ITEM 1 -- BUSINESS
BUSINESS OVERVIEW
Harris Bankcorp, Inc. ("Bankcorp") is a Delaware multibank holding company headquartered in Chicago. Bankcorp is a wholly-owned subsidiary of Bankmont Financial Corp. ("Bankmont"), a wholly-owned U.S. subsidiary of Bank of Montreal ("BMO").
Bankcorp provides banking, trust and other financial services domestically and internationally through 14 bank and 15 active nonbank subsidiaries and an Edge Act subsidiary. The bank subsidiaries include Harris Trust and Savings Bank; Harris Bank Barrington, N.A.; Harris Bank Frankfort; Harris Bank Glencoe- Northbrook, N.A.; Harris Bank Hinsdale, N.A.; Harris Bank Libertyville; Harris Bank Naperville; Harris Bank Roselle; Harris Bank Argo; Harris Bank Wilmette, N.A.; Harris Bank Winnetka, N.A.; Harris Bank St. Charles; Harris Bank Batavia, N.A.; and Harris Trust Bank of Arizona. All bank subsidiaries, with the exception of Harris Trust Bank of Arizona, are located in Illinois. Nonbank subsidiaries consist of trust companies and other specialized financial services companies. The trust companies include Harris Trust Company of California and Harris Trust Company of New York. The trust companies provide specialized nondeposit services, notably stock transfer, personal trust and indenture trust. On February 1, 2000, Bankcorp announced its agreement to sell its subsidiaries' stock transfer and indenture trust businesses in separate transactions. Other principal nonbank subsidiaries include Harris Investors Direct, Inc., a discount brokerage company, Harris Investment Management, Inc., a registered investment adviser, and Harris Preferred Capital Corporation ("HPCC"), a real estate investment trust ("REIT"). For further information on publicly traded preferred stock issued by HPCC, see Item 5 -- Market for Registrant's Common Equity and Related Stockholder Matters section on page 6. Throughout this Form 10-K ("Report"), the term "Corporation" refers to Harris Bankcorp, Inc. and subsidiaries.
Bankcorp's lead bank subsidiary is Harris Trust and Savings Bank ("HTSB"), an Illinois state-chartered bank with its principal office, 57 domestic branch offices and 97 automated teller machines ("ATMs") located in the Chicago area. Additionally, HTSB has representative offices in Dallas, Houston, Los Angeles, New York, San Francisco and Tokyo; a foreign branch office in Nassau; and an Edge Act subsidiary, Harris Bank International Corporation ("HBIC"), in New York.
HTSB provides a variety of banking and financial services to commercial and industrial companies, financial institutions, governmental units, not-for-profit organizations and individuals throughout the U.S. and abroad. Services rendered and products sold to customers include numerous types of demand, savings and time deposit accounts; certificates of deposit; various types of loans including term, real estate and those under lines of credit and revolving credit facilities; sales and purchases of foreign currencies; interest rate management products including swaps, forward rate agreements and interest rate guarantees; cash management services including lockbox and controlled disbursement processing; underwriting of municipal bonds; and financial consulting. Additionally, HTSB trades foreign currencies and a variety of debt securities for its own account and utilizes interest rate swaps, financial futures and options, principally to manage its risk exposure. In 1995, HTSB and BMO combined their U.S. foreign exchange activities ("FX"). Under this arrangement, FX net profit is shared by HTSB and BMO in accordance with a specific formula set forth in the agreement and an amendment in 1996.
On January 29, 1998, HTSB transferred its credit card portfolio to a company to be owned by BankBoston Corporation, First Annapolis Consulting, Inc. and Bankmont. At the time of the sale, HTSB's charge card portfolio balance amounted to approximately $693 million, representing less than 5 percent of the Corporation's total consolidated assets. Upon completion of the transfer, HTSB received cash and an equity interest in the newly formed company, Partner's First Holdings, LLC, which it immediately sold for cash to Bankmont.
HTSB's overseas activities are conducted through its representative offices, a foreign branch and HBIC. Services include various types of loans and deposits, letters of credit, personal trust services, export and import financing and foreign exchange products. See the International Banking section on page 40.
HTSB's Trust Department furnishes a variety of trust services to individuals, businesses, municipalities and charitable organizations. HTSB acts as trustee of personal, corporate, pension and other employee benefit trusts; serves as executor and administrator of estates; and, until the sale of these businesses as noted, acts as stock and bond registrar and transfer agent, dividend reinvestment agent and paying agent.
The Corporation has four primary operating segments, identified by the customers served, the products and services they offer and the channels by which the products and services are delivered. Corporate and Institutional Financial Services is comprised of the Corporation's corporate banking distribution to middle-market companies across the Midwest and nationally in selected specialties. Chicagoland Banking comprises community banking, which serves individuals through a Chicagoland retail bank network and small business/lower middle-market banking. The Private Client Group serves the needs of affluent individuals in Chicagoland and nationally through the integrated delivery of a comprehensive portfolio of wealth management services, including personal trust, investment management, customized lending and financial planning. Electronic Financial Services includes cash management services, mbanx(sm), the Corporation's virtual banking unit, and the bankcard business unit, including merchant services and, until its sale in January 1998, the Corporation's charge card business. For further information on operating results by segment, see the Operating Segment Review section on page 11.
FORWARD-LOOKING INFORMATION
This Report contains certain forward-looking statements and information based on the beliefs of, and information currently available to, the Corporation's management, as well as estimates and assumptions made by the Corporation's management. Forward-looking statements, which describe future plans, strategies and expectations of the Corporation, are generally identifiable by use of words such as "anticipate," "believe," "estimate," "expect," "future," "intend," "plan," "project," "target" and similar expressions. The Corporation's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Corporation include, but are not limited to, changes in: interest rates, general economic conditions, legislative or regulatory environment, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or securities portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Corporation's market areas, unforeseen business risks and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements. The Corporation assumes no obligation to update any such forward-looking statements.
HARRIS BANK GROWTH STRATEGY
The Corporation is a key strategic asset and competitive advantage for BMO in the United States. Harris Bank (which includes both the Corporation and its sister company, Harris Bankmont, Inc.) has announced a growth strategy to continue to aggressively build value -- becoming the dominant full-service bank in "Chicagoland"; the premier mid-market corporate/investment bank in the Midwest; and expand in fast-growing "Sunbelt" markets.
The first component of Harris Bank's strategy is continued strong organic growth in three advantaged core businesses: community banking, private banking, and mid-market corporate banking. Community banking is reflected in the Chicagoland Banking operating segment, while private banking and mid-market corporate banking are reflected in the Private Client Group and Corporate and Institutional Financial Services operating segments, respectively. See Operating Segment Review section on page 11 of this Report. Harris Bank has experienced sustained market momentum in large, high opportunity markets: the extremely fragmented and under-served Chicagoland marketplace where the largest banks combine for a 30% market share of retail deposits; a strong and diversified Midwest mid-market, which is broadly defined from Ohio west
to Colorado, and Minnesota south to Missouri; and more broadly in the U.S. in private banking, mid-market specialized industry sectors and cash management nation-wide.
Since 1994, Harris Bank has turned in consistent growth in earnings and profitability. Net income has more than doubled to $227 million and cash ROE has increased from the 10-11% level to the 17-18% range. Since 1994, in Chicagoland, Harris Bank has substantially built a retail bank. It has tripled its customer base from 300,000 to 900,000; increased market penetration from 1 household in 14 in 1994 to 1 household in 5 today; and tripled distribution from 40 to 140 branches, including state-of-the-art "multi-channel" delivery, call center, internet, and data mining capability. Retail deposit share has more than tripled from 2.7% to 8.4% during the period, and Harris Bank is the number two home equity and mortgage lender in Chicagoland.
Harris Bank has carved out a unique "locally rooted/centrally leveraged" market position by keeping local bank charters; stripping out and centralizing overhead and operations and creating a network of local marketing, sales and service units. At the same time Harris Bank is achieving a reduction in branch headcount of 30% over a three year period (1998-2000) with levels of customer satisfaction which surveys show to be substantially above Harris Bank's large bank competitors and the only one of the major banks gaining market share. Harris Bank has set a goal to become the dominant full-service bank in Chicagoland, through building small business, private, commercial and corporate mid-market segments across Chicagoland, on top of a retail distribution system already in place. Specifically, Harris Bank is importing BMO's small business capability from Canada; and Hispanic banking capability from its Mexican affiliate, Bancomer, to serve the rapidly growing and underserved market of 1.2 million Hispanics in Chicagoland. Harris is one of the premier mid-market corporate banks in the Midwest. As a major growth initiative, Harris is combining its mid-market corporate banking activity with BMO's investment bank, Nesbitt Burns, to create a fully integrated mid-market corporate/investment bank focused on the Midwest and specialized industry sectors nation-wide. In the Sunbelt, Harris will be leveraging its "multi-channel" platform in Chicago, its investment and strategic alliance with Bancomer, and its current operations in Arizona and Florida -- to build its business in fast growing Sunbelt markets.
While Harris Bank has an internal growth strategy for various U.S. lines of business, it will continue to assess selective merger, acquisition and joint venture opportunities, to strategically enhance organic growth. This includes the recent acquisitions of Chicago-based discount broker, Burke, Christensen & Lewis Securities, Inc. and Village Banc of Naples in Florida by Bankmont which will extend Harris Bank's participation in U.S. markets. It also encompasses exiting those lines of business in which it lacks the scale and competitive advantages, such as its corporate trust business. Harris Bank will continue to grow and expand in Chicagoland, the Midwest and beyond -- and the combined target for the Corporation and Harris Bankmont remains sustained double-digit growth in earnings, with cash ROE rising to the 20% level by 2003.
EFFECT OF GOVERNMENT POLICIES
The operations of the Corporation are affected by general economic conditions and the policies of various governmental regulatory authorities. In particular, the Federal Reserve System regulates money and credit conditions and interest rates in order to influence general economic conditions, primarily through open market operations in U.S. Government securities, varying the discount rate on bank borrowings, setting reserve requirements against financial institution deposits and prescribing minimum capital requirements for member banks. These policies have a significant influence on overall growth and distribution of bank loans, investments and deposits, and affect interest rates charged on loans and earned on investments or paid for time, savings and other deposits. Federal Reserve Board monetary policies have had a significant effect on the operating results of commercial banks in the past and this is expected to continue. The effect of such policies upon the future business and earnings of the Corporation cannot accurately be predicted.
REGULATION AND SUPERVISION
Bankcorp is a legal entity, separate and distinct from its subsidiaries. There are various legal limitations on the ability of its banking subsidiaries to finance or otherwise supply funds to Bankcorp or various of its other affiliates. Notes 15 and 16 to Financial Statements on pages 74 through 76 of this Report provide details with respect to regulatory capital and dividend restrictions.
In addition, the banking subsidiaries are subject to certain restrictions on any extensions of credit to Bankcorp and (with certain exceptions) other affiliates, on investments in stock or other securities thereof and on the taking of such securities as collateral for loans. As a bank holding company, Bankcorp is subject to the Bank Holding Company Act of 1956, as amended, which generally limits the activities of the holding company and its subsidiaries to those so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Gramm-Leach-Bliley Financial Modernization Act of 1999 generally broadens the ability of eligible bank holding companies, including Bankcorp, to affiliate with other industries, particularly insurance and investment banking. Regulatory authorities have issued or will issue regulations implementing the Act's provisions. The Corporation's ongoing strategic analysis will include the impact of the regulations on its business.
Bankcorp and its banking subsidiaries are subject to regulation by various state and Federal authorities. Applicable laws and regulations relate to reserves, deposit insurance, investments, loans, mergers and consolidations, issuance of securities, payment of dividends, capital adequacy and other aspects of their operations. Bankcorp and its nonbank subsidiaries are affiliates of the banking subsidiaries within the meaning of the Federal Reserve Act and the Illinois Banking Act. Certain nonbank subsidiaries including the trust companies, Harris Investment Management, Inc., Harris Investors Direct, Inc. and others are subject to a variety of state and Federal regulations.
COMPETITION
Active competition exists in all principal geographic and product line areas in which the Corporation is presently engaged. Competitors include other commercial banks, investment banks, savings and loan associations, finance companies, credit unions, insurance companies, mutual funds, mortgage banks, investment managers and advisors, leasing companies, other domestic and foreign financial institutions and various nonfinancial intermediaries.
EMPLOYEES
The Corporation and HTSB had full-time equivalent employees of 6,164 and 4,886, respectively, at December 31, 1999.
ITEM 2
ITEM 2 -- PROPERTIES
The Corporation's headquarters and HTSB's main banking premises are located at 111 West Monroe Street, Chicago, Illinois. This bank and office building complex is comprised of three connected buildings containing a total of approximately 1,590,000 gross square feet. Approximately 60 percent of the rentable space is committed to use by HTSB. Virtually all of the remaining space in the entire building complex has been rented to tenants, including BMO. HTSB holds title to this property, which is used by all of the Corporation's segments.
HTSB also owns an operations center. This 15-story building contains approximately 415,000 gross square feet and is totally dedicated to bank use. It is located at 311 West Monroe Street, Chicago. In addition, HTSB owns premises used to conduct certain branch banking activities which are part of the Chicagoland Banking segment.
Certain banking subsidiaries, other than HTSB, individually own premises used to conduct banking business. Nonbank subsidiaries, certain branches and divisions of HTSB and certain other subsidiaries conduct activities from leased premises.
ITEM 3
ITEM 3 -- LEGAL PROCEEDINGS
For information on the Corporation's legal proceedings, see Note 17 to Financial Statements on page 76 of this Report.
ITEM 4
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the stockholder during the fourth quarter of 1999.
PART II
ITEM 5
ITEM 5 -- MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Bankmont presently owns all 6,667,490 shares of the voting stock of Bankcorp, which are not listed or traded on any securities exchange. In 1999, Bankcorp declared and paid to Bankmont approximately $66 million in cash dividends on common stock and $17 million in cash dividends on preferred stock. In 1998, Bankcorp declared and paid to Bankmont approximately $182 million in cash dividends on common stock and $17 million in cash dividends on preferred stock. In 1997, Bankcorp declared and paid to Bankmont approximately $42 million in cash dividends and $3 million in noncash dividends on common stock and $17 million in cash dividends on preferred stock. At December 31, 1999, 1998 and 1997, the Corporation's equity capital included $225 million of preferred stock, respectively.
Effective February 11, 1998, HPCC issued $250 million of 7 3/8% noncumulative, exchangeable Series A preferred stock. The preferred stock, which is listed and traded on the New York Stock Exchange, is nonvoting except in certain circumstances as outlined in HPCC's Form S-11 Registration Statement ("S-11"). Dividends on the preferred stock are noncumulative and are payable at the rate of 7 3/8% per annum of the $25 per share liquidation preference. The preferred shares can be redeemed in whole or in part at HPCC's option on or after March 30, 2003 or upon the occurrence of a tax event as defined in the S-11. Upon the occurrence of specific events described in the S-11, including HTSB becoming less than "adequately capitalized," HTSB being placed into conservatorship or receivership or the Board of Governors of the Federal Reserve Bank directing such an exchange, each preferred share would be exchanged automatically for one newly issued HTSB preferred share. During 1999 and 1998, HPCC paid $18 million and $16 million of dividends on preferred stock, respectively.
ITEM 6
ITEM 6 -- SELECTED FINANCIAL DATA
HARRIS BANKCORP, INC. AND SUBSIDIARIES COMPARATIVE CONSOLIDATED STATEMENTS OF INCOME
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* See the Return on Assets and Common Stockholder's Equity section of this Report on page 20 for further information.
HARRIS BANKCORP, INC. AND SUBSIDIARIES COMPARATIVE CONSOLIDATED STATEMENTS OF CONDITION
ITEM 7
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7A
ITEM 7A -- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
SUMMARY
1999 COMPARED TO 1998
The Corporation had 1999 earnings of $203.1 million, an 11 percent increase from $182.6 million in 1998. Earnings comparability was affected by the sale of the Corporation's credit card portfolio in January 1998. Excluding the results from credit card activities sold, "core earnings" increased 16 percent in 1999 compared to 1998. "Core revenue" on the same basis increased by 7 percent for the current year.
For 1999, return on average common equity ("ROE") was 13.56 percent compared to ROE of 11.92 percent for 1998. Return on average assets ("ROA") was 0.86 percent in 1999 compared to 0.86 percent in the prior year. Cash return on average common stockholder's equity ("cash ROE") represents net income applicable to common stock plus after-tax amortization expense of goodwill and other valuation intangibles, divided by average common stockholder's equity less gross average intangible assets. For the current year, cash ROE was 18.14 percent compared to cash ROE of 16.24 percent in 1998.
Net interest income on a fully taxable equivalent basis was $577.4 million, up $40.2 million or 7 percent from $537.2 million in 1998. Net interest margin declined from 2.93 percent to 2.82 percent currently, reflecting a relatively greater use of wholesale funding sources to support earning asset growth. Average earning assets rose $2.12 billion or 12 percent to $20.46 billion in the current year, attributable to an increase of 7 percent or $853 million in average loans and $1.42 billion in investment securities. Commercial loans and residential mortgages were the primary contributors to the growth in loans.
Noninterest income of $463.0 million was up $11.9 million or 3 percent year-to-year, due to strong growth in trust and investment management fees and service charge fees. Trust and investment management fees rose $12.1 million or 8 percent from the prior year while service fees and charges rose $7.1 million or 6 percent. Income from bank-owned insurance investments increased $9.1 million or 28 percent from 1998 due to increased investment balances. Other income, which includes syndication fees, mortgage loan sales and other gains and fee income, increased $5.3 million from 1998. Gains from sales of securities were substantially less in 1999, $14.1 million compared to $27.0 million in 1998. Money market and bond trading profits declined $1.6 million in 1999.
The 1999 noninterest expenses of $714.8 million rose $36.2 million or 5 percent from last year. The major categories reflecting increases were employment expense and equipment/systems expense. The increase in employment related expenses reflects both salary adjustments and growth in benefit costs. Employee benefits increases were in part a function of lower discount rates applied to projected retirement liabilities. The increase in equipment expense primarily reflects expenditures related to the Y2K issue. Income taxes declined $4.8 million during the current year, reflecting a lower effective tax rate in 1999.
The 1999 provision for loan losses of $25.0 million was down $1.9 million from 1998. Net loan charge-offs during the current year were $18.4 million compared to $17.2 million in the same period last year, with the difference primarily reflecting lower recoveries in the commercial portfolio in the current year, partially offset by lower write-offs in both the consumer and commercial loan portfolios.
Nonperforming assets at December 31, 1999 totaled $27 million, or 0.21 percent of total loans, compared to $27 million or 0.21 percent at September 30, 1999, and $21 million or 0.17 percent a year ago. At December 31, 1999, the allowance for possible loan losses was $147 million, equal to 1.12 percent of loans outstanding compared to $141 million at the end of 1998, equal to 1.15 percent of loans outstanding. As a result, the ratio of the allowance for possible loan losses to nonperforming assets was 536 percent at December 31, 1999 compared to 677 percent at December 31, 1998.
At December 31, 1999, consolidated equity capital of the Corporation amounted to $1.58 billion, down from $1.65 billion at December 31, 1998. Bankcorp paid $66 million in dividends on common stock and
$17 million of preferred dividends. Unrealized securities losses, net of tax, were $156 million at December 31, 1999 compared to unrealized securities gains, net of tax, of $38 million at December 31, 1998. At December 31, 1999 and 1998, the Corporation's equity capital included $225 million of preferred stock.
The Corporation's regulatory capital leverage ratio was 7.07 percent in 1999 compared to 7.26 percent in 1998. Regulators require most banking institutions to maintain capital leverage ratios of not less than 4.0 percent. At December 31, 1999, the Corporation's Tier 1 and total risk-based capital ratios were 8.88 percent and 11.54 percent, respectively, compared to respective ratios of 8.66 percent and 11.57 percent at December 31, 1998. The 1999 year-end ratios substantially exceeded minimum required regulatory ratios of 4.0 percent and 8.0 percent, respectively.
In February 1998, HPCC, a subsidiary of HTSB, issued $250 million of noncumulative preferred stock in a public offering (See Note 15 to Financial Statements on page 74 of this Report). The preferred stock qualifies as Tier 1 capital of the Corporation for U.S. banking regulatory purposes.
1998 COMPARED TO 1997
The Corporation had 1998 earnings of $182.6 million, a 17 percent increase from $156.6 million in 1997. Earnings comparability was affected by the sale of the Corporation's credit card portfolio in January 1998. Excluding the results from credit card activities sold, "core earnings" increased 24 percent in 1998 compared to 1997. "Core revenue" on the same basis increased by 11 percent in 1998.
For 1998, ROE was 11.92 percent compared to ROE of 10.54 percent for 1997. ROA was 0.86 percent in 1998 compared to 0.82 percent in 1997. For 1998, cash ROE was 16.24 percent compared to cash ROE of 15.43 percent in 1997.
Net interest income on a fully taxable equivalent basis was $537.2 million in 1998, down $60.7 million or 10 percent from $597.8 million in 1997. Net interest margin declined from 3.56 percent in 1997 to 2.93 percent in 1998, reflecting the impact of the credit card portfolio sale in January 1998. Average earning assets rose $1.56 billion or 9 percent to $18.34 billion in 1998, attributable to an increase of 6 percent or $699 million in average loans and $1.17 billion in the investment securities portfolio. Excluding the charge card portfolio, average loans rose $1.50 billion or 15 percent. Commercial loans and residential mortgages were the primary contributors to this growth.
Noninterest income of $451.0 million was up $73.3 million or 19 percent in 1998 from 1997 despite a $23.3 million decline in merchant and credit card fees resulting from the 1998 first quarter card portfolio sale. Trust and investment management fees rose 7 percent from 1997 while service fees and charges rose 14 percent. Other income, which includes syndication fees, gains on mortgage sales and other gains and fee income, increased $55.2 million from 1997. Securities gains were $27.0 million in 1998 compared to $13.2 million in 1997, while money market and bond trading profits were up $3.2 million in 1998.
1998 noninterest expenses of $678.6 million rose 2 percent from 1997. Excluding the costs associated with the credit card portfolio, expenses increased 7 percent year-to-year, reflecting modest growth in employment- related expenses, partially offset by reductions in non-employment costs.
Income taxes increased $3.1 million during 1998, reflecting higher pretax income somewhat offset by a reduction in the Corporation's effective tax rate.
The 1998 provision for loan losses of $27.0 million was down from $58.4 million in 1997. Net loan charge-offs during 1998 were $17.2 million compared to $69.8 million in the same period in 1997, with the difference primarily attributable to lower write-offs as a result of the credit card portfolio sale.
Nonperforming assets at December 31, 1998 totaled $21 million, or 0.17 percent of total loans, compared to $36 million or 0.30 percent at September 30, 1998, and $20 million or 0.20 percent at December 31, 1997. At December 31, 1998, the allowance for possible loan losses was $141 million, equal to 1.15 percent of loans outstanding compared to $131 million at the end of 1997, equal to 1.20 percent of loans outstanding. As a result, the ratio of the allowance for possible loan losses to nonperforming assets of 677 percent at December 31, 1998 remained essentially unchanged from December 31, 1997.
At December 31, 1998, consolidated equity capital of the Corporation amounted to $1.65 billion, up from $1.63 billion at December 31, 1997. Bankcorp paid $182 million in dividends on common stock and $17 million of preferred dividends. At December 31, 1998, the Corporation's equity capital included $225 million of preferred stock.
The Corporation's regulatory capital leverage ratio was 7.26 percent in 1998 compared to 6.81 percent in 1997. Regulators require most banking institutions to maintain capital leverage ratios of not less than 4.0 percent. At December 31, 1998, the Corporation's Tier 1 and total risk-based capital ratios were 8.66 percent and 11.57 percent, respectively, compared to respective ratios of 7.94 percent and 10.72 percent at December 31, 1997. The 1998 year-end ratios substantially exceeded minimum required regulatory ratios of 4.0 percent and 8.0 percent, respectively.
OPERATING SEGMENT REVIEW
The Corporation's segments are identified by the customers served, the products and services they offer and the channels by which the products and services are delivered. Corporate and Institutional Financial Services is comprised of the Corporation's corporate banking distribution to middle-market companies across the Midwest and nationally in selected specialties and corporate trust activities, including national stock transfer and indenture trust distribution. Chicagoland Banking comprises community banking, which serves individuals through a Chicagoland retail bank network and small business/lower middle-market banking. Electronic Financial Services includes cash management services, mbanx(sm), the Corporation's virtual banking unit, and the bankcard business unit, including merchant services and, until its sale in January 1998, the Corporation's charge card business. The Private Client Group serves the needs of affluent individuals both within Chicagoland and nationally through the integrated delivery of a comprehensive offering of wealth management services, including investment management, personal trust, customized lending and financial planning. Businesses within this group include private banking, mutual fund management, retirement plan services and Harris Investment Management, Inc. (the Corporation's institutional investment manager).
The "Other" category is comprised of the Corporation's Treasury unit, which serves as the Corporation's funding unit, as well as income from bank-owned insurance investments and inter-segment eliminations and residual revenues and expenses, representing the difference between actual amounts incurred and the amounts allocated to operating segments.
Selected segment information is included in the following table:
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(1) Includes gain on sale of charge card portfolio. A $12 million gain was reported in January 1998 and average loans decreased by $693 million.
CORPORATE AND INSTITUTIONAL FINANCIAL SERVICES
Net income for Corporate and Institutional Financial Services in 1999 was $90.5 million, up 12 percent from 1998. Total revenue of $306.8 million represented a growth of 10 percent from $278.7 million in 1998. The growth of $20.3 million or 11 percent in net interest income was primarily the result of a 10 percent or $638 million increase in the corporate banking loan portfolio from $6.16 billion in 1998 to $6.80 billion in 1999, along with an increase in margins. The growth in noninterest income of $7.8 million or 8 percent was largely due to increased corporate trust, foreign exchange, cash management and other fees. The decrease in the provision for loan losses of $2.9 million is primarily attributable to continued high credit quality of the existing portfolio. Noninterest expense increased $14.7 million or 12 percent to $137.8 million from $123.1 million in 1998, primarily in support of business volume growth. Income taxes increased by $6.8 million during the year, reflecting higher pretax income.
Corporate and Institutional Financial Services' 1998 net income increased 76 percent or $35.0 million to $81.0 million from 1997. Total revenue increased $69.3 million or 33 percent to $278.7 million from $209.4 million in 1997. The 42 percent or $52.5 million year-to-year growth in net interest revenue was primarily attributed to a 22 percent or $1.13 billion increase in the corporate banking loan portfolio. The growth in noninterest revenue of $16.8 million or 20 percent was largely due to increased syndication, corporate trust, letter of credit and foreign exchange fees. The increase in the provision for loan losses of $6.1 million is attributable to the growth in the corporate loan portfolio. Noninterest expense increased by $5.3 million to $123.1 million from $117.8 million in 1997, primarily in support of business volume growth. Income taxes increased by $22.9 million in 1998, primarily due to higher pretax earnings.
On February 1, 2000, the Corporation announced the sale of its corporate trust businesses. In separate and unrelated transactions, the indenture trust business is being sold to a subsidiary of The Bank of New York Company, Inc., and the shareholder services business to Computershare Limited. The combined sales will result in an estimated pre-tax gain to Bankcorp of approximately $50 million in first quarter 2000, not including revenue contingent upon the outcome of certain events, expected in second half 2000. The sales are subject to regulatory approval and are expected to close during first quarter 2000. In 1999, noninterest revenue from the corporate trust businesses amounted to $51.7 million. The Corporation does not believe that the sale of these businesses will have a material impact on the results of operations for this segment in future periods.
CHICAGOLAND BANKING
Net income for Chicagoland Banking in 1999 was $24.4 million, up 33 percent from 1998. Total revenue of $330.0 million represented a growth of $20.2 million or 7 percent from $309.8 million in 1998. Net interest income increased by $14.8 million or 6 percent from $240.8 million, largely generated by increased spreads on earning assets. Noninterest income of $74.4 million increased $5.4 million or 8 percent over 1998 levels, primarily due to higher service charges. The increase in the provision for loan losses of $0.9 million was primarily attributable to community banking activities and reflected growth in the retail loan portfolio. Noninterest expense increased $10.3 million or 4 percent to $281.6 million from $271.3 million in 1998. The increase was primarily due to continuing costs related to various retail initiatives including the enhancement of products and services for retail and business banking customers. Income taxes increased by $2.9 million during 1999, reflecting higher pretax income.
Net income for Chicagoland Banking in 1998 was $18.3 million, up 38 percent from 1997. Total revenue of $309.8 million represented a growth of $25.7 million or 9 percent from $284.1 million in 1997. Net interest income increased by $6.6 million or 3 percent from $234.2 million, largely generated by an increase in the investment portfolio. Noninterest income of $69.0 million increased $19.1 million or 38 percent over 1997 levels, primarily due to higher mortgage loan originations in 1998. The increase in the provision for loan losses of $3.9 million was primarily attributable to community banking activities and reflected growth in the retail loan portfolio and lower recoveries in 1998 compared to 1997. Noninterest expense increased $12.6 million or 5 percent to $271.3 million from $258.7 million in 1997. The increase was primarily due to investments in various retail initiatives including completing the conversion, begun in 1995, of remaining retail accounts to a common retail banking platform; expansion of the centralized operations facility and consumer loan utility in
support of increased business volumes and the creation of a distinct mortgage loan utility. Income taxes increased by $4.2 million during 1998, reflecting higher pretax income.
ELECTRONIC FINANCIAL SERVICES
Net income for Electronic Financial Services was $22.5 million in 1999, reflecting a decrease of $4.1 million or 15 percent from $26.6 million in 1998. Comparability between years was impacted by the first quarter 1998 sale of the Corporation's credit card portfolio. Excluding the gain, net income on a comparative basis increased $3.1 million from 1998. Total revenue of $171.6 million decreased by $4.9 million or 3 percent from $176.5 million in 1998. Net interest income fell by $0.9 million or 1 percent from $68.1 million in 1998. Noninterest income declined $4.0 million or 4 percent. Excluding the gain on the sale of the credit card portfolio, noninterest income growth was $8.0 million or 8 percent primarily due to growth in service charges. Noninterest expense increased $2.2 million or 2 percent to $134.2 million from $132.0 million in 1998. Income taxes decreased by $2.9 million during the year, reflecting lower pretax income.
Net income for Electronic Financial Services was $26.6 million in 1998, reflecting a decrease of $0.5 million or 2 percent from $27.1 million in 1997. Comparability between years is impacted by the first quarter 1998 sale of the Corporation's credit card portfolio. Total revenue of $176.5 million decreased by $72.5 million or 29 percent from $249.0 million in 1997. Net interest income fell by $67.0 million or 50 percent from $135.1 million in 1997, attributable to the charge card sale, which resulted in a decline in average loan balances from $841 million in 1997 to $59 million in 1998. Noninterest income declined $5.5 million or 5 percent due to reduced fee income from the credit card portfolio, partly offset by the $12.0 million pre-tax ($7.2 million after-tax) gain on sale of the credit card portfolio and an increase in cash management service fees. The decrease in the provision for loan losses of $49.9 million was attributable to the sale of the credit card portfolio. Noninterest expense decreased $21.2 million or 14 percent to $132.0 million from $153.2 million in 1997, primarily due to a reduction in operating expenses related to the credit card sale. This was partly offset by the cost of support for business volume increases in cash management services.
PRIVATE CLIENT GROUP
Net income for Private Client Group in 1999 was $17.4 million, down 18 percent from 1998. Total revenue of $180.2 million represented a growth of $12.9 million or 8 percent from $167.3 million in 1998. Net interest income increased by $3.5 million or 8 percent from $45.5 million, reflecting the 14 percent growth in loan volume. Noninterest income of $131.2 million increased $9.4 million or 8 percent over 1998 levels, primarily due to increased personal trust and investment management revenue. Noninterest expense increased $19.5 million or 15 percent to $150.8 million from $131.3 million in 1998. The increase was due to the expansion of private banking activities in Chicagoland, the opening of two new full service banking facilities in Florida, and investments made in marketing and distribution of the Harris Insight Mutual Funds. Income taxes decreased by $2.8 million during 1999, reflecting lower pretax income.
Net income for Private Client Group in 1998 was $21.2 million, up 64 percent from 1997. Total revenue of $167.3 million represented growth of $21.5 million or 15 percent from $145.8 million in 1997. Net interest income increased by $7.8 million or 21 percent from $37.7 million, largely the result of loan volume growth. Noninterest income of $121.8 million increased $13.7 million or 13 percent over 1997 levels, due to a combination of increased personal trust and investment management revenue and growth in mortgage origination and sale fees. Noninterest expense increased $6.5 million or 5 percent to $131.3 million from $124.8 million in 1997. The increase represents minimal investments in all private client business. Income taxes increased by $6.6 million during 1998, reflecting higher pretax income.
OTHER
The results for this segment include income from bank-owned insurance, which increased $9.1 million or 28 percent in 1999 compared to 1998 and $19.4 million in 1998 compared to 1997. In addition, the tax benefits from the bank-owned insurance program reduced the effective tax rate in both 1999 and 1998 compared to 1997.
HARRIS BANKCORP, INC. AND SUBSIDIARIES NET INTEREST INCOME
- ------------------------- NOTES TO NET INTEREST INCOME TABLES: 1. FULLY TAXABLE EQUIVALENT ADJUSTMENT Tax-exempt interest income (for Federal purposes) has been restated to a comparable taxable level. The Federal statutory tax rate used for this purpose was 35 percent in 1999, 1998 and 1997. This adjustment also includes a state tax component. 2. INTEREST INCOME The impact of restructured and nonaccrual loans is reflected in all average balance, net interest income and related yield calculations. Average balances include restructured and nonaccrual loans. Interest income and yields on these assets reflect income recorded on a cash basis. 3. VOLUME AND RATE VARIANCES The change in interest income/expense attributable to volume is calculated by multiplying the annual change in volume by the prior year's rate. The rate variance is calculated by multiplying the annual change in rate by the prior year's volume. Any variance attributable jointly to volume and rate changes is prorated on a weighted basis between volume and rate. 4. AVERAGE RATE ON SECURITIES Yields on securities classified as available-for-sale are based on amortized cost.
HARRIS BANKCORP, INC. AND SUBSIDIARIES NET INTEREST INCOME
NET INTEREST INCOME
Net interest income, the difference between interest and fees recognized on earning assets and total interest expense, is the major component of operating income for the Corporation. Since income on certain earning assets may be exempt from Federal and/or state income taxes, the Management's Discussion and Analysis section of this Report is prepared on a fully taxable equivalent (FTE) basis, which, in effect, restates tax-advantaged income to a comparable level with nontax-advantaged income. In 1999, the Corporation's FTE net interest income was $577.4 million, up 8 percent from $537.2 million in 1998.
The year-to-year change in net interest income is typically explained by analyzing its two principal components, average earning assets and net interest margin. Average earning assets represent the average volume of assets employed by the Corporation during the year, which generate interest income. Net interest margin is the difference between the overall FTE yield on earning assets and the average cost of supporting liabilities, including noninterest-bearing funds. For 1999, the Corporation's average earning assets grew 12 percent, while net interest margin decreased 11 basis points from 2.93 percent in 1998 to 2.82 percent in 1999.
Average earning assets in 1999 totaled $20.46 billion, up $2.12 billion, or 12 percent, from $18.34 billion in 1998. This growth is primarily the result of an increase in average securities of $1.41 billion, or 23 percent, to $7.50 billion, led by increased holdings of Federal agency securities amounting to $1.34 billion. Average loans increased $853 million, or 7 percent, to $12.51 billion, led by increases in average commercial and real estate loan outstandings of $672 million (9 percent) and $167 million (5 percent), respectively. The growth in average loans is attributable to a growing demand for credit in the U.S. economy coupled with an aggressive marketing effort by the Corporation. Loans and investment securities, as a percent of earning assets, were 61 percent and 37 percent, respectively, compared to 64 percent and 33 percent, respectively, in 1998. Average Federal funds sold and securities purchased under agreement to resell increased 23 percent or $37 million compared to 1998.
Changes in the mix of total supporting funds are a function of loan demand, consumer preferences for maintaining funds in core deposits and wholesale market spreads. The Corporation manages its wholesale funding activity at the margin primarily by using the least expensive products given requirements for matched funding, maturity, ability and expected cost to refund, reserve requirements and deposit insurance costs. Secured borrowings, such as repurchase agreements, may also depend on availability of collateral. In 1999, Federal funds purchased and securities sold under agreement to repurchase increased $1.02 billion or 34 percent, which resulted in an increase in short-term borrowings of $1.02 billion or 30 percent from 1998 levels. Domestic interest-bearing deposits increased $296 million, or 3 percent, from 1998. Average foreign office time deposits totaled $1.59 billion, up 28 percent or $345 million, compared to $1.25 billion in 1998. Noninterest-bearing funds supporting earning assets decreased $72 million, and declined from 15 percent to 11 percent year to year as a percentage of average supporting liabilities.
The Corporation's consolidated net interest margin declined to 2.82 percent from 2.93 percent in 1998. This decrease primarily reflects the continued reliance on wholesale interest-bearing funds to support growth in earning assets.
NONINTEREST INCOME
Noninterest income for the year was $463.0 million in 1999, up $11.9 million or 3 percent from 1998. In the first quarter of 1998, the Corporation realized a gain of $12.0 million on the sale of the credit card portfolio. Excluding the credit card gain, noninterest income increased 5 percent over 1998. The primary contributors to the increase were trust and investment management fees and service fees and charges. Gains from sales of securities of $14.1 million were substantially less in 1999 compared to the $27.0 million in 1998.
Trust and investment management fees were $155.8 million, up $12.1 million or 8 percent from the prior year, primarily from increased personal trust and corporate trust revenue. Service fees and charges were $116.4 million in 1999, up $7.1 million or 6 percent over 1998 due primarily to product growth. Income from bank-owned insurance investments increased $9.1 million or 28 percent from 1998 due to increased investment balances. Other income, which includes syndication fees and mortgage loan sales, increased $6.0 million or 10 percent.
Trading account gains, primarily from municipal bond trading, totaled $8.9 million, down $1.6 million from 1998. Financial results from trading activities will typically exhibit greater fluctuations over time than other business activities. Foreign exchange revenues (FX) were $8.3 million, up $1.5 million or 23 percent from 1998. HTSB and BMO combine their U.S. FX trading. Under this arrangement, FX net profit is shared by HTSB and BMO in accordance with a specific formula set forth in the agreement. This agreement expires in April 2002 but may be extended at that time. Either party may terminate the arrangement at its option.
On February 1, 2000, the Corporation announced the sale of its corporate trust businesses. In separate and unrelated transactions, the indenture trust business is being sold to a subsidiary of The Bank of New York Company, Inc., and the shareholder services business to Computershare Limited. The combined sales will result in an estimated pre-tax gain to Bankcorp of approximately $50 million in first quarter 2000, not including revenue contingent upon the outcome of certain events, expected in second half 2000. The sales are subject to regulatory approval and are expected to close during first quarter 2000. In 1999, noninterest revenue from the corporate trust businesses amounted to $51.7 million. The Corporation does not believe that the sale of these businesses will have a material impact on the results of operations for future periods.
NONINTEREST EXPENSE
Noninterest expenses totaled $714.8 million, up $36.2 million or 5 percent from 1998. Employment-related expenses totaled $422.2 million, an increase of $35.2 million or 9 percent. The increase reflects both salary adjustments and growth in benefit costs. Employee benefit increases were in part a function of lower discount rates applied to projected retirement liabilities. Net occupancy expenses totaled $48.6 million, down $2.8 million from 1998. Equipment expenses totaled $61.8 million, up $9.2 million or 17 percent from 1998 primarily due to additional depreciation from a new retail applications system and a new trust applications system, both placed in service during 1999. Expert services and contract programming decreased $5.0 million and $11.4 million, respectively, primarily due to limits on new systems development in order to devote resources to ensuring that all current systems were Y2K compliant. Amortization of goodwill and other valuation intangibles increased $0.9 million or 4 percent from 1998.
INCOME TAXES
The Corporation recorded income tax expense of $65.1 million in 1999, compared to $69.9 million in 1998. The Corporation's effective tax rate decreased to 24.3 percent in 1999 from 27.7 percent in 1998 primarily as a result of an increase in tax-advantaged assets.
At December 31, 1999, the Corporation's Federal and state net deferred tax assets were $68 million and $10 million, respectively. The Corporation has recognized its Federal and state deferred tax assets as management believes that it is more likely than not that the deferred tax assets will be realized.
The deferred taxes reported on the Corporation's Statement of Condition at December 31, 1999 also include a $103 million asset for the tax effect of unrealized losses associated with marking to market certain securities designated as available-for-sale.
IMPACT OF NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." The Statement establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires all derivatives to be recognized as either assets or liabilities in the statement of financial position and to be measured at fair value. As issued, the Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. In June 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133." The Statement was effective upon issuance and amended SFAS No. 133 to be effective for all fiscal quarters of fiscal years beginning after June 15, 2000, which for the Corporation would be the quarter ending March 31, 2001. The Corporation is in the process of assessing the impact of adopting the Statements on its financial position and results of operations.
RETURN ON ASSETS AND COMMON STOCKHOLDER'S EQUITY
Return on assets ("ROA"), measured by net income as a percentage of average total assets, was 0.86 percent in 1999, remaining unchanged from 1998. The current year's ROA was equal to the average ROA of 0.86 percent for the five-year period ended December 31, 1999. Average common stockholder's equity to average total assets provides a measure of leverage for the Corporation. The ratio of average common stockholder's equity to average total assets was 5.85 percent in 1999 compared to 6.56 percent in 1998. For 1999, the return on average common stockholder's equity ("ROE") was 13.56 percent, up from the 11.92 percent achieved in 1998 and the 12.24 percent five-year average return for the period ended December 31, 1999.
Cash ROA of 0.94 percent in 1999 remained unchanged from 1998. Cash ROE was 18.14 percent and 16.24 percent in 1999 and 1998, respectively.
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(1) Total average assets and average common equity used in these calculations include average gross and net unrealized gains or losses on available-for-sale securities, respectively.
(2) Cash return on average assets is calculated as net income plus after-tax amortization expenses of goodwill and other valuation intangibles, divided by average assets less average intangible assets.
(3) Cash return on average common stockholder's equity is calculated as net income applicable to common stock plus after-tax amortization expenses of goodwill and other valuation intangibles, divided by average common stockholder's equity less gross average intangible assets.
(4) Dividends on common and preferred stock as a percent of net income. 1997 includes both cash and noncash dividends. 1998 ratio includes impact of special dividends equal to $125 million. Excluding the payment of the special dividends as part of a capital restructuring and the sale of HTSB's credit card portfolio, the 1998 dividend payout ratio would have been 40.02%
(5) Earnings retained is defined as net income minus dividends. 1998 includes the impact of special dividends of $125 million. Excluding the payment of the special dividends, earnings retained as a percentage of common stockholder's equity would have been 7.86% in 1998.
CAPITAL POSITION
The Corporation's equity capital of $1.58 billion at December 31, 1999 has increased significantly from five years earlier when equity capital amounted to $1.02 billion. During 1999 and 1998, Bankcorp declared and paid common dividends of $66 million and $182 million, respectively, and preferred dividends of $17 million in both years. 1998 common dividends included special dividends of $125 million of which $50 million related to
the sale of HTSB's credit card portfolio. During 1999, the Corporation's equity capital was reduced by $194 million representing after-tax unrealized holding losses related to the Corporation's securities available-for-sale. During 1998, equity capital was increased by $27 million of after-tax unrealized holding gains. Average consolidated equity capital was $1.60 billion in 1999 compared to $1.62 billion in 1998.
Bankcorp's double leverage ratio, which is the Bankcorp parent company only net equity investment in bank and nonbank subsidiaries as a percentage of its equity capital, was 106 percent at December 31, 1999, down from 110 percent at December 31, 1998. This ratio generally measures the extent to which holding company equity investments are supported, in part, by parent-issued debt instruments. A double leverage ratio greater than 100 percent indicates that parent company equity investments are supported, in part, by parent-issued debt. In the case of Bankcorp, outstanding long-term debt is sufficient to fund equity investments not otherwise covered by equity capital.
RISK-BASED CAPITAL
U.S. banking regulators have issued risk-based capital guidelines, based on the international "Basle Committee" agreement, which are applicable to all U.S. banks and bank holding companies. These guidelines serve to: 1) establish a uniform capital framework which is more sensitive to risk factors, including off-balance-sheet exposures; 2) promote the strengthening of capital positions; and 3) diminish a source of competitive inequality arising from differences in supervisory requirements among countries. Bankcorp, as a U.S. bank holding company, and HTSB, as a state-member bank, must each adhere to the guidelines of the Federal Reserve Board (the "Board"), which are not significantly different than those published by other U.S. banking regulators. The guidelines specify minimum ratios for Tier 1 capital to risk-weighted assets of 4 percent and total regulatory capital to risk-weighted assets of 8 percent.
Risk-based capital guidelines define total capital to consist of Tier 1 (core) and Tier 2 (supplementary) capital. In general, Tier 1 capital is comprised of stockholder's equity, including certain types of preferred stock, less goodwill and certain other intangibles. Core capital must comprise at least 50 percent of total capital. Tier 2 capital basically includes subordinated debt (less a discount factor during the five years prior to maturity), other types of preferred stock and the allowance for possible loan losses. The portion of the allowance for possible loan losses includable in Tier 2 capital is limited to 1.25 percent of risk-weighted assets. The Corporation's Tier 1 and total risk-based capital ratios were 8.88 percent and 11.54 percent, respectively, at December 31, 1999.
The Board also requires an additional measure of capital adequacy, the Tier 1 leverage ratio, which is evaluated in conjunction with risk-based capital ratios. The Tier 1 leverage ratio is computed by dividing period-end Tier 1 capital by adjusted quarterly average assets. The Board established a minimum ratio of 3 percent applicable only to the strongest banking organizations having, among other things, excellent asset quality, high liquidity, good earnings and no undue interest rate risk exposure. Other institutions are expected to maintain a minimum ratio of 4 percent. The Corporation's Tier 1 leverage ratio was 7.07 percent for fourth quarter 1999.
In February 1998, Harris Preferred Capital Corporation, a subsidiary of HTSB, issued $250 million of noncumulative preferred stock in a public offering (see Note 15 to Financial Statements on page 74 of this Report). The preferred stock qualifies as Tier 1 capital at both HTSB and the Corporation for U.S. banking regulatory purposes.
The Federal Deposit Insurance Corporation Improvement Act of 1991 contains several provisions that established five capital categories for all Federal Deposit Insurance Corporation ("FDIC")-insured institutions ranging from "well capitalized" to "critically undercapitalized." See Note 15 to Financial Statements on page 74 of this Report. Based on those regulations effective at December 31, 1999 all of the Corporation's subsidiary banks were designated as "well capitalized" at year-end 1999, the highest capital category.
Capital adequacy guidelines generally restrict the inclusion of intangible assets in Tier 1 capital. However, mortgage servicing rights and the premium on purchased credit card relationships may be included with (i.e., not deducted from) Tier 1 capital provided that certain percentage limitations are not violated. Identifiable
intangibles acquired before February 19, 1992 continue to be included with Tier 1 capital. All other intangibles (including core deposit premiums and goodwill), along with amounts in excess of the above limits, are deducted from Tier 1 capital for purposes of risk-based and leverage capital ratio calculations. At December 31, 1999 the Corporation's intangible assets totaled $250 million, including approximately $233 million of intangibles excluded under capital guidelines. The Corporation's tangible Tier 1 leverage ratio (which excludes all intangibles) was 7.01 percent for the fourth quarter of 1999.
Risk-based capital guidelines exclude from Tier 1 capital net unrealized holding gains (losses) associated with marking to market debt securities designated as available-for-sale. Net unrealized losses on marketable equity securities are deducted from Tier 1 capital. Up to 45 percent of the pretax net unrealized holding gains on available-for-sale equity securities may be included in Tier 2 capital. Net unrealized holding gains (losses) excluded from Tier 1 capital for risk-based capital purposes amounted to ($155) million and $38 million at December 31, 1999 and 1998, respectively.
The following table summarizes the Corporation's risk-based capital ratios and Tier 1 leverage ratio for the past three years:
LIQUIDITY AND SOURCES OF FUNDS
SUMMARY
Effective liquidity management allows a banking institution to accommodate the changing net funds flow requirements of customers who may deposit or withdraw funds, or modify their credit requirements. One of the principal obligations of the banking system, and individual banks, is to provide for the legitimate credit demands of customers. The liquidity of the banking system as a whole may be viewed as the ability of the system to satisfy aggregate credit demand; however, individual banks experience changes in liquidity resulting from interbank transfers of deposits which do not affect the liquidity of the banking system. Therefore, liquidity management within individual banks must deal with the potential for greater volatility of net deposit flows which have little or no impact on the banking system itself.
The Corporation manages its liquidity position through continuous monitoring of profitability trends, asset quality, interest rate sensitivity, maturity schedules of earning assets and supporting liabilities, the composition of managed and other (primarily demand) liabilities, and prospective customer credit demand based upon knowledge of major customers and overall economic conditions. Appropriate responses to changes
in these conditions preserve customer confidence in the ability of the Corporation to continually serve their credit and deposit withdrawal requirements. The Corporation maintains a liquidity risk policy within its comprehensive risk management framework and manages and monitors liquidity risk within the parameters of this policy.
Some level of liquidity is provided by maintaining assets which mature within a short time-frame or could be sold quickly without significant loss. The Corporation's liquid assets include cash and demand balances due from banks, money market assets, securities available-for-sale and trading account assets. Liquid assets represented approximately 40 percent of the Corporation's total assets and amounted to $9.89 billion at December 31, 1999 compared to liquid assets of $8.83 billion or approximately 39 percent of total assets one year earlier. However, the most important source of liquidity is the ability to raise funds, as required, in a variety of markets using multiple instruments. This fund-raising activity involves the identification of broadly distributed sources of funds, typically referred to as managed liabilities, which are varied by type, maturity and geographical location of customers. The Corporation monitors and controls the sources of these funds to avoid unwarranted market activity or customer concentrations.
The principal sources of external funds available to the Corporation are retail and wholesale liabilities. Retail liabilities are comprised of demand deposits, money market accounts, NOW accounts, passbook savings and nonnegotiable certificates of deposit, typically of small denomination. Wholesale funding sources include Eurodollar deposits in foreign offices, Federal funds borrowed, securities sold under agreement to repurchase, negotiable large denomination certificates of deposit and commercial paper. HTSB offers to institutional investors from time to time, unsecured short-term and medium-term bank notes in an aggregate principal amount of up to $1.50 billion outstanding at any time. The term of each note could range from fourteen days to fifteen years. The notes are subordinated to deposits and rank pari passu with all other senior unsecured indebtedness of HTSB. As of December 31, 1999, $1.50 billion of senior notes were outstanding with original maturities ranging from 366 to 385 days (remaining maturities ranging from 18 to 223 days) and stated interest rates ranging from 5.00 percent to 5.85 percent. As of December 31, 1998, $940 million of senior notes were outstanding with original maturities ranging from 31 to 182 days (remaining maturities ranging from 22 to 130 days) and stated interest rates ranging from 5.00 percent to 5.50 percent.
The Corporation's average volume of core deposits, consisting of demand deposits, interest checking deposits, savings deposits and certificates, and money market accounts, increased from $11.41 billion or 61 percent of total non-equity funding at December 31, 1998 to $11.87 billion or 57 percent of total non-equity funding at December 31, 1999. Total wholesale deposits and short-term borrowings increased from $7.23 billion or 39 percent of total non-equity funding at December 31, 1998 to $9.03 billion or 43 percent of total non-equity funding at December 31, 1999.
Average money market liabilities increased 30 percent to $4.43 billion from $3.42 billion for 1998, primarily as a result of increases in Federal funds borrowed and securities sold under repurchase agreements. Average money market assets decreased $93 million or 20 percent from 1998. These assets represented 2 percent of average earning assets in 1999 compared to 3 percent in 1998, primarily reflecting decreases in interest bearing deposits at banks.
The Corporation, in connection with the issuance of commercial paper and for other corporate purposes, had a $150 million revolving credit agreement with five nonaffiliated banks and BMO that terminated on December 18, 1999. At that time, the Corporation entered into a new $150 million revolving credit agreement with five nonaffiliated banks and BMO that terminates on December 8, 2000. There were no borrowings under either credit facility in 1999 or 1998.
The maintenance of an appropriate balance of maturity and interest rate sensitivity risks between assets and liabilities is an integral component of overall liquidity management. Mismatches of actual asset and liability maturities, or interest rate sensitivity of assets and liabilities, will increase the potential for profit or loss relative to changes in the general level of interest rates. Asset and liability mismatches result in the normal course of servicing customer credit and deposit requirements. The Corporation uses interest rate swaps and financial futures, as appropriate, to reduce the level of financial risk inherent in asset and liability mismatches. Gross cash flows from the Corporation's derivative positions as an end-user were not material to gross cash
flows from financing and investing activities. The Corporation's Asset/Liability Management Committee monitors and adjusts its strategies in response to changing liquidity demands.
INTEREST SENSITIVITY
Interest rate sensitivity information, in the form of interest sensitivity gap schedules and simulations reflecting exposure of earnings to future changes in interest rates, is used in conjunction with other data by the Corporation's banking subsidiaries to monitor and manage their individual interest rate exposures. The Corporation uses various derivative products, including interest rate swaps, forward rate agreements, futures, options, and forward commitments to manage interest rate sensitivities corresponding to various balance sheet items, thereby modifying its exposure to changing interest rates.
The schedule above presents the Corporation's consolidated interest sensitivity gap at December 31, 1999. This point-in-time analysis depicts repricing dates for earning assets, supporting funds and related off- balance-sheet activities. Generally, dates for repricing are included on a contractual basis. Certificates of deposit are reported based upon scheduled maturity without reference to early redemption or renewal options. Fixed term assets such as residential mortgages and consumer loans are reported based upon scheduled repayments and estimated prepayments based on historical behavior. A negative gap in a given time span indicates an excess of interest-bearing liabilities over interest earning assets which reprice in that period. After including interest rate swaps, derivative products and forward commitments, at December 31, 1999, the Corporation had a cumulative negative one-year interest rate gap of $5.5 billion. This measure, called the "contractual gap" position, is calculated without regard to the existence of nonrepricing items, the behavior of which must be considered in the evaluation of the Corporation's overall interest rate sensitivity.
In addition to gap measurements, the Corporation uses simulation modeling to measure earnings risk and valuation risk, defined as risk to net equity valuation, as a result of various interest rate scenarios and balance sheet structures. These risk measurements include the impact of changes in interest rates on all of the Corporation's assets, liabilities and off-balance-sheet positions. They do not contemplate actions the Corporation could take to reduce risk or actions customers might take in response to changing rates. Earnings risk represents the 12-month impact on net income, and valuation risk represents the change in value of the Corporation's assets and liabilities from adverse changes in interest rates over the period that would be
required to eliminate open positions. The model of earnings risk and valuation risk is based on a statistical analysis of historical data to calculate with 99% confidence the potential loss in earnings/change in value the Corporation might experience if an adverse change in market rates were to occur. Shifts in the yield curve and changes in the shape of the yield curve are among the variables considered. Limits are established for valuation risk at individual bank and consolidated levels, and actual exposure is monitored to ensure that these limits are not exceeded.
Given a static balance sheet at December 31, 1999, for an immediate 100 basis point upward movement in interest rates, net interest income would decrease by approximately $19.2 million over the next year compared to what it would otherwise have been, and the net equity value of all interest-sensitive positions would decrease by $126.6 million. Conversely, a decline in rates would have approximately the same absolute impacts but in the opposite direction. At December 31, 1998, the same analysis using similar assumptions indicated that net interest income would have decreased by approximately $17.5 million and the net equity value of all interest-sensitive positions would have decreased by $152.8 million.
Management believes that the Corporation is well-positioned with its mix of assets and liabilities to respond to interest rate movements in either direction.
CASH FLOWS
Cash flow analysis is an essential element for evaluating a company's ability to satisfy its obligations to short- and long-term creditors, bondholders and investors. The Corporation's Consolidated Statements of Cash Flows can be found on page 48 of this Report. This financial statement is based on period-end balances and does not reflect average investment or financing levels.
As a bank holding company, the Corporation regularly receives and disperses large volumes of cash and cash equivalents. Since these gross numbers provide little additional information to financial statement users, the FASB permits bank holding companies to net certain cash receipts and payments in their cash flow statements. The Corporation has adopted this net presentation for loans and deposits.
The Corporation's Consolidated Statements of Cash Flows divide its activities into three main categories: operating, investing and financing. Operating activities consist of those activities not categorized as investing or financing and generally include cash revenues and expenses associated with providing services to customers. Investing cash flows are defined as those arising from the acquisition or disposal of loans, securities, money market assets, subsidiaries, and fixed assets. Financing cash flows include deposits, both infusions from and dividend payments to the stockholder, along with borrowings and principal repayments to bondholders or other creditors.
Cash flows from operations are a significant source of operating capital. Since applicable accounting statements require that cash transactions involving assets held for sale and trading assets be included with operating cash flows, normal year-end fluctuations in these holdings may not appropriately portray the company's cash flows generated from operations. Core operating cash flows, consisting of net income before provision for loan losses and depreciation and amortization, increased by $27 million. Year-end trading account assets decreased $52 million year to year, while loans held for sale (primarily residential mortgages) decreased $153 million.
In 1999, the Corporation's investing activities utilized a total of $2.54 billion in net cash. Securities, the primary use of new funds, increased $1.14 billion. Interest-bearing deposits at banks increased $141 million, investments in bank-owned insurance increased $47 million and Federal funds sold and securities purchased under agreement to resell increased $150 million.
In 1999, the Corporation's financing activities included accepting customer deposits, purchasing Federal funds and issuing short-term senior notes. Financing activities provided $2.04 billion of net cash available to the Corporation in 1999. Deposits decreased $28 million and short-term senior notes of $560 million were issued, net. Gross cash received and paid resulting from the Corporation's derivative positions as an end-user were not material relative to gross cash flows from financing or investing transactions.
In the past three years, the Corporation has had two significant noncash transactions. As of December 31, 1997, credit card loan balances were transferred to assets held for sale in anticipation of their sale in January 1998. In July 1997, 80 percent ownership of Harris Trust/Bank of Montreal (formerly Harris Trust Company of Florida) was transferred by way of a noncash dividend to Bankmont. See the Securities section below for further information. Noncash portions of these transactions were excluded from the Corporation's Consolidated Statements of Cash Flows.
SELECTED LOAN MATURITY SPREAD
Variable rate loans, excluding consumer loans, accounted for 60 percent of total loans in 1999 remaining unchanged from 1998. Excluding consumer loans, term loans (those with a remaining contractual maturity in excess of one year) totaled $1.28 billion. Of these loans, $1.09 billion or 85 percent are due within five years. Overall, the average FTE yield on total loans increased to 7.92 percent in 1999 from 7.40 percent in 1998. The Corporation's average prime rate in 1999 was 8.00 percent compared to 8.35 percent in 1998.
Type of Loan, by Maturity*
- ------------------------- * Excludes installment loans to individuals, real estate mortgages and lease financing.
SECURITIES
Debt and marketable equity securities are classified into two categories. Trading account securities include those securities purchased for sale in the near term. The remaining securities are classified as "available-for-sale." These securities are classified as available-for-sale, even if the company has no current intent to dispose of them. Available-for-sale securities are carried at fair value, with net unrealized gains and losses (after-tax) reported as a separate component of equity.
At December 31, 1999, the fair value of available-for-sale securities was $258 million below amortized cost. As a result, stockholder's equity included $156 million of unrealized (after tax effect) holding losses. At December 31, 1998, the fair value of available-for-sale securities was $63 million above amortized cost, and stockholder's equity included $38 million of unrealized (after tax effect) holding gains.
Securities averaged $7.39 billion in 1999. On an FTE basis, interest income from securities increased $68.9 million to $455.3 million. The overall FTE yield on the Corporation's securities averaged 6.07 percent during 1999. Yields on average available-for-sale securities are based on amortized cost.
The Corporation periodically repositions its investment portfolio in response to changes in laws, in order to meet regulatory capital requirements or, as part of asset/liability management, to enhance future net interest income levels while maintaining an appropriate risk/reward relationship. During 1999, the Corporation purchased $12.73 billion of available-for-sale securities, sold $879 million of available-for-sale securities and had $10.71 billion of available-for-sale securities mature. During 1998, the Corporation purchased $17.41 billion of available-for-sale securities, sold $2.55 billion of available-for-sale securities and had $13.20 billion of available-for-sale securities mature. The aforementioned sales of securities generated a pretax net gain of $14.1 million during 1999 compared to a net gain of $27.0 million during 1998 and a net gain of $13.2 million in 1997. On an after-tax basis, the Corporation recorded a net gain from securities sales of $8.6 million in 1999 compared to $16.5 million in 1998 and $8.1 million in 1997. In some cases, security gains are taken in order to realize otherwise unrealized profits in anticipation of near-term increases in interest rates.
Unrealized holding losses for available-for-sale securities, as of December 31, 1999, amounted to $258 million compared to unrealized holding gains of $63 million as of December 31, 1998. The change in unrealized gains and losses of $321 million was due to losses in market value as a result of increases in interest rates at year-end 1999 versus year-end 1998, and a change in the mix of the portfolio.
Carrying Value
At year-end 1999, the weighted average maturity of the Corporation's available-for-sale securities was 5 years and 2 months, a decrease of 3 years and 1 month from the average maturity at the end of 1998. The maturity distribution of the investment portfolio at December 31, 1999, together with the approximate taxable equivalent yield of the portfolio, is presented in the following table. The weighted average yields shown are computed by dividing an annualized interest income amount, including the accretion of discounts and the
amortization of premiums, by the amortized cost of the securities outstanding at December 31, 1999. Yields on tax-exempt securities have been calculated on an FTE basis.
Other than securities of the U.S. Government and its agencies and corporations, at December 31, 1999, there were no securities of any one issuer aggregating more than 10 percent of stockholder's equity of the Corporation. In the opinion of management, there were no material investments in securities which would have constituted an unusual risk or uncertainty for the Corporation at December 31, 1999.
DEPOSITS
Total deposits in 1999 averaged $15.14 billion, up $767 million or 5 percent from 1998. The Corporation's average core deposits, consisting of demand deposits, interest checking deposits, money market accounts, passbook and statement savings accounts, and savings certificates grew $459 million or 4 percent to $11.87 billion. Money market accounts experienced the largest growth, up $955 million or 31 percent over 1998 levels. Interest checking deposits and savings certificates decreased by $70 million or 21 percent and by $270 million or 8 percent over 1998 levels, respectively. Demand deposits also experienced a decrease of $209 million or 6 percent over 1998 levels to $3.11 billion. Passbook and statement savings accounts and other time deposits totaling $1.45 and $1.67 billion respectively, remained at relatively the same level as 1998. Deposits in foreign offices increased by $345 million or 28 percent to $1.59 billion. Daily averages and year-to-year comparisons are summarized below.
Interest expense on deposits decreased by $18.5 million or 4 percent in 1999 primarily due to lower interest rates. Interest expense on domestic deposits decreased 7 percent from 1998, while interest on foreign office deposits increased by 19 percent compared to the prior year. Effective interest rates on both domestic and foreign office interest-bearing deposits are summarized below:
Average Interest Rates Paid
Certificates of deposit in denominations of $100,000 or more issued by domestic offices totaled $2.35 billion at December 31, 1999. Total interest expense on domestic office certificates of deposit of $100,000 or more amounted to approximately $136.7 million compared to $150.7 million in 1998 and $115.1 million in 1997. Virtually all time deposits in foreign offices were in denominations of $100,000 or more.
The remaining maturity of domestic office certificates of deposit of $100,000 or more is as follows:
Domestic Office Certificates of Deposit
MONEY MARKET ASSETS AND LIABILITIES
The Corporation conducts most of its money market activities through HTSB. Average money market assets, consisting primarily of interest-bearing deposits at banks, Federal funds sold and securities purchased under agreement to resell, decreased 20 percent to $367 million in 1999 from $460 million in 1998. The average yield on money market assets decreased from 4.31 percent in 1998 to 3.31 percent in 1999. Interest income earned on these assets decreased 40 percent to $11.9 million in 1999. At December 31, 1999, interest-bearing deposits at banks and Federal funds sold totaled $240 million and $306 million, respectively, compared to $99 million and $156 million at year-end 1998. There were no reverse repurchase agreements outstanding at December 31, 1999 or December 31, 1998.
Money market liabilities, consisting of Federal funds purchased, securities sold under agreement to repurchase, commercial paper, senior notes and other short-term borrowings, represent a managed source of funds for the Corporation. During 1999, money market liabilities averaged $5.76 billion, an increase of 35 percent from 1998, when money market liabilities averaged $4.27 billion. The average rate paid on these borrowings decreased from 5.24 percent in 1998 to 4.94 percent in 1999, reflecting generally lower short-term
interest rates experienced by the market during 1999. At December 31, 1999, repurchase agreements totaled $3.26 billion compared to $2.46 billion at year-end 1998. Federal funds purchased and securities sold under agreement to repurchase consist of overnight Federal funds borrowed and securities sold to banks, brokers and corporations under agreement to repurchase. The repurchase agreements are generally outstanding for periods ranging from one day to six months. The following amounts and rates applied during 1999, 1998 and 1997:
Federal Funds Purchased and Securities Sold Under Agreement to Repurchase
Short-term borrowings consist primarily of term borrowings in excess of three days, term Federal funds purchased and short sales of securities. The following amounts and rates applied during 1999, 1998 and 1997:
Short-Term Borrowings
Commercial paper has been sold directly by Bankcorp to a number of investors, including individuals, partnerships, corporations, banks and other financial institutions in various amounts with initial terms not exceeding 270 days. The following amounts and rates applied during 1999, 1998 and 1997:
Commercial Paper
Senior notes are short- and medium-term notes issued to institutional investors from time-to-time. During 1999, 1998 and 1997 only short-term notes were outstanding. The following amounts and rates applied during 1999, 1998 and 1997:
Senior Notes
DISTRIBUTION OF LOANS BY TYPE OF BORROWER
SUMMARY
In 1999, significant year-to-year loan growth occurred among the following loan categories: manufacturing and processing, public and private service industries, other commercial, mortgages secured by residential and commercial property and other installment.
Average loans increased by 7 percent during 1999 compared to 1998. daily average loans over the last five years were as follows:
Lending is diversified into several categories at the Corporation. Concentrations to individual and related customers are monitored and risks within specific industries are tracked in order to reduce overall exposure. When lending to specialized industries, such as Agribusiness or Futures and Securities, the risks are mitigated by following specifically developed policies and procedures in the underwriting process as well as obtaining security for most of these transactions. Secured and unsecured loans totaled $9.77 billion and $3.34 billion, respectively, of total loans at 1999 year-end.
RISK MANAGEMENT
SUMMARY
In a commercial banking environment, corporate personnel must identify, quantify, monitor, evaluate and manage the risks inherent in its businesses, product lines and other activities. Through its risk management framework, operations, the Corporation:
1) Maintains a clear philosophy, approach and accountabilities towards risk-taking activities in well-documented policies, directives and procedures.
2) Fosters an environment where risks incurred are commensurate with an individual's qualifications, skills and expertise.
3) Implements risk measures and limits to contain, diversify, or otherwise mitigate certain risks the Corporation faces.
4) Continuously enhances information flows and reporting to monitor exposures and ensure timely responses to any change in risk profiles.
The risk management framework helps to ensure that the Corporation employs its capital efficiently and achieves returns commensurate with the risk undertaken. The Corporation's risk management process includes continuous monitoring and review of the following classes of risk:
1) Credit risk, which is risk of loss of principal, interest or revenues due to the obligor's inability or failure to repay a financial obligation. This includes loan loss risk, replacement risk and settlement risk.
2) Market risk (also often referred to as Position Risk), is the risk of a potential negative impact on the Bank's balance sheet and income statement resulting from adverse changes in the price or value of open or unhedged market positions.
3) Operational Risk is defined as the risk of loss resulting from an internal control breakdown, for example in communications, information or transactional processing, legal/compliance issues, technology/systems or procedural failures, human errors, disasters or criminal activity.
4) Fiduciary risk, which arises when the Corporation, or its employees acting purportedly on its behalf, take actions which violate the trust and confidence properly placed in the Corporation by the client.
The Corporation applies a comprehensive risk assessment framework to monitor these risks by line of business, customer and product line. The roles and relationships of the Corporation's management committees and the Board of Directors' oversight committees are well-defined and ensure comprehensive risk management and oversight. The Risk Management and Fiduciary Risk Management Committees are manned by senior managers from various business units of the Corporation who bring specialized expertise to bear on risk management issues. Through this risk management structure, the Corporation evaluates risks, establishes formal policies, sets risk/return parameters and reviews performance versus objectives. Management believes that effective policies, procedures, monitoring and review systems are in place to determine that risk is thoroughly and effectively analyzed, risk is well-diversified, any exceptions are dealt with in a timely manner and compensation for risk is appropriately established and meets return objectives.
Although the majority of the Corporation's customers are located in the Midwestern region of the United States, this concentration risk is mitigated by a number of factors (see Note 10 to Financial Statements on page 67 of this Report for a detailed discussion). Further, the Corporation maintains a watch on the economic health of the region, primarily to address risk in its consumer lending business.
The level of credit risk inherent in the Corporation's earning assets is evidenced, in part, by nonperforming assets consisting of loans placed on nonaccrual status when collection of interest is doubtful, restructured loans on which interest is being accrued but which have terms that have been renegotiated to provide for a reduction of interest or principal, and real estate or other assets which have been acquired in full or partial settlement of defaulted loans. These assets, as a group, are not earning at rates comparable to other earning assets. Assets received in satisfaction of debt are recorded by the Corporation at lower of cost or fair value less estimated sales costs. Losses of principal on nonperforming assets are charged off when, in management's opinion, the amounts are uncollectible. Interest on nonaccrual loans is recognized as income only at the time cash is received, although such interest may be applied to reduce a loan's carrying value if the collectibility of principal is in doubt. Information is reported monthly to the Board of Directors regarding nonperforming loans and other nonperforming assets owned, primarily real estate.
Management places an individual commercial or real estate credit on nonaccrual status when the collection of interest is doubtful or when principal or interest is 90 days past due unless the past due amounts are in process of collection and the loan is adequately collateralized. Consumer loans are charged off when 180 days past due. Consumer loans are not normally placed on nonaccrual status. The purpose of this policy is to avoid excessive administrative costs for relatively insignificant balances.
The Corporation extends credit to both commercial and retail customers. Lending activities are centered in those industries in which it has demonstrated expertise and specialized knowledge. All recognized risks are mitigated, to the fullest extent possible, through loan structure and the perfection of a security interest in collateral. The Corporation prescribes, within policy guidelines, specific advance rates to be used in lending against readily marketable collateral. These rates take into consideration the collateral type and the term. Other collateral advances are set to reflect the marketability and liquidation value of the collateral and normal advance rates are set by corporate policy with deviations necessitating specific documentation and approval.
In addition to risks on earning assets, the Corporation has various commitments and contingent liabilities outstanding that are not reflected on its Statement of Condition. Examples of these "off-balance-sheet" items include foreign exchange and interest rate contracts, assets held in trust, loan commitments and letters of credit. Virtually all off-balance-sheet items must conform to the same risk review process as loans and are subject to the Corporation's preset limits on customer and product risk. Various hedging strategies are
employed to reduce certain types of exposure. Management reviews the magnitude and quality of outstanding commitments and contingent liabilities.
The Corporation's exposure to interest rate risk (referred to as Position Risk) is primarily managed within the Corporation's Treasury Group. The Corporation follows the Treasury Group Directives to define the maximum potential exposures that are permissible for activities involving interest rate risk. The Standard is defined in terms of both earnings risk and valuation risk for the Corporation's banking subsidiaries. For further information on interest rate risk, see the Interest Sensitivity section on page 24 of this Report.
YEAR 2000
The Corporation's systems and other date sensitive assets successfully transitioned to the Year 2000. Since the identification of the Year 2000 issue, the Corporation's objective was to ensure that all aspects of the Year 2000 issue affecting the Corporation were fully resolved. Therefore, the Corporation continues to monitor the compliance of its own actions, as well as third parties that it interfaces with, such as vendors, counterparties, customers, and payment systems, to mitigate the potential risks that Year 2000 poses. In addition, the Corporation continues to monitor the compliance of companies that have borrowed from or are counterparties of the Corporation or its subsidiaries to ensure that incremental Year 2000-related credit risks are addressed as part of the Corporation's existing credit risk management framework.
The principal costs of solving the Year 2000 issue were those associated with the remediation and testing of computer applications. A major portion of these costs was met from existing resources, through a reprioritization of technology development initiatives, with the remainder representing incremental costs. As a result, the Corporation's management does not anticipate significant cost savings to occur after 1999 when the Year 2000 issue was satisfactorily remedied. In total the cost of solving the Year 2000 issue amounted to approximately $50.8 million, including $11.2 million of capital costs. A more detailed breakdown follows:
NONACCRUAL, RESTRUCTURED AND PAST DUE LOANS
Management closely monitors nonperforming assets, including assets received in satisfaction of debt. Nonperforming assets were 0.21 percent of total loans at December 31, 1999, compared with 0.17 percent at year-end 1998. All nonperforming loans are domestic.
Interest shortfall is the difference between the gross amount of interest that would have been recorded if all year-end nonperforming loans had been accruing at their original terms and the cash-basis interest income actually recognized. Interest shortfall was $1.2 million in 1999 compared to $1.4 million in 1998.
LOAN CONCENTRATIONS
Management monitors industry loan concentrations in an effort to maintain a well-diversified loan portfolio. Excluding total residential mortgage loans, at December 31, 1999 the Corporation's loan portfolio did not include any single industry concentration in excess of 10 percent of total consolidated loans.
The largest category of the Corporation's loans was domestic commercial, which totaled $6.94 billion, or 53 percent of total outstandings at year-end 1999. Most of these credits were extended to manufacturing and service-related companies. Outstandings to food and beverage industries represented 24 percent of all manufacturing loans and 5 percent of total consolidated loans. The largest concentration within service-related industries was services (business and personal), which accounted for 38 percent of all service-related credits and 8 percent of total loans.
Foreign loans totaled $38 million at year-end 1999, accounting for 0.3 percent of the Corporation's total outstandings.
Real estate loans, including residential mortgages, totaled $3.66 billion at December 31, 1999, or 28 percent of total outstandings. Mortgage loans collateralized by residential property totaled $2.78 billion, or 21 percent of loans. Commercial real estate mortgages and construction loans totaled $880 million at the end of 1999, representing 7 percent of loans. Further details on the Corporation's commercial real estate outstandings can be found below.
COMMERCIAL REAL ESTATE
The commercial real estate market in certain areas of the country has historically experienced depressed conditions from time to time. Many banks with loans to borrowers, in this industry, have reported large increases in nonperforming assets and corresponding increases in their allowances for loan losses resulting from commercial real estate transactions. This phenomenon tends to be cyclical and varies by location.
As of December 31, 1999, the Corporation, primarily through its banking subsidiaries, had outstanding commercial real estate loans of approximately $880 million which included both construction loans and
commercial credits collateralized by commercial real estate. The vast majority of these loans are collateralized by real estate located in the Chicago metropolitan area. Of the outstanding commercial real estate loans, approximately $0.6 million were classified as nonperforming assets representing less than 1 percent of total consolidated loans. There were no material charge-offs related to commercial real estate loans during 1999 or 1998. Management does not currently anticipate the need to increase its allowance for possible loan losses to reflect potential charge-offs in its commercial real estate loan portfolio.
PROVISION AND ALLOWANCE FOR POSSIBLE LOAN LOSSES
The provision for loan losses is based upon management's estimate of potential loan losses and its evaluation of the adequacy of the allowance for possible loan losses. Factors which influence management's judgment in estimating loan losses and the adequacy of the allowance include the impact of anticipated general economic conditions, the nature and volume of the current loan portfolio, historical loss experience, the balance of the allowance in relation to total loans outstanding and the evaluation of risks associated with nonperforming loans.
In 1994, the Corporation adopted the guidelines set forth under the December 1993 "Interagency Policy Statement on the Allowance for Loan and Lease Losses" issued by the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the Federal Deposit Insurance Corporation and the Federal Reserve Board. This statement outlines a methodology management should follow in order to properly measure the adequacy of the allowance for possible loan losses. It includes specific quantitative measures as well as certain subjective factors that may cause estimated loan losses to differ from historical loss experience. The quantitative measures basically require a bank to place its loans into "separate pools" with like characteristics and then measure the historical loss experience of these loan pools. In the case of "non-classified loans," it is sufficient to estimate loan losses for the upcoming twelve months. But in the case of "classified loans," the losses must be projected for the remaining effective lives of the loans. The subjective factors that should also be considered and that could potentially modify some of the conclusions reached by only looking at the quantitative measures are: significant changes in the institution's lending policies and procedures; changes in national and local business and economic conditions; changes in the nature and volume of the loan portfolio; changes in the experience, ability, and depth of lending management and staff; changes in the trend of the volume and severity of past due and classified loans; changes in the quality of the institution's loan review system; the existence and effect of any concentrations, and changes in the level of such concentrations; and the effect of external factors such as competition or any special legal or regulatory changes.
The Corporation's aggregate allowance for possible loan losses is derived from the combination of allowances at its individual subsidiaries, primarily banks. Each subsidiary has a responsibility to maintain an adequate allowance based on an evaluation of its own loan portfolio and considering the guidelines set forth in the aforementioned interagency credit statement. Although allocations of the Corporation's allowance are made for reporting purposes, each subsidiary's individual allowance for possible loan losses is available for use against its total loan portfolio.
On a regular basis, management identifies portions of specific commercial and real estate credits as "doubtful." These credits include loans where less than full repayment is reasonably possible, the loan is classified as nonaccrual and the borrower is experiencing serious financial problems. Approximately 8 percent, 4 percent, 5 percent, 5 percent and 12 percent of the consolidated allowance for possible loan losses was represented by doubtful portions of loans at December 31, 1999, 1998, 1997, 1996 and 1995, respectively. At December 31, 1999, the Corporation had allocated $10.2 million to loans internally categorized as doubtful, compared to $6.4 million at year-end 1998.
At December 31, 1999 and 1998, the Corporation designated all of the allocated portion of the allowance to cover total domestic credit exposure only; accordingly, no allocation was deemed necessary for foreign exposure.
During 1999, the provision for loan losses decreased to $25.0 million, compared to $27.0 million in 1998. At year-end 1999, the allowance for possible loan losses was $147.2 million, or 1.12 percent of total loans
outstanding, compared to $140.6 million or 1.15 percent of total loans in 1998. The provision for loan losses is established and reviewed based on the following criteria: current economic trends, current status of loan portfolio, federal regulatory requirements, expected net charge-offs and peer group analysis. With regard to establishing the provision and as a monitoring tool, the ratio of the allowance for possible loan losses to total loans and the ratio of the allowance for possible loan losses to nonperforming loans are evaluated on a regular basis. At year-end 1999, the ratios of the allowance for possible loan losses to total loans and to nonperforming loans were 1.12 percent and 555 percent, respectively.
Net charge-offs in 1999 were $18.4 million, or 0.15 percent of average loans outstanding as compared to $17.2 million, or 0.15 percent of average loans outstanding in 1998. Net charge-offs of domestic commercial loans amounted to $13.9 million in 1999, or 0.16 percent of average domestic commercial loans outstanding, an increase from $11.0 million, or 0.14 percent of average domestic commercial loans outstanding in 1998. Installment loans, including real estate mortgages, had net charge-offs of $4.5 million in 1999, or 0.12 percent of average outstandings, and $6.2 million, or 0.17 percent of average outstandings in 1998. Over the five-year period ending December 31, 1999, combined total net charge-offs were 0.37 percent of average total loans outstanding.
The Federal Reserve Board has established rules requiring banking institutions to establish special reserves against the risks presented in certain international assets, as determined by the Board. At December 31, 1999 and 1998, the Corporation was not required to maintain any special reserve under the aforementioned regulation.
The following table sets forth the Corporation's allocation of the allowance for possible loan losses. This allocation is based on management's subjective estimates. The amount allocated to a particular category should not be interpreted as the only amount available for future charge-offs that may occur within that category; it may not be indicative of future charge-off trends and it may change from year to year based on management's assessment of the risk characteristics of the loan portfolio.
Allocation of the Allowance for Possible Loan Losses
Analysis of Allowance for Possible Loan Losses
INTERNATIONAL BANKING
SUMMARY
International banking services of the Corporation include extension of foreign credits, foreign exchange trading activities and dealings in Eurocurrencies. These services are conducted through the Chicago headquarters; the Nassau branch office; representative offices in Los Angeles and Tokyo; and HBIC.
International banking services contributed $19.4 million, or 10 percent, of the Corporation's 1999 consolidated net income, compared to $25.4 million or 14 percent in 1998. International operating income was $47.0 million in 1999 and represented 3 percent of the Corporation's total operating income. In 1998 and 1997, international operating income represented 3 and 4 percent, respectively, of the Corporation's total operating income. Assets and liabilities associated with foreign domiciled customers are summarized as follows:
Foreign Assets and Liabilities
GEOGRAPHIC DISTRIBUTION
As of year-end 1999, substantially all international loans, interest-bearing deposits at banks and deposits in foreign offices represented U.S. dollar claims. The geographical distribution of international loans and interest-bearing deposits at banks is presented in the following table:
International Banking by Domicile of Obligor
FOURTH QUARTER 1999 COMPARED WITH FOURTH QUARTER 1998
Net income for the fourth quarter of 1999 was $50.9 million, up 11 percent from fourth quarter 1998 earnings of $45.7 million. The earnings increase is attributable primarily to strong earnings momentum in community banking, private banking and mid-market corporate banking reflecting continued growth and expansion, cost control and top tier asset quality. ROE for fourth quarter 1999 was 13.70 percent and ROA was 0.82 percent, compared to respective returns of 11.66 percent and 0.82 percent in last year's fourth quarter. Cash ROE and cash ROA were 18.28 percent and 0.90 percent, respectively, compared to cash ROE and cash ROA of 15.74 percent and 0.89 percent, respectively, in the same quarter a year ago.
Fourth quarter 1999 net interest income on a fully taxable equivalent basis was $153.0 million, up $16.4 million or 12 percent from $136.6 million in 1998's fourth quarter. Average earning assets rose 13 percent to $21.56 billion from $19.09 billion in fourth quarter 1998 attributable to an increase of $1.45 billion, or 22 percent in securities available-for-sale and an 8 percent or $960 million increase in average
loans. Commercial lending was the strongest contributor to this loan growth. Net interest margin declined slightly to 2.81 percent from 2.84 percent in the same quarter last year.
Noninterest income of $110.7 million decreased 5 percent in fourth quarter 1999 from the same quarter last year despite higher trust income, merchant and charge card fees and service charge fees. In the current quarter trust fees rose $2.5 million, merchant and charge card fees rose $1.7 million and service charge fees increased $1.7 million. There were virtually no net securities gains in the current quarter compared to net securities gains of $7.3 million in the year-earlier quarter. Other income, which includes syndication fees, income from tax-advantaged investments, gains on mortgage sales and other gains and fee income, declined $4.1 million from 1998.
Fourth quarter 1999 noninterest expenses of $183.2 million rose $8.2 million or 5 percent from fourth quarter last year. Employment expense increased $6.7 million, or 7 percent from the prior year. Equipment expense increased $2.7 million or 20 percent. Income taxes declined by $1.4 million during the current quarter primarily reflecting a lower effective tax rate due to an increase in tax-advantaged assets.
The fourth quarter 1999 provision for loan losses of $5.2 million was down $2.0 million from $7.2 million in the fourth quarter of 1998. Net loan charge-offs during the current quarter of $3.6 million were slightly higher, compared to $3.4 million in the same period last year.
ITEM 8
ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SUPPLEMENTARY DATA
HARRIS BANKCORP, INC. AND SUBSIDIARIES QUARTERLY FINANCIAL DATA (UNAUDITED) SUMMARY OF EARNINGS AND NET INTEREST INCOME
Rows may not add to annual amounts because of rounding.
FINANCIAL STATEMENTS
HARRIS BANKCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
The accompanying notes to the financial statements are an integral part of these statements.
HARRIS BANKCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
The accompanying notes to the financial statements are an integral part of these statements.
HARRIS BANKCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CONDITION
The accompanying notes to financial statements are an integral part of these statements.
HARRIS BANKCORP, INC. (CONSOLIDATED AND PARENT COMPANY ONLY) STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
The accompanying notes to the financial statements are an integral part of these statements.
HARRIS BANKCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes to the financial statements are an integral part of these statements.
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Nature of Operations
Harris Bankcorp, Inc. ("Bankcorp"), a Delaware corporation, is a wholly-owned subsidiary of Bankmont Financial Corp. ("Bankmont"), a Delaware corporation and a wholly-owned subsidiary of Bank of Montreal ("BMO"). Throughout these Notes to Financial Statements, the term "Corporation" refers to Bankcorp and subsidiaries.
The consolidated financial statements include the accounts of Bankcorp and its wholly-owned subsidiaries including Harris Trust and Savings Bank ("HTSB"). Significant intercompany accounts and transactions have been eliminated. Certain reclassifications were made to conform prior years' financial statements to the current year's presentation. See Note 21 of Financial Statements for additional information on business combinations and Note 22 for additional information on related party transactions on pages 82-83 of this Report.
The Corporation provides banking, trust and other services domestically and internationally through 14 bank and 15 active nonbank subsidiaries and an Edge Act subsidiary. HTSB and the Corporation's other banking and nonbank subsidiaries provide a variety of banking and financial services to commercial and industrial companies, financial institutions, governmental units, not-for-profit organizations and individuals throughout the U.S., primarily the Midwest, and abroad. Services rendered and products sold to customers include demand and time deposit accounts and certificates; various types of loans; sales and purchases of foreign currencies; interest rate management products; cash management services; underwriting of municipal bonds; and financial consulting.
Basis of Accounting
The accompanying financial statements are prepared in accordance with generally accepted accounting principles and conform to practices within the banking industry.
Foreign Currency and Foreign Exchange Contracts
Assets and liabilities denominated in foreign currencies have been translated into United States dollars at respective year-end rates of exchange. Monthly translation gains or losses are computed at rates prevailing at month-end. There were no material translation gains or losses during any of the years presented. Foreign exchange trading positions including spot, forward, futures and option contracts are revalued monthly using prevailing market rates. Exchange adjustments are included with foreign exchange income in the Consolidated Statements of Income.
Derivative Financial Instruments
The Corporation uses various interest rate and foreign exchange derivative contracts in the management of its risk strategy or as part of its dealer and trading activities. Interest rate contracts may include futures, forward rate agreements, option contracts, guarantees (caps, floors and collars) and swaps. Foreign exchange contracts may include spot, futures, forwards, option contracts and swaps.
Derivative financial instruments which are used as part of the Corporation's dealer and trading activities are marked to market and the resulting unrealized gains and losses are recognized in noninterest income in the period of change. Realized and unrealized gains and losses on interest rate contracts and foreign exchange contracts are recorded in trading account income and foreign exchange income, respectively.
Derivative financial instruments which are used in the management of the Corporation's risk strategy may qualify for hedge accounting. A derivative financial instrument may be a hedge of an existing asset, liability, firm commitment or anticipated transaction. Hedge accounting is used when the following criteria are met: the hedged item exposes the Corporation to price, currency or interest rate risk; the hedging instrument reduces
the exposure to risk and the hedging instrument is designated as a hedge. At the inception of the hedge and throughout the hedge period, a high correlation of changes in both the market value of the hedging instrument and the fair value of the hedged item should be probable. Additional criteria for using hedge accounting for anticipated transactions are: the significant characteristics and expected terms of the anticipated transaction are identified and it is probable that the anticipated transaction will occur.
If hedge criteria are met, then unrealized gains and losses on derivative financial instruments other than interest rate swaps are generally recognized in the same period and in the same manner in which gains and losses from the hedged item are recognized. Unrealized gains and losses on a hedging instrument are deferred when the hedged item is accounted for on historical cost basis. The hedging instrument is marked to market when the hedged item is accounted for on a mark to market basis.
Deferred gains and losses on interest rate futures contracts used to hedge existing assets and liabilities are included in the basis of the item being hedged. For hedges of anticipated transactions, the Corporation recognizes deferred gains or losses on futures transactions as adjustments to the cash position eventually taken. Gains or losses on termination of an interest rate futures contract designated as a hedge are deferred and recognized when the offsetting gain or loss is recognized on the hedged item. When the hedged item is sold, existing unrealized gains or losses on the interest rate futures contract are recognized as part of net income at the time of the sale. Thereafter, unrealized gains and losses on the hedge contract are recognized in income immediately.
The Corporation engages in interest rate swaps in order to manage its interest rate risk exposure. Contractual payments under interest rate swaps designated as hedges are accrued in the Statements of Income as a component of interest income or expense. There is no recognition of unrealized gains and losses on the Consolidated Statements of Condition. Gains or losses on termination of an interest rate swap contract designated as a hedge are deferred and amortized as an adjustment of the yield on the underlying balance sheet position over the remainder of the original contractual life of the terminated swap. When the hedged item is sold, existing unrealized gains or losses on the swap contract are recognized in income at the time of the sale. Thereafter, unrealized gains and losses on the hedge contract are recognized as part of net income when they occur.
Interest rate options are used to manage the Corporation's interest rate risk exposure from rate lock commitments and fixed rate mortgage loans intended to be sold in the secondary market. Changes in the market value of options designated as hedges are deferred from income recognition and effectively recognized as other noninterest income when the loans are sold and the hedge position is closed. Loans intended to be sold in the secondary market are carried at lower of amortized cost or current market value. When a hedge contract with an embedded gain is terminated early, the deferred gain is recorded as an adjustment to the carrying value of the loans. When a hedge contract with an embedded loss is terminated early, the deferred loss is charged to other noninterest income. When the hedged item is sold before the hedge contract is terminated and the hedge contract has an embedded gain or loss, the deferred gain or loss is recorded as other noninterest income in the same period as part of the gain or loss on the sale of the loans. Thereafter, unrealized gains and losses on the hedge contract are recognized as part of net income when they occur.
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." The Statement establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires all derivatives to be recognized as either assets or liabilities in the statement of financial position and to be measured at fair value. As issued, the Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133." The Statement is effective upon issuance and it amends SFAS No. 133 to be effective for all fiscal quarters of fiscal years beginning after June 15, 2000, which for the Corporation would be the quarter ending March 31, 2001. The Corporation is in the process of assessing the impact of adopting the Statements on its financial position and results of operations.
Securities
The Corporation classifies securities as either trading account assets or available-for-sale. Trading account assets include securities acquired as part of trading activities and are typically purchased with the expectation of near-term profit. These assets consist primarily of municipal bonds and U.S. government securities. All other securities are classified as available-for-sale, even if the Corporation has no current plans to divest. Trading account assets are reported at fair value with unrealized gains and losses included in trading account income, which also includes realized gains and losses from closing such positions. Available-for-sale securities are reported at fair value with unrealized gains and losses included, on an after-tax basis, in a separate component of stockholder's equity.
Interest income on securities, including amortization of discount or premium, is included in earnings. Realized gains and losses, as a result of securities sales, are included in securities gains, with the cost of securities sold determined on the specific identification basis.
Loans, Loan Fees and Commitment Fees
Loans not held for sale are recorded at the principal amount outstanding, net of unearned income, deferred fees and origination costs. Origination fees collected on commercial loans, loan commitments, mortgage loans and standby letters of credit, which are not held for sale, are generally deferred and amortized over the life of the related facility. Other loan-related fees that are not the equivalent of yield adjustments are recognized as income when received or earned. At December 31, 1999 and 1998, the Corporation's Consolidated Statements of Condition included approximately $21 million and $14 million, respectively, of deferred loan-related fees net of deferred origination costs.
In conjunction with its mortgage and commercial banking activities, the Corporation will originate loans with the intention of selling them in the secondary market. These loans are carried at the lower of allocated cost or current market value, on a portfolio basis. Deferred origination fees and costs associated with these loans are not amortized, and are included as part of the basis of the loan at time of sale. Realized gains and unrealized losses are included with other noninterest income.
The Corporation engages in the servicing of mortgage loans and acquires mortgage servicing rights by purchasing or originating mortgage loans and then selling those loans with servicing rights retained. The rights to service mortgage loans for others are recognized as separate assets by allocating the total cost of the mortgage loans to the mortgage servicing rights and the loans (without the mortgage servicing rights) based on their relative fair values. The capitalized mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income. The capitalized mortgage servicing rights are periodically evaluated for impairment based on the fair value of those rights. Fair values are estimated using discounted cash flow analyses. The risk characteristics of the underlying loans used to stratify capitalized mortgage servicing rights for purposes of measuring impairment are current market interest rates, loan type and repricing interval.
Commercial and real estate loans are placed on nonaccrual status when the collection of interest is doubtful or when principal or interest is 90 days past due, unless the credit is adequately collateralized and the past due amount is in process of collection. When a loan is placed on nonaccrual status, all interest accrued but not yet collected which is deemed uncollectible is charged against interest income in the current year. Interest on nonaccrual loans is recognized as income only when cash is received and the Corporation expects to collect the entire principal balance of the loan. Interest income on restructured loans is accrued according to the most recently agreed upon contractual terms.
Commercial and real estate loans are charged off when, in management's opinion, the loan is deemed uncollectible. Charge card and consumer installment loans are charged off when 180 days past due. Accrued interest on these loans is charged to interest income. Such loans are not normally placed on nonaccrual status.
Loan commitments and letters of credit are executory contracts and are not reflected on the Corporation's Consolidated Statements of Condition. Fees collected are generally deferred and recognized over the life of the facility.
Impaired loans (primarily commercial credits) are measured based on the present value of expected future cash flows (discounted at the loan's effective interest rate) or, alternatively, at the loan's observable market price or the fair value of supporting collateral. Impaired loans are defined as those where it is probable that amounts due according to contractual terms, including principal and interest, will not be collected. Both nonaccrual and certain restructured loans meet this definition. Large groups of smaller-balance, homogeneous loans, primarily charge card, residential real estate and consumer installment loans, are excluded from this definition of impairment. The Corporation determines loan impairment when assessing the adequacy of the allowance for possible loan losses.
Allowance for Possible Loan Losses
The allowance for possible loan losses is maintained at a level considered adequate to provide for estimated loan losses. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. Known losses of principal on impaired loans are charged off. The provision for loan losses is based on past loss experience, management's evaluation of the loan portfolio under current economic conditions and management's estimate of losses inherent in the portfolio. Such estimates are reviewed periodically and adjustments, if necessary, are recorded during the periods in which they become known.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization. In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The Corporation adopted this statement in January 1998 and it did not have a material effect on the Corporation's financial position or results of operations. Interest costs associated with long-term construction projects are capitalized and then amortized over the life of the related asset after the project is completed. For financial reporting purposes, the provision for depreciation and amortization is computed on the straight-line basis over the estimated useful lives of the assets.
Bank-Owned Insurance Investments
The Corporation has purchased life insurance coverage for certain officers. The one-time premiums paid for the policies, which coincide with the initial cash surrender value, are recorded as other assets on the Consolidated Statements of Condition. Increases or decreases in cash surrender value (other than proceeds from death benefits) are recorded as other income or other expense. Proceeds from death benefits first reduce the cash surrender value attributable to the individual policy and any additional proceeds are recorded as other income.
Goodwill and Other Valuation Intangibles
The Corporation records specifically identifiable and unidentifiable (goodwill) intangibles in connection with the acquisition of assets from unrelated parties or the acquisition of new subsidiaries. Original lives range from 3 to 15 years. Goodwill is amortized on the straight-line basis. Identifiable intangibles are amortized on either an accelerated or straight-line basis depending on the character of the acquired asset. Goodwill and other valuation intangibles are reviewed for impairment when events or future assessments of profitability indicate that the carrying value may not be recoverable. When assessing recoverability, goodwill and other valuation intangibles are included as part of the group of assets which were acquired in the transaction that gave rise to the intangibles.
Other Assets
Property or other assets received in satisfaction of debt are included in "Other Assets" on the Corporation's Consolidated Statements of Condition and are recorded at the lower of remaining cost or fair value. Fair values for other real estate owned generally are reduced by estimated costs to sell. Losses arising from subsequent write-downs to fair value are charged directly to expense.
Retirement and Other Postemployment Benefits
The Corporation has noncontributory defined benefit pension plans covering virtually all its employees. For its primary plan, the policy of the Corporation is to, at a minimum, fund annually an amount necessary to satisfy the requirements under the Employee Retirement Income Security Act ("ERISA"), without regard to prior years' contributions in excess of the minimum.
Postemployment benefits provided to former or inactive employees after employment but before retirement are accrued if they meet the conditions for accrual of compensated absences. Otherwise, postemployment benefits are recorded when expenses are incurred.
Cash Flows
As of December 31, 1997, credit card loan balances were transferred to assets held for sale in anticipation of the sale in January 1998. See Note 21 to Financial Statements on page 82 of this Report. This transfer was a noncash transaction and was excluded from the Consolidated Statements of Cash Flows. In July 1997, 80 percent ownership of Harris Trust/Bank of Montreal (formerly Harris Trust Company of Florida) was transferred through a noncash dividend to Bankmont. This noncash transaction was excluded from the Corporation's Consolidated Statements of Cash Flows.
Income Taxes
Bankmont, the Corporation and their wholly-owned subsidiaries file a consolidated Federal income tax return. Accordingly, no Federal income tax is applicable to dividends received by Bankmont from Bankcorp, or to dividends received by Bankcorp from its subsidiaries. Income tax return liabilities for the Corporation are not materially different than they would have been if computed on a separate return basis.
Segment Information
In 1998, the Corporation adopted SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information." SFAS No. 131 requires disclosure of operating segments based on the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Corporation's reportable segments. The adoption of SFAS No. 131 did not affect the Corporation's financial position or results of operations. See Note 18 to Financial Statements on page 76 of this Report.
Management's Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The areas requiring significant management judgment include provision and allowance for possible loan losses, income taxes, pension cost, postemployment benefits, valuation of intangible assets, fair values and temporary vs. other-than-temporary impairment.
Reclassifications
Certain reclassifications were made to conform prior years' financial statements to the current year's presentation.
2. SECURITIES
The amortized cost and estimated fair value of securities available-for-sale were as follows:
At December 31, 1999 and 1998, available-for-sale and trading account securities having a par value of $5.82 billion and $3.13 billion, respectively, were pledged as collateral for certain liabilities, securities sold under agreement to repurchase, public and trust deposits, trading account activities and for other purposes where permitted or required by law. Securities carried at approximately $3.26 billion and $2.46 billion were sold under agreement to repurchase at December 31, 1999 and 1998, respectively.
The amortized cost and estimated fair value of available-for-sale securities at December 31, 1999, by contractual maturity, are shown below. Expected maturities can differ from contractual maturities since borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
In 1999, 1998 and 1997, proceeds from the sale of securities available-for-sale amounted to $879 million, $2.55 billion and $1.31 billion, respectively. Gross gains of $14.1 million and no gross losses were realized on these sales in 1999, while gross gains of $28.5 million and gross losses of $1.5 million were realized on these sales in 1998, and gross gains of $13.5 million and gross losses of $0.3 million were realized in 1997. Net unrealized holding gains on trading securities included in earnings at December 31, 1999 was $1.4 million compared to an unrealized gain of $0.8 million at December 31, 1998.
3. LOANS
The following table summarizes loan balances by category:
Nonaccrual loans, restructured loans and other nonperforming assets are summarized below:
At December 31, 1999 and 1998, the Corporation had no aggregate public and private sector outstandings to any single country experiencing a liquidity problem which exceeded one percent of the Corporation's consolidated assets.
MORTGAGE SERVICING RIGHTS
Mortgage servicing rights, included in other assets, of $6.4 million were capitalized during both 1999 and 1998. Amortization expense associated with the mortgage servicing rights was $2.5 million and $1.2 million in 1999 and 1998, respectively. There were no direct write-downs in 1999 or 1998. The net capitalized assets of $13.1 million and $9.2 million at December 31, 1999 and 1998, respectively, are reflective of the fair value of those rights.
4. ALLOWANCE FOR POSSIBLE LOAN LOSSES
The changes in the allowance for possible loan losses are as follows:
Details on impaired loans and related allowance are as follows:
5. PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation and amortization. A summary of these accounts is set forth below:
The provision for depreciation and amortization was $52.9 million in 1999, $44.3 million in 1998, and $40.0 million in 1997.
6. SECURITIES PURCHASED UNDER AGREEMENT TO RESELL AND SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE
The Corporation enters into purchases of U.S. Treasury and Federal agency securities under agreements to resell identical securities. The amounts advanced under these agreements represent short-term loans and are reflected as receivables in the Consolidated Statements of Condition. There were no securities purchased under agreement to resell outstanding at December 31, 1999 and December 31, 1998. The securities underlying the agreements are book-entry securities. Securities are transferred by appropriate entry into the Corporation's account with Bank of New York at the Federal Reserve Bank of New York under a written custodial agreement with Bank of New York that explicitly recognizes the Corporation's interest in these securities.
The Corporation also enters into sales of U.S. Treasury and Federal agency securities under agreements to repurchase identical securities. The amounts received under these agreements represent short-term borrowings and are reflected as liabilities in the Consolidated Statements of Condition. Securities sold under agreement to repurchase totaled $3.26 billion and $2.46 billion at December 31, 1999 and 1998, respectively. Securities sold under agreement to repurchase are transferred via book-entry to the counterparty, if transacted with a financial institution or a broker-dealer, or are delivered to customer safekeeping accounts.
7. SHORT, MEDIUM AND LONG-TERM NOTES AND UNUSED LINES OF CREDIT
The following table summarizes the Corporation's long-term notes:
All of the Bankcorp notes are unsecured obligations, ranking on a parity with all unsecured and subordinated indebtedness of the Corporation and are not subject to redemption prior to maturity at the election of the debtholders. The interest rate on the floating rate notes reprices semiannually and floats at 50 basis points above 180 day LIBOR. At year-end 1999, 180 day LIBOR was 6.13 percent.
The Corporation, in connection with the issuance of commercial paper and for other corporate purposes, had a $150 million revolving credit agreement with five nonaffiliated banks and BMO that terminated on December 18, 1999. At that time the Corporation entered into a new $150 million revolving credit agreement with a group of five nonaffiliated banks and BMO that terminates on December 8, 2000. There were no borrowings under either credit facility during 1999 or 1998.
On June 29, 1999, Bankcorp borrowed (Canadian) $266 million (U.S. $180 million) from BMO (US) Finance, LLC ("FinCo"), a Delaware limited liability company and an indirect subsidiary of BMO. This new loan is 10 year subordinated debt, bearing interest at Bankers' Acceptance (BA) + 43 bps, and matures June 29, 2009. Bankcorp entered into a currency and interest rate swap agreement to exchange the C$266 million for U.S. $180 million and makes quarterly interest payments on the swap. The interest rate converts to LIBOR + 44.5 bps under the swap.
HTSB offers to institutional investors from time to time, unsecured short-term and medium-term bank notes in an aggregate principal amount of up to $1.50 billion outstanding at any time. The term of each note could range from fourteen days to fifteen years. The notes are subordinated to deposits and rank pari passu with all other unsecured senior indebtedness of HTSB. As of December 31, 1999, $1.50 billion of senior notes were outstanding with original maturities ranging from 366 to 385 days (remaining maturities ranging from 18 to 223 days) and stated interest rates ranging from 5.00 percent to 5.85 percent. As of December 31, 1998, $940 million of short-term notes were outstanding with original maturities ranging from 31 to 182 days (remaining maturities ranging from 22 to 130 days) and stated interest rates ranging from 5.00 percent to 5.50 percent.
8. FAIR VALUE OF FINANCIAL INSTRUMENTS
Generally accepted accounting principles require the disclosure of estimated fair values for both on- and off-balance-sheet financial instruments. The Corporation's fair values are based on quoted market prices when available. For financial instruments not actively traded, such as certain loans, deposits, off-balance-sheet transactions and long term borrowings, fair values have been estimated using various valuation methods and assumptions. Although management used its best judgment in estimating these values, there are inherent limitations in any estimation methodology. In addition, accounting pronouncements require that fair values be estimated on an item-by-item basis, thereby ignoring the impact a large sale would have on a thin market and
intangible values imbedded in established lines of business. Therefore, the fair value estimates presented herein are not necessarily indicative of the amounts the Corporation could realize in an actual transaction. The fair value estimation methodologies employed by the Corporation were as follows:
The carrying amounts for cash and demand balances due from banks along with short-term money market assets and liabilities reported on the Corporation's Consolidated Statements of Condition were considered to be the best estimates of fair value for these financial instruments. Fair values of trading account assets and investment securities were based on quoted market prices.
A variety of methods were used to estimate the fair value of loans. Changes in estimated fair value of loans reflect changes in credit risk and general interest rates which have occurred since the loans were originated. Fair values of floating rate loans, including commercial, broker dealer, financial institution, construction, consumer and home equity, were assumed to be the same as carrying value since the loans' interest rates automatically reprice to market. Fair values of residential mortgages were based on current prices for securities backed by similar loans. For long-term fixed rate loans, including consumer installment and commercial mortgage loans, fair values were estimated based on the present value of future cash flows with current market rates as discount rates. A fair-value discount related to nonperforming loans included in the above categories, along with a discount for future credit risk throughout the portfolio, was based on an analysis of expected and unidentified future losses. Accordingly, the fair value estimate for total loans was reduced by these discounts, which in total approximated the allowance for possible loan losses on the Corporation's Consolidated Statements of Condition. Additionally, management considered appraisal values of collateral when nonperforming loans were secured by real estate.
The fair values of customers' liability on acceptances and acceptances outstanding approximate carrying value due to the short-term nature of these assets and liabilities and the generally negligible credit losses associated with them.
The fair values of accrued interest receivable and payable approximate carrying values due to the short-term nature of these assets and liabilities.
The fair values of bank-owned insurance investments approximate carrying value, because upon liquidation of these investments the Corporation would receive the cash surrender value, which equals carrying value.
The fair values of demand deposits, savings accounts, interest checking deposits, and money market accounts were the amounts payable on demand at the reporting date, or the carrying amounts. The fair value of time deposits was estimated using a discounted cash flow calculation with current market rates offered by the Corporation as discount rates.
The fair value of senior notes approximates carrying value because the average maturity on these notes is less than a year.
The fair value of minority interest -- preferred stock of subsidiary (Harris Preferred Capital Corporation) approximates carrying value as the preferred stock has a liquidation preference that equals book value.
The fair value of long-term notes was determined using a discounted cash flow calculation with current rates available to the Corporation for similar debt as discount rates.
The fair value of credit facilities are presented as an obligation in order to represent the approximate cost the Corporation would incur to induce third parties to assume these commitments.
The estimated fair values of the Corporation's financial instruments at December 31, 1999 and 1998 are presented in the following table. See Note 9 to Financial Statements on page 61 of this Report for additional information regarding fair values of off-balance-sheet financial instruments.
9. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Corporation utilizes various financial instruments with off-balance-sheet risk in the normal course of business to a) meet its customers' financing and risk management needs, b) reduce its own risk exposure, and c) produce fee income and trading profits. The Corporation's major categories of financial instruments with off-balance-sheet risk include credit facilities, interest rate and foreign exchange contracts and various securities-related activities. Fair values of off-balance-sheet instruments are based on fees currently charged to enter into similar agreements, market prices of comparable instruments, pricing models using year-end rates and counterparty credit ratings.
Credit Facilities
Credit facilities with off-balance-sheet risk include commitments to extend credit, standby letters of credit and commercial letters of credit.
Commitments to extend credit are contractual agreements to lend to a customer as long as contract terms have been met. They generally require payment of a fee and have fixed expiration dates. The Corporation's commitments serve both business and individual customer needs, and include commercial loan commitments, credit card lines, home equity lines, commercial real estate loan commitments and mortgage loan commitments. The Corporation's maximum risk of accounting loss is represented by the total contractual amount of commitments which was $8.42 billion and $8.32 billion at December 31, 1999 and 1998, respectively. Since only a portion of commitments will ultimately be drawn down, the Corporation does not expect to provide funds for the total contractual amount. Risks associated with certain commitments are reduced by participations to third parties, which at December 31, 1999, totaled $301 million and at December 31, 1998, totaled $408 million.
Standby letters of credit are unconditional commitments which guarantee the obligation of a customer to a third party should that customer default. They are issued to support financial and performance-related obligations including brokers' margin maintenance, industrial revenue bond repayment, debt repayment, construction contract performance and trade agreement performance. The Corporation's maximum risk of accounting loss for these items is represented by the total commitments outstanding of $1.95 billion at December 31, 1999 and $2.07 billion at December 31, 1998. Risks associated with standby letters of credit are reduced by participations to third parties which totaled $401 million at December 31, 1999 and $491 million at December 31, 1998.
Commercial letters of credit are commitments to make payments on behalf of customers when letter of credit terms have been met. Maximum risk of accounting loss is represented by total commercial letters of credit outstanding of $92 million at December 31, 1999 and $101 million at December 31, 1998.
Credit risks associated with all of these facilities are mitigated by reviewing customers' creditworthiness on a case-by-case basis, obtaining collateral, limiting loans to individual borrowers, setting restrictions on long-duration maturities and establishing stringent covenant terms outlining performance expectations which, if not met, may cause the Corporation to terminate the contract. Credit risks are further mitigated by monitoring and maintaining portfolios that are well-diversified.
Collateral is required to support certain of these credit facilities when they are drawn down and may include equity and debt securities, commodities, inventories, receivables, certificates of deposit, savings instruments, fixed assets, real estate, life insurance policies and seats on national or regional exchanges. Requirements are based upon the risk inherent in the credit and are more stringent for firms and individuals with greater default risks. The Corporation monitors collateral values and appropriately perfects its security interest. Periodic evaluations of collateral adequacy are performed by Corporation personnel.
The fair value of credit facilities (i.e. deferred income) is approximately equal to their carrying value of $20.9 million at December 31, 1999 and $13.6 million at December 31, 1998.
Interest Rate Contracts
Interest rate contracts include futures, forward rate agreements, option contracts, guarantees (caps, floors and collars) and swaps. The Corporation enters into these contracts for dealer, trading and risk management purposes.
Dealer and Trading Activity
As dealer, the Corporation serves customers seeking to manage interest rate risk by entering into contracts as a counterparty to their (customer) transactions. In its trading activities, the Corporation uses interest rate contracts to profit from expected future market movements.
These contracts may create exposure to both credit and market risk. Replacement risk, the primary component of credit risk, is the risk of loss should a counterparty default following unfavorable market movements and is measured as the Corporation's cost of replacing contracts at current market rates. The Corporation manages credit risk by establishing credit limits for customers and products through an independent corporate-wide credit review process and continually monitoring exposure against those limits to ensure they are not exceeded. Credit risk is, in many cases, further mitigated by the existence of netting agreements which provide for netting of contractual receivables and payables in the event of default or bankruptcy.
Market risk is the potential for loss arising from potential adverse changes in underlying market factors, including interest and foreign exchange rates. The Corporation manages market risk through the imposition of integrated value-at-risk limits and an active, independent monitoring process.
Value at risk methodology is used for measuring the market risk of the Corporation's trading positions. This statistical methodology uses recent market volatility to estimate the maximum daily trading loss that the Corporation would expect to incur, on average, 99 percent of the time. The model also measures the effect of correlation among the various trading instruments to determine how much risk is eliminated by offsetting positions.
Futures and forward contracts are agreements in which the Corporation is obligated to make or take delivery, at a specified future date, of a specified instrument, at a specified price or yield. Futures contracts are exchange traded and, because of exchange requirements that gains and losses be settled daily, create negligible exposure to credit risk.
Forward rate agreements are arrangements between two parties to exchange amounts, at a specified future date, based on the difference between an agreed upon interest rate and reference rate applied to a notional principal amount. These agreements enable purchasers and sellers to fix interest costs and returns.
Options are contracts that provide the buyer the right (but not the obligation) to purchase or sell a financial instrument, at a specified price, either within a specified period of time or on a certain date. Interest rate guarantees (caps, floors and collars) are agreements between two parties that, in general, establish for the purchaser a maximum level of interest expense or a minimum level of interest revenue based on a notional principal amount for a specified term. Options and guarantees written create exposure to market risk. As a writer of interest rate options and guarantees, the Corporation receives a premium at the outset of the agreement and bears the risk of an unfavorable change in the price of the financial instrument underlying the option or guarantee. Options and guarantees purchased create exposure to credit risk and, to the extent of the premium paid or unrealized gain recognized, market risk.
Interest rate swaps are contracts involving the exchange of interest payments based on a notional amount for a specified period. Most of the Corporation's activity in swaps is as intermediary in the exchange of interest payments between customers, although the Corporation also uses swaps to manage its own interest rate exposure (see discussion of risk management activity on page 64).
The following table summarizes the Corporation's dealer/trading interest rate contracts and their related contractual or notional amounts and maximum replacement costs. Contractual or notional amount gives an indication of the volume of activity in the contract. Maximum replacement cost reflects the potential loss
resulting from customer defaults and is computed as the cost of replacing, at current market rates, all outstanding contracts with unrealized gains.
The following table summarizes average and end of period fair values of dealer/trading interest rate contracts for the years ended December 31, 1999 and 1998:
Net gains (losses) from dealer/trading activity in interest rate contracts and nonderivative trading account assets for the years ended December 31, 1999, 1998 and 1997 are summarized below:
The following table summarizes the maturities and weighted average interest rates paid and received on dealer/trading interest rate swaps:
The following table summarizes the bank's dealer/trading equities and commodities contracts and their related contractual or notional amounts and maximum replacement costs.
The following table summarizes average and end of period fair values of dealer/trading equities contracts and commodities contracts for the years ended December 31, 1999 and 1998:
There were no net gains (losses) from dealer/trading activity in equities or commodities contracts for the years ended December 31, 1999 and 1998.
Risk Management Activity
In addition to its dealer activities, the Corporation uses interest rate contracts, primarily swaps, and foreign exchange contracts to reduce the level of financial risk inherent in mismatches between the interest rate
sensitivities and foreign currency exchange rate fluctuations of certain assets and liabilities. For non-trading risks, market risk is controlled by actively managing the asset and liability mix, either directly through the balance sheet or with off-balance sheet derivative instruments. Measures also focus on interest rate exposure gaps and sensitivity to rate changes. During 1999 and 1998, interest rate swaps were primarily used to alter the character of revenue earned on certain fixed rate loans. During 1999 foreign exchange contracts were used to stabilize any currency exchange rate fluctuations for certain senior notes. The Corporation had $436 million notional amount of swap contracts, used for risk management purposes, outstanding at December 31, 1999 with a fair value of $8.7 million. At December 31, 1998, the Corporation had $152 million notional amount of swap contracts outstanding with a loss in fair value of $4.7 million. Gross unrealized gains and losses, representing the difference between fair value and carrying value (i.e. accrued interest payable or receivable) on these contracts, totaled $2.8 million and $3.0 million, respectively, at December 31, 1999 and $0.2 and $4.5 million, respectively, at December 31, 1998. Risk management activity, including the related cash positions, had no material effect on the Corporation's net income for the year ended December 31, 1999 or 1998. There were no deferred gains or losses on terminated contracts at December 31, 1999 or 1998.
The following table summarizes swap activity for risk management purposes:
The following table summarizes the maturities and weighted average interest rates paid and received on interest rate swaps used for risk management:
At December 31, 1999, swap contracts with BMO represent $19.6 million and $4.5 million of unrealized gains and unrealized losses, respectively. Guarantee contracts purchased from BMO represent $0.8 million and $0.2 million of unrealized gains and unrealized losses, respectively. Guarantee contracts written with BMO represent $1.8 million and $0.4 million of unrealized gains and unrealized losses, respectively.
Foreign Exchange Contracts
Dealer Activity
The Corporation is a dealer in foreign exchange. Foreign exchange contracts may create exposure to market and credit risk, including replacement risk and settlement risk. Credit risk is managed by establishing limits for customers through an independent corporate-wide credit approval process and continually monitor-
ing exposure against those limits. In addition, both settlement and replacement risk are reduced through netting by novation, agreements with counterparties to offset certain related obligations. Market risk is managed through establishing exposure limits by currency and monitoring actual exposure against those limits, entering into offsetting positions, and closely monitoring price behavior. HTSB and BMO combine their U.S. FX. Under this arrangement, FX net profit is shared by HTSB and BMO in accordance with a specific formula set forth in the agreement. This agreement expires in April 2002 but may be extended at that time. Either party may terminate the arrangement at its option. FX revenues are reported net of expenses. This agreement did not have a material impact on the Corporation's 1999, 1998 or 1997 net income or financial position.
At December 31, 1999, approximately 75 percent of the Corporation's gross notional positions in foreign currency contracts are represented by seven currencies: English pounds, German deutsche marks, Japanese yen, French francs, Swiss francs, Canadian dollars and Italian lira.
Foreign exchange contracts include spot, future, forward and option contracts that enable customers to manage their foreign exchange risk. Spot, future and forward contracts are agreements to exchange currencies at a future date, at a specified rate of exchange. Foreign exchange option contracts give the buyer the right and the seller an obligation (if the buyer asserts his right) to exchange currencies during a specified period (or on a certain date in the case of "European" options) at a specified exchange rate.
The following table summarizes the Corporation's dealer/trading foreign exchange contracts and their related contractual or notional amount and maximum replacement cost:
The following table summarizes average and end of period fair values of dealer/trading foreign exchange contracts for the years ended December 31, 1999 and 1998:
At December 31, 1999, spot, futures and forward contracts with BMO represent $8.2 million and $10.0 million of unrealized gains and unrealized losses, respectively. Options contracts with BMO represent $4.1 million and $4.1 million of options purchased and options written, respectively. Cross currency swaps with BMO represent $7.8 million and $5.8 million of unrealized gains and unrealized losses, respectively.
Net gains (losses) from dealer/trading foreign exchange contracts, for the years ended December 31, 1999, 1998 and 1997 totaled $8.3 million, $6.8 million and $5.4 million, respectively, of net profit under the aforementioned agreement with BMO.
Securities Activities
The Corporation's securities activities that have off-balance-sheet risk include municipal bond underwriting and short selling of securities.
Through its municipal bond underwriting activities, the Corporation commits to buy and offer for resale newly issued bonds. The Corporation is exposed to market risk because it may be unable to resell its inventory of bonds profitably as a result of unfavorable market conditions. In syndicate arrangements, the Corporation is obligated to fulfill syndicate members' commitments should they default. The syndicates of which the Corporation was a member had underwriting commitments totaling $50 million at December 31, 1999 and $83 million at December 31, 1998.
Security short selling, defined as selling of securities not yet owned, exposes the Corporation to off-balance-sheet market risk because the Corporation may be required to buy securities at higher prevailing market prices to cover its short positions. The Corporation had no short position at December 31, 1999 or 1998.
10. CONCENTRATIONS OF CREDIT RISK IN FINANCIAL INSTRUMENTS
The Corporation had one concentration of credit risk arising from financial instruments at December 31, 1999 and 1998. This concentration was the Midwest geographic area. This concentration exceeded 10 percent of the Corporation's total credit exposure, which is the total potential accounting loss should all customers fail to perform according to contract terms and all collateral prove to be worthless.
Midwestern Geographic Area
A majority of the Corporation's customers are located in the Midwestern region of the United States, defined here to include Illinois, Indiana, Iowa, Michigan, Minnesota, Missouri, Ohio and Wisconsin. The Corporation provides credit to these customers through a broad array of banking and trade financing products including commercial loans, commercial loan commitments, commercial real estate loans, consumer installment loans, mortgage loans, home equity loans and lines, standby and commercial letters of credit and banker's acceptances. The financial viability of customers in the Midwest is, in part, dependent on the region's economy. Corporate customers headquartered in the region and serving a national or international market are not included in this concentration because their business is broad-based and not dependent on the region's economy. The Corporation's maximum risk of accounting loss, should all customers making up the Midwestern concentration fail to perform according to contract terms and all collateral prove to be worthless, was approximately $13.5 billion or 41 percent of the Corporation's total credit exposure at December 31, 1999 and $15.1 billion or 49 percent of the Corporation's total credit exposure at December 31, 1998.
The Corporation manages this exposure by continually reviewing local market conditions and customers, adjusting individual and industry exposure limits within the region and by obtaining or closely monitoring collateral values. See Note 9 to Financial Statements on page 61 of this Report for information on collateral supporting credit facilities.
11. EMPLOYEE BENEFIT PLANS
The Corporation has noncontributory defined benefit pension plans covering virtually all its employees as of December 31, 1999. Most of the employees participating in retirement plans were included in one primary plan ("primary plan") during the three-year period ended December 31, 1999. The benefit formula for this plan is based upon length of service and an employee's highest qualifying compensation during five consecutive years of active employment. The plan is a multiple-employer plan covering the Corporation's employees as well as persons employed by certain affiliated entities.
The policy for this plan is to have the participating entities, at a minimum, fund annually an amount necessary to satisfy the requirements under ERISA, without regard to prior years' contributions in excess of
the minimum. For 1999, 1998 and 1997, cumulative contributions were greater than the amounts recorded as pension expense for financial reporting purposes.
The total consolidated pension expense of the Corporation, including the supplemental plan (excluding settlement losses), for 1999, 1998 and 1997 was $15.2 million, $10.0 million and $8.7 million, respectively.
In addition to pension benefits, the Corporation provides medical care benefits for retirees (and their dependents) who have attained age 55 and have at least 10 years of service. The Corporation also provides medical care benefits for disabled employees and widows of former employees (and their dependents). The Corporation provides these medical care benefits through a self-insured plan. Under the terms of the plan, the Corporation contributes to the cost of coverage based on employees length of service. Cost sharing with plan participants is accomplished through deductibles, coinsurance and out-of-pocket limits. Funding for the plan largely comes from the general assets of the Corporation, supplemented by contributions to a trust fund created under Internal Revenue Code Section 401(h).
The following tables set forth the change in benefit obligation and plan assets for the pension and postretirement medical care benefit plans:
- ------------------------- * Benefit Obligation is projected for Pension Benefits and accumulated for Postretirement Medical Benefits. ** Plan assets consist primarily of participation units in collective trust funds or mutual funds administered by HTSB. *** Plan assets and obligation measured as of September 30.
- ------------------------- * Discount rates are used to determine service costs for the subsequent year.
For measurement purposes, a 6.5 percent annual rate of increase in the per capita cost of covered health care benefits was assumed for 2000. The rate was assumed to decrease gradually to 6.0 percent in 2001 and remain level thereafter.
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
Certain employees participating in the primary plan are also covered by a supplemental unfunded retirement plan. The purpose of this plan is to extend full retirement benefits to individuals without regard to
statutory limitations for qualified funded plans. The following table sets forth the status of this supplemental plan:
The Corporation has a defined contribution profit sharing plan covering virtually all its employees. The plan includes a matching contribution and a profit sharing contribution. The matching contribution is based on the amount of eligible employee contributions. The profit sharing contribution is based on the annual financial performance of the Corporation relative to predefined targets. The Corporation's total expense for this plan was $11.5 million, $10.6 million and $10.3 million in 1999, 1998 and 1997, respectively.
12. STOCK OPTIONS
The Corporation has two stock-based compensation plans, which are accounted for under the fair value based method of accounting for stock based compensation plans and are described below.
Harris Bank Stock Option Program
The Harris Bank Stock Option Program was established under the Bank of Montreal Stock Option Plan for certain designated executives and other employees of the Corporation and affiliated companies in order to provide incentive to attain long-term strategic goals and to attract and retain services of key employees.
The Corporation granted stock options with a ten-year term which are exercisable only during the second five years of their term, assuming cumulative performance goals are met. The stock options are exercisable for BMO common stock equal to the market price on the date of grant. The compensation expense related to this program totaled $2.7 million, $1.3 million and $0.8 million in 1999, 1998 and 1997 respectively.
The following table summarizes the stock option activity for 1999, 1998 and 1997 and provides details of stock options outstanding at December 31, 1999:
The fair value of the stock options granted has been estimated using the Bloomberg Model with the following assumptions:
Harris Bank Stock Appreciation Rights Plan
The Corporation maintains the Harris Bank Stock Appreciation Rights Plan which was established in January 1995. The rights granted under this plan have either a three-year or five-year term and are exercisable after the expiration of the respective term, assuming cumulative performance goals are met. Compensation expense for the Harris Bank Stock Appreciation Rights Plan totaled $0.4 million, $0.6 million and $5.9 million in 1999, 1998 and 1997 respectively.
The following table details the rights outstanding at December 31, 1999, 1998 and 1997.
13. LEASE EXPENSE AND OBLIGATIONS
Rental expense for all operating leases was $19.3 million in 1999, $17.6 million in 1998 and $20.8 million in 1997. These amounts include real estate taxes, maintenance and other rental-related operating costs of $3.6 million, $3.1 million and $4.3 million for 1999, 1998 and 1997, respectively, paid under net lease arrangements. Lease commitments are primarily for office space.
Minimum rental commitments as of December 31, 1999 for all noncancelable operating leases are as follows:
Occupancy expenses for 1999, 1998 and 1997 have been reduced by $13.0 million, $14.0 million and $14.3 million, respectively, for rental income from leased premises.
14. INCOME TAXES
The 1999, 1998, and 1997 applicable income tax expense (benefit) was as follows:
Deferred tax assets (liabilities) are comprised of the following at December 31, 1999, 1998 and 1997:
At December 31, 1999 and 1998, the respective net deferred tax assets of $78 million and $72 million included $68 million and $60 million for Federal taxes and $10 million and $12 million for state taxes, respectively. Bankcorp has recognized its Federal and state deferred tax assets as management believes that it is more likely than not that the net deferred tax assets will be realized. The deferred taxes reported on the Corporation's Consolidated Statements of Condition at December 31, 1999 and 1998 also include a $103 million deferred tax asset and a $25 million deferred tax liability, respectively, for the tax effect of the net unrealized gains or losses associated with marking to market certain securities designated as available-for-sale, in accordance with SFAS No. 115.
Total income tax expense of $65.1 million for 1999, $69.9 million for 1998, and $70.1 million for 1997 reflects effective tax rates of 24.3 percent, 27.7 percent, and 30.9 percent, respectively. The reasons for the differences between actual tax expense and the amount determined by applying the U.S. Federal income tax rate of 35 percent to income before income taxes were as follows:
The tax expense from net gains on security sales amounted to $5.5 million, $10.5 million, and $5.1 million in 1999, 1998, and 1997, respectively.
15. REGULATORY CAPITAL
Bankcorp, as a U.S. bank holding company, and HTSB, as a state-member bank, must each adhere to the capital adequacy guidelines of the Federal Reserve Board, which are not significantly different than those published by other U.S. banking regulators. The guidelines specify minimum ratios for Tier 1 capital to risk-weighted assets of 4 percent and total regulatory capital to risk-weighted assets of 8 percent.
Risk-based capital guidelines define total capital to consist of Tier 1 (core) and Tier 2 (supplementary) capital. In general, Tier 1 capital is comprised of stockholder's equity, including certain types of preferred stock, less goodwill and certain other intangibles. Core capital must comprise at least 50 percent of total capital. Tier 2 capital basically includes subordinated debt (less a discount factor during the five years prior to maturity), other types of preferred stock and the allowance for possible loan losses. The portion of the allowance for possible loan losses includable in Tier 2 capital is limited to 1.25 percent of risk-weighted assets.
The Board also requires an additional measure of capital adequacy, the Tier 1 leverage ratio, which is evaluated in conjunction with risk-based capital ratios. The Tier 1 leverage ratio is computed by dividing period-end Tier 1 capital by adjusted quarterly average assets. The Board established a minimum ratio of 3 percent applicable only to the strongest banking organizations having, among other things, excellent asset quality, high liquidity, good earnings and no undue interest rate risk exposure. Other institutions are expected to maintain a minimum ratio of 4 percent.
The Federal Deposit Insurance Corporation Improvement Act of 1991 contains prompt corrective action provisions that established five capital categories for all Federal Deposit Insurance Corporation ("FDIC")-insured institutions ranging from "well capitalized" to "critically undercapitalized." Classification within a category is based primarily on the three capital adequacy measures. An institution is considered "well capitalized" if its capital level significantly exceeds the required minimum levels, "adequately capitalized" if it meets the minimum levels, "undercapitalized" if it fails to meet the minimum levels, "significantly
undercapitalized" if it is significantly below the minimum levels and "critically undercapitalized" if it has a ratio of tangible equity to total assets of 2 percent or less.
Noncompliance with minimum capital requirements may result in regulatory corrective actions which could have a material effect on the Corporation. Depending on the level of noncompliance, regulatory corrective actions may include the following: requiring a plan for restoring the institution to an acceptable capital category, restricting or prohibiting certain activities and appointing a receiver or conservator for the institution.
As of December 31, 1999, the most recent notification from the FDIC categorized the Corporation and HTSB as "well capitalized" under the regulatory framework for prompt corrective action. Management is not aware of any conditions or events since December 31, 1999 that have changed the capital category of the Corporation and HTSB.
Effective February 11, 1998, Harris Preferred Capital Corporation ("HPCC"), an indirect, wholly-owned subsidiary of HTSB, issued $250 million of 7 3/8% noncumulative, exchangeable Series A preferred stock. The preferred stock, which is listed and traded on the New York Stock Exchange, is nonvoting except in certain circumstances as outlined in HPCC's Form S-11 Registration Statement ("S-11"). Dividends on the preferred stock are noncumulative and are payable at the rate of 7 3/8% per annum of the $25 per share liquidation preference. The preferred shares can be redeemed in whole or in part at HPCC's option on or after March 30, 2003 or upon the occurrence of a tax event as defined in the S-11. Upon the occurrence of specific events described in the S-11, including HTSB becoming less than "adequately capitalized," HTSB being placed into conservatorship or receivership or the Board of Governors of the Federal Reserve System directing such an exchange, each preferred share would be exchanged automatically for one newly issued HTSB preferred share.
The following table summarizes the Corporation's and HTSB's risk-based capital ratios and Tier 1 leverage ratio for the past two years as well as the minimum amounts and ratios as per capital adequacy guidelines and FDIC prompt corrective action provisions.
- ------------
* Greater than or equal to.
16. INVESTMENTS IN SUBSIDIARIES AND STATUTORY RESTRICTIONS
Bankcorp's investment in the combined net assets of its wholly-owned subsidiaries was $1.68 billion and $1.74 billion at December 31, 1999 and 1998, respectively.
Provisions of both Illinois and Federal banking laws place restrictions upon the amount of dividends that can be paid to Bankcorp by its bank subsidiaries. Illinois law requires that no dividends may be paid in an amount greater than the net profits then on hand, reduced by certain loan losses (as defined). In addition to these restrictions, Federal Reserve member banking subsidiaries require prior approval of Federal banking authorities if dividends declared by a subsidiary bank, in any calendar year, will exceed its net profits (as defined in the applicable statute) for that year, combined with its retained net profits, as so defined, for the preceding two years. Based on these and certain other prescribed regulatory limitations, Bankcorp subsidiaries could have declared, without regulatory approval, $412 million of dividends at December 31, 1999. Actual dividends paid, however, would be subject to prudent capital maintenance. Cash dividends paid to Bankcorp by its subsidiaries amounted to $104 million and $134 million in 1999 and 1998, respectively.
The Federal Reserve Act also places restrictions on certain transactions between Bankcorp and its affiliates, including loans from subsidiary banks. Such restrictions include collateralization requirements and quantitative limitations. Essentially, a member bank's aggregate involvement in these restricted transactions may not exceed 20 percent of its capital and surplus, as defined by the Federal Reserve Board. In addition, restricted transactions involving an individual affiliate are limited to 10 percent of its capital and surplus.
The bank subsidiaries of Bankcorp are required by the Federal Reserve Act to maintain reserves against certain of their deposits. Reserves are held either in the form of vault cash or balances maintained with the Federal Reserve Bank. Required reserves are essentially a function of daily average deposit balances and statutory reserve ratios prescribed by type of deposit. During 1999 and 1998, daily average reserve balances of $209 million and $225 million, respectively, were required for those subsidiaries of Bankcorp that must maintain such balances. At year-end 1999 and 1998, balances on deposit at the Federal Reserve Bank totaled $226 million and $195 million, respectively.
17. CONTINGENT LIABILITIES
Certain subsidiaries of Bankcorp are defendants in various legal proceedings arising in the normal course of business. In the opinion of management, based on the advice of legal counsel, the ultimate resolution of these matters will not have a material adverse effect on the Corporation's financial position and results of operations.
18. SEGMENT INFORMATION
The Corporation's segments are identified by the customers served, the products and services they offer and the channels by which the products and services are delivered. The Corporation's reportable segments are Corporate and Institutional Financial Services, Chicagoland Banking, Electronic Financial Services and Private Client Group. Corporate and Institutional Financial Services is comprised of the Corporation's corporate banking distribution to middle-market companies across the Midwest and nationally in selected specialties and corporate trust activities, including national stock transfer and indenture trust distribution. Chicagoland Banking comprises community banking, which serves individuals through a Chicagoland retail bank network and small business/lower middle-market banking. Electronic Financial Services includes cash management services, mbanx(sm), the Corporation's virtual banking unit, and the bankcard business unit, including merchant services and, until its sale in January 1998, the Corporation's charge card business. The Private Client Group serves the needs of affluent individuals both within Chicagoland and nationally through the integrated delivery of a comprehensive offering of wealth management services, including investment management, personal trust, customized lending and financial planning. Businesses within this group include private banking, mutual fund management, retirement plan services and Harris Investment Management (the Corporation's institutional investment manager).
The "Other" category is comprised of the Corporation's Treasury unit, which serves as the Corporation's funding unit, as well as income from bank-owned insurance investments and inter-segment eliminations and residual revenues and expenses, representing the difference between actual amounts incurred and the amounts allocated to operating segments.
The accounting policies of the segments are the same as those described in Note 1 to Financial Statements, Summary of Significant Accounting Policies, except that segment results are presented on a fully taxable equivalent ("FTE") basis and income tax expense is allocated to the segments by an application of the Corporation's statutory tax rate to the pretax FTE basis profit or loss of each segment. Segment data includes intersegment revenues, as well as corporate overhead costs allocated to each segment based upon estimated usage of centrally provided services. The Corporation evaluates the performance of its segments and allocates resources to them based on FTE basis income before income taxes. Selected segment information is included in the following table.
Selected segment information is included in the following table:
- ------------------------- (1) Includes gain on sale of charge card portfolio. A $12 million gain was reported in January 1998 and average loans decreased by $693 million.
19. FOREIGN ACTIVITIES (BY DOMICILE OF CUSTOMER)
Income and expenses identifiable with foreign and domestic operations are summarized in the table below:
Determination of rates for foreign funds generated or used are based on the actual external costs of specific interest-bearing sources or uses of funds for the periods. Internal allocations for certain unidentifiable income and expenses were distributed to foreign operations based on the percentage of identifiable foreign income to total income. As of December 31, 1999, 1998 and 1997, identifiable foreign assets accounted for 1, 1 and 4 percent, respectively, of total consolidated assets.
20. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Presented below are the statements of income, statements of condition and statements of cash flows for Harris Bankcorp, Inc. (parent company only):
Statements of Income
Statements of Condition
Statements of Cash Flows
21. BUSINESS COMBINATIONS AND DISPOSITIONS/INTANGIBLES
At December 31, 1999 and 1998, intangible assets, including goodwill resulting from business combinations, amounted to $250 million and $268 million, respectively. Amortization of these intangibles amounted to $25.0 million in 1999, $24.1 million in 1998, and $27.8 million in 1997. The impact of purchase accounting adjustments, other than amortization of intangibles, was not material to the Corporation's reported results.
On January 29, 1998, HTSB sold its credit card portfolio to Partners First Holdings, LLC ("PFH"), a corporation owned by BankBoston Corporation, First Annapolis Consulting, Inc. and Bankmont. At the time of the sale, the assets had a carrying value of $693.0 million, representing less than 5 percent of the Corporation's total consolidated assets. Upon completion of the sale, HTSB received cash and an equity interest in the newly formed company, which it immediately sold for cash to Bankmont. The Corporation recorded a pretax gain of $12.0 million on this transaction.
22. RELATED PARTY TRANSACTIONS
Bankcorp is a wholly-owned subsidiary of Bankmont, a Delaware corporation. Bankmont is a wholly-owned subsidiary of BMO. Unamortized goodwill of $11.6 million at December 31, 1999 associated with the acquisition of Bankcorp in 1984 is reflected on the accounting records of Bankmont and has not been "pushed down" to the Corporation.
During 1999, 1998 and 1997, the Corporation engaged in various transactions with BMO and its subsidiaries. These transactions included the payment and receipt of service fees and occupancy expenses, and purchasing and selling Federal funds, repurchase and reverse repurchase agreements, long-term borrowings, interest rate and foreign exchange rate contracts. The purpose of these transactions was to facilitate a more efficient use of combined resources and to better serve customers. Fees for these services were determined in accordance with applicable banking regulations. During 1999, 1998 and 1997, the Corporation received from BMO approximately $14.6 million, $17.1 million and $20.9 million respectively, primarily for trust services, data processing and other operations support provided by the Corporation.
HTSB and BMO combine their U.S. foreign exchange activities. Under this arrangement, FX net profit is shared by HTSB and BMO in accordance with a specific formula set forth in the agreement. This agreement expires in April 2002 but may be extended at that time. Either party may terminate the arrangement at its option. FX revenues are reported net of expenses. 1999, 1998 and 1997 foreign exchange revenues included $8.3 million, $6.8 million and $5.4 million of net profit, respectively, under this agreement.
On June 29, 1999, Bankcorp borrowed (Canadian) $266 million from FinCo. The loan is subordinated debt, due to mature July 29, 2009. Bankcorp entered into a currency and interest rate swap agreement to exchange the C$266 million for U.S. $180 million and makes quarterly interest payments on the swap. The loan interest rate is BA + 43 bps and converts to 90 day LIBOR + 44.5 bps under the swap.
23. SUBSEQUENT EVENT
On February 1, 2000, the Corporation announced the sale of its corporate trust businesses. In separate and unrelated transactions, the indenture trust business is being sold to a subsidiary of The Bank of New York Company, Inc., and the shareholder services business to Computershare Limited. The combined sales will result in an estimated pre-tax gain to Bankcorp of approximately $50 million in first quarter 2000, not including revenue contingent upon the outcome of certain events, expected in second half 2000. The sales are subject to regulatory approval and are expected to close during first quarter 2000. In 1999, noninterest revenue from the corporate trust businesses amounted to $51.7 million. The Corporation does not believe that the sale of these businesses will have a material impact on the results of operations for future periods.
JOINT INDEPENDENT AUDITORS
The Board of Directors of Harris Bankcorp, Inc. engaged the firms of KPMG LLP and PricewaterhouseCoopers LLP to serve as joint auditors for each of the three years in the three year period ended December 31, 1999.
BMO has elected to appoint two firms of independent public accountants to be auditors of BMO and all significant subsidiaries. The Corporation's independent public accountants reflect the appointments made by BMO.
INDEPENDENT AUDITORS' REPORT
To the Stockholder and Board of Directors of Harris Bankcorp, Inc.:
We have audited the accompanying consolidated statements of condition of Harris Bankcorp, Inc. and Subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income, comprehensive income, changes in stockholder's equity and cash flows for each of the years in the three year period ended December 31, 1999. These consolidated financial statements are the responsibility of Harris Bankcorp, Inc.'s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Harris Bankcorp, Inc. and Subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 1999 in conformity with generally accepted accounting principles.
KPMG LLP PricewaterhouseCoopers LLP Chicago, Illinois January 28, 2000 except for Note 23, as to which the date is March 10, 2000
ITEM 9
ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There were no disagreements between the Corporation and its independent auditors related to accounting matters and/or financial disclosures.
PART III
ITEM 10
ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Bankcorp's Board of Directors consists of fourteen members. Directors are elected annually. Each present director has been employed in an executive capacity by his or her employer for more than five years. Set forth below is certain biographical information concerning each director, including principal occupation, age, the year first elected a director of Bankcorp and HTSB and other directorships.
MARTIN R. CASTRO, age 36, Attorney-at-Law. Elected in 1999.
PASTORA SAN JUAN CAFFERTY, age 59, Professor, University of Chicago School of Social Service Administration and a Director of WMX Technologies, Peoples Energy Corporation and Kimberly-Clark Corporation. Elected in 1997.
HAVEN E. COCKERHAM, age 52, Senior Vice President, Human Resources, R. R. Donnelley & Sons Company (printing company). Prior to joining R. R. Donnelley & Sons in 1998, Mr. Cockerham headed Human Resources for Detroit Edison. Elected in 1999.
F. ANTHONY COMPER, age 54, Chairman and Chief Executive Officer and a Director of Bank of Montreal. Elected in 1990.
SUSAN T. CONGALTON, age 53, Managing Director, Lupine L.L.C. (consulting and private investments). Elected in 1988.
WILBUR H. GANTZ, age 62, Chairman of the Board and Chief Executive Officer of PathoGenesis Corporation (diagnostic health care) and a Director of W.W. Grainger and Gillette Corporation. Elected in 1984.
JAMES J. GLASSER, age 65, Chairman Emeritus of GATX Corporation (capital equipment and services for extracting, processing and distributing dry and liquid bulk commodities) and a Director of The B. F. Goodrich Company and Stone Container Corporation. Elected in 1980.
DR. LEO M. HENIKOFF, age 60, President and Chief Executive Officer of Rush-Presbyterian-St. Luke's Medical Center (health care and related services). Elected in 1986.
RICHARD M. JAFFEE, age 64, Chairman, Oil-Dri Corporation of America (a developer, manufacturer and marketer of sorbent products). Elected in 1995.
EDWARD W. LYMAN, JR., age 57, Vice Chair of the Board of Bankcorp and Harris Trust and Savings Bank. Elected in 1995.
ALAN G. MCNALLY, age 54, Chairman of the Board and Chief Executive Officer of Bankcorp and Harris Trust and Savings Bank and a Director of Walgreen Co. Elected in 1993.
CHARLES H. SHAW, age 67, Chairman, The Charles H. Shaw Company (real estate development). Elected in 1990.
RICHARD E. TERRY, age 62, Chairman and Chief Executive Officer, Peoples Energy Corporation (public utility) and a Director of Amsted Industries. Elected in 1992.
JAMES O. WEBB, age 68, President, James O. Webb & Associates, Inc. (consultant in new ventures and business development). Elected in 1995.
In addition to Messrs. McNally and Lyman, the Corporation had twenty-one executive officers at December 31, 1999 -- Jeffrey D. Butterfield, age 53; Timothy S. Crane, age 38; Dennis L. Dean, age 48; Emilia DiMenco, age 45; Pierre O. Greffe, age 47; Louis F. Lanwermeyer, age 51; Michael W. Lewis, age 50; Michael B. Lowe, age 54; Erin E. McInerney, age 44; Peter B. McNitt, age 45; Richard J. Moreland, age 53; Charles R. Piermarini, age 43; Paul V. Reagan, age 53; Steven R. Rothbloom, age 44; Randall W. Teteak, age 55; William E. Thonn, age 51; Charles R. Tonge, age 52; Philip A. Washburn, age 53; William W. Whipple, age 47; Edward J. Williams, age 57; and Sohrab Zargham, age 58. Each officer, other than
Messrs. Piermarini and Teteak, has held executive positions with the Corporation or an affiliate for at least the past five years. Prior to 1997, Mr. Piermarini was Senior Vice President, Portfolio Management, NationsBank. Prior to 1997, Mr. Teteak was Senior Vice President at First Union National Bank responsible for technology and automation planning.
ITEM 11
ITEM 11 -- OMITTED PURSUANT TO GENERAL INSTRUCTION (I)(2)(c) OF FORM 10-K.
ITEM 12
ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Bank of Montreal, through its subsidiary, Bankmont Financial Corp., a U.S. bank holding company chartered in Delaware, owns all 6,667,490 issued and outstanding shares of Bankcorp's common stock.
ITEM 13
ITEM 13 -- OMITTED PURSUANT TO GENERAL INSTRUCTION (I)(2)(c) OF FORM 10-K.
PART IV
ITEM 14
ITEM 14 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed with Report:
(1) Financial Statements (See page 1 for a listing of all financial statements included in Item 8)
(2) Financial Statement Schedules
All Schedules normally required by Form 10-K are omitted since they are either not applicable or the required information is shown in the financial statements or the notes thereto.
(3) Exhibits:
3. Articles of Incorporation and By-laws
a) Restated Certificate of Incorporation (filed as an Exhibit to Bankcorp's 1987 Form 10-K and incorporated herein by reference)
b) By-laws of Bankcorp
4. Indenture dated as of June 1, 1989 relating to Bankcorp's 9 3/8% Subordinated Notes Due 2001 (filed as an Exhibit to Bankcorp's May 24, 1989 Registration Statement on Form S-3 and incorporated herein by reference). In addition, Bankcorp has issued two Floating Rate Subordinated Notes and one Fixed Rate Subordinated Note to its parent company, Bankmont. Bankcorp has also issued a Floating Rate Subordinated Note to FinCo. The principal amount of these notes totals $280 million for the floating rate notes and $75 million for the fixed rate note, respectively. The floating rate notes mature in 2005, 2006 and 2009, respectively. The fixed rate note matures in 2010. Bankcorp hereby agrees to file a copy of the agreement relating to any such notes with the Commission upon request.
10. Material Contracts and Compensatory Plans
a) Managerial Incentive Plan (filed as an Exhibit to Bankcorp's 1997 Form 10-K and incorporated herein by reference)
b) Employees' Savings and Profit Sharing Plan (filed as an Exhibit to Bankcorp's 1995 Form 10-K and incorporated herein by reference).
c) 1995 Stock Appreciation Rights Plan (filed as an Exhibit to Bankcorp's 1995 Form 10-K and incorporated herein by reference).
d) Harris Retirement Benefit Replacement Plan (filed as an Exhibit to Bank of Montreal's August 3, 1994 Registration Statement on Form, File No. 33-82358, and incorporated herein by reference)
e) Harris Bank Stock Option Program, pursuant to which certain designated executives and certain other employees of the Corporation participate in the Bank of Montreal
Stock Option Plan (filed as an Exhibit to Bank of Montreal's May 9, 1995 Registration Statement on Form S-8, File No. 33-92112, and incorporated herein by reference)
23. Consents of Experts and Counsel (consents of Independent Auditors)
24. Power of Attorney
27. Financial Data Schedule
(b) No Current Report on Form 8-K was filed during the quarter ended December 31, 1999. - ------------------------- * Copies of Exhibits (a) (3) 3, 4, 10, 23, 24 and 27 not contained herein, may be obtained at a cost of 25 cents per page upon written request to the Secretary of Harris Bankcorp, Inc.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Harris Bankcorp, Inc. has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on the 22nd day of March 2000.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by Alan G. McNally, Chairman of the Board and Chief Executive Officer of the Corporation, as attorney-in-fact for the following Directors on behalf of Harris Bankcorp, Inc. on the 22nd day of March 2000.
Supplemental Information
No annual report or proxy statement will be sent to security holders in 2000.