<PAGE>
Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly period ended March 31, 1999
OR
[_] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________ to___________________________
Commission File Number: 0-22399
HARRIS FINANCIAL, INC.
- ----------------------
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2889833
- ------------ ----------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
235 North Second Street PO Box 1711, Harrisburg, Pennsylvania 17105
- ------------------------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(Registrant's telephone number, including area code) 717-236-4041
------------
- --------------------------------------------------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No _____.
-----
Indicate the number of shares outstanding of each of the Bank's classes of
common stock, as of the latest practicable date 33,584,200 shares of stock, par
-------------------------------
value of $.01 per share, outstanding at April 30, 1999.
- ------------------------------------------------------
Page 1
<PAGE>
Part I. Financial Information.
Part 1, Item 1 Financial Statements.
(Balance of this page is left intentionally blank.)
Page 2
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------ ------------
<S> <C> <C>
Assets
- ------
Cash and cash equivalents $ 60,082 $ 56,741
Marketable securities available for sale (Note 2) 1,245,598 1,274,837
Loans receivable, net 1,134,676 1,051,642
Loans held for sale, net 11,618 14,418
Loan servicing rights 10,718 10,996
Real estate investments 6,497 7,262
Premises and equipment, net of accumulated
depreciation of $ 17,926 and $ 17,230 22,029 21,614
Accrued interest receivable 15,192 15,523
Income taxes receivable - 635
Intangible assets 16,309 16,909
Other assets 14,712 26,892
------------ ------------
Total assets $ 2,537,431 $ 2,497,469
============ ============
Liabilities and Stockholders' Equity
- ------------------------------------
Deposits $ 1,224,184 $ 1,205,379
Escrow 11,693 7,906
Accrued interest payable 12,338 6,965
Postretirement benefit obligation 2,841 2,452
Other borrowings (Note 3) 1,064,520 1,069,254
Deferred tax liability 5,258 5,472
Income taxes payable 564 -
Other liabilities 22,684 10,071
------------ ------------
Total Liabilities $ 2,344,082 $ 2,307,499
------------ ------------
Common stock, $ .01 par value, authorized 100,000,000 shares
34,003,500 shares issued and 33,594,200 outstanding at March 31, 1999,
33,993,500 shares issued and 33,584,200 shares outstanding at December 31, 1998
(Note 6) $ 340 $ 340
Paid in capital 30,069 29,960
Retained earnings 162,841 158,386
Other comprehensive income 6,896 8,106
Employee stock ownership plan (371) (396)
Recognition and retention plans (456) (456)
Treasury Stock 409,3000 shares (Note 9) (5,970) (5,970)
------------ ------------
Total stockholders' equity 193,349 189,970
------------ ------------
Total liabilities and stockholders' equity $ 2,537,431 $ 2,497,469
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
Page 3
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(in thousands, except for per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
------------------------------
Interest Income: 1999 1998
---------- ----------
<S> <C>
Loans Receivable:
First mortgage loans $ 11,970 $ 12,340
Commercial 4,255 2,199
Consumer and other loans 5,681 4,707
Taxable investments 7,998 7,435
Taxfree investments 1,583 1,534
Dividends 2,226 2,245
Mortgage backed securities 7,979 9,928
Money market securities 16 19
---------- ----------
Total Interest Income 41,708 40,407
---------- ----------
Interest Expense:
Deposits 12,470 12,980
Borrowed funds (Note 3) 14,092 13,312
Escrow 25 17
---------- ----------
Total interest expense 26,587 26,309
---------- ----------
Net interest income 15,121 14,098
Provision for loan losses 795 830
---------- ----------
Net int. inc. after provision for loan losses 14,326 13,268
---------- ----------
Non-interest income:
Service charges on deposits 1,233 936
Other svc. charges/commissions/fees 324 179
Net servicing income - (54)
Gain on sale of securities, net 1,353 2,384
Gain on sale of loans, net 1,172 1,074
Other (61) 409
---------- ----------
Total non-interest income 4,021 4,928
---------- ----------
Non-interest expense:
Salaries and benefits 5,772 5,335
Equipment expense 962 679
Occupancy expense 802 729
Advertising and public relations 483 492
FDIC insurance 169 179
Director fees 83 76
Income from real estate operations (216) (161)
Amortization of intangibles and write-offs 600 605
Other 2,937 1,889
---------- ----------
Total non-interest expense 11,592 9,823
---------- ----------
Income before income taxes 6,755 8,373
Income tax expense 1,822 2,624
---------- ----------
Net Income $ 4,933 $ 5,749
========== ==========
Basic earnings per share (Note 6) $ 0.15 $ 0.17
========== ==========
Diluted earnings per share (Note 6) $ 0.15 $ 0.17
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements
Page 4
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Other Employee Recognition
Compre- Stock And
Common Paid in Retained hensive Ownership Retention Treasury
Stock Capital Earnings Income Plan Plan Stock Total
--------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1998 $ 338 $ 28,016 $ 141,043 $ 10,732 $ (529) $ (566) $ - $ 179,034
Net income 5,749 5,749
Dividends paid at $.055 per
share (437) (437)
Exercised stock options 1 503 504
Unrealized gains on
securities (1) (1,647) (1,647)
Comprehensive income
ESOP stock committed for
release 58 58
Earned portion of RRP plan 35 35
Excess of fair value above
cost of ESOP stock committed
for release 289 289
Excess of fair value above
cost of earned portion of RRP
stock 173 173
--------------------------------------------------------------------------------------------
Balance at March 31, 1998 $ 339 $ 28,981 $ 146,355 $ 9,085 $ (471) $ (531) $ - $ 183,758
============================================================================================
Balance at January 1, 1999 340 29,960 158,386 8,106 (396) (456) (5,970) 189,970
Net income 4,933 4,933
Dividends paid at $.06 per
share (478) (478)
Exercised stock options 33 33
Unrealized gains on
securities (1) (1,210) (1,210)
Comprehensive income
ESOP stock committed for
release 25 25
Excess of fair value above
cost of
ESOP stock committed for
release 76 76
--------------------------------------------------------------------------------------------
Balance at March 31, 1999 $ 340 $ 30,069 $ 162,841 $ 6,896 $ (371) $ (456) $ (5,970) $ 193,349
============================================================================================
<CAPTION>
Compre-
hensive
Income
------------
<S> <C>
Balance at January 1, 1998
Net income $ 5,749
Dividends paid at $.055 per
share
Exercised stock options
Unrealized gains on
securities (1) (1,647)
------------
Comprehensive income $ 4,102
============
ESOP stock committed for
release
Earned portion of RRP plan
Excess of fair value above
cost of ESOP stock committed
for release
Excess of fair value above
cost of earned portion of RRP
stock
Balance at March 31, 1998
Balance at January 1, 1999
Net income 4,933
Dividends paid at $.06 per
share
Exercised stock options
Unrealized gains on
securities (1) (1,210)
------------
Comprehensive income $ 3,723
============
ESOP stock committed for
release
Excess of fair value above
cost of
ESOP stock committed for
release
Balance at March 31, 1999
</TABLE>
(1) Net of reclassification adjustment and net of tax effect of $(784) and
($1,110) for 1999 and 1998, respectively.
See accompanying notes to consolidated financial statements.
Page 5
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net Income $ 4,933 $ 5,749
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 795 830
Net depreciation, amortization, and accretion. 1,286 2,768
Decrease (increase) in loans held for sale 3,526 (4,833)
Net gain on sales of interest earning assets (2,525) (3,458)
Gain on sale of foreclosed real estate (123) (1)
Equity losses/(income) from joint ventures 57 (4)
Decrease (increase) in accrued interest receivable 331 (1,968)
Increase in accrued interest payable 5,373 6,626
Amortization and write-off of intangibles 600 605
Earned ESOP shares 101 347
Earned RRP shares - 208
Provision for deferred income taxes 559 (452)
Decrease in income taxes receivable 1,199 6,104
Other, net 12,244 (4,035)
------------ ------------
Net cash provided by operating activities 28,356 8,486
------------ ------------
Cash flows from investing activities:
Proceeds from maturities and principal reductions of marketable
securities:
Held to Maturity - 1,032
Available-for-sale 136,651 159,666
Proceeds from sales of marketable securities; available for sale 133,841 267,231
Purchase of marketable securities; available for sale (227,766) (445,931)
Loans Sold 33,629 31,554
Net increase in loan originations less principal payments on
loans (118,027) (31,598)
Acquisition of loan servicing rights (570) (433)
Investment in real estate held for investment 61 -
Proceeds from payments on real estate held for investment 161 14
Purchases of premises and equipment, net (1,114) (736)
Cash proceeds received from the sale of foreclosed real
estate 706 325
------------ ------------
Net cash used in investing activities $ (42,428) $ (18,876)
------------ ------------
</TABLE>
See accompanying notes to the consolidated financial statements.
(Continued)
Page 6
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
(continued)
<TABLE>
<CAPTION>
Three Months Ended March 31,
1999 1998
------------- ------------
<S> <C> <C>
Cash flows from financing activities:
Net increase (decrease) in deposits $ 18,805 $ (7,064)
Net (decrease) increase in other borrowings (4,734) 48,900
Net increase in escrow 3,787 1,178
Cash dividends (478) (437)
Proceeds from the exercise of stock options 33 504
------------- ------------
Net cash provided by financing operations 17,413 43,081
------------- ------------
Net increase in cash and cash equivalents 3,341 32,691
Cash and cash equivalents at beginning of period 56,741 24,466
------------- ------------
Cash and cash equivalents at end of period $ 60,082 $ 57,157
============= ============
Supplemental disclosures:
Cash paid during the periods for:
Interest on deposits, advances and other borrowings
(includes interest credited to deposit accounts) $ 21,314 $ 18,166
Income taxes 125 69
Cash received during the periods for:
Income tax refunds $ - $ 3,089
Non-cash investing activities:
Transfer from loans to foreclosed real estate $ 144 $ 484
</TABLE>
See accompanying notes to consolidated financial statements.
Page 7
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables are in thousands)
(Unaudited)
(1) Accounting Policies
-------------------
The Consolidated Financial Statements include the accounts of Harris
Financial, Inc. and its wholly-owned subsidiary Harris Savings Bank. In turn,
Harris Savings Bank is comprised of the following subsidiaries: AVSTAR Mortgage
Corporation, Harris Delaware Corporation, H. S. Service Corporation, First
Harrisburg Service Corporation and C.B.L. Service Corporation. All intercompany
balances have been eliminated in consolidation.
The accompanying interim financial statements have been prepared in
accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, they do not include all the information and footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management all adjustments, consisting of normal recurring
accruals, necessary for a fair presentation of the results of interim periods
have been made. Operating results for the three month period ended March 31,
1999 are not necessarily indicative of the results that may be expected for the
year ended December 31, 1999 or any other interim period.
The accounting policies followed in the presentation of interim
financial results are consistent with those followed on an annual basis. These
policies are presented on pages 46 through 50 of the 1998 Annual Report to
Stockholders.
(2) Marketable Securities
---------------------
In January 1998, the remaining held-to-maturity portfolio with a book
value of $96.4 million was transferred to the available-for-sale segment of the
portfolio and $63.0 million of the amount transferred was subsequently sold for
a gain of $1.4 million. The market value of these securities at time of transfer
was $97.5 million. This decision resulted from analysis performed in January of
1998 which indicated that the Bank was heavily invested in fixed rate assets,
which increased the risk of earnings compression in a rising rate environment.
The analysis showed that the Registrant could liquidate the majority of its
issues in the held-to-maturity portfolio and reinvest the majority of the
proceeds in a mix of fixed and floating rate assets that would maintain the
Registrant's earnings stream, while increasing the level of variable rate
assets. This course of action was approved by the Registrant's Board of
Directors in January, 1998 and the sale was conducted in the same month. Under
generally accepted accounting principles, the sale of these securities
eliminated the Registrant's ability to use the held-to-maturity classification
of securities for a period of at least two years.
Marketable Securities consist of the following as of the date indicated:
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------ --------------
<S> <C> <C>
Available-for-sale, at amortized cost $ 1,234,451 $ 1,261,696
Available-for-sale, net unrealized gain 11,147 13,141
------------ --------------
Available-for-sale, at fair value 1,245,598 1,274,837
------------ --------------
Total Marketable securities $ 1,245,598 $ 1,274,837
============ ==============
</TABLE>
Page 8
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables are in thousands)
(Unaudited)
(3) Other Borrowings
----------------
The following table presents the composition of the Registrant's other
borrowings as of the dates indicated.
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------ ------------
<S> <C> <C>
FHLB advances $ 751,520 $ 746,581
Repurchase Agreements 313,000 322,673
------------ ------------
Total other borrowings $ 1,064,520 $ 1,069,254
============ ============
</TABLE>
(4) New Accounting Standards
------------------------
During June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for
Derivative Instruments and Hedging Activities". The Statement establishes
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be
recorded on the balance sheet as either an asset or liability measured at its
fair value. SFAS 133 requires that changes in the derivative's fair value be
recognized currently in earnings unless specific hedge criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the income statement, and requires
that a company must formally document, designate and assess the effectiveness of
transactions that receive hedge accounting treatment.
SFAS 133 is effective for fiscal years beginning after June 15, 1999.
A company may also implement the Statement as of the beginning of any fiscal
quarter after issuance. The Statement cannot be applied retroactively.
Management has not yet quantified the impact of adopting SFAS 133 on
the financial statements and has not determined the timing of or method of
adoption of the Statement. However, the application of the Statement could
increase volatility in earnings and comprehensive income.
Page 9
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables are in thousands)
(Unaudited)
(5) Commitments and Contingent Liabilities
--------------------------------------
In the ordinary course of business, the Registrant makes commitments
to extend letters of credit to its customers. At March 31, 1999 and December 31,
1998, standby letters of credit issued and outstanding amounted to $11,397,000
and $4,703,000 respectively. These letters of credit are not reflected in the
accompanying financial statements. Management does not anticipate any
significant losses as a result of these transactions.
At March 31, 1999, the Registrant has $114,640,000 in unused line of
credit commitments extended to its customers, $40,131,000 of undistributed funds
on construction loans and $76,910,000 of loan origination commitments.
(6) Earnings per share
------------------
The following table shows the allocation of earnings per share to
basic earnings per share and diluted earnings per share.
<TABLE>
<CAPTION>
PER SHARE
FOR THE QUARTER ENDED MARCH 31, 1999 INCOME SHARES AMOUNT
-----------------------------------------
<S> <C> <C> <C>
Basic earnings per share
Income available to common shareholders $ 4,933,000 33,593,065 $ 0.15
-----------------------------------------
Options held by management and directors 90,049
-----------------------------------------
Diluted earnings per share
Income available to common shareholders
plus assumed conversions $ 4,933,000 33,683,114 $ 0.15
=========================================
FOR THE QUARTER ENDED MARCH 31, 1998
Basic earnings per share
Income available to common shareholders $ 5,749,000 33,880,514 $ 0.17
-----------------------------------------
Options held by management and directors 299,606
-----------------------------------------
Diluted earnings per share
Income available to common shareholders
plus assumed conversions $ 5,749,000 34,180,120 $ 0.17
=========================================
</TABLE>
(7) Loan Servicing
--------------
On March 15, 1999, the Registrant sold the rights to service loans
totaling $79.4 million. Concurrent with this sale, the Registrant also sold an
interest rate floor that was purchased in 1998 to hedge against the
deterioration in the carrying value of the servicing rights related to these
loans. The floor was recorded at its fair market value on the balance sheet at
December 31, 1998, with an offsetting entry to the value of the mortgage
servicing rights. In addition, the Registrant paid a premium to enter into the
floor contract and the premium was being amortized over the life of the
contract. As a result of the sale of the mortgage servicing rights and the
floor, the Registrant recognized a net loss of $194,000.
Page 10
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables are in thousands)
(unaudited)
(8) Dividend Waivers by the Mutual Holding Company
----------------------------------------------
The Mutual Company has generally waived the receipt of dividends
declared by the Bank, or, subsequent to the Two-Tier Reorganization, dividends
paid by the Registrant. The Mutual Company has not been required to obtain
approval of the Federal Reserve Bank (the "FRB" ) prior to any such waiver, and
through the date hereof has not sought or received FRB approval of any such
waiver. In connection with the FRB and Federal Deposit Insurance Corporation
(the "FDIC") approvals of the Bank's acquisition of First Harrisburg Bancor,
Inc. and its wholly owned subsidiary, First Federal Savings and Loan Association
of Harrisburg ("First Federal"), the Bank and the Mutual Company made several
commitments to the FDIC and the FRB regarding the waiver of dividends by the
Mutual Company. These commitments include the following: (1) Any dividends
waived by the Mutual Company shall be taken into account in any valuation of the
Bank and the Mutual Company, and factored into the calculation used in
establishing a fair and reasonable basis for exchanging Bank shares for holding
company shares in any subsequent conversion of the Mutual Company to stock form;
(2) Dividends waived by the Mutual Company shall not be available for payment to
or the value thereof transferred to Minority Stockholders by any means including
through dividend payments or at liquidation; (3) Beginning five years after
April 19, 1996, the date of consummation of the Bank's acquisition of First
Federal, the Mutual Company will make prior application to and shall receive the
approval of the FRB prior to waiving any dividends declared on the capital stock
of the Bank, and the FRB shall have the authority to approve or deny any
dividend waiver request in its discretion, and after such date such application
may be made on an annual basis with respect to any year in which the Mutual
Company intends to waive dividends paid by the Bank; (4) After April 19, 1996,
the date of consummation of the Bank's acquisition of First Federal, the amount
of waived dividends that are identified as belonging to the Mutual Company shall
not be available for payment to, or the value transferred to, Minority
Stockholders, either through dividend payments, upon the conversion of the
Mutual Company to stock form, upon the redemption of shares of the Bank, upon
the Bank's issuance of additional shares, at liquidation, or by any other means;
(5) The Mutual Company shall notify the FRB of all such transactions and will
make available to the FRB such information as the FRB determines to be
appropriate;(6) The Bank will take into account when setting its dividend rate
the declaration rate in relation to net income and the rate's effect on the
Bank's ability to issue capital; and (7) The dividend rate will be reasonable
and sustainable upon a full conversion to stock form of the Mutual Company; (8)
In the event that the FRB adopts regulations regarding dividends waivers by
mutual holding companies, the Mutual Company will comply with the applicable
requirements of such regulations. After the completion of the two-tier
reorganization, the commitments became applicable to dividends paid by the
Registrant that are waived by the Mutual Company. If the Mutual Company decides
that it is in its best interest to waive the right to receive a particular
dividend to be paid by the Registrant, and, if necessary, the FRB approves such
waiver, then the Registrant pays such dividend only to Minority Stockholders,
and the amount of the dividend waived by the Mutual Company is treated in the
manner described above. The Mutual Company's decision as to whether or not to
waive a particular dividend depends on a number of factors, including the Mutual
Company's capital needs, the investment alternatives available to the Mutual
Company as compared to those available to the Registrant, and the receipt of
required regulatory approvals.
There can be no assurance that (a) the Mutual Company will waive
dividends paid by the Registrant, (b) the FRB will approve any dividend waivers
by the Mutual Company after April 2001, or (c) the terms that may be imposed by
the FRB on any dividend waiver will be favorable to Minority Stockholders. As of
the date hereof, the Mutual Company has waived the right to receive all
dividends paid by the Bank and the Registrant. As of April 19, 1996, the Mutual
Company had waived $9.1 million of dividends declared by the Bank, and through
March 31, 1999, had waived a total of $23.8 million of dividends paid by the
Bank and the Registrant.
Page 11
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables are in thousands)
(unaudited)
(9) Treasury Stock Repurchase Program
---------------------------------
On February 28, 1998, HFI received authorization from the Pennsylvania
Department of Banking to repurchase 450,000 shares of its outstanding
common stock. The assumed price for the repurchase of the shares was $16
per share for an aggregate cost of $7,200,000. The proposed repurchase of
shares must be completed one year from the approval date of February 28,
1998. Management is currently in the process of seeking a one year
extension of this authorization. During the third and fourth quarters of
1998, the Registrant purchased 409,300 shares with a market value of
$5,970,000. The shares will be used to facilitate several stock ownership
and stock option plans. These plans will benefit directors, executive
officers, non-executive officers, and newly appointed executives or
directors. On April 20, 1999, the shareholders ratified and approved the
1999 Stock Option Plan (For Employees) and the 1999 Stock Option Plan for
Outside Directors. These option plans authorize a maximum of 1,125,000
shares in aggregate for awards in the form of stock options.
Page 12
<PAGE>
Item 2 Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following is management's discussion and analysis of the
significant changes in the results of operations, capital resources and
liquidity presented in its accompanying interim consolidated financial
statements for Harris Financial, Inc. and subsidiaries. This discussion should
be read in conjunction with the 1998 Annual Report. Current performance does not
guarantee, and may not be indicative of similar performance in the future.
In addition to historical information, this Quarterly Report on Form
10-Q contains forward-looking statements, as such term is defined in the
Securities and Exchange Act of 1934 and the regulations thereunder. The
forward-looking statements contained herein are subject to certain risks and
uncertainties that could cause actual results to differ materially from those
projected in the forward-looking statements. Important factors that might cause
such a difference include, but are not limited to, those discussed in the
section entitled "Management's Discussion and Analysis of Financial Condition
and Results of Operations". Readers are cautioned not to place undue reliance on
these forward-looking statements, which reflect management's analysis only as of
the date hereof. The Registrant undertakes no obligation to publicly revise or
update these forward-looking statements to reflect events or circumstances that
arise after the date hereof.
(a) Results of Operations
NET INCOME OR LOSS The net income for the three month period ended March
31, 1999 was $4,933,000, representing a decrease of $816,000 or 14.2% from
the $5,749,000 net income figure reported during the first three months of
1998.
NET INTEREST INCOME HFI's principle source of revenue is net interest
income, which represents the difference between interest income generated
by earning assets and the interest expense of deposits and external sources
of funds. Furthermore, net interest income is significantly dependent on
the volume and composition of earning assets and interest earning
liabilities as well as the yield/cost of interest earning
assets/liabilities.
Net interest income, on a tax equivalent basis, totaled $15,973,000 for the
three months ended March 31, 1999, which represents an increase of
$1,047,000, or 7.0%, from the $14,926,000 of net interest income recorded
in the three months ended March 31, 1998. This increase reflected a
favorable volume variance of $1,624,000 due to a $194.0 million increase in
total average earning assets to $2.390 billion during the year to date
period ended March 31, 1999 as compared to $2.196 billion recorded during
the same period ending March 31, 1998. At the same time, decreases in
general market interest rates created an unfavorable rate variance of
$577,000 for the three months ended March 31, 1999. The interaction of
positive volume variances and negative rate variances generated the net
positive change of $1,047,000 mentioned above.
For the three months ended March 31, 1999, the yield on interest earning
assets was 7.12%. This figure is a 39 basis point decrease from the 7.51%
yield reported for the three month period ended March 31, 1998. During this
same period the cost of funds decreased 40 basis points to 4.67% for the
period ending March 31, 1999, versus 5.07% for the three months ended March
31, 1998. As a result, the interest spread (the difference between the
yield on assets minus the cost of funds) increased by one basis point to
2.45% for the three month period ending March 31, 1999, versus 2.44% for
the comparable period ending March 31, 1998. Yields on interest earning
assets fell uniformly from the comparable period ending March 31, 1998 with
the exception of the 107 basis point increase (9.23% versus 8.16%) in
indirect consumer loans. HFI has increased its marketing efforts in this
area especially in the segment of mobile home indirect loans.
HFI continues to rely on wholesale funding sources to support an investment
leveraging strategy and uses external borrowings to offset the impact of
net increases/decreases in time deposits. During the
Page 13
<PAGE>
three month period ending March 31, 1999, total deposits (net of escrow
deposits) increased $18.8 million or 1.6% while other borrowings decreased
by $4.7 million or .4%. The strategy relies on wholesale funding to support
a redeployment of capital generated from ongoing operations (leveraging)
into an interest earning capacity, via the investment portfolio. The
objective of this strategy is to increase the absolute dollar amount of
interest income and boost the Registrant's return on equity. However, this
strategy compresses the Registrant's net interest margins. This is caused
by the higher marginal cost of funds associated with external borrowings
over the cost of core deposits. These factors are reflected in the net
interest margin decline of 5 basis points to the 2.67% yield for the three
months ended March 31,1999, versus the yield of 2.72% for the comparable
period ending March 31, 1998.
The following table summarizes the impact of the leveraging strategy on the
return on average assets (ROAA), net interest margin (NIM), and return on
equity (ROE) for the three month periods ended March 31, 1999, and March
31, 1998, respectively.
<TABLE>
<CAPTION>
Comparison of Financial Performance with and without a Capital Leveraging Strategy
- -------------------------------------------------------------------------------------
(All figures in 000's)
- --------------------------------
With Without Difference in
Three month period ended March 31, 1999 Leveraging Leveraging Basis Points
- -------------------------------------------- ------------- ---------------- ----------------
<S> <C> <C> <C>
Return on Average Assets 0.79% 0.58% 21
Net Interest Margin 2.67% 3.50% (83)
Return on Equity 10.37% 6.86% 351
Three month period ended March 31, 1998
- --------------------------------------------------
Return on Average Assets 1.01% 0.97% 4
Net Interest Margin 2.72% 3.52% (80)
Return on Equity 12.58% 9.77% 281
</TABLE>
Table 1 on the following page presents the Registrant's average asset and
liability balances, interest rates, interest income, and interest expense for
each of the three month periods ended March 31, 1999 and March 31, 1998,
respectively. Table 2 presents a rate-volume analysis of changes in net interest
income.
For information on qualitative and quantitative disclosures regarding market
risk, refer to Management's Discussion and Analysis included in the 1998 Annual
Report to Stockholders. There have been no significant changes in the
Registrant's market risk profile or the Registrant's risk management procedures,
in the current year.
Page 14
<PAGE>
TABLE 1 - AVERAGE BALANCE SHEETS, RATE, AND INTEREST INCOME AND EXPENSE SUMMARY
(ALL FIGURES IN 000'S)
<TABLE>
<CAPTION>
For the three months ended,
---------------------------------------------------------------------------------
March 31, 1999 March 31, 1998
---------------------------------------------------------------------------------
Average (1) (2) Average Average (1) (2) Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
---------------------------------------- ---------------------------------------
(Dollar amounts in thousands)
<S> <C> <C> <C> <C> <C> <C>
Assets:
Interest Bearing assets:
Mortgage Loans, net $ 609,208 $ 11,970 7.86% $ 566,712 $ 12,340 8.71%
Commercial loans 224,465 4,255 7.58% 98,393 2,199 8.94%
Direct consumer loans 158,759 2,941 7.41% 154,535 2,892 7.49%
Indirect consumer loans 118,753 2,740 9.23% 89,022 1,815 8.16%
Marketable Securities - Taxable 1,131,738 17,853 6.31% 1,134,668 19,153 6.75%
Marketable Securities - Taxfree 117,697 2,435 8.28% 114,124 2,362 8.28%
Other interest earning assets 29,077 366 5.03% 38,053 474 4.98%
------------------------ -------------------------
Total interest-earning assets 2,389,697 42,560 7.12% 2,195,507 41,235 7.51%
--------- ---------
Noninterest-earning assets 101,290 78,759
---------- ----------
Total assets $2,490,987 $2,274,266
========== ==========
Liabilities and stockholders' equity:
Interest bearing liabilities:
Savings deposits $ 143,872 $ 686 1.91% $ 148,586 $ 958 2.58%
Time deposits 768,883 10,094 5.25% 749,082 10,280 5.49%
NOW and money market deposits 292,092 1,690 2.31% 237,876 1,742 2.93%
Escrow 10,729 25 0.93% 10,094 17 0.67%
Borrowed Funds 1,060,310 14,092 5.32% 931,108 13,312 5.72%
------------------------ -------------------------
Total interest bearing liabilities $2,275,886 26,587 4.67% $2,076,746 26,309 5.07%
--------- ---------
Non interest bearing liabilities 24,765 14,657
---------- ----------
Total liabilities 2,300,651 2,091,403
Stockholders' equity 190,336 182,863
---------- ----------
Total liabilities and stockholder
equity $2,490,987 $2,274,266
========== ==========
Net interest income before
before provision for loan loss $ 15,973 $ 14,926
========== =========
Interest rate spread (3) 2.45% 2.44%
===== =====
Net interest-earning assets $ 113,811 $ 118,761
========== ==========
Net interest margin (4) 2.67% 2.72%
===== =====
Ratio of interest earning assets to
interest bearing liabilities 1.05 1.06
========== ==========
</TABLE>
(1) Includes income recognized on deferred loan fees of $444,000 and $949,000
for the comparable 1999 and 1998 periods, respectively.
(2) Interest income and yields are shown on a tax equivalent basis.
(3) Represents the difference between the average yield on interest-earning
assets and the average cost on interest-bearing liabilities.
(4) Represents the annualized net interest income before the provision for loan
losses divided by average interest-earning assets.
Page 15
<PAGE>
TABLE 2 - RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME (ALL FIGURES IN
000'S)
<TABLE>
<CAPTION>
Quarter Ended March 31, 1999
Compared to
Quarter Ended March 31, 1998
Increase (Decrease)
-------------------------------------
Volume Rate Net
-------------------------------------
<S> <C> <C> <C>
Interest-earning assets:
Mortgage loans, net $ 886 $ (1,256) $ (370)
Commercial loans 2,436 (380) 2,056
Direct consumer loans 80 (31) 49
Indirect consumer loans 664 261 925
Marketable securities - Taxable (50) (1,250) (1,300)
Marketable securities - Taxfree 73 - 73
Other interest earning assets (113) 5 (108)
-------------------------------------
Total interest earning assets 3,976 (2,651) 1,325
-------------------------------------
Interest-bearing liabilities:
Savings Deposits (30) (242) (272)
Time deposits 269 (455) (186)
NOW and money market deposits 355 (407) (52)
Escrow and stock subscriptions 1 7 8
Borrowed funds 1,757 (977) 780
-------------------------------------
Total interest-bearing liabilities 2,352 (2,074) 278
-------------------------------------
Net change in net interest income $ 1,624 $ (577) $ 1,047
=====================================
</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
Page 16
<PAGE>
PROVISION FOR LOAN LOSSES The Registrant recognized a provision for loan
loss of $795,000 for the three months ended March 31, 1999. This represents
a decrease of $35,000 from the $830,000 provision recorded for the three
months ending March 31, 1998.
NONINTEREST INCOME Noninterest income totaled $4,021,000 for the three
months ended March 31, 1999. This represents a decrease of $907,000, or
18.4%, from the $4,928,000 recorded in the three months ended March 31,
1998. This decrease can be attributed to several factors:
(1) The net gain on securities decreased $1,031,000 or 43.2% to $1,353,000
recognized in the three month period ended March 31, 1999, versus
$2,384,000 for the comparable period ended March 31, 1998.
(2) Other income decreased $470,000 or 114.9% to the net loss of $61,000
recognized in the three month period ending March 31, 1999, versus
income of $409,000 for the comparable period ended March 31, 1998. The
main reason for this decline was the one time recognition of $389,000
by the Registrant's AVSTAR mortgage subsidiary for gains in the sale
of servicing rights which occurred in the three month period ended
March 31, 1998. In addition, joint venture activity generated a
$58,000 decline for the three month period ended March 31, 1999.
(3) These decreases were offset by service charges on deposits generating
$1,233,000, or a $297,000 increase over the prior three month period
ended March 31, 1998, figure of $936,000. This trend reflects the
Registrant's increased emphasis on fee generating transaction
accounts, income generated by an expanded ATM network and the
imposition of ATM surcharging.
NONINTEREST EXPENSE Noninterest expense equalled $11,592,000 for the three
months ended March 31, 1999. This is an increase of $1,769,000, or 18.0%,
from the $9,823,000 reported for the three month period ended March 31,
1998. The increase in noninterest expense was caused, primarily, by a
$1,048,000 increase in other expense. During the three months ended March
31, 1999, other expense equalled $2,937,000 versus the $1,889,000
recognized in the comparable period ending March 31, 1998. This increase
was attributable to one time expenses related to several internal
conversion projects.
Another major contributor to the increase in noninterest expense is salary
and benefits expense increasing $437,000 ($5,772,000 for the three months
ended March 31, 1999, versus $5,335,000 for the three months ended March
31, 1998). The increase represents salary expenditures for the acquisition
of staff to support the Registrant's transition to a full service community
bank.
PROVISION FOR INCOME TAXES Corporate income tax expense totaled $1,822,000
for the three month period ended March 31, 1999, which resulted in an
effective tax rate of 27.0% on pretax income of $6,755,000. This represents
a decrease of $802,000 from the $2,624,000 of corporate tax expense, or an
effective tax rate of 31.3% on pretax income of $8,373,000, recorded during
the three month period ended March 31, 1998. The decrease in the effective
tax rate is the result of the Registrant's continued focus on increasing
tax exempt sources of income.
STOCKHOLDERS' EQUITY Stockholders' equity totaled $193.3 million, and
$190.0 million at March 31, 1999, and December 31, 1998, respectively.
Stockholders' equity amounted to 7.6% of total assets equalling $ 2.537
billion as of March 31, 1999, compared to 7.6% of total assets of $2.497
billion at December 31, 1998.
The increase in Stockholders' equity of $3.3 million or 1.8% in the three
months ended March 31, 1999 resulted mainly from $4.9 million in income
from ongoing operations. Offsetting this increase is a $1.2 million decline
in the market value, net of tax effect, of the available-for-sale
securities portfolio and $.5 million in dividends paid.
Page 17
<PAGE>
REGULATORY CAPITAL COMPLIANCE Risk-based capital standards are issued by
bank regulatory agencies in the United States. These capital standards link
a banking company's capital to the risk profile of its assets and provide
the basis by which all banking companies and banks are evaluated in terms
of capital adequacy. These risk-based capital standards require all banks
to have Tier 1 capital of at least 4.0 % and total capital, including Tier
1 capital, equal to at least 8.0 % of risk-adjusted assets. Tier 1 capital
consists of common stockholders' equity and qualifying perpetual preferred
stock along with related surpluses and retained earnings. Total capital is
comprised of Tier 1 capital, limited life preferred stock, qualifying debt
instruments, and the reserves for loan losses. Furthermore, the banking
regulators also issue leverage ratio requirements. The leverage ratio
equals the ratio of Tier 1 capital to adjusted average assets. The
following table provides a comparison of Harris Financial, Inc.'s risk-
based capital ratios and leverage ratio to the minimum regulatory
requirements for the period indicated.
<TABLE>
<CAPTION>
Minimum Minimum
Requirement Requirement
for Capital to be "Well
HARRIS FINANCIAL, INC. Actual Adequacy Capitalized"
------ -------- ------------
As of March 31, 1999 Amount Ratio Amount Ratio Amount Ratio
- --------------------- ------ ----- ------- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Total Capital
(to Risk Weighted Assets) $184,808 12.3% $ 120,305 8.0% $ 150,381 10.0%
Tier 1 Capital
(to Risk Weighted Assets) 170,144 11.3% 60,152 4.0% 90,228 6.0%
Tier 1 Capital
(to Avg. Assets) 170,144 6.9% 98,692 4.0% 123,365 5.0%
As of December 31, 1998
- -----------------------
Total Capital
(to Risk Weighted Assets) $179,157 12.0% $ 119,160 8.0% $ 148,949 10.0%
Tier 1 Capital
(to Risk Weighted Assets) 164,955 11.1% 59,580 4.0% 89,370 6.0%
Tier 1 Capital
(to Avg. Assets) 164,955 6.8% 97,553 4.0% 121,941 5.0%
</TABLE>
Page 18
<PAGE>
The following table provides a comparison of Harris Savings Bank's
risk-based capital ratios and leverage ratio to the minimum regulatory
requirements for the period indicated.
<TABLE>
<CAPTION>
Minimum Minimum
Requirement Requirement
for Capital to be "Well
HARRIS SAVINGS BANK Actual Adequacy Capitalized"
------ -------- ------------
As of March 31, 1999 Amount Ratio Amount Ratio Amount Ratio
- --------------------- ------ ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Total Capital
(to Risk Weighted Assets) $179,816 12.0% $120,037 8.0% $150,046 10.0%
Tier 1 Capital
(to Risk Weighted Assets) 165,034 11.0% 60,018 4.0% 90,028 6.0%
Tier 1 Capital
(to Avg. Assets) 165,034 6.7% 98,548 4.0% 123,185 5.0%
As of December 31, 1998
- -----------------------
Total Capital
(to Risk Weighted Assets) $174,663 11.8% $118,879 8.0% $148,598 10.0%
Tier 1 Capital
(to Risk Weighted Assets) 160,317 10.8% 59,439 4.0% 89,159 6.0%
Tier 1 Capital
(to Avg. Assets) 160,317 6.6% 97,395 4.0% 121,744 5.0%
</TABLE>
During the quarter ended March 31, 1999, the Registrant adhered to the
6.5% Tier 1 minimum stipulated by the Pennsylvania Department of Banking
("Department"). This minimum threshold was a condition required by the
Department for the Treasury Stock Repurchase Program that was approved on
February 27, 1998.
Page 19
<PAGE>
MARKETABLE SECURITIES In January 1998, the Registrant sold securities
from the held-to-maturity (HTM) portfolio. The book value of these
securities totalled $63.0 million and a gain of $1.4 million was
realized from the transaction. This decision resulted from analysis
performed in January of 1998 which indicated that the Bank was heavily
invested in fixed rate assets, which increased the risk of earnings
compression in a rising rate environment. The analysis showed that the
Registrant could liquidate the majority of its issues in the held-to-
maturity portfolio and reinvest the majority of the proceeds in a mix
of fixed and floating rate assets that would maintain the Registrant's
earnings stream, while increasing the level of variable rate assets.
This course of action was approved by the Registrant's Board of
Directors in January, 1998 and the sale was conducted in the same
month. Under generally accepted accounting principles, the sale of
these securities eliminated the Registrant's ability to use the held-
to-maturity classification on any securities for a period of two years.
As a result, the remaining securities in the held-to-maturity portfolio
were transferred to the available-for-sale portfolio. This transfer
resulted in a $209,565 increase, net of taxes, to the net unrealized
gains on marketable securities.
Marketable securities, excluding the Federal Home Loan Bank cash
account, totaled $1,245.6 million, at March 31, 1999, and $1,274.8
million at December 31, 1998. Total marketable securities decreased
$29.2 million, or 2.3%, during the first three months of 1999.
TABLE 3 - COMPOSITION OF MARKETABLE SECURITIES PORTFOLIOS (ALL FIGURES IN 000'S)
The following table sets forth certain information regarding the amortized cost
and fair values of the Registrant's marketable securities portfolio at March 31,
1999 and December 31, 1998.
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
-------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
-------------------------------------------------------------
<S> <C> <C> <C> <C>
Available-for-sale:
U.S. Government and agencies $ 335,971 $ 333,666 $ 298,247 $ 299,196
Corporate bonds 111,846 109,698 148,731 142,240
Municipal obligations 116,407 121,790 113,557 119,233
FHLB stock 37,829 37,829 37,579 37,579
Equities (Common and Preferred) 105,235 116,366 112,403 123,765
Asset Backed Securities - - 15,146 15,661
Mortgage-backed securities:
FHLMC PC's 1,058 1,110 1,421 1,494
FNMA CMO's 67,177 67,112 104,276 105,864
FHLMC CMO's 103,479 102,809 75,137 75,157
Private Issue CMO's 355,449 355,218 355,199 354,649
-------------------------------------------------------------
Total mortgage-backed securities 527,163 526,249 536,033 537,164
-------------------------------------------------------------
Total securities available-for-sale $ 1,234,451 $ 1,245,598 $ 1,261,696 $ 1,274,838
-------------------------------------------------------------
Other interest-earning securities:
FHLB daily investment $ 29,620 $ 29,620 $ 22,423 $ 22,423
-------------------------------------------------------------
Total marketable securities and
interest bearing investments $ 1,264,071 $ 1,275,218 $ 1,284,119 $ 1,297,261
=============================================================
</TABLE>
Page 20
<PAGE>
LOANS Loans Receivable, excluding the reduction for the Allowance for
Loan Losses, totaled $1,144.3 million and $1,060.7 million at March 31,
1999, and December 31, 1998. The increase of $83.6 million, or 7.9%,
for the three months ended March 31, 1999, reflects growth in
commercial loans of $48.6 million, a $18.3 million increase in consumer
and other loans, and first mortgage loan increases amounting to $16.7
million
Loan charge-offs, net of recoveries, totaled $228,000 for the three
month period ended March 31, 1999, and $1,141,000 for the twelve month
period ended December 31, 1998. Based on management's continuing review
of the loan portfolio the Registrant recorded provisions for loan
losses of $795,000 for the three months ending March 31, 1999, and
$2,540,000 for the twelve month period ending December 31, 1998.
Prior to the quarter ended March 31, 1999, the Registrant considered
all loans that were delinquent 90 days or more with respect to
principal and interest repayments to be in a non accrual status. During
the quarter ended March 31, 1999, the Registrant adopted a policy that
follows the Federal Financial Institutions Examination Council
("FFIEC") uniform bank examination guidelines. The major provisions of
the policy are:
(1) Loans that are 90 days past due are still considered to be in an
accrual status.
(2) Any loan that is 90 days past due will be reviewed on a monthly
basis to determine its loss potential.
(3) Once the loan is 120 days past due, the Registrant will charge-off
any unsecured loan balance.
(4) Interest income recognized from the filing date of the most recent
Federal Deposit Insurance Corporation Report of Condition up to and
including the date of charge-off will be reversed against the
current accounting periods recognition of interest income. Any
remaining accrued interest receivable will be reversed and offset
against the allowance for loan loss.
Using these new policy guidelines, non accrual loans were $2,038,000
and $7,651,000 at March 31, 1999, and December 31, 1998, respectively.
In addition, loans 90 days past due, but still accruing were $4,950,000
at March 31, 1999 and $0 at December 31, 1998, respectively. The
combined total of non accrual loans and loans 90 days past due, but
still accruing interest as a percentage of total loans receivable
(including Loans held for sale, net), before deducting the Allowance
for Loan Loss, equalled .60% and .71% at March 31, 1999, and December
31, 1998, respectively.
The Registrant conducts an external third party loan review to identify
those loans which are considered performing and current with respect to
payments of principal and interest but display an above normal risk of
becoming non performing or requiring restructuring in the future. This
review is conducted on a quarterly basis.
The allowance for loan losses totaled $9,655,000 and $9,088,000 at
March 31, 1999 and December 31, 1998, respectively. Stated as a
percentage of total loans receivable (including Loans held for sale,
net), the allowance for loan losses amounted to .84% and .85% at March
31, 1999 and December 31, 1998, respectively.
Table 4 on the following page depicts the trend of charge-offs,
recoveries, and provisions to the allowance for loan losses for the
three months ended March 31, 1999, and the year ended December 31,
1998, respectively. In addition, Table 5 on the following page
highlights the allowance for loan losses as a percent of non accrual
loans, loans 90 days past due, but still accruing and specifically
designated problem loans for the three months ended March 31, 1999, and
the year ended December 31, 1998, respectively.
Page 21
<PAGE>
TABLE 4 ANALYSIS OF ALLOWANCE FOR LOAN LOSSES (ALL FIGURES IN 000'S)
<TABLE>
<CAPTION>
AS OF OR FOR THE AS OF OR FOR THE
ALLOWANCE FOR LOAN LOSS THREE MONTHS ENDED TWELVE MONTHS ENDED
(ALL FIGURES IN 000'S) MARCH 31, 1999 DECEMBER 31, 1998
- ------------------------------------------- ---------------------------- -----------------------------
<S> <C> <C>
Balance at beginning of the period $ 9,088 $ 8,192
Provision for loan losses 795 2,540
Provision component related to unfunded
commitements 0 (503)
CHARGE OFFS:
Commercial (50) (591)
One-to-four family (67) (173)
Other mortgage loans - (83)
Consumer loans (170) (344)
---------------------------- -----------------------------
Total Charge Offs (287) (1,191)
---------------------------- -----------------------------
RECOVERIES:
Commercial 52 -
One-to-four family 3 -
Other mortgage loans - 2
Consumer loans 4 48
---------------------------- -----------------------------
Total Recoveries 59 50
---------------------------- -----------------------------
NET CHARGE OFFS (228) (1,141)
---------------------------- -----------------------------
Balance at end of period $ 9,655 $ 9,088
============================ =============================
Net Charge Offs to Average Loans Outstanding (1) 0.08% 0.12%
============================ =============================
</TABLE>
(1) Year to date ratio is annualized
TABLE 5-- ALLOWANCE FOR LOAN LOSSES COVERAGE RATIOS (ALL DOLLAR FIGURES IN
000'S)
<TABLE>
<CAPTION>
As of or for the As of or for the
three months ended twelve months ended
March 31, 1999 December 31, 1998
--------------------- -------------------------
<S> <C> <C>
Allowance at the end of period $ 9,655 $ 9,088
Non accrual loans $ 2,038 $ 7,651
90 Days past due, but still accruing $ 4,950 $ -
Problem loans $ 9,933 $ 9,800
Allowance/non accrual loans 473.75% 118.78%
-------------------- -------------------------
Allowance/90 days past due, but still accruing 195.05% 0.00%
-------------------- -------------------------
Allowance/non accrual loans and 90 days past due,
but still accruing 138.17% 118.78%
-------------------- -------------------------
Allowance/problem loans 97.20% 92.73%
-------------------- -------------------------
</TABLE>
Page 22
<PAGE>
ASSET QUALITY Virtually all of HFI's credit risk lies with the Bank,
which holds all of HFI's loan assets. As part of its conversion from a
thrift institution, the Bank created a Business Banking Group to offer
commercial financial products and services to 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 and hired a senior executive as Chief Credit
Officer.
As part of its credit risk management activities, the Bank follows a
policy of continuous credit loss monitoring, including assessment of
the adequacy of the allowance for loan losses. The assessment of the
adequacy of the allowance for loan losses is based on internal and
external factors. The external factors include the general economic
condition of the Bank's market area and those factors described in
regulatory guidelines. The internal factors include the current
composition of the portfolio, portfolio growth trends, and the current
emphasis on commercial lending.
Quarterly, the commercial loan portfolio is analyzed on an individual
loan basis and a specific reserve is developed for each known loss,
using a risk rating system. In addition, the Bank assigns reserves for
existing losses which are determined using factors such as charge-off
history, portfolio delinquencies and current economic conditions. The
mortgage and consumer portfolios are analyzed in pools of similar loans
with similar risk characteristics. The reserve factor applied to each
pool is based on actual charge-off history, adjusted for other factors
such as credit concentrations and delinquency trends.
In addition to the allowance for loan loss, the Registrant maintains a
reserve for unfunded commitments. This reserve represents the Bank's
estimation of loss incurred relative to available funds committed to
customers, but that have yet to be disbursed. The reserve factor
assigned to this pool is developed using factors such as credit
concentrations and economic conditions. The reserve established for
unfunded commitments is classified as a separate liability from the
allowance for loan losses, in accordance with generally accepted
accounting principles.
OTHER BORROWINGS During the three month period ended March 31, 1999,
the Registrant maintained wholesale leveraging activities to deploy its
excess capital. This strategy relies on using external sources of funds
to invest in interest earning assets at a positive spread between the
yield on interest earning asset and the cost of the support borrowing.
Other borrowings totaled $1,064.5 million and $1,069.3 million at March
31, 1999, and December 31, 1998, respectively. Borrowings from non-
deposit funding sources decreased $4.8 million, or .4%, during the
three months ended March 31, 1999. Federal Home Loan Bank advances
increased by $4.9 million or .7%, while repurchase agreements decreased
by $9.7 million or 3.0% for the three month period ending March 31,
1999.
As of March 31, 1999, the Registrant had maximum available FHLB lines
of credit totalling $1,086.9 million versus $943.5 million in available
FHLB credit at December 31, 1998. This increase of 15.2% or $143.4
million is based on increases in the amount of securities that qualify
as security for FHLB advances. HFI had borrowings totaling $751.5
million and $746.6 million outstanding to the FHLB as of March 31,
1999, and December 31, 1998, respectively.
LIQUIDITY The Registrant's primary sources of funds are deposits and
proceeds from principal and interest payments on loans and mortgage-
backed securities. While maturities and scheduled amortization of loans
and mortgage-backed securities are a predictable source of funds,
deposit flows and mortgage prepayments are greatly influenced by
general interest rates, economic conditions, and competition. The
Page 23
<PAGE>
Registrant anticipates that it will have sufficient funds available to
meet its current commitments.
The Registrant exceeded all regulatory standards for liquidity at March
31, 1999 and December 31, 1998.
YEAR 2000 COMPLIANCE The efficient and reliable operation of the
Registrant's business is significantly dependent upon its computer
hardware, software programs, and operating systems (collectively
"computer systems"). As a financial services company, the Registrant
relies on computer systems in virtually all significant business
operations. Management considers Year 2000 readiness to be a major
business issue and has implemented a Year 2000 Compliance Effort to
identify all major compliance risks.
The Registrant's Year 2000 Compliance Effort ("Y2K Project") can be
broken down into several distinct stages or phases. The first stage
("Awareness Phase") dates from October 1996, and marks the beginning of
the Y2K Project initiative. The senior staff of HFI created a Y2K task
force that represented all the major functional areas of the
Registrant. The task force started monthly meetings during October
1997, and in July 1998 accelerated to the current bi-weekly meeting
schedule to intensify the Registrant's focus on the issue. This task
force has the commitment of the Registrant's senior management team and
monthly updates are provided to the Registrant's board of directors.
The second stage is termed the ("Inventory Phase") and covers the time
period from October 1997 to December 1997. During this phase the
Registrant reviewed all existing hardware, software and embedded
technology to determine their Year 2000 Compliance profile. In December
1997, the Registrant created a pamphlet that identified the existence
of Year 2000 Compliance issues and provided a high level review of the
Registrant's efforts to ensure compliance. This pamphlet is available
in branch locations and the information is provided on our web site. In
addition, the Registrant developed a data base to track external
vendors' responses to the Registrant's questionnaire to determine the
external vendors state of Year 2000 Compliance. The results from the
internal review and the questionnaire surveys were used as inputs to
the "Analysis Phase".
The third phase ("Analysis Phase") focused on the hardware and software
identified from the Inventory Phase that was crucial for the Registrant
to conduct its business operations. The systems were ranked "mission
critical" or "non mission critical". These two classifications were
further segmented into low, medium, or high risk ratings. Therefore, a
"mission critical" system with a high risk rating received the most
testing focus. The following list details the high priority "mission
critical" systems:
(1) The AS400 mainframe hardware and operating system is certified
Year 2000 Compliant by the vendor, IBM.
(2) All Alltel core systems (which include the general ledger, all
major lending and deposit applications and customer information
databases), are certified Year 2000 compliant.
(3) The Registrant purchased software to test the BIOS (Basic Input
Output Systems) of all personal computers (PCs) in the local area
network (LAN) and wide area network (WAN). This testing targeted
non compliant PCs that were later replaced by the Registrant
during the fourth phase of the Y2K Project.
The subsequent fourth stage dubbed ("Testing/Renovation") phase of the
Y2K Project started in March 1998 and is scheduled for completion by
June 30, 1999. During this phase, the Registrant's goal is to test all
mission critical systems, provide the results of those tests to the
Registrant's Internal Audit Department for review/analysis and correct
non compliant mission critical systems. At this time, all mission
critical systems have been renovated.
Page 24
<PAGE>
In addition, the Registrant has tested other stand alone PC software
programs. The Registrant has dedicated a separate PC, printer and
accessory environment to conduct tests in a controlled manner with the
PC's internal clock set to five specific, internally designated, Year
2000 dates. The testing procedure was approved by the Registrant's
Internal Audit Department and the results of the tests were provided to
the Registrant's Internal Audit Department for review and analysis. At
this point, the results of internal testing and the identification and
ensuing risk assessment of external vendors and significant customers
have been combined into an overall risk assessment for the Registrant's
Year 2000 Compliance profile. The ensuing profile is the basis for a
business resumption contingency plan to address any unexpected Year
2000 events. The contingency planning process includes four major
steps: defining the planning strategy; performing the business
analysis; developing the plan; validating the plan. The first two steps
were completed by March 31, 1999, and the final two steps are scheduled
for completion by June 30, 1999. Estimated costs to complete the Year
2000 Compliance Effort are listed in the following table.
Dollar
Tasks Amount
----- ------
Loan support PCs $ 39,000
Mortgage origination PCs 12,000
Software upgrades 20,000
Operations Ctr. alternative power supply 50,000
Internal resources
(Testing and planning) 53,000
--------
Total Costs $174,000
========
Beyond the scope of the Y2K Project, the Registrant installed new
mainframe hardware, operating systems and application software that was
described in the preceding paragraphs. This conversion commenced in
April 1997, and replaced a prior system that was not capable of
supporting the Registrant's strategic transition to a commercial bank
and was lacking Year 2000 Compliance certification. The costs of that
conversion consist of capitalized costs of approximately $4,083,000 for
hardware and software replacements and teller platform upgrades.
Furthermore, another $632,000 in operating expenses were incurred for
consulting fees, training, travel, communication and other associated
conversion costs
DISCONTINUED OPERATIONS During the three months ended March 31, 1999,
HFI completed a substantial winding down of its mortgage banking
operations, known as "AVSTAR", resulting in a net charge to earnings of
approximately $.3 million during this period. On April 30, 1999, HFI
consummated the sale of certain mortgage banking assets. This sale is
expected to result in an estimated charge to earnings totaling $.2
million in the quarter ending June 30, 1999.
Page 25
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
None.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 27 Financial Data Schedule
Page 26
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange
Act of 1934, the Registrant has caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
HARRIS FINANCIAL, INC.
(Registrant)
By /s/ Charles C. Pearson, Jr.
--------------------------
Charles C. Pearson, Jr., President
and Chief Executive Officer
By /s/ James L. Durrell
--------------------
James L. Durrell, Executive Vice President
and Chief Financial Officer
Dated: May 7, 1999
Page 27
<PAGE>
EXHIBIT INDEX
Exhibit Number
- --------------
Exhibit 27 Financial Data Schedule
Page 28
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1999
<CASH> 30,462
<INT-BEARING-DEPOSITS> 29,620
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1,245,598
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 1,155,949
<ALLOWANCE> 9,655
<TOTAL-ASSETS> 2,537,431
<DEPOSITS> 1,224,184
<SHORT-TERM> 141,520
<LIABILITIES-OTHER> 55,378
<LONG-TERM> 923,000
0
0
<COMMON> 340
<OTHER-SE> 193,009
<TOTAL-LIABILITIES-AND-EQUITY> 2,537,431
<INTEREST-LOAN> 21,906
<INTEREST-INVEST> 19,802
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 41,708
<INTEREST-DEPOSIT> 12,470
<INTEREST-EXPENSE> 26,587
<INTEREST-INCOME-NET> 15,121
<LOAN-LOSSES> 795
<SECURITIES-GAINS> 1,353
<EXPENSE-OTHER> 11,592
<INCOME-PRETAX> 6,755
<INCOME-PRE-EXTRAORDINARY> 6,755
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,933
<EPS-PRIMARY> .15
<EPS-DILUTED> .15
<YIELD-ACTUAL> 6.98
<LOANS-NON> 2,038
<LOANS-PAST> 4,950
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 9,993
<ALLOWANCE-OPEN> 9,088
<CHARGE-OFFS> 287
<RECOVERIES> 59
<ALLOWANCE-CLOSE> 9,655
<ALLOWANCE-DOMESTIC> 9,413
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 242
</TABLE>
