<PAGE>
UNITED STATES
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 June 30, 2000
or
[ ] TRANSITION 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, P.O. Box 1711, Harrisburg, Pennsylvania 17105
---------------------------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
717-236-4041
------------
(Registrant's telephone number, including area code)
--------------------------------------------------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the Bank's classes of
common stock, as of the latest practicable date. 34,062,875 shares of stock, par
-------------------------------
value of $.01 per share, outstanding at July 14, 2000.
------------------------------------------------------
Page 1
<PAGE>
Part I. Financial Information.
Part 1, Item 1 Financial Statements.
(Balance of this page is intentionally left blank)
Page 2
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
(in thousands, except for share data)
(Unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
--------------- ---------------
<S> <C> <C>
Assets
------
Cash and cash equivalents $ 50,115 $ 73,613
Marketable securities available-for-sale 1,315,328 1,257,603
Loans receivable, net 1,382,896 1,267,983
Loans held for sale, net 6,433 1,646
Loan servicing rights 1,867 7,616
Premises and equipment, net of accumulated
depreciation of $17,503 and $15,484 29,295 23,228
Accrued interest receivable 18,501 18,302
Intangible assets 16,178 17,617
Deferred tax asset, net 23,823 17,402
Other assets 6,965 6,390
--------------- ---------------
Total assets $ 2,851,401 $ 2,691,400
=============== ===============
Liabilities and Stockholders' Equity
------------------------------------
Deposits $ 1,452,738 $ 1,373,870
Escrow 4,644 3,511
Accrued interest payable 11,827 10,292
Postretirement benefit obligation 2,702 2,538
Other borrowings (Note 3) 1,198,375 1,118,000
Income taxes payable - 2,302
Other liabilities 12,445 11,563
--------------- ---------------
Total liabilities $ 2,682,731 $ 2,522,076
--------------- ---------------
Common stock, $ .01 par value, authorized 100,000,000 shares,
34,062,875 shares issued and 33,613,575 outstanding
at June 30, 2000, 34,023,625 shares issued
and 33,574,325 shares outstanding at December 31, 1999 $ 341 $ 340
Paid in capital 30,499 30,323
Retained earnings 182,857 175,158
Accumulated other comprehensive income (37,932) (29,347)
Employee stock ownership plan (246) (296)
Recognition and retention plans (451) (456)
Treasury stock, 449,300 shares at June 30, 2000
and 449,300 shares at December 31, 1999 (Note 7) (6,398) (6,398)
--------------- ---------------
Total stockholders' equity 168,670 169,324
--------------- ---------------
Total liabilities and stockholders' equity $ 2,851,401 $ 2,691,400
=============== ===============
</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>
Six Months Ended June 30, Three Months Ended June 30,
-------------------------------- ---------------------------------
Interest Income: 2000 1999 2000 1999
-------------- -------------- --------------- --------------
<S> <C> <C> <C> <C>
Loans receivable:
First mortgage loans $ 19,540 $ 23,726 $ 9,796 $ 11,756
Commercial loans 16,160 9,447 9,024 5,192
Consumer and other loans 16,073 12,057 8,282 6,377
Taxable investments 14,592 15,215 7,294 7,217
Taxfree investments 1,757 3,145 896 1,562
Dividends 3,613 4,273 1,861 2,047
Mortgage-backed securities 26,335 16,214 13,714 8,235
Money market investments 64 59 31 42
-------------- -------------- --------------- --------------
Total interest income 98,134 84,136 50,898 42,428
-------------- -------------- --------------- --------------
Interest Expense:
Deposits 32,293 25,026 16,711 12,555
Borrowed funds 34,008 28,735 17,888 14,644
Escrow 27 53 11 28
-------------- -------------- --------------- --------------
Total interest expense 66,328 53,814 34,610 27,227
-------------- -------------- --------------- --------------
Net interest income 31,806 30,322 16,288 15,201
Provision for loan losses 1,666 1,590 831 795
-------------- -------------- --------------- --------------
Net interest income after provision for
loan losses 30,140 28,732 15,457 14,406
-------------- -------------- --------------- --------------
Noninterest Income:
Service charges on deposits 3,335 2,740 1,734 1,507
Other service charges/commissions/fees 620 688 327 364
Net servicing income 338 120 96 120
Gain on sale of securities, net 14 1,365 30 12
Gain on sale of loans, net 819 1,914 311 742
Other 201 705 95 766
-------------- -------------- --------------- --------------
Total noninterest income 5,327 7,532 2,593 3,511
-------------- -------------- --------------- --------------
Noninterest Expense:
Salaries and benefits 11,731 10,921 6,001 5,149
Equipment expense 2,050 2,000 1,034 1,038
Occupancy expense 2,119 1,559 1,118 757
Advertising and public relations 853 868 423 385
FDIC insurance 139 346 71 177
Director fees 162 179 68 96
Expense (income) from real estate operations 99 (347) 94 (131)
Amortization and write-off of intangibles 1,439 1,200 719 600
Consulting and other fees 1,260 1,020 520 555
Supplies, telephone and postage 1,680 1,745 794 857
Other 2,134 3,434 992 1,850
-------------- -------------- --------------- --------------
Total noninterest expense 23,666 22,925 11,834 11,333
-------------- -------------- --------------- --------------
Income before income taxes 11,801 13,339 6,216 6,584
Income tax expense 3,142 3,669 1,577 1,847
-------------- -------------- --------------- --------------
Net Income $ 8,659 $ 9,670 $ 4,639 $ 4,737
============== ============== =============== ==============
Basic earnings per share (Note 5) $ 0.26 $ 0.29 $ 0.14 $ 0.14
============== ============== =============== ==============
Diluted earnings per share (Note 5) $ 0.26 $ 0.29 $ 0.14 $ 0.14
============== ============== =============== ==============
</TABLE>
See accompanying notes to consolidated financial statements.
Page 4
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
(in thousands, except for per share data)
(Unaudited)
<TABLE>
<CAPTION>
Other Employee Recognition Compre-
Compre- Stock And hensive
Common Paid in Retained hensive Ownership Retention Treasury Income
Stock Capital Earnings Income (Loss) Plan Plan Stock Total (Loss)
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1999 $ 340 $ 29,960 $ 158,386 $ 8,106 $ (396) $ (456) $(5,970) $189,970
Net income 9,670 9,670 $ 9,670
Dividends paid at $.12 per share (956) (956)
Exercised stock options 43 43
Unrealized losses on securities (12,648) (12,648) (12,648)
---------
Comprehensive income (loss) $ (2,978)
=========
ESOP stock committed for release 50 50
Excess of fair value above cost of
ESOP stock committed for release 138 138
Treasury stock purchased -
10,000 shares (127) (127)
-----------------------------------------------------------------------------------------
Balance at June 30, 1999 $ 340 $ 30,141 $ 167,100 $ (4,542) $ (346) $ (456) $(6,097) $186,140
=========================================================================================
Balance at January 1, 2000 340 30,323 175,158 (29,347) (296) (456) (6,398) 169,324
Net income 8,659 8,659 $ 8,659
Dividends paid at $.12 per share (960) (960)
Exercised stock options 1 130 131
Unrealized losses on securities (8,585) (8,585) (8,585)
---------
Comprehensive income (loss) $ 74
=========
ESOP stock committed for release 50 50
Earned portion of RRP plan 5 5
Excess of fair value above cost of
ESOP stock committed for release 41 41
Excess of fair value above cost of
earned portion of RRP plan 5 5
-----------------------------------------------------------------------------------------
Balance at June 30, 2000 $ 341 $ 30,499 $ 182,857 $ (37,932) $ (246) $ (451) $(6,398) $168,670
=========================================================================================
</TABLE>
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>
Six Months Ended June 30,
------------------------------------
2000 1999
------------ -------------
<S> <C> <C>
Cash flows from operating activities:
Net Income $ 8,659 $ 9,670
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 1,666 1,590
Net depreciation, amortization, and accretion 33 2,767
(Increase) decrease in loans held for sale (4,787) 13,656
Net gain on sales of interest-earning assets (833) (3,279)
Gain (loss) on sale of foreclosed real estate 84 (162)
Equity losses from joint ventures 174 57
(Increase) decrease in accrued interest receivable (199) (2,151)
Increase in accrued interest payable 1,535 672
Amortization of intangibles 1,439 1,200
Earned ESOP shares 91 188
Earned RRP shares 10 -
Provision for deferred income taxes (6,421) (1,445)
(Increase) decrease in current income taxes (2,302) 1,329
Other, net 4,166 29,376
------------ -------------
Net cash provided by operating activities 3,315 53,468
------------ -------------
Cash flows from investing activities:
Proceeds from maturities and principal reductions of marketable
securities:
Available-for-sale 13,643 162,352
Proceeds from sales of marketable securities; available-for-sale 80,355 225,730
Purchase of marketable securities; available-for-sale (162,180) (370,263)
Loans sold 29,179 57,249
Net increase in loan originations less principal payments on
loans (146,191) (261,054)
Loan servicing rights sold 7,643 -
Acquisition of loan servicing rights (512) 153
Investments in real estate held for investment and other joint ventures (533) (239)
Proceeds from payments on real estate held for investment 109 419
Purchases of premises and equipment, net (8,164) (2,479)
Cash proceeds received from the sale of foreclosed real
estate 291 1,549
Branch purchase - 22,134
------------ -------------
Net cash used in investing activities (186,360) (164,449)
------------ -------------
</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>
Six Months Ended June 30,
-------------------------------------
2000 1999
------------- ------------
<S> <C> <C>
Cash flows from financing activities:
Net increase in deposits $ 78,868 $ 34,082
Net increase in other borrowings 80,375 68,746
Net increase in escrow 1,133 9,741
Payments to acquire treasury stock - (127)
Cash dividends (960) (956)
Proceeds from the exercise of stock options 131 43
------------- ------------
Net cash provided by financing operations 159,547 111,529
------------- ------------
Net (decrease) increase in cash and cash equivalents (23,498) 548
Cash and cash equivalents at beginning of period 73,613 56,741
------------- ------------
Cash and cash equivalents at end of period $ 50,115 $ 57,289
============= ============
Supplemental disclosures:
Cash paid during the periods for:
Interest on deposits, advances and other borrowings
(includes interest credited to deposit accounts) $ 64,791 $ 53,218
Income taxes 8,479 636
Non-cash investing activities:
Transfer from loans to foreclosed real estate $ 213 $ 922
Branch acquisition:
Fair value of assets acquired $ - $ 11,870
Deposit premium paid - 3,269
Fair value of liabilities assumed - 37,273
</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,
except per share data)
(Unaudited)
(1) Accounting Policies
-------------------
The Consolidated Financial Statements include the accounts of Harris Financial,
Inc. (the "Registrant" or "HFI") and its wholly-owned subsidiary Harris Savings
Bank (the "Bank"). In turn, the Bank holds the following subsidiaries: AVSTAR
Mortgage Corporation, Harris Delaware Corporation, H. S. Service Corporation,
First Harrisburg Service Corporation and C.B.L. Service Corporation. Both AVSTAR
Mortgage Corporation and C.B.L. Service Corporation are inactive and both of the
subsidiaries have immaterial assets and liabilities. 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 six month period ended June 30, 2000
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2000 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 34 through 36 of the 1999 Annual Report to Stockholders.
(2) 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, 2000. A company
may also implement the Statement as of the beginning of any fiscal quarter after
issuance. The Statement cannot be applied retroactively.
Management plans to adopt the Statement as of January 1, 2001. The impact of
adopting SFAS 133 on the financial statements would be immaterial if adopted
today, given the Company's current derivative positions and the current interest
rate environment. However, the impact of the ultimate adoption of SFAS 133 could
be material depending on changes in the Company's derivative positions or the
rise or fall in interest rates.
Page 8
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables are in thousands,
except per share data)
(Unaudited)
(3) Other Borrowings
----------------
The following table presents the composition of HFI's other borrowings as of the
dates indicated.
June 30, December 31,
2000 1999
------------------ -------------------
FHLB advances $ 1,040,000 $ 805,000
Repurchase agreements 158,375 313,000
------------------ -------------------
Total other borrowings $ 1,198,375 $ 1,118,000
================== ===================
(4) Commitments to Extend Credit
----------------------------
In the ordinary course of business, HFI makes commitments to extend letters of
credit to its customers. Standby letters of credit issued and outstanding
amounted to $14,311,000 at June 30, 2000 and $7,372,000 at December 31, 1999.
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 June 30, 2000, HFI had $166,051,000 in unused line of credit commitments
extended to its customers, $28,652,000 of undistributed funds on construction
loans and $55,809,000 of loan origination commitments.
(5) 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
Income Shares Amount
----------------------------------------------
<S> <C> <C> <C>
For the six months ended June 30, 2000
Basic earnings per share:
Income available to common shareholders $ 8,659 33,592,724 $ 0.26
----------------------------------------------
Dilutive effect of management and director stock options 33,856
----------------------------------------------
Diluted earnings per share:
Income available to common shareholders
plus assumed conversions $ 8,659 33,626,580 $ 0.26
==============================================
For the six months ended June 30, 1999
Basic earnings per share:
Income available to common shareholders $ 9,670 33,804,463 $ 0.29
----------------------------------------------
Dilutive effect of management and director stock options 86,863
----------------------------------------------
Diluted earnings per share:
Income available to common shareholders
plus assumed conversions $ 9,670 33,891,326 $ 0.29
==============================================
</TABLE>
Page 9
<PAGE>
HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables are in thousands,
except per share data)
(unaudited)
<TABLE>
<CAPTION>
Per Share
Income Shares Amount
---------------------------------------------
<S> <C> <C> <C>
For the three months ended June 30, 2000
Basic earnings per share:
Income available to common shareholders $ 4,639 33,607,371 $ 0.14
---------------------------------------------
Dilutive effect of management and director stock options 26,632
---------------------------------------------
Diluted earnings per share:
Income available to common shareholders
plus assumed conversions $ 4,639 33,634,003 $ 0.14
=============================================
For the three months ended June 30, 1999
Basic earnings per share:
Income available to common shareholders $ 4,737 33,809,603 $ 0.14
---------------------------------------------
Dilutive effect of management and director stock options 82,643
---------------------------------------------
Diluted earnings per share:
Income available to common shareholders
plus assumed conversions $ 4,737 33,892,246 $ 0.14
=============================================
</TABLE>
(6) Dividend Waivers by the Mutual Holding Company
----------------------------------------------
Harris Financial, MHC, (the "Mutual Company"), a Pennsylvania mutual holding
company that owns approximately 76% of the outstanding shares of HFI's common
stock, has generally waived the receipt of dividends declared by the Bank, or,
subsequent to its formation in the two-tier reorganization, dividends paid by
HFI. The Mutual Company has not been required to obtain approval of the Federal
Reserve Board (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:
. 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.
. Dividends waived by the Mutual Company shall not be available for
payment to or the value thereof transferred to stockholders other than
the Mutual Company ("Minority Stockholders") by any means including
through dividend payments or at liquidation;
. 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;
. 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;
. 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;
. 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;
. The dividend rate will be reasonable and sustainable upon a full
conversion to stock form of the Mutual Company; and,
Page 10
<PAGE>
. In the event that the FRB adopts regulations regarding dividend
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 HFI 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 HFI, and, if necessary, the FRB
approves such waiver, then HFI 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 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 HFI and the receipt of required
regulatory approvals.
There can be no assurance that:
. the Mutual Company will waive dividends paid by HFI,
. the FRB will approve any dividend waivers by the Mutual Company after
April 2001, or
. 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 HFI.
As of April 19, 1996, the Mutual Company had waived $9.1 million of dividends
declared by the Bank and through June 30, 2000, had waived a total of $31.5
million of dividends paid by the Bank and HFI.
Also see "Regulatory Environment related to the Plan of Conversion of Harris
Financial, MHC."
(7) Treasury Stock Repurchase Program
---------------------------------
On February 27, 1998, HFI received authorization from the Pennsylvania
Department of Banking to repurchase 472,500 shares of its outstanding common
stock. On June 2, 1999, HFI received approval from the Department of Banking to
extend the period for repurchasing 472,500 shares of its outstanding common
stock until June 1, 2000. This deadline has not been extended. As of December
31, 1999, HFI's share repurchases total 449,300. HFI did not repurchase any
treasury stock during the six months ended June 30, 2000.
(8) Merger Agreement and Stock Conversion of Mutual Company
-------------------------------------------------------
On March 28, 2000 HFI and the Bank announced that they entered into an agreement
to merge with York Financial Corp., the parent of York Federal Savings and Loan
Association. To accomplish the merger, the Board of Trustees of Harris
Financial, MHC has adopted a plan of conversion pursuant to which it would
convert from a mutual to a capital stock form of organization. Harris Financial,
MHC is the mutual holding company parent of Harris Financial, Inc. and owns
approximately 76% of the Corporation's outstanding common shares. The
transactions are expected to be completed during the fourth quarter of 2000.
In connection with the planned merger and conversion, Harris Financial, Inc.
filed on June 23, 2000, Forms S-1 and S-4 Registration Statements with the
Securities and Exchange Commission. Harris Financial also filed on June 27, 2000
an application with the Office of Thrift Supervision ("OTS") seeking approval
for Harris Financial to become a unitary savings and loan holding company and
for Harris Savings Bank to convert its charter to that of a federal stock
savings bank. If approved, both Harris Financial and Harris Savings Bank would
be subject to the regulation and supervision of the OTS.
Page 11
<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
1999 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
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" in the 1999 Annual Report. Readers are cautioned not to place undue
reliance on these forward-looking statements, which reflect management's
analysis only as of the date hereof. HFI 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
Net income for the six month period ended June 30, 2000 was $8,659,000,
representing a decrease of $1,011,000, or 10.5%, from the $9,670,000 net income
figure reported during the comparable six month period ended June 30, 1999. The
decrease was primarily due to a reduction of $2,205,000, or 29.3%, in
noninterest income during the six month period ended June 30, 2000 versus the
comparable prior period. The reduction in noninterest income was due primarily
to decreases in gains realized from the sale of loans and securities. Partially
offsetting the decrease in noninterest income was an increase of $1.5 million,
or 4.9%, in net interest income for the six months ended June 30, 2000, compared
to the six months ended June 30, 1999. An analysis of the changes in noninterest
income is presented in Table 5 which appears later in this report.
For the three month period ended June 30, 2000, net income was $4,639,000 which
was $98,000, or 2.1%, lower than the net income figure of $4,737,000 for the
comparable period in 1999. The decrease was primarily due to a reduction of
$918,000 in noninterest income during the three month period ended June 30, 2000
versus the comparable prior period. The reduction in noninterest income was due
primarily to a decrease in gains from sales of loans and a decrease in other
income. Partially offsetting the decrease in noninterest income was an increase
of $1.1 million, or 7.2%, in net interest income for the three months ended June
30, 2000, as compared to the three months ended June 30, 1999. An analysis of
the changes in noninterest income is presented in Table 5 which appears later in
this report.
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. The following discussion of interest income
and yields is presented on a tax equivalent basis to reflect HFI's portfolio of
tax exempt securities.
Net interest income, on a tax equivalent basis, totaled $33,024,000 for the six
months ended June 30, 2000, which represented an increase of $774,000 or 2.4%,
from the $32,250,000 of net interest income recorded in the six months ended
June 30, 1999. This increase reflected a favorable volume variance of $1,777,000
due to a $216.3 million increase in total average earning assets to $2.645
billion during the year to date period ended June 30, 2000 as compared to $2.429
billion recorded during the same period ended June 30, 1999. Also reflected in
this volume variance was a $242.8 million increase in average interest-bearing
liabilities. At the same time, general market interest rate trends created an
unfavorable rate variance of $1,003,000 for the six months ended June 30, 2000.
The combination of positive volume variances and negative rate variances
generated the net positive change of $774,000 mentioned above.
For the six months ended June 30, 2000, the yield on interest-earning assets was
7.51%. This figure was 42 basis points higher than the 7.09% yield reported for
the six month period ended June 30, 1999. At same time, the cost of funds
increased 54 basis points to 5.20% for the period ended June 30, 2000, versus
4.66% for the six months ended June 30, 1999. As a result, the interest spread
(the difference between the yield on assets minus the cost of funds) decreased
by 12 basis points to 2.31% for the six month period ended June 30, 2000, versus
2.43% for the six month period ended June 30, 1999.
Net interest income, on a tax equivalent basis, totaled $16,907,000 for the
three months ended June 30, 2000, which represented an increase of $742,000 or
4.6%, from the $16,165,000 of net interest income recorded in the three months
ended June 30, 1999. This increase reflected a favorable volume variance of
$876,000 due to a $226.7 million increase in total average earning assets to
$2.694 billion during the three month period ended June 30, 2000 as compared to
Page 12
<PAGE>
$2.467 billion recorded during the same period ended June 30, 1999. Also
reflected in this volume variance was a $262.0 million increase in average
interest-bearing liabilities. At the same time, general market interest rate
trends created an unfavorable rate variance of $134,000 for the three months
ended June 30, 2000. The combination of positive volume variances and negative
rate variances generated the net positive change of $742,000 mentioned above.
For the three months ended June 30, 2000, the yield on interest-earning assets
was 7.65%. This figure was 61 basis points higher than the 7.04% yield reported
for the three month period ended June 30, 1999. At same time, the cost of funds
increased 67 basis points to 5.32% for the period ended June 30, 2000, versus
4.65% for the three months ended June 30, 1999. As a result, the interest spread
(the difference between the yield on assets minus the cost of funds) decreased
by 6 basis points to 2.33% for the three month period ended June 30, 2000,
versus 2.39% for the three month period ended June 30, 1999. On a linked quarter
basis, interest spread increased by 6 basis points for the three month period
ended June 30, 2000 versus the three month period ended March 31, 2000.
HFI continues to rely on wholesale funding sources to support an investment
leveraging strategy and uses external borrowings to supplement funding provided
by savings and time deposits. During the six month period ended June 30, 2000,
total deposits (net of escrow deposits) increased $78.9 million, or 5.7%, while
other borrowings increased by $80.4 million, or 7.2%, from December 31, 1999.
During the twelve month period ended June 30, 2000, total deposits (net of
escrow deposits) increased $176.0 million, or 13.8%, while other borrowings
increased by $60.4 million, or 5.3% from June 30, 1999. The leveraging 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 interest
income and boost HFI's return on equity.
The following table summarizes the impact of the leveraging strategy on the
return on average assets (ROAA) and net interest margin (NIM) for the six month
periods ended June 30, 2000 and June 30, 1999 and for the three month periods
ended June 30, 2000 and June 30, 1999. During the six month and three month
periods ended June 30, 2000, as compared to the comparable periods in 1999, the
leverage strategy results have increased return on assets and have lessened the
relative decrease in net interest margins.
Table 1 Comparison of Financial Performance with and without a Capital
Leveraging Strategy
<TABLE>
<CAPTION>
With Without Difference in
Six month period ended June 30, 2000 Leveraging Leveraging Basis Points
---------------------------------------------- -------------- ---------------- ---------------
<S> <C> <C> <C>
Return on Average Assets 0.63% 0.43% 20
Net Interest Margin 2.50% 3.06% (56)
Six month period ended June 30, 1999
----------------------------------------------
Return on Average Assets 0.77% 0.58% 19
Net Interest Margin 2.66% 3.48% (82)
Three month period ended June 30, 2000
----------------------------------------------
Return on Average Assets 0.66% 0.47% 19
Net Interest Margin 2.51% 3.06% (55)
Three month period ended June 30, 1999
----------------------------------------------
Return on Average Assets 0.74% 0.59% 15
Net Interest Margin 2.62% 3.45% (83)
</TABLE>
Table 2 presents HFI's average asset and liability balances, interest rates,
interest income and interest expense for each of the six month periods ended
June 30, 2000 and June 30, 1999. Table 3 presents HFI's average asset and
liability balances, interest rates, interest income and interest expense for
each of the three month periods ended June 30, 2000 and June 30, 1999. Table 4
presents a rate-volume analysis of changes in net interest income for the six
month periods ended June 30, 2000 and June 30, 1999 and the three month periods
ended June 30, 2000 and June 30, 1999.
During the six months ended June 30, 2000, HFI's commercial and direct consumer
loan yields and marketable securities yields increased relative to the six
months ended June 30, 1999. This increase was primarily due to HFI significantly
increasing these portfolio balances at increasing rates during the twelve months
ended June 30, 2000. The increase in interest income from this portfolio was
attributable to an increase of $161.2 million, or 4.1%, in the average balances
of such loans as well as an improvement of 89 basis points and 30 basis points
in the average yield on the commercial loan portfolio and the direct consumer
loan portfolio, respectively, for the six months ended June 30, 2000, compared
to the six months ended June 30, 1999. HFI decreased its holdings of mortgage
loans and sold substantially all of its conventional mortgage loan production
during the twelve months ended June 30, 2000, which resulted in an
Page 13
<PAGE>
overall decrease in the yield on the mortgage loan portfolio. For the six months
ended June 30, 2000, the average balance of conventional mortgage loans, net,
decreased to $548.8 million and the average yield on such loans decreased to
7.12%, compared to an average balance of $615.8 million and an average yield of
7.71% for the six months ended June 30, 1999. Also, HFI elected to constrict its
growth in indirect consumer loans since September 30, 1999 due to reaching its
internal asset allocation thresholds for this portfolio. This constriction on
growth occurred during a period of rising interest rates and accordingly limited
yield enhancement in these portfolios.
During the quarter ended June 30, 2000, HFI's commercial and direct consumer
loan yields and marketable securities yields increased relative to the quarter
ended June 30, 1999. Again, this was primarily because HFI significantly
increased these portfolio balances at increasing rates during the twelve months
ended June 30, 2000. For the three months ended June 30, 2000, the average
balance of such loans increased by $165.4 million, or 39.7%, compared to the
three months ended June 30, 1999. The average yield on commercial loans and
direct consumer loans improved to 9.05% and 8.96%, respectively, for the three
months ended June 30, 2000, from 7.73% and 8.86%, respectively, for the three
months ended June 30, 1999. Partially offsetting these yield increases were
decreases in portfolio yields on mortgage and indirect consumer loans. HFI
decreased its holdings of mortgage loans and sold substantially all of its
conventional mortgage loan production during the twelve months ended June 30,
2000, which resulted in an overall decrease in the yield on the mortgage loan
portfolio. The average balance of residential mortgage loans, net, decreased to
$548.7 million for the three months ended June 30, 2000 from $622.3 million for
the three months ended June 30, 1999. Also, HFI elected to constrict its growth
in indirect consumer loans since September 30, 1999 due to reaching its internal
asset allocation thresholds for this portfolio. This constriction on growth
occurred during a period of rising interest rates and accordingly limited yield
enhancement in these portfolios.
For information on qualitative and quantitative disclosures regarding market
risk, refer to Management's Discussion and Analysis included in the 1999 Annual
Report to Stockholders. There have been no significant changes noted in HFI's
market risk profile or HFI's risk management procedures in the current year.
Page 14
<PAGE>
Table 2 Average Balance Sheets, Rates and Interest Income and Expense Summary -
Year-to-Date (All dollar amounts presented in table are in 000's)
<TABLE>
<CAPTION>
For the six months ended,
---------------------------------------------------------------------------------
June 30, 2000 June 30, 1999
---------------------------------------------------------------------------------
Average (1) (2) Average Average (1) (2) Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
--------------------------------------- ---------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Mortgage loans, net $ 548,754 $ 19,540 7.12% $ 615,765 $ 23,726 7.71%
Commercial loans 380,239 16,432 8.64% 249,803 9,682 7.75%
Direct consumer loans 173,530 7,651 8.82% 142,743 6,080 8.52%
Indirect consumer loans 226,032 8,422 7.45% 152,845 5,977 7.82%
Marketable securities - taxable 1,232,814 44,097 7.15% 1,121,005 35,092 6.26%
Marketable securities - taxfree 60,400 2,703 8.95% 117,907 4,838 8.21%
Other interest-earning assets 23,238 507 4.36% 28,596 669 4.68%
--------------------------------------- ---------------------------------------
Total interest-earning assets 2,645,007 99,352 7.51% 2,428,664 86,064 7.09%
------------------------ -------------------------
Noninterest-earning assets 100,639 98,121
--------------- --------------
Total assets $ 2,745,646 $ 2,526,785
=============== ==============
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Savings deposits $ 129,909 $ 1,692 2.60% $ 144,832 $ 1,408 1.94%
Time deposits 948,428 26,016 5.49% 773,084 20,222 5.23%
NOW and money market deposits 337,700 4,585 2.72% 296,424 3,396 2.29%
Escrow 3,742 27 1.44% 13,078 53 0.81%
Borrowed funds 1,131,385 34,008 6.01% 1,080,955 28,735 5.32%
--------------------------------------- ---------------------------------------
Total interest-bearing liabilities 2,551,164 66,328 5.20% 2,308,373 53,814 4.66%
------------------------ -------------------------
Noninterest-bearing liabilities 27,781 27,486
--------------- --------------
Total liabilities 2,578,945 2,335,859
Stockholders' equity 166,701 190,926
--------------- --------------
Total liabilities and stockholder equity $ 2,745,646 $ 2,526,785
=============== ==============
Net interest income before
provision for loan loss $ 33,024 $ 32,250
============ ============
Interest rate spread (3) 2.31% 2.43%
============ =============
Net interest-earning assets $ 93,843 $ 120,291
=============== ==============
Net interest margin (4) 2.50% 2.66%
============ =============
Ratio of interest-earning assets to
interest-bearing liabilities 1.04 1.05
=============== ==============
</TABLE>
(1) Includes income recognized on deferred loan fees of $498,000 for the six
months ended June 30, 2000 and $972,000 for the six months ended June 30,
1999.
(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 3 Average Balance Sheets, Rates and Interest Income and Expense Summary -
Quarter (All dollar amounts presented in table are in 000's)
<TABLE>
<CAPTION>
For the three months ended,
---------------------------------------------------------------------------------
June 30, 2000 June 30, 1999
---------------------------------------------------------------------------------
Average (1) (2) Average Average (1) (2) Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
--------------------------------------- ---------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Mortgage loans, net $ 548,657 $ 9,796 7.14% $ 622,250 $ 11,756 7.56%
Commercial loans 404,706 9,161 9.05% 274,863 5,315 7.73%
Direct consumer loans 177,263 3,969 8.96% 141,746 3,140 8.86%
Indirect consumer loans 230,650 4,313 7.48% 171,719 3,237 7.54%
Marketable securities - taxable 1,248,804 22,672 7.26% 1,110,389 17,238 6.21%
Marketable securities - taxfree 61,399 1,378 8.98% 118,115 2,403 8.14%
Other interest-earning assets 22,433 228 4.07% 28,120 303 4.31%
--------------------------------------- ---------------------------------------
Total interest-earning assets 2,693,912 51,517 7.65% 2,467,202 43,392 7.04%
------------------------ -------------------------
Noninterest-earning assets 106,053 94,989
--------------- --------------
Total assets $ 2,799,965 $ 2,562,191
=============== ==============
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Savings deposits $ 135,618 $ 1,015 2.99% $ 145,782 $ 721 1.98%
Time deposits 955,884 13,327 5.58% 777,289 10,128 5.21%
NOW and money market deposits 341,370 2,369 2.78% 300,709 1,706 2.27%
Escrow 3,821 11 1.15% 15,401 28 0.73%
Borrowed funds 1,165,815 17,888 6.14% 1,101,372 14,644 5.32%
--------------------------------------- ---------------------------------------
Total interest-bearing liabilities 2,602,508 34,610 5.32% 2,340,553 27,227 4.65%
------------------------ -------------------------
Noninterest-bearing liabilities 30,683 30,179
--------------- --------------
Total liabilities 2,633,191 2,370,732
Stockholders' equity 166,774 191,459
--------------- --------------
Total liabilities and stockholder equity $ 2,799,965 $ 2,562,191
=============== ==============
Net interest income before
before provision for loan loss $ 16,907 $ 16,165
============ ============
Interest rate spread (3) 2.33% 2.39%
============ =============
Net interest-earning assets $ 91,404 $ 126,649
=============== ==============
Net interest margin (4) 2.51% 2.62%
============ =============
Ratio of interest-earning assets to
interest-bearing liabilities 1.04 1.05
=============== ==============
</TABLE>
(1) Includes income recognized on deferred loan fees of $287,000 for the three
months ended June 30, 2000 and $528,000 for the three months ended June 30,
1999.
(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 16
<PAGE>
Table 4 - Rate/Volume Analysis of Changes in Net Interest Income (All dollar
amounts presented in table are in 000's)
<TABLE>
<CAPTION>
Six Months Ended June 30, 2000 Three Months Ended June 30, 2000
Compared to Compared to
Six Months Ended June 30, 1999 Three Months Ended June 30, 1999
Increase (Decrease) Increase (Decrease)
------------------------------------- -------------------------------------
Volume Rate Net Volume Rate Net
------------------------------------- -------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Mortgage loans, net $ (2,458) $ (1,728) $ (4,186) $ (1,334) $ (626) $ (1,960)
Commercial loans 5,533 1,217 6,750 2,825 1,021 3,846
Direct consumer loans 1,351 220 1,571 793 36 829
Indirect consumer loans 2,740 (295) 2,445 1,102 (26) 1,076
Marketable securities - taxable 3,713 5,292 9,005 2,306 3,128 5,434
Marketable securities - taxfree (2,538) 403 (2,135) (1,252) 227 (1,025)
Other interest-earning assets (119) (43) (162) (59) (16) (75)
------------------------------------- -------------------------------------
Total interest-earning assets 8,222 5,066 13,288 4,381 3,744 8,125
------------------------------------- -------------------------------------
Interest-bearing liabilities:
Savings deposits (156) 440 284 (53) 347 294
Time deposits 4,752 1,042 5,794 2,444 755 3,199
NOW and money market deposits 506 683 1,189 249 414 663
Escrow (52) 26 (26) (28) 11 (17)
Borrowed funds 1,395 3,878 5,273 893 2,351 3,244
-----------------------------------------------------------------------------
Total interest-bearing liabilities 6,445 6,069 12,514 3,505 3,878 7,383
-----------------------------------------------------------------------------
Net change in net interest income $ 1,777 $ (1,003) $ 774 $ 876 $ (134) $ 742
=============================================================================
</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.
Provision for Loan Losses
HFI recognized a provision for loan loss of $1,666,000 for the six months ended
June 30, 2000. This represents an increase of $76,000, or 4.8%, from the
$1,590,000 provision recorded for the six months ended June 30, 1999. For the
three months ended June 30, 2000, HFI recognized a provision for loan loss of
$831,000. This is a $36,000, or 4.5%, increase over the $795,000 provision for
the three month period ended June 30, 1999. The increase in HFI's provision
reflects management's assessment of the adequacy of the allowance for loan
losses in light of such factors as growth of the portfolio, portfolio
composition, and general economic conditions. Management's methodology for
assessing the adequacy of the allowance for loan losses is more fully discussed
in the Asset Quality section.
Noninterest Income
The table below presents an analysis of change in noninterest income for the six
month periods ended June 30, 2000 and June 30, 1999 and the three month periods
ended June 30, 2000 and June 30, 1999.
Table 5 Changes in Noninterest Income (All dollar amounts presented in table are
in 000's)
Page 17
<PAGE>
<TABLE>
<CAPTION>
Six months ended June 30, Three months ended June 30,
------------------------------------ -----------------------------------------
Noninterest Income: 2000 1999 % Change 2000 1999 % Change
----------- ----------- ----------- ------------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Service charges on deposits $ 3,335 $ 2,740 21.7% $ 1,734 $ 1,507 15.1%
Other service charges/commissions/fees 620 688 (9.9%) 327 364 (10.2%)
Net servicing income 338 120 181.7% 96 120 (20.0%)
Gain on sale of securities, net 14 1,365 (99.0%) 30 12 150.0%
Gain on sale of loans, net 819 1,914 (57.2%) 311 742 (58.1%)
Other 201 705 (71.5%) 95 766 (87.6%)
----------- ----------- ------------- -------------
Total noninterest income $ 5,327 $ 7,532 (29.3%) $ 2,593 $ 3,511 (26.1%)
=========== =========== ============= =============
</TABLE>
Total noninterest income decreased 29.3% for the six months ended June 30, 2000
compared to the six months ended June 30, 1999. The decrease in noninterest
income was primarily the result of reduced reliance on gains from sales in the
securities portfolio which was partially offset by growth in fee income on core
banking products. The gain on sale of loans decreased primarily due to rising
interest rates and diminished loan activity due to winding up of our AVSTAR
mortgage operations. Service charges increased 21.7% due to growth in deposit
accounts and the addition of two new branches during the twelve months ended
June 30, 2000.
Total noninterest income decreased 26.1% for the three months ended June 30,
2000 compared to the three months ended June 30, 1999. This decrease came
primarily in other income which was enhanced in the quarter ended June 30, 1999
by a $700,000 fraud recovery related to the 1996 acquisition of First Harrisburg
Bancorp. Revenue from mortgage loan sales also declined $455,000 for the reason
cited in the preceding paragraph. Service charges on deposits increased 15.1%
due to growth in deposit accounts.
Noninterest Expense
An analysis of changes in noninterest expense for the six month periods ended
June 30, 2000 and June 30, 1999 and the three month periods ended June 30, 2000
and June 30, 1999 is presented in the table below.
Table 6 Changes in Noninterest Expense (All dollar amounts presented in table
are in 000's)
<TABLE>
<CAPTION>
Six Months Ended June 30, Three Months Ended June 30,
----------------------------------- -----------------------------------
2000 1999 % Change 2000 1999 % Change
---------- ---------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Noninterest Expense:
Salaries and benefits $ 11,731 $ 10,921 7.4% $ 6,001 $ 5,149 16.5%
Equipment expense 2,050 2,000 2.5% 1,034 1,038 (0.4%)
Occupancy expense 2,119 1,559 35.9% 1,118 757 47.7%
Advertising and public relations 853 868 (1.7%) 423 385 9.9%
FDIC insurance 139 346 (59.8%) 71 177 (59.9%)
Director fees 162 179 (9.5%) 68 96 (29.2%)
Expense (income) from real estate operations 99 (347) NM 94 (131) NM
Amortization of intangibles 1,439 1,200 19.9% 719 600 19.8%
Consulting and other fees 1,260 1,020 23.5% 520 555 (6.3%)
Supplies, telephone and postage 1,680 1,745 (3.7%) 794 857 (7.4%)
Other 2,134 3,434 (37.9%) 992 1,850 (46.4%)
---------- ---------- ---------- -----------
Total noninterest expense $ 23,666 $ 22,925 3.2% $ 11,834 $ 11,333 4.4%
========== ========== ========== ===========
</TABLE>
Total noninterest expense increased 3.2% for the six months ended June 30, 2000
compared to the six months ended June 30, 1999. Increases in noninterest expense
were commensurate with the expansion of branch networks and the expansion of
traditional and non-traditional business lines. The decrease in other
noninterest expense resulted primarily from the winding up of the AVSTAR
operations in the second quarter of 1999.
Total noninterest expense increased 4.4% for the three months ended June 30,
2000 compared to the three months ended June 30, 1999. Increases in noninterest
expense were commensurate with the expansion of branch networks and the
expansion of traditional and non-traditional business lines. The decrease in
other noninterest expense
Page 18
<PAGE>
resulted primarily from the winding up of the AVSTAR operations in the second
quarter of 1999.
Income Tax Expense
Income tax expense totaled $3,142,000 for the six month period ended June 30,
2000, which resulted in an effective tax rate of 26.6% on pretax income of
$11,801,000. This represented a decrease of $527,000 from the recorded corporate
tax expense of $3,669,000 on pretax income of $13,339,000 during the six month
period ended June 30, 1999. The effective tax rate for the six month period
ended June 30, 1999 was 27.5%. The effective tax rate is less than the statutory
rates due to HFI's continued focus on tax exempt sources of income.
Income tax expense was $1,577,000 for the three months ended June 30, 2000,
which resulted in an effective tax rate of 25.4% on pretax income of $6,216,000.
This represented a decrease of $270,000 from the $1,847,000 of corporate tax
expense on pretax income of $6,584,000 during the three month period ended June
30, 1999. The effective tax rate for the three month period ended June 30, 1999
was 28.1%. The effective tax rate is less than the statutory rates due to HFI's
continued focus on tax exempt sources of income and a one time state tax
benefit.
(b) Financial Condition
Stockholders' Equity
Stockholders' equity totaled $168.7 million at June 30, 2000 and $169.3 million
at December 31, 1999. Stockholders' equity amounted to 5.9% of total assets
equalling $2.851 billion as of June 30, 2000, compared to 6.3% of total assets
of $2.691 billion at December 31, 1999.
The decrease in stockholders' equity of $.7 million, or .4%, for the six months
ended June 30, 2000, resulted mainly from a $8.6 million decline in the market
value, net of tax effect, of the available-for-sale securities and $1.0 million
in dividends paid. The drop in the market value of the available-for-sale
portfolio reflects the impact of recent market rate increases on the market
value of fixed rate issues in HFI's investment portfolio. Offsetting these
decreases was an $8.7 million increase from net income.
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
tables provide a comparison of HFI's and HSB's risk-based capital ratios and
leverage ratio to the minimum regulatory requirements for the period indicated.
Table 7 Risk-based Capital Ratios and Leverage Ratios (All dollar amounts
presented in table are in 000's)
<TABLE>
<CAPTION>
HARRIS FINANCIAL, INC. Minimum Requirement for Minimum Requirement to be
Actual Capital Adequacy "Well Capitalized"
------ ---------------- ------------------
As of June 30, 2000 Amount Ratio Amount Ratio Amount Ratio
------------------- ------ ----- ------- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Total Capital
(to Risk Weighted Assets) 202,868 11.3% 144,185 8.0 % 180,232 10.0 %
Tier 1 Capital
(to Risk Weighted Assets) 190,424 10.6% 72,093 4.0 % 108,139 6.0 %
Tier 1 Capital
(to Avg. Assets) 190,424 6.7% 112,865 4.0 % 141,081 5.0 %
<CAPTION>
As of December 31, 1999
-----------------------
Total Capital
(to Risk Weighted Assets) $194,582 12.0% $130,173 8.0% $162,716 10.0%
Tier 1 Capital
(to Risk Weighted Assets) 181,053 11.1% 65,086 4.0% 97,630 6.0%
Tier 1 Capital
(to Avg. Assets) 181,053 6.8% 106,502 4.0% 133,127 5.0%
</TABLE>
Page 19
<PAGE>
<TABLE>
<CAPTION>
HARRIS SAVINGS BANK Minimum Requirement for Minimum Requirement to be
Actual Capital Adequacy "Well Capitalized"
------ ---------------- ------------------
As of June 30, 2000 Amount Ratio Amount Ratio Amount Ratio
------------------- ------ ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Total Capital
(to Risk Weighted Assets) 198,549 11.0% 143,930 8.0% 179,912 10.0%
Tier 1 Capital
(to Risk Weighted Assets) 185,784 10.3% 71,965 4.0% 107,947 6.0%
Tier 1 Capital
(to Avg. Assets) 185,784 6.6% 112,733 4.0% 140,916 5.0%
As of December 31, 1999
-----------------------
Total Capital
(to Risk Weighted Assets) $189,925 11.7% $129,880 8.0% $162,350 10.0 %
Tier 1 Capital
(to Risk Weighted Assets) 176,262 10.9% 64,940 4.0% 97,410 6.0 %
Tier 1 Capital
(to Avg. Assets) 176,262 6.6% 106,347 4.0% 132,934 5.0 %
</TABLE>
Marketable Securities
Marketable securities, excluding the Federal Home Loan Bank cash account,
totaled $1,315.3 million at June 30, 2000 and $1,257.6 million at December 31,
1999 Total marketable securities increased $57.7 million, or 4.6%, during the
first six months of 2000.
The following table sets forth certain information regarding the amortized cost
and fair values of HFI's marketable securities portfolio at June 30, 2000 and
December 31, 1999.
Page 20
<PAGE>
Table 8 Composition of Marketable Securities Portfolios (All dollar amounts
presented in table are in 000's)
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
-------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
-------------------------------------------------------------
<S> <C> <C> <C> <C>
Available-for-sale:
U.S. Government and agencies $ 349,401 $ 325,796 $ 348,705 $ 324,619
Corporate bonds 63,501 59,778 63,352 59,826
Municipal obligations 62,775 62,613 63,980 63,492
FHLB stock 55,250 55,250 45,400 45,400
Equities (Common and Preferred) 70,354 70,371 73,034 76,711
Mortgage-backed securities:
GNMA CMO's 34,070 33,676 - -
FNMA CMO's 97,734 92,362 99,032 98,267
FHLMC CMO's 101,993 96,799 139,328 136,584
Private Issue CMO's 542,525 518,683 473,170 452,704
-------------------------------------------------------------
Total mortgage-backed securities 776,322 741,520 711,530 687,555
-------------------------------------------------------------
Total securities available-for-sale $ 1,377,603 $ 1,315,328 $ 1,306,001 $ 1,257,603
-------------------------------------------------------------
Other interest-earning securities:
FHLB daily investment $ 18,917 $ 18,917 $ 36,860 $ 36,860
-------------------------------------------------------------
Total marketable securities and
interest-earning investments $ 1,396,520 $ 1,334,245 $ 1,342,861 $ 1,294,463
=============================================================
</TABLE>
Loans
Loans receivable, excluding loans held for sale, totaled $1,382.9 million at
June 30, 2000 and $1,268.0 million at December 31, 1999. The increase of $114.9
million, or 9.1%, for the six months ended June 30, 2000, primarily reflects
growth in commercial loans of $89.2 million and a $28.5 million increase in
automobile, consumer and other loans. The loan growth trends in 2000 reflect
HFI's continued focus on expanding its commercial and consumer loan portfolios
and its reduced reliance on investing in residential mortgage loans.
Loan charge-offs, net of recoveries, totaled $1,103,000 for the six month period
ended June 30, 2000 and $412,000 for the six month period ended June 30, 1999.
Based on management's continuing review of the loan portfolio, HFI recorded
provisions for loan losses of $1,666,000 for the six months ended June 30, 2000
compared to $1,590,000 for the six months ended June 30, 1999.
Non-accrual loans were $4,218,000 at June 30, 2000 and $10,007,000 at December
31, 1999. The decrease of $5,789,000 in non-accrual loans during the six month
period ended June 30, 2000 came primarily in commercial loans. During the
quarter ended June 30, 2000, two commercial loans totaling $7.1 million were
refinanced with other lenders. In addition, loans 90 days past due, but still
accruing were $5,606,000 at June 30, 2000 and $6,128,000 at December 31, 1999.
The combined total of non-accrual loans and loans 90 days past due, but still
accruing interest as a percentage of total gross loans receivable, excluding
loans held for sale, equalled .71% at June 30, 2000 and 1.27% at December 31,
1999.
The allowance for loan losses totaled $12,436,000 at June 30, 2000 and
$11,873,000 at December 31, 1999. Stated as a percentage of total gross loans
receivable, excluding loans held for sale, the allowance for loan losses
amounted to .90% at June 30, 2000 and .94% at December 31, 1999.
Table 9 depicts the trend of charge-offs, recoveries and provisions to the
allowance for loan losses for the six months ended June 30, 2000, six months
ended June 30, 1999, and the year ended December 31, 1999. In addition, Table 10
highlights the allowance for loan losses as a percentage of non-accrual loans,
loans 90 days past due, but still accruing and specifically designated problem
loans for the six months ended June 30, 2000 and the year ended December 31,
1999. Finally, Table 11 presents an allocation of the allowance for loan losses
by category of loans as of June 30, 2000 and December 31, 1999.
Page 21
<PAGE>
Table 9 Analysis of the Allowance for Loan Losses (All dollar amounts presented
in table are in 000's)
<TABLE>
<CAPTION>
As of or for the As of or for the As of or for the
six months ended six months ended twelve months ended
Allowance for Loan Loss June 30, 2000 June 30, 1999 December 31, 1999
---------------------------------------------- -------------------- -------------------- ---------------------
<S> <C> <C> <C>
Balance at beginning of period $ 11,873 $ 9,088 $ 9,088
Provision for loan losses 1,666 1,590 3,180
Provision component related to unfunded
commitments - - 617
Charge offs:
Commercial loans (22) (50) (50)
One-to-four family loans (125) (349) (253)
Other mortgage loans - - -
Consumer and other loans (1,208) (115) (970)
-------------------- -------------------- ---------------------
Total Charge offs (1,355) (514) (1,273)
-------------------- -------------------- ---------------------
Recoveries:
Commercial loans 4 55 61
One-to-four family loans 1 5 73
Other mortgage loans - - -
Consumer and other loans 247 42 127
-------------------- -------------------- ---------------------
Total Recoveries 252 102 261
-------------------- -------------------- ---------------------
Net charge offs (1,103) (412) (1,012)
-------------------- -------------------- ---------------------
Balance at end of period $ 12,436 $ 10,266 $ 11,873
==================== ==================== =====================
Net charge offs to average loans outstanding (1) 0.17% 0.07% 0.08%
==================== ==================== =====================
</TABLE>
(1) Year-to-date ratio is annualized
The increase in charge offs for the six months ended June 30, 2000 is primarily
due to increased charge offs in automobile loans and, to a lesser extent, other
consumer loans.
Page 22
<PAGE>
Table 10 Allowance for Loan Losses Coverage Ratios (All dollar amounts presented
in table are in 000's)
<TABLE>
<CAPTION>
As of June 30, 2000 As of December 31, 1999
---------------------- ------------------------
<S> <C> <C>
Allowance at the end of period $ 12,436 $ 11,873
Non-accrual loans $ 4,218 $ 10,007
90 days past due, but still accruing $ 5,606 $ 6,128
Potential problem loans $ 18,353 $ 16,263
Allowance/non-accrual loans 294.83% 118.65%
---------------------- ------------------------
Allowance/90 days past due, but still accruing 221.83% 193.75%
---------------------- ------------------------
Allowance/non-accrual loans and 90 days past due,
but still accruing 126.59% 73.59%
---------------------- ------------------------
Allowance/problem loans 67.76% 73.01%
---------------------- ------------------------
</TABLE>
Table 11 Allocation of the Allowance for Loan Losses (All dollar amounts
presented in table are in 000's)
<TABLE>
<CAPTION>
As of June 30, 2000 As of December 31, 1999
------------------------------ ------------------------------
% of Total % of Total
Amount Reserves Amount Reserves
-------------- ------------- --------------- --------------
<S> <C> <C> <C> <C>
One-to-four family mortgage loans $ 840 6.76% $ 838 7.06%
Commercial loans 7,232 58.15% 7,154 60.25%
Consumer and other loans 3,346 26.90% 3,073 25.88%
Unallocated 1,018 8.19% 808 6.81%
-------------- ------------- --------------- --------------
Total $ 12,436 100.00% $ 11,873 100.00%
============== ============= =============== ==============
Reserve for unfunded commitments $ 308 $ 308
============== ===============
</TABLE>
Asset Quality
Virtually all of HFI's credit risk lies with the Bank, which holds substantially
all of HFI's loan assets. As part of the conversion of its operations from those
of a traditional 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 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 under the direction of a 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, concentrations of
credit risk and the current emphasis on commercial lending.
Each quarter 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 a reserve for existing losses on
commercial loans that are not specifically reviewed. This reserve is determined
using factors such as charge-off history, portfolio delinquencies and current
economic conditions. The mortgage and consumer portfolios are also analyzed in
pools of similar loans with similar risk characteristics. The reserve factor
applied to each pool
Page 23
<PAGE>
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, HFI maintains a reserve for unfunded
commitments. This reserve represents the Bank's estimation of loss incurred
relative to unfunded credit balances committed to customers. The reserve
assigned to this pool is developed using factors such as portfolio trends,
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.
The reserve for unfunded commitments totaled $308,000 at June 30, 2000 and at
December 31, 1999.
Other Borrowings
HFI engages in wholesale leveraging activities to deploy a portion of its
capital. This strategy relies on using external sources of funds to invest in
interest-earning assets at a positive spread between the yield on
interest-earning asset and the cost of the supporting borrowing.
Other borrowings totaled $1,198.4 million at June 30, 2000 and $1,118.0 million
at December 31, 1999. Borrowings from non-deposit funding sources increased
$235.0 million, or 7.2%, during the six months ended June 30, 2000. Federal Home
Loan Bank advances increased by $235.0 million, or 29.2%, to $1,040.0 million,
while repurchase agreements decreased by $154.6 million, or 49.4%, to $158.4
million during the six month period ended June 30, 2000.
As of June 30, 2000, HFI had maximum available FHLB lines of credit totaling
$1,148.5 million versus $1,059.5 million in available FHLB credit as of December
31, 1999. This increase of $89.0 million, or 8.4%, is based on increases in the
amount of securities that qualify as security for FHLB advances. HFI had
borrowings outstanding to the FHLB totaling $1,040.0 million as of June 30, 2000
and $805.0 million as of December 31, 1999.
Liquidity
HFI'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. HFI anticipates
that it will have sufficient funds available to meet its current commitments.
HFI exceeded all applicable regulatory standards for liquidity at June 30, 2000
and December 31, 1999.
Discussion of Market Risk
The financial condition and results of HFI are impacted by three primary market
risk factors: interest rate risk, credit risk and concentration risk. These risk
factors are discussed below based on management's belief as to the order of
potential impact to the Corporation's earnings and capital, from most critical
to least critical.
Interest Rate Risk
Currently, HFI's primary component of market risk 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 almost all of its interest-earning
assets are located at the Bank level. Fluctuations in market interest rates will
impact both the level of net interest income 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 leverage portfolios. The Bank's leverage portfolios include
investments in marketable securities which are funded through wholesale
borrowings, most of which are matched funded. The Bank also sells a significant
portion of its conforming 30-year mortgage loan originations to mitigate its
interest rate risk exposure. In addition, the Bank's investments and borrowing
activities are managed to mitigate the Bank's overall interest rate risk
profile.
Management employs an Asset/Liability Committee ("ALCO") that meets at least
monthly to manage interest rate risk exposure. HFI primarily employs dynamic GAP
analysis and Net Interest Income Volatility ("NII") analysis to assist in the
management of interest rate risk. The ALCO communicates monthly to the Board of
Directors on all matters relevant to interest rate risk exposures. 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. The
table below presents the Bank's GAP position as of June 30, 2000. As of this
date, the Bank's liability sensitive cumulative one-year GAP ratio was -12.7%
and liability sensitive three-year GAP ratio was -9.7%. Management attributes
this liability sensitivity to the effect of certain assumed conversions on
specific convertible borrowings and to assumed extensions on mortgage loans and
mortgage-backed securities. These assumptions reflect the rising interest rates
existing in the market at June 30, 2000.
Page 24
<PAGE>
Table 12 GAP Analysis (All dollar amounts presented in table are in 000's)
<TABLE>
<CAPTION>
At June 30, 2000
---------------------------------------------------------------
More Than More Than
One Year One Year Three Years
or Less to Three Years to Five Years
---------------------------------------------------------------
Balance Rate Balance Rate Balance Rate
---------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INEREST-EARNING ASSETS:
Cash and cash equivalents $ 18,917 4.38% $ - 0.00% $ - 0.00%
Marketable securities (1)(3) 622,416 7.50% 58,420 6.82% 58,194 6.75%
Commercial loans 228,003 8.62% 108,538 7.92% 69,977 7.83%
Mortgage loans (2) 128,059 7.12% 133,032 6.87% 103,761 6.79%
Consumer loans 147,723 9.02% 159,173 8.54% 65,885 8.71%
Total interest-earning
---------------------------------------------------------------
assets $ 1,145,118 7.82% $ 459,163 7.69% $ 297,817 7.45%
---------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
Savings accounts $ 30,578 5.35% $ - 0.00% $ - 0.00%
Interest-bearing
DDA accounts - 0.00% - 0.00% - 0.00%
Noninterest-bearing
DDA accounts - 0.00% - 0.00% - 0.00%
Money market accounts 177,151 4.94% - 0.00% - 0.00%
Time deposits 531,762 5.39% 333,916 5.98% 101,406 6.57%
Escrow - 0.00% - 0.00% - 0.00%
Other borrowings 758,375 6.36% 40,000 4.73% 250,000 6.63%
Total interest-bearing
---------------------------------------------------------------
liabilities $ 1,497,866 5.83% $ 373,916 5.85% $ 351,406 6.61%
---------------------------------------------------------------
Interest sensitivity gap
per period $ (352,748) $ 85,247 $ (53,589)
------------- ------------- -------------
Cumulative interest
sensitivity gap $ (352,748) $ (267,501) $ (321,090)
------------- ------------- -------------
Cumulative interest sensitivity gap
as a percent of total assets -12.75% -9.67% -11.60%
------------- ------------- -------------
Cumulative net interest-earning assets as a
percentage of net interest-bearing liabilities 76.45% 85.71% 85.56%
------------- ------------- -------------
<CAPTION>
At June 30, 2000
----------------------------------------
More Than
Five
Years Total
------------------------------------------
Balance Rate Balance Rate
------------------------------------------
<S> <C> <C>
INEREST-EARNING ASSETS:
Cash and cash equivalents $ 31,198 0.00% $ 50,115 1.65%
Marketable securities (1)(3) 638,573 6.62% 1,377,603 7.03%
Commercial loans 30,001 6.55% 436,519 8.18%
Mortgage loans (2) 188,971 6.84% 553,823 6.90%
Consumer loans 20,205 8.49% 392,986 8.74%
Total interest-earning
------------------------------------------
assets $ 908,948 6.48% $ 2,811,046 7.33%
------------------------------------------
INTEREST-BEARING LIABILITIES:
Savings accounts $ 125,044 2.25% $ 155,622 2.86%x
Interest-bearing
DDA accounts 97,910 1.10% 97,910 1.10%
Noninterest-bearing
DDA accounts 51,943 0.00% 51,943 0.00%
Money market accounts - 0.00% 177,151 4.94%x
Time deposits 3,028 5.83% 970,112 5.72%x
Escrow 4,644 1.28% 4,644 1.28%x
Other borrowings 150,000 6.00% 1,198,375 6.31%x
Total interest-bearing
------------------------------------------
liabilities $ 432,569 3.04% $ 2,655,757 5.48%
------------------------------------------
Interest sensitivity gap
per period $ 476,379 $ 155,289
-------------- --------------
Cumulative interest
sensitivity gap $ 155,289
-------------
Cumulative interest sensitivity gap
as a percent of total assets 5.61%
-------------
Cumulative net interest-earning assets as a
percentage of net interest-bearing liabilities 105.85%
-------------
</TABLE>
(1) Book value (net of allowance for sale adjustment) of investment portfolio.
(2) Excludes deferred loan costs and fees.
(3) Includes amounts presented on a tax equivalent basis.
Page 25
<PAGE>
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-year and two-year projections for NII
volatility to be 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 June 30, 2000,
management projects net interest income for the next twelve months to increase
$1.8 million, or 2.7% if market rates decrease 200 basis points over the next
twelve months and to decrease $5.9 million, or 8.8% if market rates increase 200
basis points over the next twelve months. These NII volatility values are within
the thresholds established by the Board of Directors for market rate shocks.
<TABLE>
<CAPTION>
Rate Scenarios -200 bp -100 bp 0 bp +100 bp +200 bp
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Absolute Change in NII (in millions) $1.8 $1.5 $0.0 $(2.7) $(5.9)
Relative Change in NII 2.7% 2.3% 0.0% (4.0%) (8.8%)
Board of Directors Limit +/-10.0% +/-5.0% 0.0% +/-(5.0%) +/-(10.0%)
</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 underwriting
standards and credit and collections management, the Bank's experience in credit
losses has been satisfactory. The Bank follows a comprehensive loan policy that
details credit underwriting, credit management and loan loss provisioning
techniques. With regard to its marketable securities portfolio, at June 30,
2000, over 89% of the marketable securities in HFI's portfolio were rated "AAA",
with the remainder rated "AA" or "A". At December 31, 1999, over 87% of the
marketable securities in HFI's portfolio were rated "AAA", with the remainder
rated "AA" or "A".
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. Except for the Bank's manufactured home loan portfolio,
virtually all of the Bank's loans and deposits are dependent on this primary
market area. The southcentral Pennsylvania and northern Maryland area have
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.
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 its
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" that
appears later in this report.
Merger Agreement
On March 28, 2000 Harris Financial announced that it entered into an agreement
to merge with York Financial Corporation, the parent of York Federal Savings and
Loan Association. To accomplish the merger, the Board of Trustees of Harris
Financial, MHC has adopted a plan of conversion pursuant to which it would
convert from a mutual to a capital stock form of organization. Harris Financial,
MHC is the mutual holding company parent of Harris Financial, Inc. and owns
approximately 76% of the Corporation's outstanding common shares. The
transactions are expected to be completed during the fourth quarter of 2000.
Merger Update
In preparation for the completion of merger-related transactions in the fourth
quarter of 2000, the management teams of Harris Financial, Inc. and York
Financial Corporation are working closely on business integration matters. The
executive team and board of directors of the new corporation have been selected,
with the selections communicated publicly in the related Harris Financial, Inc.
Form S-4 Registration Statement filed with the Securities and Exchange
Commission on June 23, 2000. The new executive team is currently engaged in
managing the merger integration process and has already completed certain key
integration milestones such as:
Page 26
<PAGE>
. established executive, line of business and operational integration teams
. implemented a detailed integration schedule
. selected all core information technology systems
. confirmed the feasibility of achieving operational savings estimates
developed during due diligence
. completed preliminary strategic planning exercises for the purpose of
developing a strategic plan for the new corporation
As of the date of this report, the merger integration of Harris Financial, Inc.
and York Financial Corporation is proceeding in accordance with the schedule
established by executive management.
Regulatory Environment related to the Plan of Conversion of Harris Financial,
MHC
As part of Harris Financial, Inc.'s agreement to merge with York Financial
Corporation as announced on March 28, 2000, Harris Financial, MHC adopted a plan
of conversion pursuant to which it would convert from a mutual to a capital
stock form of organization. Should Harris receive approval of all regulatory
applications, prior to the completion of the mutual-to-stock conversion, Harris
Savings Bank will convert its charter to that of a federal stock savings bank
and will be subject to the regulation and supervision of the Office of Thrift
Supervision ("OTS"). As a result of the Harris Savings Bank charter conversion,
Harris Financial, Inc. will become a unitary savings and loan holding company
and will also be subject to the regulation and supervision of the OTS. After the
charter conversion, the Pennsylvania Department of Banking will no longer
regulate or supervise Harris Financial, Inc. or Harris Savings Bank, and the
Board of Governors of the Federal Reserve System will no longer regulate or
supervise Harris Financial, Inc.
Effective July 12, 2000, the OTS adopted interim final rules regarding mutual
holding companies. Specific provisions of relevance to Harris are as follows:
. Recently converted thrifts would be permitted to repurchase stock without
limitation one year after going public. Previously, the amount of stock
that a converted thrift could repurchase was restricted for the first three
years after an offering.
. Mutual holding company parents of stock thrifts would be permitted to waive
all dividends due it without incurring a corresponding dilution to minority
shareholders interests in the event of a second-step conversion.
Previously, the OTS prohibited the waiver of excess dividends and required
that all waived dividends be accounted for in the calculation of minority
ownership interest in a second-step conversion.
The OTS also issued proposed rules, with the following specific provision of
relevance to Harris. The OTS notified the public that it expects to limit
acquisitions for most converting thrifts within three years after a conversion.
Previously, the OTS generally waived the three-year rule in cases where the
transaction was non-hostile and received shareholders approval.
Harris Financial, Inc. has also received written approval from the OTS that the
OTS would permit Harris, as part of its merger with York Financial, Inc. in the
fourth quarter of 2000, to issue up to 10 million authorized but unissued shares
to York Financial, Inc. shareholders as merger consideration in the event that
the related share offering fell below the minimum range as established in the
offering prospectus.
Page 27
<PAGE>
<TABLE>
<CAPTION>
PART II. OTHER INFORMATION
<S> <C> <C> <C>
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
(b) Reports on Form 8-K
The Registrant filed the following Current Reports on Form 8-K during
the second quarter of 2000:
(i) Current Report on Form 8-K, dated March 27, 2000, re: Agreement
and Plan of Reorganization by and between Harris Financial, MHC,
Harris Financial, Inc., New Harris Financial, Inc., and Harris
Savings Bank, and York Financial Corp. and York Federal Savings and
Loan Association, filed with the Securities and Exchange Commission
on April 7, 2000; and
(ii) Current Report on Form 8-K, dated June 23, 2000, re: Issuance of
press release regarding filing of registration Form S-1 relating to
a stock offering conducted as part of the mutual-to-stock
conversion of Harris Financial, MHC, and a registration statement
on Form S-4 relating to the merger of York Financial Corp. and the
Registrant, filed with the Securities and Exchange Commission on
June 27, 2000.
</TABLE>
Page 28
<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.,
Chairman, President and
Chief Executive Officer
By /s/ James L. Durrell
--------------------
James L. Durrell,
Executive Vice President
and Chief Financial Officer
Dated: August 9, 2000
Page 29
<PAGE>
EXHIBIT INDEX
Exhibit Number
--------------
Exhibit 27 Financial Data Schedule
