<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 March 31, 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 34,039,875 shares of stock, par
value of $.01 per share, outstanding at May 2, 2000.
Page 1
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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)
March 31, December 31,
Assets 2000 1999
- ------ ------------ ------------
Cash and cash equivalents $ 54,532 $ 73,613
Marketable securities available-for-sale 1,303,825 1,257,603
Loans receivable, net 1,313,645 1,267,983
Loans held for sale, net 1,761 1,646
Loan servicing rights 1,839 7,616
Premises and equipment, net of accumulated
depreciation of $16,285 and $15,484 27,565 23,228
Accrued interest receivable 16,735 18,302
Intangible assets 16,898 17,617
Deferred tax asset, net 22,191 17,402
Other assets 8,059 6,390
------------ ------------
Total assets $ 2,767,050 $ 2,691,400
============ ============
Liabilities and Stockholders' Equity
- ------------------------------------
Deposits $ 1,439,688 $ 1,373,870
Escrow 3,354 3,511
Accrued interest payable 16,867 10,292
Postretirement benefit obligation 2,670 2,538
Other borrowings (Note 3) 1,123,375 1,118,000
Income taxes payable 2,377 2,302
Other liabilities 11,521 11,563
------------ ------------
Total liabilities $ 2,599,852 $ 2,522,076
------------ ------------
Common stock, $ .01 par value, authorized
100,000,000 shares, 34,024,875 shares
issued and 33,575,575 outstanding at
March 31, 2000, 34,023,625 shares issued
and 33,574,325 shares outstanding at
December 31, 1999 $ 340 $ 340
Paid in capital 30,348 30,323
Retained earnings 178,698 175,158
Accumulated other comprehensive income (35,065) (29,347)
Employee stock ownership plan (271) (296)
Recognition and retention plans (454) (456)
Treasury stock, 449,300 shares at
March 31, 2000 and 449,300 shares at
December 31, 1999 (Note 8) (6,398) (6,398)
------------ ------------
Total stockholders' equity 167,198 169,324
------------ ------------
Total liabilities and stockholders'
equity $ 2,767,050 $ 2,691,400
============ ============
See accompanying notes to consolidated financial statements.
Page 3
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HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(in thousands, except for per share data)
(Unaudited)
Three Months Ended March 31,
--------------------------------
Interest Income: 2000 1999
-------------- --------------
Loans receivable:
First mortgage loans $ 9,744 $ 11,970
Commercial loans 7,136 4,255
Consumer and other loans 7,791 5,681
Taxable investments 7,298 7,998
Taxfree investments 861 1,583
Dividends 1,752 2,226
Mortgage-backed securities 12,621 7,979
Money market investments 33 16
-------------- --------------
Total interest income 47,236 41,708
-------------- --------------
Interest Expense:
Deposits 15,582 12,470
Borrowed funds 16,120 14,092
Escrow 16 25
-------------- --------------
Total interest expense 31,718 26,587
-------------- --------------
Net interest income 15,518 15,121
Provision for loan losses 835 795
-------------- --------------
Net interest income after provision for
loan losses 14,683 14,326
-------------- --------------
Noninterest Income:
Service charges on deposits 1,601 1,233
Other service charges/commissions/fees 293 324
Net servicing income 242 -
Gain (loss) on sale of securities, net (16) 1,353
Gain on sale of loans, net 508 1,172
Other 106 (61)
-------------- --------------
Total noninterest income 2,734 4,021
-------------- --------------
Noninterest Expense:
Salaries and benefits 5,730 5,772
Equipment expense 1,016 962
Occupancy expense 1,001 802
Advertising and public relations 430 483
FDIC insurance 68 169
Director fees 94 83
Income from real estate operations 5 (216)
Amortization and write-off of intangibles 720 600
Consulting and other fees 740 465
Supplies, telephone and postage 886 888
Other 1,142 1,584
-------------- --------------
Total noninterest expense 11,832 11,592
-------------- --------------
Income before income taxes 5,585 6,755
Income tax expense 1,565 1,822
-------------- --------------
Net Income $ 4,020 $ 4,933
============== ==============
Basic earnings per share (Note 5) $ 0.12 $ 0.15
============== ==============
Diluted earnings per share (Note 5) $ 0.12 $ 0.15
============== ==============
See accompanying notes to consolidated financial statements.
Page 4
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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>
Balance at January 1, 1999 $ 340 $ 29,960 $ 158,386 $ 8,106 $ (396) $ (456)$ (5,970) $ 189,970
Net income 4,933 4,933 $ 4,933
Dividends paid at $.06 per share (478) (478)
Exercised stock options 33 33
Unrealized losses on securities (1,210) (1,210) (1,210)
----------
Comprehensive income (loss) $ 3,723
==========
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
==========================================================================================
Balance at January 1, 2000 340 30,323 175,158 (29,347) (296) (456) (6,398) 169,324
Net income 4,020 4,020 $ 4,020
Dividends paid at $.06 per share (480) (480)
Exercised stock options 4 4
Unrealized losses on securities (5,718) (5,718) (5,718)
----------
Comprehensive income (loss) $ (1,698)
==========
ESOP stock committed for release 25 25
Earned portion of RRP plan 2 2
Excess of fair value above cost of
ESOP stock committed for release 18 18
Excess of fair value above cost of
earned portion of RRP plan 3 3
------------------------------------------------------------------------------------------
Balance at March 31, 2000 $ 340 $ 30,348 $ 178,698 $ (35,065) $ (271) $ (454)$ (6,398) $ 167,198
==========================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
Page 5
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HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
------------------------------------
2000 1999
------------ -------------
<S> <C> <C>
Cash flows from operating activities:
Net Income $ 4,020 $ 4,933
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 835 795
Net depreciation, amortization, and accretion (276) 1,286
(Increase) decrease in loans held for sale (115) 3,526
Net gain on sales of interest-earning assets (492) (2,525)
Gain on sale of foreclosed real estate - (123)
Equity (income) losses from joint ventures (45) 57
Decrease in accrued interest receivable 1,567 331
Increase in accrued interest payable 6,575 5,373
Amortization of intangibles 720 600
Earned ESOP shares 43 101
Earned RRP shares 5 -
Provision for deferred income taxes (1,019) 559
Decrease in income taxes payable 75 1,199
Other, net (4,123) 12,244
------------ -------------
Net cash provided by operating activities 7,770 28,356
------------ -------------
Cash flows from investing activities:
Proceeds from maturities and principal reductions of marketable securities:
Available-for-sale 7,517 136,651
Proceeds from sales of marketable securities; available-for-sale 59,192 133,841
Purchase of marketable securities; available-for-sale (119,579) (227,766)
Loans sold 13,215 33,629
Net increase in loan originations less principal payments on
loans (59,483) (118,027)
Loan servicing rights sold 7,643 -
Acquisition of loan servicing rights (424) (570)
Investments in real estate held for investment and other joint
ventures - 61
Proceeds from payments on real estate held for investment 58 161
Purchases of premises and equipment, net (5,556) (1,114)
Cash proceeds received from the sale of foreclosed real
estate 6 706
------------ -------------
Net cash used in investing activities $ (97,411) $ (42,428)
------------ -------------
</TABLE>
See accompanying notes to the consolidated financial statements.
(Continued)
Page 6
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HARRIS FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
(continued)
<TABLE>
<CAPTION>
Three Months Ended March 31,
-------------------------------------
2000 1999
------------- ------------
<S> <C> <C>
Cash flows from financing activities:
Net increase in deposits $ 65,818 $ 18,805
Net increase (decrease) in other borrowings 5,375 (4,734)
Net (decrease) increase in escrow (157) 3,787
Cash dividends (480) (478)
Proceeds from the exercise of stock options 4 33
------------- ------------
Net cash provided by financing operations 70,560 17,413
------------- ------------
Net (decrease) increase in cash and cash equivalents (19,081) 3,341
Cash and cash equivalents at beginning of period 73,613 56,741
------------- ------------
Cash and cash equivalents at end of period $ 54,532 $ 60,082
============= ============
Supplemental disclosures:
Cash paid during the periods for:
Interest on deposits, advances and other borrowings
(includes interest credited to deposit accounts) $ 24,720 $ 21,314
Income taxes 2,528 125
Non-cash investing activities:
Transfer from loans to foreclosed real estate $ 9 $ 144
</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. 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,
2000 are not necessarily indicative of the results that may be expected for the
year ended 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 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 8
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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.
March 31, December 31,
2000 1999
------------------ -------------------
FHLB advances $ 915,000 $ 805,000
Repurchase agreements 208,375 313,000
------------------ -------------------
Total other borrowings $ 1,123,375 $ 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 $13,165,000 at March 31, 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 March 31, 2000, HFI had $161,009,000 in unused line of credit commitments
extended to its customers, $24,761,000 of undistributed funds on construction
loans and $37,866,000 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 three months ended March 31, 2000
Basic earnings per share:
Income available to common shareholders $ 4,020 33,578,078 $ 0.12
------------------------------------------------
Dilutive effect of management and director stock options 42,132
------------------------------------------------
Diluted earnings per share:
Income available to common shareholders
plus assumed conversions $ 4,020 33,620,210 $ 0.12
================================================
For the three months ended March 31, 1999
Basic earnings per share:
Income available to common shareholders $ 4,933 33,593,065 $ 0.15
------------------------------------------------
Dilutive effect of management and director stock options 90,049
------------------------------------------------
Diluted earnings per share:
Income available to common shareholders
plus assumed conversions $ 4,933 33,683,114 $ 0.15
================================================
</TABLE>
Page 9
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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)
(6) Loan Servicing
--------------
During the quarter ended March 31, 2000, HFI sold mortgage servicing rights with
a carrying value of $6.2 million on loans serviced for investors totaling $589.9
million. As a result of the sale of the mortgage servicing rights and the
clearing of related custodial accounts, HFI recognized a net gain of $.1
million. This gain is reflected in noninterest income.
During the quarter ended March 31, 1999, HFI sold the rights to service loans
totaling $79.4 million. Concurrent with this sale, HFI 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, HFI paid a premium to enter into the floor contract. The premium was
amortized over the life of the contract. As a result of the sale of the mortgage
servicing rights and the floor, HFI recognized a combined net loss of $220,000.
(7) 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
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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)
. 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 March 31, 2000, had waived a total of $29.9
million of dividends paid by the Bank and HFI.
(8) 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. As of March 31, 2000, HFI has repurchased 449,300
shares under this program.
(9) Merger Agreement
----------------
On March 28, 2000 Harris Financial announced that it 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.
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
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. 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
The net income for the three month period ended March 31, 2000 was $4,020,000,
representing a decrease of $913,000, or 18.5%, from the $4,933,000 net income
figure reported during the comparable three month period ending March 31, 1999.
The decrease is primarily due to a reduction of $1.4 million in the gain on sale
of securities to a loss of $16,000 for the three months ended March 31, 2000. In
addition, the gain on sale of loans decreased $.7 million to $.5 million for the
three months ended March 31, 2000 from $1.2 million for the three months ended
March 31, 1999.
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 $15,982,000 for the
three months ended March 31, 2000, which represents an increase of $9,000 or
.06%, from the $15,973,000 of net interest income recorded in the three months
ended March 31, 1999. This increase reflected a favorable volume variance of
$801,000 due to a $206.4 million increase in total average earning assets to
$2.596 billion during the year to date period ended March 31, 2000 as compared
to $2.390 billion recorded during the same period ending March 31, 1999. Also
reflected in this volume variance was a $223.9 million increase in average
interest-bearing liabilities. At the same time, general market interest rate
trends created an unfavorable rate variance of $792,000 for the three months
ended March 31, 2000. The interaction of positive volume variances and negative
rate variances generated the net positive change of $9,000 mentioned above.
For the three months ended March 31, 2000, the yield on interest-earning assets
was 7.35%. This figure is 23 basis points higher than the 7.12% yield reported
for the three month period ended March 31, 1999. At same time, the cost of funds
increased 41 basis points to 5.08% for the period ending March 31, 2000, versus
4.67% for the three months ended March 31, 1999. As a result, the interest
spread (the difference between the yield on assets minus the cost of funds)
decreased by 18 basis points to 2.27% for the three month period ending March
31, 2000, versus 2.45% for the comparable period ending March 31, 1999.
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 three month period ending March 31,
2000, total deposits (net of escrow deposits) increased $65.8 million, or 4.8%,
while other borrowings increased by $5.4 million, or .5%, from December 31,
1999. During the twelve month period ended March 31, 2000, total deposits (net
of escrow deposits) increased $215.5, or 17.6%, while other borrowings increased
by $58.9 million, or 5.5% from March 31, 1999. 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 interest income and boost HFI's
return on equity. However, this strategy compresses HFI's net interest margins
due to the higher cost of non-deposit funds as compared to core deposits. These
factors are reflected in the net interest margin decline of 21 basis points to
the 2.46% for the three months ended March 31, 2000, versus 2.67% for the
comparable period ended March 31, 1999. Net interest margin declined 5 basis
points to 2.46% for the three months ended March 31, 2000 versus 2.51% for the
three month period ended December 31, 1999.
The following table summarizes the impact of the leveraging strategy on the
return on average assets (ROAA) and net interest margin (NIM) for the three
month periods ended March 31, 2000, December 31, 1999, and March 31, 1999.
Page 12
<PAGE>
Table 1 Comparison of Financial Performance with and without a Capital
Leveraging Strategy
<TABLE>
<CAPTION>
With Without Difference in
Three month period ended March 31, 2000 Leveraging Leveraging Basis Points
- ----------------------------------------------- ---------------- ---------------- ---------------
<S> <C> <C> <C>
Return on Average Assets 0.60% 0.37% 23
Net Interest Margin 2.46% 3.03% (57)
Three month period ended December 31, 1999
- -----------------------------------------------
Return on Average Assets 0.73% 0.56% 17
Net Interest Margin 2.51% 3.07% (56)
Three month period ended March 31, 1999
- -----------------------------------------------
Return on Average Assets 0.79% 0.58% 21
Net Interest Margin 2.67% 3.50% (83)
</TABLE>
Table 2 presents HFI's average asset and liability balances, interest rates,
interest income and interest expense for each of the three month periods ended
March 31, 2000 and March 31, 1999. Table 3 presents a rate-volume analysis of
changes in net interest income for the three month periods ended March 31, 2000
and March 31, 1999.
During the quarter ended March 31, 2000, HFI's commercial and direct consumer
loan yields significantly increased relative to the prior quarter. This is
primarily because HFI significantly increased these portfolio balances at
increasing rates during the twelve months ended March 31, 2000. Partially
offsetting these yield increases were decreasing portfolio yields on mortgage
and indirect consumer loans. HFI decreased its mortgage loan investments and
sold substantially all of its conventional mortgage loan production during the
twelve months ended March 31, 2000, which greatly limited any potential yield
enhancements from rising interest rates during this period. Also, HF1 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.
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 13
<PAGE>
Table 2 Average Balance Sheets, Rates and Interest Income and Expense Summary
(All dollar amounts presented in table are in 000's)
<TABLE>
<CAPTION>
For the three months ended,
---------------------------------------------------------------------------------
March 31, 2000 March 31, 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 $ 548,851 $ 9,744 7.10% $ 609,208 $ 11,970 7.86%
Commercial loans 355,772 7,136 8.02% 224,465 4,255 7.58%
Direct consumer loans 169,797 3,682 8.67% 143,750 2,941 8.18%
Indirect consumer loans 221,414 4,109 7.42% 133,762 2,740 8.19%
Marketable securities - taxable 1,216,824 21,425 7.04% 1,131,738 17,853 6.31%
Marketable securities - taxfree 59,401 1,325 8.92% 117,697 2,435 8.28%
Other interest-earning assets 24,044 279 4.64% 29,077 366 5.03%
---------------------------------------- ---------------------------------------
Total interest-earning assets 2,596,103 47,700 7.35% 2,389,697 42,560 7.12%
------------------------- -------------------------
Noninterest-earning assets 97,692 101,290
--------------- --------------
Total assets $ 2,693,795 $ 2,490,987
=============== ==============
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Savings deposits $ 124,200 $ 676 2.18% $ 143,872 $ 686 1.91%
Time deposits 940,971 12,689 5.39% 768,883 10,094 5.25%
NOW and money market deposits 334,029 2,217 2.65% 292,092 1,690 2.31%
Escrow 3,664 16 1.75% 10,729 25 0.93%
Borrowed funds 1,096,956 16,120 5.88% 1,060,310 14,092 5.32%
---------------------------------------- ---------------------------------------
Total interest-bearing liabilities 2,499,820 31,718 5.08% 2,275,886 26,587 4.67%
------------------------- -------------------------
Noninterest-bearing liabilities 27,347 24,765
--------------- --------------
Total liabilities 2,527,167 2,300,651
Stockholders' equity 166,628 190,336
--------------- --------------
Total liabilities and stockholder
equity $ 2,693,795 $ 2,490,987
=============== ==============
Net interest income
before provision for loan loss $ 15,982 $ 15,973
============ =============
Interest rate spread (3) 2.27% 2.45%
============= ============
Net interest-earning assets $ 96,283 $ 113,811
=============== ==============
Net interest margin (4) 2.46% 2.67%
============= ============
Ratio of interest-earning assets to
interest-bearing liabilities 1.04 1.05
=============== ==============
</TABLE>
(1) Includes income recognized on deferred loan fees of $211,000 for the three
months ended March 31, 2000 and $444,000 for the three months ended March
31, 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 14
<PAGE>
Table 3 Rate/Volume Analysis of Changes in Net Interest Income (All dollar
amounts presented in table are in 000's)
Three Months Ended March 31, 2000
Compared to
Three Months Ended March 31, 1999
Increase (Decrease)
-------------------------------------
Volume Rate Net
-------------------------------------
Interest-earning assets:
Mortgage loans, net $ (1,129) $ (1,097) $ (2,226)
Commercial loans 2,621 260 2,881
Direct consumer loans 557 184 741
Indirect consumer loans 1,648 (279) 1,369
Marketable securities - taxable 1,407 2,165 3,572
Marketable securities - taxfree (1,286) 176 (1,110)
Other interest-earning assets (60) (27) (87)
-------------------------------------
Total interest-earning assets 3,758 1,382 5,140
-------------------------------------
Interest-bearing liabilities:
Savings deposits (100) 90 (10)
Time deposits 2,319 276 2,595
NOW and money market deposits 260 267 527
Escrow and stock subscriptions (23) 14 (9)
Borrowed funds 501 1,527 2,028
-------------------------------------
Total interest-bearing liabilities 2,957 2,174 5,131
-------------------------------------
Net change in net interest income $ 801 $ (792) $ 9
=====================================
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 $835,000 for the three months ended
March 31, 2000. This represents an increase of $40,000, or 5.0%, from the
$795,000 provision recorded for the three months ended March 31, 1999. The
changes in HFI's provision are discussed in the Asset Quality section that
follows.
Noninterest Income
The table below presents noninterest income for the three months ended March 31,
2000 and 1999.
Table 4 Changes in Noninterest Income (All dollar amounts presented in table are
in 000's)
Three months ended March 31,
------------------------------------
Noninterest Income: 2000 1999 % Change
----------- ----------- -----------
Service charges on deposits $ 1,601 $ 1,233 29.8%
Other service charges/commissions/fees 293 324 (9.6%)
Net servicing income 242 - NM
Gain (loss) on sale of securities, net (16) 1,353 NM
Gain on sale of loans, net 508 1,172 (56.7%)
Other 106 (61) NM
----------- -----------
Total noninterest income $ 2,734 $ 4,021 (32.0%)
=========== ===========
Page 15
<PAGE>
Total noninterest income decreased 32.0% for the three months ended March 31,
2000 compared to the three months ended March 30, 1999. The decrease in
noninterest income is the result of reduced reliance on gains from sales in the
securities portfolio partially offset by the effects of a concentrated effort on
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 AVSTAR mortgage operations. Service charges increased 30% due
to growth in deposit accounts and the addition of two new branches.
Noninterest Expense
Noninterest expense for the three months ended March 31, 2000 and 1999 is
presented in the table below.
Table 5 Changes in Noninterest Expense (All dollar amounts presented in table
are in 000's)
Three Months Ended March 31,
----------------------------------
2000 1999 % Change
--------- ---------- -----------
Noninterest Expense:
Salaries and benefits $ 5,730 $ 5,772 (0.7%)
Equipment expense 1,016 962 5.6%
Occupancy expense 1,001 802 24.8%
Advertising and public relations 430 483 (11.0%)
FDIC insurance 68 169 (59.8%)
Director fees 94 83 13.3%
(Expense) income from real estate operations 5 (216) NM
Amortization of intangibles 720 600 20.0%
Consulting and other fees 740 465 59.1%
Supplies, telephone and postage 886 888 (0.2%)
Other 1,142 1,584 (27.9%)
--------- ----------
Total noninterest expense $11,832 $11,592 2.1%
========= ==========
Total noninterest expense increased 2.1% for the three months ended March 31,
2000 compared to the three months ended March 31, 1999. Increases in noninterest
expense were commensurate with the expansion of branch networks and the addition
of traditional and non-traditional business lines.
Provision for Income Taxes
Corporate income tax expense totaled $1,565,000 for the three month period ended
March 31, 2000, which resulted in an effective tax rate of 28.0% on pretax
income of $5,585,000. HFI recorded $1,822,000 of corporate tax expense resulting
in an effective tax rate of 27.0%, on pretax income of $6,755,000 during the
three month period ended March 31, 1999. The effective tax rate is less than the
statutory rates due to HFI's continued focus on tax exempt sources of income.
Stockholders' Equity
Stockholders' equity totaled $167.2 million at March 31, 2000 and $169.3 million
at December 31, 1999. Stockholders' equity amounted to 6.0% of total assets
equalling $2.767 billion as of March 31, 2000, compared to 6.3% of total assets
of $2.691 billion at December 31, 1999.
The decrease in stockholders' equity of $2.1 million, or 1.3%, for the three
months ended March 31, 2000, resulted mainly from a $5.7 million decline in the
market value, net of tax effect, of the available-for-sale securities and $.5
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 this decrease is a $4.0 million increase attributable to income from
ongoing operations.
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
Page 16
<PAGE>
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 6 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 March 31, 2000 Amount Ratio Amount Ratio Amount Ratio
-------------------- ------ ----- ------- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Total Capital
(to Risk Weighted Assets) $198,816 11.7% $136,404 8.0 % $170,506 10.0 %
Tier 1 Capital
(to Risk Weighted Assets) 185,366 10.9% 68,202 4.0 % 102,303 6.0 %
Tier 1 Capital
(to Avg. Assets) 185,366 6.8% 108,370 4.0 % 135,462 5.0 %
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%
<CAPTION>
HARRIS SAVINGS BANK Minimum Requirement for Minimum Requirement to be
Actual Capital Adequacy "Well Capitalized"
------ ---------------- ------------------
As of March 31, 2000 Amount Ratio Amount Ratio Amount Ratio
-------------------- ------ ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Total Capital
(to Risk Weighted Assets) $194,379 11.4% $136,131 8.0% $170,163 10.0%
Tier 1 Capital
(to Risk Weighted Assets) 180,727 10.6% 68,065 4.0% 102,098 6.0%
Tier 1 Capital
(to Avg. Assets) 180,727 6.7% 108,238 4.0% 135,297 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 $1,303.8 million at March 31, 2000 and $1,257.6 million at December 31,
1999 Total marketable securities increased $46.2 million, or 3.7%, during the
first three months of 2000.
The following table sets forth certain information regarding the amortized cost
and fair values of HFI's marketable securities portfolio at March 31, 2000 and
December 31, 1999.
Page 17
<PAGE>
Table 7 Composition of Marketable Securities Portfolios (All dollar amounts
presented in table are in 000's)
<TABLE>
<CAPTION>
March 31, 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 $ 348,108 $ 324,545 $ 348,705 $ 324,619
Corporate bonds 63,429 60,433 63,352 59,826
Municipal obligations 62,664 62,301 63,980 63,492
FHLB stock 45,750 45,750 45,400 45,400
Equities (Common and Preferred) 70,482 73,632 73,034 76,711
Mortgage-backed securities:
GNMA CMO's 25,000 25,031 - -
FNMA CMO's 98,988 95,026 99,032 98,267
FHLMC CMO's 123,413 116,650 139,328 136,584
Private Issue CMO's 523,878 500,457 473,170 452,704
-------------------------------------------------------------
Total mortgage-backed securities 771,279 737,164 711,530 687,555
-------------------------------------------------------------
Total securities available-for-sale $ 1,361,712 $ 1,303,825 $ 1,306,001 $ 1,257,603
-------------------------------------------------------------
Other interest-earning securities:
FHLB daily investment $ 26,737 $ 26,737 $ 36,860 $ 36,860
-------------------------------------------------------------
Total marketable securities and
interest-earning investments $ 1,388,449 $ 1,330,562 $ 1,342,861 $ 1,294,463
=============================================================
</TABLE>
Loans
Loans receivable, excluding the reduction for the allowance for loan losses,
totaled $1,327.4 million at March 31, 2000 and $1,281.5 million at December 31,
1999. The increase of $45.9 million, or 3.5%, for the three months ended March
31, 2000, reflects growth in commercial loans of $30.3 million, a $15.4 million
increase in automobile, consumer and other loans, first mortgage loan decreases
amounting to $.3 million and an increase in dealer reserves of $.5 million. The
loan growth trends in 2000 reflect HFI's continued focus on expanding it's
commercial and consumer loan portfolios and its reduced reliance on investing in
residential mortgage loans. Loan charge-offs, net of recoveries, totaled
$676,000 at March 31, 2000 and $228,000 at March 31, 1999. Based on management's
continuing review of the loan portfolio, HFI recorded provisions for loan losses
of $835,000 at March 31, 2000 and $795,000 at March 31, 1999.
Non-accrual loans were $10,774,000 at March 31, 2000 and $10,007,000 at December
31, 1999. In addition, loans 90 days past due, but still accruing were
$5,125,000 at March 31, 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 loans receivable (including loans held for
sale, net), before deducting the allowance for loan loss, equalled 1.20% at
March 31, 2000 and 1.26% at December 31, 1999.
The allowance for loan losses totaled $12,032,000 at March 31, 2000 and
$11,873,000 at December 31, 1999. Stated as a percentage of total loans
receivable (including loans held for sale, net), the allowance for loan losses
amounted to .91% at March 31, 2000 and .94% at December 31, 1999.
Table 8 depicts the trend of charge-offs, recoveries and provisions to the
allowance for loan losses for the three months ended March 31, 2000, three
months ended March 31, 1999 and the year ended December 31, 1999. In addition,
Table 9 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 three months ended March 31, 2000 and the year ended
December 31, 1999. Finally, Table 10 presents an allocation of the allowance for
loan losses by category of loans for the three months ended March 31, 2000 and
the year ended December 31, 1999.
Page 18
<PAGE>
Table 8 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
three months ended three months ended twelve months ended
Allowance for Loan Loss March 31, 2000 March 31, 1999 December 31, 1999
- --------------------------------------------------------------------------- ------------------------- ------------------------
<S> <C> <C> <C>
Balance at beginning of period $ 11,873 $ 9,088 $ 9,088
Provision for loan losses 835 795 3,180
Provision component related to unfunded
commitments - - 617
Charge Offs:
Commercial loans - (50) (50)
One-to-four family loans (48) (67) (253)
Other mortgage loans - - -
Consumer and other loans (709) (170) (970)
------------------------- ------------------------- ------------------------
Total Charge Offs (757) (287) (1,273)
------------------------- ------------------------- ------------------------
Recoveries:
Commercial loans 2 52 61
One-to-four family loans - 3 73
Other mortgage loans - - -
Consumer and other loans 79 4 127
------------------------- ------------------------- ------------------------
Total Recoveries 81 59 261
------------------------- ------------------------- ------------------------
Net Charge Offs (676) (228) (1,012)
------------------------- ------------------------- ------------------------
Balance at end of period $ 12,032 $ 9,655 $ 11,873
========================= ========================= ========================
Net Charge Offs to Average Loans Outstanding (1) 0.21% 0.08% 0.08%
========================= ========================= ========================
</TABLE>
(1) Year-to-date ratio is annualized
The increase in charge offs for the three months ended March 31, 2000 is
primarily increased change offs from our auto loan portfolio and, to a lesser
extent, other consumer loans.
Page 19
<PAGE>
Table 9 Allowance for Loan Losses Coverage Ratios (All dollar amounts presented
in table are in 000's)
<TABLE>
<CAPTION>
As of or for the As of or for the
three months ended twelve months ended
March 31, 2000 December 31, 1999
------------------------- ------------------------
<S> <C> <C>
Allowance at the end of period $ 12,032 $ 11,873
Non-accrual loans $ 10,774 $ 10,007
90 days past due, but still accruing $ 5,125 $ 6,128
Potential problem loans $ 13,539 $ 16,263
Allowance/non-accrual loans 111.68% 118.65%
------------------------- ------------------------
Allowance/90 days past due, but still accruing 234.77% 193.75%
------------------------- ------------------------
Allowance/non-accrual loans and 90 days past due,
but still accruing 75.68% 73.59%
------------------------- ------------------------
Allowance/problem loans 88.87% 73.01%
------------------------- ------------------------
</TABLE>
Table 10 Allocation of the Allowance for Loan Losses (All dollar amounts
presented in table are in 000's)
<TABLE>
<CAPTION>
As of March 31, 2000 As of December 31, 1999
------------------------------ ------------------------------
% of Total % of Total
Amount Loans Amount Loans
-------------- ------------- --------------- --------------
<S> <C> <C> <C> <C>
One-to-four family mortgage loans $ 838 42.36% $ 838 42.06%
Commercial loans 7,218 28.74% 7,154 27.38%
Consumer and other loans 3,250 28.90% 3,073 30.56%
Unallocated 726 N/A 808 N/A
-------------- ------------- --------------- --------------
Total $ 12,032 100.00% $ 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 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 under the direction of an executive 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
Page 20
<PAGE>
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 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 March 31, 2000 and at
December 31, 1999.
Other Borrowings
HFI maintains wholesale leveraging activities to deploy a portion of it's
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 $1,123.4 million at March 31, 2000 and $1,118.0 million
at December 31, 1999. Borrowings from non-deposit funding sources increased $5.4
million, or .5%, during the three months ended March 31, 2000. Federal Home Loan
Bank advances increased by $110.0 million, or 13.7%, while repurchase agreements
decreased by $104.6 million, or 33.4%, during the three month period ending
March 31, 2000.
As of March 31, 2000, HFI had maximum available FHLB lines of credit totaling
$1,009.4 million versus $1,059.5 million in available FHLB credit as of December
31, 1999. This decrease of 4.7%, or $50.1 million, is based on decreases in the
amount of securities that qualify as security for FHLB advances. HFI had
borrowings outstanding to the FHLB totaling $915.0 million as of March 31, 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 regulatory standards for liquidity at March 31, 2000 and
December 31, 1999.
Year 2000 Compliance
In preparation for the impact of the Year 2000 on HFI's computer hardware,
software programs and operating systems, HFI performed an extensive compliance
project. This project was broken down into several distinct phases and is
described in detail in the Form 10-Q filed for the quarter ending September 30,
1999. HFI believes that this project has addressed all significant Year 2000
issues. As of the report date, the rollover to Year 2000 has not resulted in any
operational problems and management does not anticipate any problems going
forward. The total costs incurred to complete the Year 2000 remediation was
$221,000.
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
Page 21
<PAGE>
monthly GAP results. The table below presents the Bank's GAP position as of
March 31, 2000. As of this date, the Bank's liability sensitive cumulative
one-year GAP ratio was -12.8% and liability sensitive three-year GAP ratio was
- -10.1%. 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 March 31, 2000.
Page 22
<PAGE>
Table 11 GAP Analysis (All dollar amounts presented in table are in 000's)
<TABLE>
<CAPTION>
At March 31, 2000
----------------------------------------------------------------------------------------------
More Than More Than More Than
One Year One Year Three Years Five
or Less to Three Years to Five Years Years Total
----------------------------------------------------------------------------------------------
Balance Rate Balance Rate Balance Rate Balance Rate Balance Rate
----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Cash and cash equivalents $ 26,737 4.93% $ - 0.00% $ - 0.00% $ 27,795 0.00% $ 54,532 2.42%
Marketable securities (1) (3) 607,587 6.93% 71,161 6.77% 65,302 6.91% 617,662 6.89% 1,361,712 6.90%
Commercial loans 188,054 8.31% 92,054 8.05% 74,640 7.81% 22,878 7.45% 377,626 8.10%
Mortgage loans (2) 126,706 7.17% 127,169 6.84% 99,982 6.76% 204,512 6.79% 558,369 6.88%
Consumer loans 143,733 8.75% 154,447 8.42% 66,478 8.59% 15,221 9.16% 379,879 8.61%
Total interest-earning
----------------------------------------------------------------------------------------------
assets $ 1,092,817 7.39% $ 444,831 7.63% $ 306,402 7.45% $ 888,068 6.71% $ 2,732,118 7.21%
----------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
Savings accounts $ 16,733 5.31% $ - 0.00% $ - 0.00% $ 128,960 2.18% $ 145,693 2.54%
Interest-bearing
DDA accounts - 0.00% - 0.00% - 0.00% 102,463 1.10% 102,463 1.10%
Noninterest-bearing
DDA accounts - 0.00% - 0.00% - 0.00% 48,780 0.00% 48,780 0.00%
Money market accounts 178,670 4.54% - 0.00% - 0.00% - 0.00% 178,670 4.54%
Time deposits 480,803 5.20% 304,831 5.79% 88,392 6.46% 3,406 5.87% 964,282 5.04%
Escrow - 0.00% - 0.00% - 0.00% 3,354 1.53% 3,354 1.53%
Other borrowings 771,711 5.87% 63,375 5.05% 175,000 6.71% 199,939 5.80% 1,123,175 6.40%
Total interest-bearing
----------------------------------------------------------------------------------------------
liabilities $ 1,447,917 5.48% $ 368,206 5.67% $ 263,392 6.63% $ 486,902 3.24% $ 2,566,417 5.20%
----------------------------------------------------------------------------------------------
Interest sensitivity gap
per period $ (355,100) $ 76,625 $ 43,010 $ 401,166 $ 165,701
------------- ------------- ------------- ------------- -------------
Cumulative interest
sensitivity gap $ (355,100) $ (278,475) $ (235,465) $ 165,701
------------- ------------- ------------- -------------
Cumulative interest sensitivity gap
as a percent of total assets -12.83% -10.06% -8.51% 5.99%
------------- ------------- ------------- -------------
Cumulative net interest-earning
assets as a percentage of net
interest-bearing liabilities 75.48% 84.67% 88.68% 106.46%
------------- ------------- ------------- -------------
</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.
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 March 31, 2000, management projects net
interest income for the next twelve months to increase $.3 million, or
.4% if market rates decrease 200 basis points over the next twelve
months and to decrease $3.9 million, or 5.9% 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.
Page 23
<PAGE>
<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) $.3 $1.1 $0.0 ($1.9) ($3.9)
Relative Change in NII .4% 1.6% 0.0% (2.8%) (5.9%)
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 March 31,
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 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.
Page 24
<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 25
<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: May 3, 2000
Page 26
<PAGE>
EXHIBIT INDEX
Exhibit Number
- --------------
Exhibit 27 Financial Data Schedule
Page 27
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
ARTICLE 9 FDS FOR HARRIS FINANCIAL, INC.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 27,795
<INT-BEARING-DEPOSITS> 26,737
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1,303,825
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 1,327,438
<ALLOWANCE> 12,032
<TOTAL-ASSETS> 2,767,050
<DEPOSITS> 1,439,688
<SHORT-TERM> 425,000
<LIABILITIES-OTHER> 36,789
<LONG-TERM> 698,375
0
0
<COMMON> 340
<OTHER-SE> 166,858
<TOTAL-LIABILITIES-AND-EQUITY> 2,767,050
<INTEREST-LOAN> 24,761
<INTEREST-INVEST> 22,565
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 47,236
<INTEREST-DEPOSIT> 15,582
<INTEREST-EXPENSE> 31,718
<INTEREST-INCOME-NET> 15,518
<LOAN-LOSSES> 835
<SECURITIES-GAINS> (16)
<EXPENSE-OTHER> 11,832
<INCOME-PRETAX> 5,585
<INCOME-PRE-EXTRAORDINARY> 5,585
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,020
<EPS-BASIC> .12
<EPS-DILUTED> .12
<YIELD-ACTUAL> 7.28
<LOANS-NON> 10,774
<LOANS-PAST> 5,125
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 13,539
<ALLOWANCE-OPEN> 11,873
<CHARGE-OFFS> 757
<RECOVERIES> 81
<ALLOWANCE-CLOSE> 12,032
<ALLOWANCE-DOMESTIC> 11,306
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 726
</TABLE>
