC
(mutual holding company) received 25,500,000 shares (76.4%) of Harris Savings
Bank (stock bank) stock. Also, the ESOP received 742,500 shares and the RRP
received 375,000 shares.
As a result of the stock offering, Harris Savings Bank received gross
proceeds of $25,250,000. Expenses associated with the offering totaled
$1,533,000, resulting in net capital additions to HSB of $23,717,000. HSB
recorded common stock at par of $111,000 and paid in capital of $23,606,000 from
the stock issuance.
On September 17, 1997, Harris Savings Bank and its existing mutual holding
company, Harris Financial, MHC, reorganized into a two-tier mutual holding
company structure with the establishment of a state chartered holding company,
Harris Financial, Inc. (HFI), as the parent of HSB. 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
interests. Accordingly, the prior period consolidated financial statements of
Harris Financial, Inc. are identical to the prior period consolidated financial
statements of Harris Savings 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.
Harris Financial, Inc. 1997 Annual Report 39
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
--------------------------------------------------------
All dollar amounts presented in the tables are in thousands.
(3) Corporate Reorganization and Stock Issuance (continued)
On October 21, 1997, the Board of Directors of Harris Financial, Inc.
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 annual report has been restated to
reflect the stock split as if it had been in effect during all periods
presented.
(4) Marketable Securities The amortized cost, gross unrealized holding gains,
gross unrealized holding losses, and fair value for held-to-maturity and
available-for-sale securities by major security type at December 31, 1997, were
as follows:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized
Amortized Holding Holding Fair
Cost Gains Losses Value
--------------------------------------------------
Held-to-maturity:
<S> <C> <C> <C> <C>
U.S. Government and agencies ....... $ 67,933 $ 721 $ (3) $ 68,651
Mortgage-backed securities:
FNMA PCs ........................ 4,050 100 0 4,150
Private issue CMOs .............. 24,429 315 0 24,744
--------------------------------------------------
Total mortgage-backed securities ... 28,479 415 0 28,894
--------------------------------------------------
Total securities held-to-maturity .. $ 96,412 $ 1,136 $ (3) $ 97,545
==================================================
Available-for-sale:
U.S. Government and agencies ....... $ 184,033 $ 938 $ (468) $ 184,503
Corporate bonds .................... 20,117 27 (29) 20,115
Municipal obligations .............. 109,351 4,672 0 114,023
FHLB stock ......................... 30,027 0 0 30,027
Other equities ..................... 116,802 8,491 (503) 124,790
Asset-backed securities ............ 24,551 295 (9) 24,837
Mortgage-backed securities:
FHLMC PCs ....................... 2,920 146 0 3,066
FNMA CMOs ....................... 151,067 1,368 (2) 152,433
FHLMC CMOs ...................... 272,927 1,761 (407) 274,281
Private issue CMOs .............. 173,419 1,326 (38) 174,707
--------------------------------------------------
Total mortgage-backed securities ... 600,333 4,601 (447) 604,487
--------------------------------------------------
Total securities
available-for-sale................ $1,085,214 $19,024 $ (1,456) $1,102,782
==================================================
</TABLE>
The amortized cost and fair value of marketable securities at December 31,
1997 by expected maturity are shown below.
Amortized Fair
Cost Value
---------------------------
Held-to-maturity:
Due in one year or less .............. $ 9,999 $ 10,013
Due after one year through
five years.......................... 57,434 58,138
Due after five years through
ten years........................... 500 500
Mortgage-backed securities ........... 28,479 28,894
---------------------------
Total securities held-to-maturity . $ 96,412 $ 97,545
===========================
Available-for-sale:
Due in one year or less .............. $ 129,811 $ 130,414
Due after one year through
five years.......................... 109,497 111,253
Due after five years through
ten years........................... 68,469 71,226
Due after ten years .................. 5,724 5,748
Equity securities .................... 146,829 154,817
Asset-backed securities .............. 24,551 24,837
Mortgage-backed securities ........... 600,333 604,487
---------------------------
Total securities
available-for-sale............... $ 1,085,214 $ 1,102,782
===========================
40 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
--------------------------------------------------------
All dollar amounts presented in the tables are in thousands.
(4) Marketable Securities (continued) Marketable securities having a market
value of $5,093,750 at December 31, 1997 were pledged to secure public deposits.
Marketable securities having a market value of $690,867,000 were pledged as
collateral for FHLB advances at December 31, 1997.
The amortized cost, gross unrealized holding gains, gross unrealized holding
losses, and fair value for held-to-maturity and available-for-sale securities by
major security type at December 31, 1996, were as follows:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized
Amortized Holding Holding Fair
Cost Gains Losses Value
----------------------------------------------
Held-to-maturity:
<S> <C> <C> <C> <C>
U.S. Government and agencies ...... $ 72,513 $ 408 $ (138) $ 72,783
Mortgage-backed securities:
FNMA PCs ....................... 4,780 121 0 4,901
Private issue CMOs ............. 32,124 110 (6) 32,228
----------------------------------------------
Total mortgage-backed securities .. 36,904 231 (6) 37,129
----------------------------------------------
Total securities
held-to-maturity ................ $109,417 $639 $(144) $109,912
==============================================
Available-for-sale:
U.S. Government and agencies ...... $143,370 312 $ (961) $142,721
Corporate bonds ................... 17,000 0 (340) 16,660
SBAs .............................. 31,522 183 0 31,705
Municipal obligations ............. 89,840 1,294 (979) 90,155
FHLB stock ........................ 20,972 0 0 20,972
Other equities .................... 81,915 4,966 (45) 86,836
Asset-backed securities ........... 2,756 2 0 2,758
Mortgage-backed securities:
FNMA PCs ....................... 10,040 37 0 10,077
FHLMC PCs ...................... 70,942 1,147 (231) 71,858
GNMA PCs ....................... 1,565 28 0 1,593
Private issue PCs .............. 36,598 155 (4) 36,749
FNMA CMOs ...................... 62,597 106 (5) 62,698
FHLMC CMOs ..................... 122,851 145 (130) 122,866
Private issue CMOs ............. 21,732 165 (52) 21,845
----------------------------------------------
Total mortgage-backed securities .. 326,325 1,783 (422) 327,686
----------------------------------------------
Total securities available-for-sale $713,700 $8,540 $(2,747) $719,493
==============================================
</TABLE>
Activity from the sale of marketable securities is as follows:
1997 1996 1995
--------------------------------
Proceeds ...... $499,633 $421,605 $2,701
================================
Gross gains ... $ 4,280 $ 514 $ 110
Gross losses .. 223 1,698 0
--------------------------------
Net gain
(loss)....... $ 4,057 $ (1,184) $ 110
================================
All sales of marketable securities occurred in the available-for-sale
portfolio in 1997, 1996 and 1995. (5) Loans Receivable Loans receivable at
December 31 are summarized as follows:
Harris Financial, Inc. 1997 Annual Report 41
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- - --------------------------------------------------------
All dollar amounts presented in the tables are in thousands.
(5) Loans Receivable Loans receivable at December 31 are summarized as follows:
1997 1996
-------------------
First mortgage loans (principally conventional):
Principal balances:
Secured by 1-4 family residences ...................... $539,248 $514,694
Construction loans (net of undistributed portion of
$29,338 and $27,401)................................. 35,209 25,647
Other ................................................. 1,605 21,777
-------------------
576,062 562,118
Less:
Unearned premiums ..................................... 855 (327)
Net deferred loan origination fees .................... 8,147 8,577
-------------------
Total first mortgage loans ............................ 567,060 553,868
-------------------
Commercial loans:
Principal balances:
Secured by other residential real estate properties ... 15,635 21,299
Commercial ............................................ 65,620 17,636
-------------------
81,255 38,935
Less:
Unearned premiums ..................................... 534 (88)
-------------------
Total commercial loans ................................ 80,721 39,023
-------------------
Consumer and other loans:
Principal balances:
Mobile Home ........................................... 71,356 65,794
Home equity and second mortgage ....................... 155,861 153,464
Other ................................................. 9,097 5,672
-------------------
236,314 224,930
Plus:
Net deferred loan origination costs ................... 499 537
Dealer reserves ....................................... 14,504 13,880
-------------------
Total consumer and other loans ........................ 251,317 239,347
-------------------
Less allowance for loan losses ........................... 8,614 8,322
-------------------
Net loans ............................................. $890,484 $823,916
===================
Loans having a carrying value of $586,362,000 were pledged as collateral for
FHLB advances at December 31, 1997.
Activity in the allowance for loan losses is summarized as follows for the
years ended December 31:
1997 1996 1995
-------------------------------
Balance at beginning of year .... $8,322 $6,114 $6,269
Addition due to acquisition ..... 0 1,074 0
Provision charge to income ...... 610 1,957 0
Charge-off and recoveries, net... (318) (823) (155)
-------------------------------
Balance at end of year .......... $8,614 $8,322 $6,114
===============================
Nonaccrual and renegotiated loans for which interest has been reduced totaled
approximately $6,938,000, $5,625,000 and $1,947,000 at December 31, 1997, 1996
and 1995, respectively. Interest income foregone on these loans amounted to
$360,000, $293,000 and $76,000 during 1997, 1996 and 1995, respectively.
At December 31, 1997 and 1996, HFI had no impaired loans, as all impaired
loans were deemed uncollectable and charged off as of the respective year end.
Consequently, HFI recorded no impairment loss reserves at December 31, 1997 and
1996. HFI's average carrying value of impaired loans was $0 in both 1997 and
1996. No interest income was recognized on impaired loans during 1997 and 1996.
42 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
--------------------------------------------------------
All dollar amounts presented in the tables are in thousands.
(5) Loans Receivable (continued) In connection with identified violations of
internal control policies and certain unauthorized external activities
concerning HFI's relationship with a mortgage brokering company that followed
the acquisition of First Harrisburg by HFI, a $4.3 million loss was incurred in
1996. Approximately $1.6 million of this was recovered in 1997 and is included
in other non-interest income.
(6) Loan Servicing Mortgage loans serviced for others are not included in the
accompanying consolidated statements of financial condition. The unpaid
principal balances of these loans at December 31 are summarized as follows:
1997 1996 1995
--------------------------------------
Mortgage loan portfolios serviced for:
FHLMC ................................ $ 670,426 $ 645,403 $424,188
FNMA ................................. 328,086 349,671 22,094
Other investors ...................... 68,389 68,912 1,476
--------------------------------------
$1,066,901 $1,063,986 $447,758
======================================
Activity associated with mortgage servicing rights is summarized as follows:
Purchased Originated Total
-------------------------------------
Balance at December 31, 1995 .... $ 5,489 $ 0 $5,489
Acquired in business
combination.................... 2,120 132 2,252
Additions ....................... 3,708 2,411 6,119
Amortization .................... (1,081) (393) (1,474)
Net change in valuation
allowance...................... (122) 0 (122)
-------------------------------------
Balance at December 31, 1996 .... 10,114 2,150 12,264
Additions ....................... 0 1,152 1,152
Amortization .................... (1,432) (154) (1,586)
-------------------------------------
Balance at December 31, 1997 .... $ 8,682 $3,148 $11,830
=====================================
Custodial escrow balances maintained in connection with the foregoing loan
servicing were approximately $10,106,000 and $11,347,000 at December 31, 1997
and 1996, respectively.
(7) Real Estate HFI and its wholly-owned subsidiaries have direct investments in
real estate projects and participate in joint ventures with third parties
engaged primarily in acquiring, developing and constructing residential housing
units. Real estate held at December 31 is summarized as follows:
1997 1996
----------------------
Investments in real estate partnerships, gross ..... $ 2,032 $ 3,104
Equity in partnerships ............................. (450) (363)
Reserves ........................................... (1,595) (1,843)
----------------------
Investments in real estate partnerships, net ....... (13) 898
Foreclosed real estate ............................. 6,711 7,042
----------------------
$ 6,698 $ 7,940
======================
Income from real estate operations for the years ended December 31 is
as follows:
1997 1996 1995
------------------------
Equity income (losses) in partnerships .......... $ 0 $ 15 $(69)
Net gain (loss) on sale of foreclosed
real estate.................................... 191 (250) 113
Foreclosed real estate income, net .............. 579 590 498
------------------------
Net income ................................... $770 $355 $542
========================
Harris Financial, Inc. 1997 Annual Report 43
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- - --------------------------------------------------------
All dollar amounts presented in the tables are in thousands.
(7) Real Estate (continued) Summaries of assets, liabilities and partners'
equity (deficit) of the partnerships and operations for the years ended December
31, 1997, 1996 and 1995 are as follows:
1997 1996 1995
------------------------------
Assets:
Cash ....................................... $ 46 $ 12 $ 72
Land, buildings and construction
in progress............................... 1,865 2,892 2,513
Other assets ............................... 132 372 538
------------------------------
Total assets ............................ $2,043 $3,276 $3,123
==============================
Liabilities and partners' deficit:
Mortgage loans payable to the Bank ......... $1,973 $3,104 $2,992
Other liabilities .......................... 914 706 847
------------------------------
Total liabilities ....................... 2,887 3,810 3,839
==============================
Partners' deficit:
HS Service Corporation ..................... (535) (423) (358)
Second Harrisburg Service Corporation ...... 86 116 0
Other ...................................... (395) (227) (358)
------------------------------
Total partners' deficit ................. (844) (534) (716)
------------------------------
Total liabilities and partners'
deficit ............................... $2,043 $3,276 $3,123
==============================
Operations of partnerships:
Real estate sales ....................... $708 $652 $425
Other income ............................ 53 8 34
------------------------------
761 660 459
Cost of sales .............................. (554) (387) (273)
Selling and other expenses ................. (226) (298) (320)
------------------------------
Net loss ................................ $(19) $(25) $(134)
==============================
(8) Premises and Equipment A summary of premises and equipment at December 31,
1997 and 1996 follows:
Estimated
1997 1996 Useful Lives
--------------------------------------------
Land ..................... $ 2,315 $2,315
Buildings and
improvements............ 13,051 11,706 5-50 years
Leasehold Improvements ... 2,313 2,126 5-10 years
Furniture and equipment .. 13,666 10,346 5-10 years
Automobiles .............. 142 164 3 years
Software ................. 2,628 1,783 3-5 years
Accumulated
depreciation ........... (15,393) (13,845)
--------------------------------------------
$ 18,722 $ 14,595
============================================
Depreciation expense for the years 1997, 1996, 1995 amounted to $1,551,000,
$1,216,000, and $934,000 respectively.
(9) Accrued Interest Receivable Accrued Interest receivable at December 31 is
summarized as follows:
1997 1996
---------------------
Government and other
securities................... $ 5,377 $5,530
Mortgage-backed securities .... 3,062 2,021
Loans receivable .............. 5,099 4,501
---------------------
$13,538 $12,052
=====================
44 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
--------------------------------------------------------
All dollar amounts presented in the tables are in thousands.
(10) Intangible Assets Harris Financial, Inc. (HFI), the holding company for
Harris Savings Bank, was organized in September, 1997. The $94,000 cost
associated with the holding company formation is being amortized over a five
year period. In November 1995, HFI and First Harrisburg Bancor, Inc. ("First
Harrisburg"), a local thrift institution, signed a definitive agreement for HFI
to acquire First Harrisburg. The acquisition, which was consummated on April 19,
1996, was a 100% cash purchase of all outstanding First Harrisburg common shares
at $14.77 per share, which resulted in a total cost of approximately $38
million, and was accounted for by HFI as a purchase transaction. As of April 19,
1996, First Harrisburg had total assets of approximately $276.6 million and
total liabilities of approximately $252.2 million. HFI recorded approximately
$13.8 million of goodwill upon consummation of this acquisition, which is being
amortized over a fifteen year period using the straight-line method.
Effective September 29, 1995, Harris Savings Bank completed an acquisition of
two banking offices located in Hagerstown, Maryland from Columbia First Bank.
The acquisition included the purchase of $126.0 million in deposit liabilities,
$115.4 million of cash and cash equivalents, and $.3 million in selected loans
and fixed assets. The acquisition was accounted for as a purchase and resulted
in a deposit premium of $10.4 million, which is being amortized over a seven
year period using the straight-line method.
The activity in intangible assets was as follows:
Deposit Organization
Premium Goodwill Costs Total
-------------------------------------------
Balance at December 31,
1995...................... $ 9,986 $ 0 $ 0 $ 9,986
Additions .................. 0 13,816 0 13,816
Amortization ............... (1,479) (628) 0 (2,107)
-------------------------------------------
Balance at December 31,
1996...................... $ 8,507 $13,188 $ 0 $21,695
Additions .................. 0 0 94 94
Amortization ............... (1,479) (908) (6) (2,393)
-------------------------------------------
Balance at December 31,
1997...................... $ 7,028 $12,280 $88 $19,396
===========================================
Accumulated amortization ... $ 3,332 $ 1,536 $ 6 $ 4,874
===========================================
(11) Deposits HFI pays deposit insurance premiums to the Savings Association
Insurance Fund ("SAIF") of the FDIC. HFI's deposit insurance premium rate was
.064% for 1997 and .23% for 1996 and 1995 of its assessed deposit base. This
resulted in total premiums assessed of $751,000, $2,261,000 and $2,115,000 in
1997, 1996 and 1995, respectively. In addition, on September 30, 1996, the
President signed into law the Deposit Insurance Funds Act of 1996 to
recapitalize the Savings Association Insurance Fund ("SAIF") administered by
the Federal Deposit Insurance Corporation ("FDIC") and to provide for repayment
of the Financial Institution Collateral Obligation bonds issued by the United
States Treasury Department. The FDIC levied a one-time special assessment on
SAIF deposits equal to 65.7 cents per $100 of the SAIF-assessable deposit base
as of March 31, 1995. The one-time special assessment amounted to an additional
expense to HFI of approximately $7.0 million in 1996.
Interest expense on deposits for the years ended December 31 is summarized
as follows:
1997 1996 1995
-------------------------------------
Money market .............. $ 5,309 $4,853 $ 3,036
Savings ................... 4,021 4,171 4,679
NOW ....................... 1,242 1,112 1,064
Certificates of
deposit (1).............. 43,760 45,615 37,871
Clubs ..................... 51 53 55
-------------------------------------
$54,383 $55,804 $46,705
=====================================
(1) On December 11, 1997, HFI participated in a brokered certificate of deposit
transaction with Merrill Lynch. The amount of the transaction was $25,000,000
with a maturity of 3 years. The certificates of deposit were issued in
denominations of less than $100,000.
(12) Other Borrowings Borrowed funds at December 31 are summarized as follows:
1997 1996
----------------------------
FHLB advances ........ $ 575,440 $ 419,146
Repurchase
agreements.......... 277,548 0
ESOP loan ............ 990 1,485
----------------------------
Total other
borrowings.......... $ 853,978 $ 420,631
============================
Pursuant to collateral agreements with the FHLB, advances are fully secured
by certain debt securities and qualifying first mortgage loans. There were
available lines of credit totaling $811,700,000 and $959,949,000 at December 31,
1997 and 1996, respectively.
In conjunction with the corporate reorganization and stock issuance
accomplished on January 25, 1994, as discussed in note (3), HFI borrowed
$2,475,000 from an unrelated local institution to fund the purchase of 742,500
shares of HFI stock. The purpose of this stock purchase was to establish HFI's
ESOP. The terms of the ESOP borrowing include five equal annual principal
installments of $495,000 beginning January 25, 1995 and on the last day of
January each year thereafter until retirement of the debt. Interest on the
borrowing accrues at the rate of 5.75% per annum and is payable monthly.
Harris Financial, Inc. 1997 Annual Report 45
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- - --------------------------------------------------------
All dollar amounts presented in the tables are in thousands.
(12) Other Borrowings (continued) During 1997 and 1996, HFI sold repurchase
agreements, the average balance of which was $165,371,000 and $22,855,000 for
the years ended December 31, 1997 and 1996, respectively. The highest month-end
balance outstanding was $284,440,500 and $54,605,000 during the years 1997 and
1996, respectively. The securities underlying the agreements were under HFI's
control.
At December 31, 1997, FHLB advances consisted of the following:
Weighted
Amount Average Rate Maturities
- - -------------------------------------------------------
$ 198,730 5.93% 1998
26,710 6.43% 1999
25,000 6.20% 2000
150,000 5.97% 2001
175,000 5.52% 2002
- - -------------------------------
$ 575,440 5.85%
===============================
Interest expense on other borrowings for the years ended December 31 is
summarized as follows:
1997 1996 1995
----------------------------------------
FHLB advances ....... $ 29,693 $ 10,040 $ 646
Repurchase
agreements......... 8,834 1,265 100
ESOP ................ 59 87 117
----------------------------------------
$ 38,586 $ 11,392 $ 863
========================================
(13) Restrictions Retained earnings are partially restricted in connection with
regulations related to the insurance of deposit accounts which require HFI to
maintain certain statutory reserves. HFI is required, by the Federal Reserve
Bank, to maintain cash reserves. At December 31, 1997, HFI's reserve requirement
was $6,758,000.
(14) Financial Instruments with Off-Balance Sheet Risk and Concentrations of
Credit Risk HFI issues financial instruments with off-balance sheet risk in the
normal course of business to meet the financial needs of its customers. These
financial instruments include commitments to extend credit and performance
standby letters of credit. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the balance sheet.
At December 31, 1997 and 1996, HFI had the following off-balance sheet risk
items:
1997 1996
------------------------
Commitments:
To extend credit:
Unused open-end consumer lines of
credit ................................. $ 37,017 $ 41,287
Unused open-end commercial lines of
credit.................................. 26,423 45,214
Funds available on construction loans .... 29,338 27,401
Loan originations and purchases .......... 23,380 18,677
To sell loans ............................... 12,098 9,053
To purchase marketable securities ........... 56,915 13,745
Performance standby letters of credit ....... 2,281 3,206
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
HFI evaluates each customer's credit worthiness on a case-by-case basis. The
amount of collateral obtained if deemed necessary by HFI upon extension of
credit is based on management's credit evaluation of the customer. Collateral
held includes residential and income-producing commercial properties.
Performance standby letters of credit are conditional commitments issued by
HFI to guarantee the performance of a customer to a third party. Those
guarantees are primarily issued to support public and private borrowing
arrangements, including commercial paper, bond financing and similar
transactions. The terms of the letters of credit vary from 6 months to 36 months
and may have renewal features. The credit risk involved in issuing letters of
credit is essentially the same as that involved in extending loans to customers.
HFI holds collateral supporting those commitments for which collateral is deemed
necessary.
Most of HFI's business activity is with customers located within HFI's
defined market area. HFI grants commercial, residential and consumer loans
throughout central Pennsylvania. Since the majority of the HFI's loan portfolio
is located in central Pennsylvania, a substantial portion of HFI's debtors'
ability to honor their contracts and increases or decreases in the market value
of the real estate collateralizing such loans may be significantly affected by
the level of economic activity in this area.
46 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
--------------------------------------------------------
All dollar amounts presented in the tables are in thousands.
(15) Employee Benefits HFI has a qualified non-contributory defined benefit
pension plan covering substantially all of its employees. Benefits are based on
years of service and the employee's average monthly pay using the five highest
years of employment. Contributions are intended to provide not only for benefits
attributed to service to date but also for those expected to be earned in the
future.
The following sets forth the plan's funded status and amounts recognized in
HFI's statement of financial condition at December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
----------------------------
Actuarial present value of benefit obligations:
<S> <C> <C>
Accumulated benefit obligation:
Vested ............................................... $ 7,082 $ 6,523
Non-vested ........................................... 142 123
----------------------------
7,224 6,646
Effect of projected future compensation ................. 2,575 2,502
----------------------------
Projected benefit obligation for service rendered
to date................................................ 9,799 9,148
Plan assets at fair value ............................... 12,192 10,999
----------------------------
Plan assets above projected benefit obligation .......... 2,393 1,851
Unrecognized net (gain) ................................. (2,033) (1,025)
Unrecognized prior service cost ......................... 180 195
Unrecognized net asset being amortized over 22 years .... (422) (461)
----------------------------
Prepaid pension costs ................................ $ 118 $ 560
============================
</TABLE>
The components of net pension expense for the years ended December 31, 1997,
1996 and 1995 are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---------------------------------
<S> <C> <C> <C>
Service cost benefits earned during the period ...................... $ 679 $ 591 $ 483
Interest cost on projected benefit obligation ....................... 652 593 558
Actual return on plan assets ........................................ (1,695) (1,335) (1,534)
Net amortization and deferral of gains and (losses) (1) ............. 807 527 845
---------------------------------
Net pension expense .............................................. $443 $376 $352
=================================
(1) This item is comprised of:
Current year's net asset gain deferred for later recognition ........ $ 837 $ 550 $ 869
Amortization of prior service cost .................................. 15 15 15
Amortization of unrecognized net asset or obligation at transaction . (38) (38) (39)
Amortization of net gain ............................................ (7) 0 0
---------------------------------
$ 807 $ 527 $ 845
=================================
</TABLE>
Assumptions used to develop the net pension cost were:
1997 1996 1995
-----------------------
Discount rate ............................. 7.5% 7.5% 7.0%
Expected long-term rate of return on assets 8.0% 8.0% 8.0%
Rate of increase in compensation levels ... 5.0% 5.0% 4.5%
Assets of HFI's qualified non-contributory defined benefit pension plan
consist primarily of U.S. Government securities, corporate bonds, and equity
securities.
HFI also has a defined contribution plan covering substantially all
employees. HFI will provide a matching contribution of 25% of employee
contributions to a maximum of 6% of employee compensation. Pension plan expense
related to the defined contribution plan was $93,000, $73,000, and $61,000 in
1997, 1996 and 1995, respectively.
In addition to pension benefits, HFI provides certain health care and
supplemental retirement benefits for retired employees. HFI accounts for these
postretirement benefits under the accrual method of accounting for
postretirement benefits other than pensions. The components of net periodic
postretirement benefit cost for the years ended December 31, 1997 and 1996 are
as follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------------------------
<S> <C> <C> <C>
Net periodic postretirement benefit cost:
Service cost .................................... $ 71 $ 120 $ 124
Interest cost ................................... 116 129 139
Amortization of unrecognized prior service
cost .......................................... (22) 4 (9)
----------------------------
Total net periodic postretirement benefit
cost........................................ $ 165 $ 253 $ 254
============================
</TABLE>
Harris Financial, Inc. 1997 Annual Report 47
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- - --------------------------------------------------------
All dollar amounts presented in the tables are in thousands.
(15) Employee Benefits (continued)
1997 1996
---------------
Accumulated postretirement benefit obligation:
Fully eligible active and former members .... $ 180 $ 345
Other active members ........................ 967 978
Retired members ............................. 573 414
---------------
1,720 1,737
Unrecognized net gain ....................... 577 623
---------------
Accumulated postretirement benefit obligation
recognized in the statement of
condition ................................ $2,297 $2,360
===============
The postretirement benefit obligation was determined using a discount rate of
7.5%. The assumed health care cost rate used in measuring the accumulated
postretirement benefit obligation was 7.5% in 1997, decreasing by 0.5% per year
to an ultimate rate of 5.5% in 2001 and thereafter over the projected period of
benefits.
The health care cost trend assumption has a significant impact on the amounts
reported. For example, a 1.0% increase in the health care trend rate would
increase the accumulated postretirement benefits obligation by approximately
$372,000 at December 31, 1997 and increase the aggregate of the service and
interest cost components by $53,000 for the year ended December 31, 1997.
(16) Employee Stock Ownership Plan On January 25, 1994, HFI established a
leveraged employee stock ownership plan (ESOP) for the benefit of substantially
all employees. HFI makes annual contributions to the ESOP equal to the ESOP's
debt service less dividends received on unearned shares. The ESOP shares
initially were pledged as collateral for its debt. As the debt is repaid, shares
are released from collateral and become eligible for allocation to employee
accounts. Actual ESOP share allocations to employee accounts are based on each
employee's relative portion of HFI's total eligible compensation recorded during
the year shares are earned. ESOP compensation expense was $1,633,000, $838,000
and $854,000 for 1997, 1996 and 1995, respectively.
HFI accounts for its ESOP in accordance with Statement of Position 93-6.
Accordingly, the debt of the ESOP is recorded as debt of HFI and the shares
pledged as collateral are reported as unearned ESOP shares in Harris Financial,
Inc.'s statement of condition. As shares are earned, HFI reports compensation
expense equal to the current market price of the shares, and the shares become
outstanding for earnings-per-share (EPS) computations. Dividends on allocated
ESOP shares are recorded as a reduction of retained earnings; dividends on
unallocated ESOP shares are recorded as a reduction of accrued interest.
The ESOP shares as of December 31, 1997, 1996 and 1995 were as follows:
1997 1996 1995
-----------------------------
Allocated shares ................................. 277,344 187,695 101,016
Shares released for allocation ................... 147,300 104,784 47,484
Earned shares not yet released for allocation .... 148,500 148,500 148,500
Shares distributed ............................... (25,135) (16,335) (4,521)
Unearned shares .................................. 148,500 297,000 445,500
-----------------------------
696,509 721,644 737,979
=============================
Fair value of unearned shares at December 31 ..... $ 2,951 $ 1,807 $ 2,970
=============================
(17) Stock Award and Option Plans HFI's stock award plans include the
Recognition and Retention Plan for Officers and Employees and the Recognition
and Retention Plan for Outside Directors (the "RRPs") which were established on
January 25, 1994 (note 3). The RRPs provide for the granting of restricted stock
awards to key employees and unrestricted stock awards to outside directors.
Restricted stock awards will vest only if HFI achieves certain financial goals
over one-year performance periods. Recipients of restricted and unrestricted
stock awards are not required to provide consideration to HFI other than
rendering service and have the right to vote the shares and receive dividends.
48 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
--------------------------------------------------------
All dollar amounts presented in the tables are in thousands.
(17) Stock Award and Option Plans (continued) The following table summarizes the
activity in HFI's RRPs during 1997, 1996 and 1995:
Restricted Unrestricted Shares in Total
Shares (1) Shares (1) Suspense (1) Shares (1)
-------------------------------------------------
Plan activity during 1995:
Unearned at December 31,
1994....................... 132,000 60,000 156,750 348,750
Earned .................... (29,775) (23,997) 0 (53,772)
-------------------------------------------------
Unearned at December 31,
1995....................... 102,225 36,003 156,750 294,978
Plan activity during 1996:
Earned .................... (29,775) (20,997) 0 (50,772)
-------------------------------------------------
Unearned at December 31,
1996....................... 72,450 15,006 156,750 244,206
Plan activity during 1997:
Forfeited ................... (16,875) 0 16,875 0
Awarded ..................... 0 4,500 (4,500) 0
Earned ...................... (36,225) (15,506) 0 (51,731)
-------------------------------------------------
Unearned at December 31,
1997....................... 19,350 4,000 169,125 192,475
=================================================
At the time of inception of the RRPs, the cost of the plan shares was
recorded as unearned compensation in stockholders' equity. As granted shares are
earned, compensation is charged to expense at market value (restricted shares)
or at cost (unrestricted shares), unearned compensation is reduced at share cost
($3.33 per share), thereby increasing stockholders' equity, and paid in capital
is increased by the appreciated portion of the restricted shares' market value.
HFI recorded compensation expense for earned RRP shares totaling $592,000,
$237,000 and $276,000 in 1997, 1996 and 1995, respectively.
HFI's stock option plans include the 1994 Incentive Stock Option Plan for
key employees and the 1994 Stock Option Plan for Outside Directors ("the Option
Plans") which were established on January 25, 1994 (note 3). Recipients of
options under the Option Plans are required to pay consideration to HFI to
exercise option shares as well as render service over the applicable vesting
periods. Recipients of options have no rights with respect to share voting or
receipt of dividends on unexercised option shares. Stock options under the
Option Plans vest over periods of one to five years, or at the time of certain
qualified events, and are exercisable within a ten-year period from the date
options become vested.
The Board of Directors has adopted the HFI 1996 Stock Option Plan ("the 1996
Stock Option Plan") and has reserved 75,000 shares of Common Stock for issuance
under the plan. This plan was approved by the stockholders at the annual meeting
of stockholders on April 16, 1996. Recipients of options under the 1996 Stock
Option Plan are required to pay consideration to HFI to exercise option shares
as well as render service over the applicable vesting periods. Recipients of
options have no rights with respect to share voting or receipt of dividends on
unexercised option shares. Stock options under the 1996 Stock Option Plan vest
over a period of three years, or at the time of certain qualified events, and
are exercisable within a ten-year period from the date the options become
vested.
The following table presents the activity in HFI's option plans during the
periods ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
-------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Number(1) Exercise Price(1) Number(1) Exercise Price(1) Number(1) Exercise Price(1)
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at beginning of year ..... 479,550 $3.41 482,550 $3.33 577,500 $3.33
Granted (forfeited) .............. (6,225)(2) $1.76 15,000 $5.65 0 $0.00
Exercised ........................ (141,200) $3.39 (18,000) $3.33 (94,950) $3.33
-------------------------------------------------------------------------------------
Balance at end of year ........... 332,125 $3.92 479,550 $3.41 482,550 $3.33
=====================================================================================
Exercisable at end of year 220,975 291,048 222,549
=====================================================================================
Weighted average grant date fair
value of options granted during
the year ...................... $3.93 $2.58 N/A
=====================================================================================
</TABLE>
(1) The number of shares granted under the Stock Option Plan and the weighted
average exercise price are adjusted for a three for one stock split (200% stock
dividend) that was effective November 18, 1998.
(2) Includes 39,750 forfeited shares.
Harris Financial, Inc. 1997 Annual Report 49
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- - --------------------------------------------------------
All dollar amounts presented in the tables, except for per share amounts,
are in thousands.
(17) Stock Award and Option Plans (continued) The following table presents the
options outstanding and exercisable at December 31, 1997:
<TABLE>
<CAPTION>
Exercise Price Exercise Price Exercise Price
$0 - $5 $5 - $10 $10 - $15 Total
-----------------------------------------------------------
Options Outstanding:
<S> <C> <C> <C> <C>
Number of options ......................... 287,100 36,025 9,000 332,125
Weighted average exercise price ........... $3.33 $6.60 $12.10 $3.92
Weighted average remaining contractual life 6 years 9 years 10 years 6 years
Options Exercisable:
Number of options ......................... 218,100 2,875 0 220,975
Weighted average exercise price ........... $3.33 $5.59 $0.00 $3.36
</TABLE>
HFI applies APB Opinion No. 25 and related interpretations in accounting for
its plans. Accordingly, no compensation cost has been recognized for its stock
option plans. Had compensation cost for HFI's 1996 stock option plan been
determined consistent with FASB Statement No. 123, HFI's net income and earnings
per share would have been reduced to the pro forma amounts indicated below:
1997 1996 1995
-----------------------------------
Net income
As reported ........... $17,771 $1,031 $9,214
Pro forma ............. $17,738 $1,027 $9,214
Basic earnings per share
As reported ........... $0.53 $0.03 $0.28
Pro forma ............. $0.53 $0.03 $0.28
Diluted earnings per share
As reported ........... $0.52 $0.03 $0.28
Pro forma ............. $0.52 $0.03 $0.28
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1997: dividend yield of 3.34 percent for all
years; expected volatility of 41.32 percent; risk-free interest rate of 5.60
percent; and expected lives of seven years. In 1996, the weighted average
assumptions for the model assumed a dividend yield of 3.36 percent for all
years, expected volatility of 38.21 percent, risk-free interest rate of 6.47
percent, and expected lives of seven years. The effects of applying SFAS No. 123
may not be representative of the effects on reported net income in future years.
(18) Income Taxes Income tax expense for the years ended December 31, 1997, 1996
and 1995 is summarized as follows:
1997 1996 1995
-------------------------------------
Federal:
Current ................. $6,905 $(2,192) $4,162
Deferred ................ (31) 1,803 836
-------------------------------------
6,874 (389) 4,998
State:
Current ................. 1,483 (3) 505
Deferred ................ (45) (125) 0
-------------------------------------
Income tax expense (benefit) $8,312 $ (517) $5,503
=====================================
Total income tax expense differed from the amounts computed by applying the
U.S. statutory income tax rate for the years ended December 31, 1997, 1996, and
1995 to income before income taxes as a result of the following:
<TABLE>
<CAPTION>
1997 1996 1995
----------------------------
<S> <C> <C> <C>
Expected income tax expense at federal tax rate ....... $9,129 $ 180 $5,151
State tax expense (benefit) net of federal income taxes 979 (165) 328
Tax-exempt interest income ............................ (2,013) (809) 0
Amortization of goodwill .............................. 318 220 0
Dividends received deduction .......................... (1,501) (423) (238)
Non-deductible employee stock option plan expense ..... 399 120 126
Interest disallowance ................................. 306 240 240
Other, net ............................................ 695 120 (104)
----------------------------
Total .............................................. $8,312 $(517) $5,503
============================
</TABLE>
50 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
--------------------------------------------------------
All dollar amounts presented in the tables are in thousands.
(18) Income Taxes (continued) On April 19, 1996, HFI acquired First Harrisburg
Bancor in a tax free acquisition. As a result of this acquisition, HFI has
approximately $3,355,000 of net operating loss carryforwards available for state
tax purposes as of December 31, 1997. $1,348,000 of the net operating loss
carryforward will expire on December 31, 1998 if not utilized, while $2,007,000
will expire on December 31, 1999 if not utilized.
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1997 and 1996 are presented below.
<TABLE>
<CAPTION>
1997 1996
-------------------
<S> <C> <C>
Deferred tax assets:
Reserve for uncollected interest ................................... $ 5 $ 326
Deferred compensation expense ...................................... 493 639
Postretirement benefits expense .................................... 928 826
Excess loan servicing fees ......................................... 107 290
Allowance for loan losses .......................................... 2,973 2,884
Deposit intangible amortization .................................... 622 346
Accrued severance costs ............................................ 251 0
Investment premium amortization .................................... 266 0
Stock-based compensation expense ................................... 180 82
State tax net operating loss carry-forward ......................... 281 245
Other .............................................................. 375 212
-------------------
Total ........................................................... 6,481 5,850
-------------------
Deferred tax liabilities:
Deferred loan costs and dealer reserves, net ....................... $ 3,834 $ 2,501
Pension expense .................................................... 41 196
Prepaid expenses ................................................... 323 210
Depreciation ....................................................... 444 160
Net unrealized gain on marketable securities
available for sale .............................................. 6,837 2,178
Deferred depreciation and amortization on acquisition related assets 383 690
Originated mortgage servicing rights ............................... 1,056 784
Excess tax bad debt reserves over base year ........................ 1,827 2,314
Other .............................................................. 15 74
-------------------
Total ........................................................... 14,760 9,107
-------------------
Net deferred tax liability .................................... $(8,279) $(3,257)
====================
</TABLE>
Management has determined that it is not required to establish a valuation
reserve for its gross deferred tax assets of $6.5 million since it is more
likely than not that the deferred tax assets will be realized through future
reversals of existing temporary differences, future taxable income, and
implementation of prudent tax planning strategies.
(19) Leases At December 31, 1997, HFI was obligated under non-cancelable
operating leases for office space. Certain leases contain escalation clauses
providing for increased rentals based on increases in the average consumer price
index. Rental expenses for these facilities aggregated $1,022,000, $836,000, and
$494,000 for 1997, 1996 and 1995, respectively.
The projected minimum rental payments under the terms of the leases at
December 31, 1997, net of projected sub-lease rentals, are as follows:
Years ending December 31 Amount
- - -------------------------------------------
1998 .............................. $906
1999 .............................. 862
2000 .............................. 861
2001 .............................. 871
2002 .............................. 821
2003 and thereafter ............... 4,886
------
$9,207
======
(20) Fair Value Accounting Harris Financial, Inc. is required to disclose the
fair value of its financial instrument assets and liabilities. For HFI, as for
most financial institutions, the majority of its assets and liabilities are
considered financial instruments as defined in SFAS 107. Many of HFI's financial
instruments, however, lack an available trading market as characterized by a
willing buyer and willing seller engaging in an exchange transaction. Since it
is HFI's general practice not to engage in trading activities, significant
assumptions and estimations were used in calculating present values in
discounted cash flow models.
Harris Financial, Inc. 1997 Annual Report 51
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- - --------------------------------------------------------
All dollar amounts presented in the tables are in thousands.
(20) Fair Value Accounting (continued) Estimated fair values at December 31,
1997 and 1996 have been determined by HFI using the best available data, as
generally provided in Harris Savings Bank's "call report" as submitted to the
FDIC with an estimation methodology suitable for each category of financial
instrument.
Fair value estimates, methods, and assumptions are set forth below for HFI's
financial instruments.
Cash and Cash Equivalents The carrying amounts for short-term investments
approximate fair value because of the short maturity of, and negligible credit
concerns within, those instruments.
1997 1996
---------------------------------------------
Estimated Carrying Estimated Carrying
Fair Value Amount Fair Value Amount
---------------------------------------------
Cash and cash equivalents ..... $24,466 $24,466 $29,693 $29,693
Marketable Securities (including available-for-sale securities) The fair
value of marketable securities actively traded in the secondary market have been
valued based on quotations received from securities dealers.
1997 1996
------------------------------------------------
Estimated Amortized Estimated Amortized
Fair Value Cost Fair Value Cost
------------------------------------------------
Securities held-to-maturity . $ 97,545 $ 96,412 $109,912 $109,417
Securities available-for-sale 1,102,782 1,085,214 719,493 713,700
------------------------------------------------
$1,200,327 $1,181,626 $829,405 $823,117
================================================
Deposit, Escrow, and Other Borrowings Under SFAS 107, the fair value of
deposits with no stated maturity, such as demand deposit accounts, NOW accounts,
money market accounts and savings accounts, is equal to the amount payable on
demand. The fair value of time deposits and other borrowings is based on the
discounted value of contractual cash flows. The discount rate is estimated using
the rates currently offered for deposits of similar remaining maturities. The
fair value of escrow, which has no stated maturity, is equal to the amount on
deposit. The fair value of other borrowings is estimated using current rates for
debt with similar terms and remaining maturities:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------
Estimated Carrying Estimated Carrying
Fair Value Amount Fair Value Amount
-------------------------------------------------
<S> <C> <C> <C> <C>
Demand and NOW accounts ........... $ 100,703 $ 100,703 $ 84,715 $ 84,715
Money market accounts ............. 128,079 128,079 129,096 129,096
Savings ........................... 148,718 148,718 150,019 150,019
Time deposits ..................... 767,668 768,738 804,247 809,593
-------------------------------------------------
$1,145,168 $1,146,238 $1,168,077 $1,173,423
=================================================
Escrow ............................ $ 8,552 $ 8,552 $ 8,203 $ 8,203
=================================================
Other borrowings $ 846,025 $ 853,978 $ 408,321 $ 420,631
=================================================
</TABLE>
Loans Fair values are estimated for portfolios of loans with similar
characteristics. Residential mortgages make up a substantial percentage of HFI's
loan portfolio. These residential mortgages, which are generally underwritten to
standards substantially in conformity with Federal Home Loan Mortgage
Corporation ("Freddie Mac") standards, have been estimated based on the
discounted value of expected cash flows.
Construction loans are of relatively short maturity and have an estimated
fair value equal to the carrying value. Fair values for all other loans have
been calculated by discounting scheduled cash flows. The discount rate used in
these calculations is the market rate for similar instruments adjusted for
non-interest operating costs, credit risk and assumed prepayment risk.
<TABLE>
<CAPTION>
1997 1996
---------------------------------------------------
Estimated Carrying Estimated Carrying
Fair Value Amount Fair Value Amount
---------------------------------------------------
<S> <C> <C> <C> <C>
One-to-four family mortgages ... $546,080 $539,248 $527,618 $530,230
Construction loans ............. 35,209 35,209 25,647 25,647
Other loans .................... 337,690 324,641 273,727 276,361
Less: Allowances for loan losses 0 (8,614) 0 (8,322)
---------------------------------------------------
$918,979 $890,484 $826,992 $823,916
===================================================
</TABLE>
52 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
--------------------------------------------------------
All dollar amounts presented in the tables, except for per share amounts,
are in thousands.
(20) Fair Value Accounting (continued)
Commitments to Extend Credit and Performance Standby Letters of Credit The
fair value of commitments to extend credit is estimated using the fees currently
charged to enter into similar agreements, taking into account the remaining
terms of the agreements, taking into account the remaining terms of the
agreements and present creditworthiness of the counterparties. For fixed rate
loan commitments, fair value also considers the difference between current
levels of interest rates and the committed rates. The fair value of performance
standby letters of credit is based on fees currently charged for similar
agreements or on the estimated cost to terminate them or otherwise settle the
obligations with the counterparties.
<TABLE>
<CAPTION>
1997 1996
-----------------------------------------------------------------
Contract Carrying Estimated Contract Carrying Estimated
Amount Amount(1) Fair Value Amount Amount(1) Fair Value
-----------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Commitments:
Commitments to extend credit:
Unused open-end consumer lines of credit . $37,017 $0 $0 $41,287 $0 $0
Unused open-end commercial lines of credit 26,423 0 0 45,214 0 0
Funds available on construction loans .... 29,338 850 850 27,401 822 822
Loan originations and purchases .......... 23,380 510 510 18,677 206 206
Performance standby letters of credit .... 2,281 2 2 3,206 3 3
-----------------------------------------------------------------
$118,439 $1,362 $1,362 $135,785 $1,031 $1,031
=================================================================
Commitments to sell loans ................... $12,098 $0 $0 $9,053 $0 $0
Commitments to purchase securities .......... $56,915 $0 $0 $13,745 $0 $0
</TABLE>
(1) The amounts shown under "carrying amount" represent accruals or deferred
income arising from these unrecognized financial instruments.
Limitations Fair value estimates are made at a specific point in time, based
on relevant market information and information about the financial instruments.
These estimates do not reflect any premium or discount that could result from
offering for sale at one time the HFI's entire holdings or of a particular
financial instrument. Because no market exists for a significant portion of the
HFI's financial instruments, fair value estimates are based on judgments
regarding future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and therefore cannot be determined with precision. Changes
in assumptions could significantly affect the estimates. Management is concerned
that reasonable comparability between financial institutions may not be likely
due to the wide range of permitted valuation techniques and the estimates and
assumptions that must be made.
(21) New Accounting Standards In June 1997, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 130 (SFAS 130),
"Reporting Comprehensive Income" SFAS 130 is effective for fiscal years
beginning after December 15, 1997. SFAS 130 requires that comprehensive income
be reported in a financial statement and be displayed with same prominence as
other financial information. Comprehensive income, as defined by SFAS 130, is
the total of net income and all other non-owner changes in equity. The
implementation of SFAS 130 will not have an impact on the operating results of
HFI.
(22) Acquisitions On April 19, 1996, Harris Financial, Inc. (HFI) acquired First
Harrisburg Bancor, Inc. ("First Harrisburg"), a local thrift institution. The
acquisition was 100% cash purchase of all outstanding First Harrisburg common
shares at $ 14.77 per share, which resulted in a total cost of approximately $38
million, and was accounted for by Harris Financial, Inc. (HFI) as a purchase
transaction. As of April 19, 1996, First Harrisburg had total assets of
approximately $276.6 million and total liabilities of approximately $252.2
million. HFI recorded approximately $13.8 million of goodwill upon consummation
of this acquisition, which is being amortized over a fifteen year period using
the straight-line method. The net effect on income before taxes of goodwill and
purchase accounting amortization was $(328,000) for the year ended December 31,
1996.
The following unaudited pro forma financial information presents the combined
results of operations of HFI and First Harrisburg Bancor as if the acquisition
had occurred as of the beginning of 1996 and 1995, after giving effect to
certain adjustments, including amortization of goodwill and related income tax
effects. The pro forma financial information does not necessarily reflect the
results of operations that would have occurred had HFI and First Harrisburg
Bancor constituted a single entity during such periods.
For the years ended December 31,
--------------------------------
1996 1995
--------------------------------
(unaudited)
Interest income ............. $114,983 $104,321
Net (loss) income ........... $(551) $ 11,583
=================================
(Loss) earnings per share ... $ (0.05) $ 1.05
=================================
Harris Financial, Inc. 1997 Annual Report 53
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- - --------------------------------------------------------
All dollar amounts presented in the tables, except for per share amounts,
are in thousands.
(23) Mortgage Banking Subsidiary In conjunction with the acquisition of First
Harrisburg, HFI acquired Avstar Mortgage Corporation, a mortgage banking
company. The condensed financial statements of this subsidiary are presented
below.
At December 31,
------------------------
1997 1996
------------------------
Assets
Cash and cash equivalents $ 4,438 $ 5,114
Loans receivable ........ 294 235
Loans held for sale ..... 12,931 6,894
Other Assets ............ 2,530 1,262
------------------------
Total assets ............ $20,193 $13,505
========================
Liabilities and Stockholder's Equity
Escrow ................................... 3,809 4,192
Other borrowings ......................... 14,044 7,000
Other liabilities ........................ 431 376
Stockholder's equity ..................... 1,909 1,937
---------------------
Total liabilities and stockholder's equity $20,193 $13,505
=====================
For the years ended December 31,
--------------------------------
1997 1996 1995
--------------------------------
Interest income .......... $2,088 $2,499 $2,954
Interest expense ......... 497 629 797
--------------------------------
Net interest income ...... 1,591 1,870 2,157
Provision for loan losses 0 265 115
Non-interest income ...... 2,628 3,305 3,118
Non-interest expense ..... 4,261 4,649 4,792
--------------------------------
Income (loss) before taxes (42) 261 368
Income tax expense ....... (14) 108 118
--------------------------------
Net income/(loss) ........ $ (28) $ 153 $ 250
================================
(24) Earnings Per Share The following tables show the allocation of earnings per
share to basic earnings per share and diluted earnings per share.
<TABLE>
<CAPTION>
Per Share
Income Shares Amount
-------------------------------------
<S> <C> <C> <C>
For the year ended December 31, 1997
Basic earnings per share:
Income available to common shareholders ................... $17,771,000 33,779,379 $0.53
-------------------------------------
Options held by management and directors .................. 296,682
-------------------------------------
Diluted earnings per share:
Income available to common shareholders
plus assumed conversions ................................ $17,771,000 34,076,061 $0.52
=====================================
For the year ended December 31, 1996
Basic earnings per share:
Income available to common shareholders ................... $1,031,000 33,027,744 $0.03
-------------------------------------
Options held by management and directors .................. 240,891
-------------------------------------
Diluted earnings per share:
Income available to common shareholders
plus assumed conversions ................................ $1,031,000 33,268,635 $0.03
=====================================
For the year ended December 31, 1995
Basic earnings per share:
Income available to common shareholders ................... $9,214,000 32,724,609 $0.28
-------------------------------------
Options held by management and directors .................. 319,140
-------------------------------------
Diluted earnings per share:
Income available to common shareholders
plus assumed conversions ................................ $9,214,000 33,043,749 $0.28
=====================================
</TABLE>
Basic earnings per common share were computed by dividing net income by the
weighted average number of shares of common stock outstanding for the year.
Diluted earnings per common share were computed by dividing net income by the
sum of the weighted average number of common shares outstanding, plus the amount
of shares outstanding assuming the conversion of stock options. The adoption of
SFAS 128 had no effect on the earnings per share amounts for the years ending
December 31, 1996 and 1995.
54 Harris Financial, Inc. 1997 Annual Report
<PAGE>
Harris Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
--------------------------------------------------------
All dollar amounts presented in the tables, except for per share amounts,
are in thousands.
(25) Harris Financial Corporation (Parent Company Only) Financial Information
Consolidated
Balance Sheet (unaudited) December 31, 1997
- - -----------------------------------------------------------
Assets:
Cash ......................................... $ 86
Marketable securities available-for-sale ..... 9,619
Investment in bank subsidiary ................ 169,144
Other assets ................................. 264
--------
Total assets ................................. $179,113
========
Liabilities:
Accounts payable and other liabilities .... $ 79
Shareholders' equity ......................... 179,034
--------
Total liabilities and shareholders' equity ... $179,113
========
Consolidated Statements Year Ended
of Income (unaudited) December 31, 1997
- - ---------------------------------------------------------
Income:
Interest income .......................... $ 73
--------
Total income ................................ 73
Expense:
Other expense ............................ 89
--------
Net loss before equity in
undistributed net income of subsidiaries . (16)
--------
Equity in undistributed net income
of subsidiaries ........................ 2,755
--------
Net income .................................. $ 2,739
========
Consolidated Statement Year Ended
of Cash Flows (unaudited) December 31, 1997
- - ---------------------------------------------------------
Cash flows from operating activities:
Net income ............................... $ 2,739
Adjustments to reconcile net income to net
cash provided by operating activities:
Undistributed earnings of subsidiary . (2,755)
(Increase) in other assets ........... (264)
Increase in other liabilities ........ 79
Total adjustments .................. (2,940)
----------
Net cash provided by operating activities ... (201)
Cash flows from investing activities:
Purchase of available-for-sale
securities, net ........................ (9,713)
Net cash used in investing activities ....... (9,713)
Dividends paid ............................. (456)
Dividends received .......................... 10,456
----------
Net cash provided by financing activities: .. 10,000
Net increase in cash ..................... 86
Cash at the beginning of the period ........ 0
----------
Cash at the end of the period ............... $ 86
==========
The statements of income and cash flows presented above reflect the activity of
the parent company level from the date of formation on September 17, 1997
through December 31, 1997.
(26) Consolidated Quarterly Data (unaudited)
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------------------------------------
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest Income .................... $31,454 $34,848 $37,376 $37,389 $21,851 $26,818 $28,251 $31,068
Interest Expense ................... 19,921 22,410 24,855 25,899 13,421 15,985 18,226 19,694
-------------------------------------------------------------------------------------
Net Interest Income ............. 11,533 12,438 12,521 11,490 8,430 10,833 10,025 11,374
Provision for loan loss ............ 152 153 153 152 210 210 942 595
Non-interest income ................ 3,275 3,443 4,310 3,531 248 1,824 1,681 243
Non-interest expense ............... 7,657 8,234 8,838 11,119 5,705 12,096 16,099 8,287
-------------------------------------------------------------------------------------
Income (loss) before income taxes 6,999 7,494 7,840 3,750 2,763 351 (5,335) 2,735
Income taxes (benefit) ............. 2,290 2,429 2,582 1,011 1,052 166 (1,940) 205
-------------------------------------------------------------------------------------
Net Income (loss) ............... $4,709 $5,065 $5,258 $2,739 $1,711 $185 $(3,395) $ 2,530
=====================================================================================
Earnings per share basic ........... $0.14 $0.15 $0.16 $0.08 $0.05 $0.01 $(0.10) $0.07
Earnings per share (diluted) ....... $0.14 $0.15 $0.15 $0.08 $0.05 $0.01 $(0.10) $0.07
=====================================================================================
</TABLE>
Harris Financial, Inc. 1997 Annual Report 55
OFFICE LOCATIONS
- - -------------------------------------------------------------------------------
PENNSYLVANIA OFFICES (Area Code 717)
Cumberland County
* 19th and Market Streets, Camp Hill 761-4460
Capital City Mall, Camp Hill 761-7218
* 3100 Market Street, Camp Hill 737-0457
* 4075 Market Street, Camp Hill 730-8626
Camp Hill Mall, Camp Hill 737-2323
* Summerdale Plaza, Enola 732-3637
West Shore Plaza, Lemoyne 761-7810
17 W. High Street, Carlisle 243-2915
* 921 Cavalry Road, Carlisle 243-8868
* 600 E. Simpson Street, Mechanicsburg 697-4603
Silver Spring Commons, Mechanicsburg 766-3100
Dauphin County
* 235 N. Second Street, Harrisburg (Main Office) 236-4041
* 526 S. 29th Street, Harrisburg 238-9720
Beaufort Farms Plaza, Harrisburg 652-0900
Colonial Park Mall, Harrisburg 545-4791
Festival Foods o Swatara Square, 6301 Grayson Road, Harrisburg
The Point Mall, Harrisburg 564-1470
* Paxton Square, Harrisburg 541-8360
* 114 W. Chocolate Avenue, Hershey 533-5500
* Hershey Square, 1161 Mae Street, Hummelstown 566-3800
Lancaster County
100 E. King Street, Lancaster 393-0705
* 1677 Oregon Pike, Lancaster 291-1072
9 S. Market Street, Elizabethtown 367-8973
36 E. Main Street, Ephrata 733-8635
33 Market Square, Manheim 665-7754
* 335 Fifth Street, Quarryville 786-4800
Lebanon County
Lebanon Plaza, Lebanon 273-8194
York County
* 2450 Eastern Boulevard, York 757-9417
Queensgate Shopping Center, York 843-4854
* Newberry Commons, Etters 938-5900
* Fairview Plaza, New Cumberland 774-4555
MARYLAND (Area Code 301)
Washington County
100 W. Washington Street, Hagerstown 739-1001
* Longmeadow Shopping Center, Hagerstown 739-1000
* Drive-in window
LOAN CENTERS
235 N. Second Street, Harrisburg (717) 231-2900
2017 Linglestown Road, Harrisburg (717) 652-4797
Paxton Square, Harrisburg (717) 657-0387
114 W. Chocolate Avenue, Hershey (717) 533-0989
4075 Market Street, Camp Hill (717) 730-0844
2500 Kingston Road, York (717) 757-9481
17 W. High Street, Carlisle (717) 243-6403
1677 Oregon Pike, Lancaster (717) 397-4338
100 W. Washington Street, Hagerstown (301) 739-1001
ATM LOCATIONS
Camp Hill Mall, Camp Hill
Capital City Mall, Camp Hill
921 Cavalry Road, Carlisle
Summerdale Plaza, Enola
Newberry Commons, Etters
234 N. Second Street, Harrisburg
Colonial Park Mall, Harrisburg
Festival Foods o Swatara Square, 6301 Grayson Road, Harrisburg
Paxton Square, Harrisburg
The Point Mall, Harrisburg
Hershey Square, 1161 Mae Street, Hummelstown
1677 Oregon Pike, Lancaster
Willow Valley Market, Lancaster
Lebanon Plaza, Lebanon
600 E. Simpson Street, Mechanicsburg
335 Fifth Street, Quarryville
2450 Eastern Boulevard, York
100 W. Washington Street, Hagerstown
Longmeadow Shopping Center, Hagerstown
Turkey Hill o 101 South Main Street, Manheim
Turkey Hill o 111 Rothsville Road, Ephrata
Turkey Hill o Route 230 & Cloverleaf Road, Elizabethtown
IMPORTANT PHONE NUMBERS
Harris Access Line(TM)
In Harrisburg, Pennsylvania area ................... 731-1135
Other areas ........................................ 1-800-327-7997
Telephone Banking Center ........................... 1-800-232-6995
Loan Servicing ..................................... 1-800-554-4572
Business Banking Group ............................. (717) 232-6661
INTERNET ADDRESS
http://www.harrissavingsbank.com
56 Harris Financial, Inc. 1997 Annual Report
<PAGE>
STOCKHOLDER INFORMATION
EXECUTIVE OFFICE
235 N. Second Street, Harrisburg, Pennsylvania 17101
(717) 236-4041
ANNUAL MEETING
The annual meeting of Harris Financial, Inc. will be held at 10:00 a.m.,
Tuesday, April 21, 1998, at Zembo Temple, Third and Division Streets,
Harrisburg, Pennsylvania.
10-K REPORT
Upon the written request of any shareholder, a copy of the Corporation's Form
10-K for the year ended December 31, 1997, including the Financial Statements
and Schedules thereto, required to be filed with the SEC pursuant to the
Securities Exchange Act of 1934, as amended, may be obtained, without charge,
from James L. Durrell, Chief Financial Officer, Harris Financial, Inc., 235 N.
Second Street, P.O. Box 1711, Harrisburg, PA 17105.
INTERNAL CONTROLS
Management's letter on internal controls is included in this report on page 29.
STOCK LISTING
The Corporation's common stock trades on the NASDAQ Stock Market under the
symbol "HARS."
MARKET MAKERS
The following investment-brokerage houses make a market in Harris Financial,
Inc.'s stock: Ryan Beck & Co.; Legg Mason; Sandler O'Neill & Partners; F.J.
Morrissey & Co., Inc.; Friedman, Billings, Ramsey & Co., Inc.; Boenning &
Scattergood, Inc.; Capital Resources, Inc.; Fahnestock & Co., Inc.
REGISTRAR AND TRANSFER AGENT
ChaseMellon Shareholder Services L.L.C.
Overpeck Centre
85 Challenger Road
Ridgefield Park, New Jersey 07660
ACCOUNTANTS
Arthur Andersen LLP
Suite 301
1869 Charter Lane
Lancaster, PA 17601
STOCKHOLDERS
The number of common stock stockholders of record as of December 31, 1997 was
3,730.
PRICE RANGE OF HARRIS FINANCIAL, INC. STOCK AND DIVIDENDS PAID
The price information provided below reflects actual high and low closing prices
as quoted on the NASDAQ Stock Market.
Cash Dividends
1997 High Low Paid Per Share
- - ------------------------------------------------------------
First Quarter 7 37/64 6 5/64 $.0483
Second Quarter 7 11/64 6 3/64 $.0483
Third Quarter 16 27/64 7 $.0483
Fourth Quarter 21 1/2 15 43/64 $.0550
Cash Dividends
1996 High Low Paid Per Share
- - ------------------------------------------------------------
First Quarter 6 48/64 5 59/64 $.0483
Second Quarter 6 16/64 5 $.0483
Third Quarter 5 43/64 4 59/64 $.0483
Fourth Quarter 6 13/64 5 $.0483
DIVIDEND REINVESTMENT PLAN
The Dividend Reinvestment Plan offers you a simple and inexpensive way to
increase your investment in Harris Financial, Inc. common stock through the
automatic investment of your dividends in additional shares of Harris Financial,
Inc. common stock under the plan.
Harris Financial, Inc. 1997 Annual Report 57
<PAGE>
