10-Q 1 c70950e10vq.txt QUARTERLY REPORT -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------- FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED JUNE 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

HARRIS BANKCORP, INC. 111 West Monroe Street Chicago, Illinois 60603 (312) 461-2121 Commission File Number 0-18179 Incorporated in the State of Delaware IRS Employer Identification No. 36-2722782 ------------------------- Harris Bankcorp, Inc. (the "Corporation") has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and has been subject to such filing requirements for the past 90 days. At August 14, 2002 the Corporation had 6,667,490 shares of $8 par value common stock outstanding. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- PART 1. FINANCIAL INFORMATION Item 1. Financial Statements. Consolidated Statements of Income and Consolidated Statements of Comprehensive Income for the quarters and six months ended June 30, 2002 and 2001. Consolidated Statements of Condition as of June 30, 2002, December 31, 2001 and June 30, 2001. Consolidated Statements of Changes in Stockholder's Equity and Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001. Notes to the Financial Statements. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Financial Review). Item 3. Quantitative and Qualitative Disclosures about Market Risk. The above financial statements, financial review and quantitative and qualitative disclosures about market risk, included in the Corporation's 2002 Second Quarter Report, are filed as Exhibit A and incorporated herein by reference. PART II. OTHER INFORMATION Items 1, 2, 3, 4, and 5 are being omitted from this report because such items are not applicable to the reporting period. Item 6. Exhibits and Reports on Form 8-K. (a) Documents filed with Report: None (b) No Current Report on Form 8-K was filed during the quarter ended June 30, 2002, for which this report is filed. SIGNATURES Pursuant to the requirements 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 14th day of August 2002. /s/ ------------------------------------------------ Pamela C. Piarowski Senior Vice President and Chief Financial Officer /s/ ------------------------------------------------ Paul R. Skubic Chief Accounting Officer FINANCIAL HIGHLIGHTS Harris Bankcorp, Inc. and Subsidiaries --------------------------------------------------------------------------------

(1) Cash earnings is defined as net income excluding the impact of amortization of goodwill and other valuation intangibles. (2) Cash return on average common stockholder's equity ("Cash ROE") is calculated as annualized 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 average intangible assets. (3) Cash return on average assets ("Cash ROA") is calculated as net income plus after-tax amortization expense of goodwill and other valuation intangibles, divided by average assets less average intangible assets. N/R - Computation not relevant. 1 REPORT FROM MANAGEMENT -------------------------------------------------------------------------------- Harris Bankcorp had net income of $76.3 million for the quarter ended June 30, 2002, a 24 percent increase from second quarter 2001 earnings of $61.8 million. For the six months ended June 30, 2002, earnings were $142.0 million, up 13 percent from $125.8 million in the comparable 2001 period. For the current quarter, cash ROE was 19.17 percent compared to 15.55 percent one year earlier. The Corporation's favorable results are attributable to continued growth in consumer, mortgage and small business loans and retail deposits, increased earnings from treasury activities, and strict cost control. In addition, improvement in the level of nonperforming assets, provision for loan losses and net charge-offs from first quarter 2002 was an important contributing factor to a strong current quarter. For the current quarter, net interest income on a fully taxable equivalent basis was $206.3 million, up 6 percent from second quarter last year. Net interest margin rose from 3.08 percent in the year-ago quarter to 3.41 percent currently, reflecting the impact of a declining interest rate environment during 2001 and a higher mix of retail loans and deposits. Average earning assets declined 4 percent to $24.22 billion currently from $25.33 billion in second quarter 2001. Consumer, mortgage and small business loans grew by $1.6 billion or 18 percent, of which 7 percent was attributable to the acquisition of First National Bank of Joliet ("Joliet") in third quarter 2001. Excluding Joliet, consumer and small business loan growth was 13 percent. Growth in these loans was offset by a decline in corporate loans and investment securities. Second quarter noninterest income of $134.5 million rose 25 percent from the same quarter last year. Growth in noninterest income primarily resulted from a $14.8 million increase in net gains from sales of investment securities, and higher service charges on deposits amounting to $9.6 million of which $1.6 million was contributed by Joliet. Second quarter 2002 noninterest expenses of $195.6 million were up $13.9 million or 8 percent compared to second quarter a year ago. Excluding operating expenses of Joliet acquired in third quarter 2001, expense growth was 2 percent. Income tax expense rose $11.9 million in the current quarter, reflecting substantially greater pretax income. Nonperforming assets at June 30, 2002 of $196 million or 1.22 percent of total loans were down from $220 million or 1.37 percent at March 31, 2002, and up from $150 million or 0.95 percent a year ago. Similarly, the second quarter 2002 provision for loan losses of $26.7 million was down 18 percent from $32.7 million in first quarter 2002, and up 3 percent from $26.0 million in second quarter a year earlier. Net loan charge-offs during the current quarter of $23.9 million were down 37 percent from $37.9 million last quarter and 12 percent from $27.1 million in the same period last year. At June 30, 2002, the allowance for possible loan losses was $290 million, equal to a ratio of 1.80 percent of loans outstanding, compared to $167 million or 1.08 percent at June 30, 2001. As a result, the ratio of the allowance for possible loan losses to nonperforming assets was 148 percent at June 30, 2002 compared to 111 percent at June 30, 2001. At June 30, 2002, regulatory Tier 1 capital of Harris Bankcorp amounted to $2.03 billion compared to $2.11 billion one year earlier. The regulatory leverage capital ratio was 7.56 percent for the second quarter of 2002, up from 7.45 percent in the same quarter of 2001. Harris Bankcorp's June 30, 2002 Tier 1 and total risk-based capital ratios were 9.02 and 12.01 percent compared to respective ratios of 9.72 percent and 12.37 percent at June 30, 2001. Harris Bankcorp's capital ratios exceed the prescribed regulatory minimum for bank holding companies. 2 -------------------------------------------------------------------------------- For the first six months of the current year, net interest income on a fully taxable equivalent basis rose 10 percent or $38.9 million, reflecting an increase in net interest margin from 3.01 percent in the six months ended June 30, 2001 to 3.42 percent currently. Earning assets declined 3 percent, although average loans increased $578 million or 4 percent. Year-to-date noninterest income was $259.8 million, an increase of $38.8 million or 18 percent. Most of this increase resulted from additional net gains from securities sales of $17.2 million and higher service charge fees of $19.2 million. Compared to first half 2001, the provision for loan losses increased by $17.4 million to $59.4 million in the first six months of 2002 while net charge-offs increased by $16.1 million to $61.8 million. Noninterest expense of $400.1 million was up 9 percent year to date. Excluding the impact of the Joliet acquisition, and a one-time cost associated with disposition of the Corporation's New York trust subsidiary following sale of the corporate trust business in 2000, noninterest expense rose 2 percent in the six-month period ended June 30, 2002. Income tax expense increased $14.8 million, reflecting higher pretax income. /s/ ALAN G. MCNALLY Alan G. McNally July 26, 2002 Chairman of the Board and Chief Executive Officer 3 CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Harris Bankcorp, Inc. and Subsidiaries

The accompanying notes to the financial statements are an integral part of these statements. 4 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) Harris Bankcorp, Inc. and Subsidiaries

The accompanying notes to the financial statements are an integral part of these statements. 5 CONSOLIDATED STATEMENT OF CONDITION Harris Bankcorp, Inc. and Subsidiaries --------------------------------------------------------------------------------

The accompanying notes to the financial statements are an integral part of these statements. 6 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY (UNAUDITED) Harris Bankcorp, Inc. and Subsidiaries --------------------------------------------------------------------------------

The accompanying notes to the financial statements are an integral part of these statements. -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Harris Bankcorp, Inc. and Subsidiaries

The accompanying notes to the financial statements are an integral part of these statements. 7 NOTES TO THE FINANCIAL STATEMENTS Harris Bankcorp, Inc. and Subsidiaries -------------------------------------------------------------------------------- 1. BASIS OF PRESENTATION Harris Bankcorp, Inc. (the "Corporation") is a wholly-owned subsidiary of Bankmont Financial Corp. (a wholly-owned subsidiary of Bank of Montreal). The consolidated financial statements of the Corporation include the accounts of the Corporation and its wholly-owned subsidiaries. Significant intercompany accounts and transactions have been eliminated. Certain reclassifications were made to conform the prior year's financial statements to the current year's presentation. The consolidated financial statements have been prepared by management from the books and records of the Corporation, without audit by independent certified public accountants. However, these statements reflect all adjustments and disclosures which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented and should be read in conjunction with the notes to the financial statements included in the Corporation's Form 10-K for the year ended December 31, 2001. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. Because the results of operations are so closely related to and responsive to changes in economic conditions, the results for any interim period are not necessarily indicative of the results that can be expected for the entire year. -------------------------------------------------------------------------------- 2. LEGAL PROCEEDINGSThe Corporation and certain of its subsidiaries 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 consolidated financial position. -------------------------------------------------------------------------------- 3. CASH FLOWS For purposes of the Corporation's Consolidated Statements of Cash Flows, cash and cash equivalents is defined to include cash and demand balances due from banks. Cash interest payments for the six months ended June 30 totaled $238.3 million and $538.1 million in 2002 and 2001, respectively. Cash income tax payments over the same periods totaled $43.8 million and $58.0 million, respectively. -------------------------------------------------------------------------------- 4. GOODWILL AND OTHER INTANGIBLE ASSETS The Corporation adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," on January 1, 2002. Under this standard, goodwill and other intangible assets that have indefinite useful lives are not subject to amortization while intangible assets with finite lives are amortized. Goodwill is periodically assessed for impairment, at least annually. The Corporation has an unidentifiable intangible asset that is accounted for in accordance with SFAS No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions." This asset is excluded from the scope of SFAS No. 142 and continues to be amortized. Upon adoption of the Statement, the Corporation's goodwill was subject to the transitional goodwill impairment test. The impairment test is a two step process. The first step identifies potential impairment through a comparison of the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount exceeds the fair value, the second step of the test is performed to measure the amount of impairment loss, if any. The second step compares the implied fair value of reporting unit goodwill with its carrying amount. If the carrying amount exceeds the implied fair value, an impairment loss is recognized in an amount equal to the excess. The Corporation's reporting units were defined as its operating segments. See Note 6 to the Financial Statements for additional information on operating segments. The first step of the transitional goodwill impairment test did not identify potential impairment. Therefore, the second step of the test was not performed and no impairment loss was recognized at transition. For the quarter and six months ended June 30, 2002, the Corporation had no goodwill amortization expense. For the quarter ended June 30, 2002, net income was $76.3 million and earnings per share was $10.77. For the quarter ended June 30, 2001, reported net income was $61.8 million, reported earnings per share was $8.59 and goodwill amortization expense after related income taxes was $0.7 million. For the same period, net income on a pro forma basis adjusted to exclude the amortization of goodwill was $62.5 million and adjusted earnings per share was $8.70. For the six months ended June 30, 2002, net income was 8 -------------------------------------------------------------------------------- $142.0 million and earnings per share was $19.94. For the six months ended June 30, 2001, reported net income was $125.8 million, reported earnings per share was $17.51 and goodwill amortization expense after related income taxes was $1.5 million. For the same period, net income on a pro forma basis adjusted to exclude the amortization of goodwill was $127.3 million and adjusted earnings per share was $17.74. The carrying value of the Corporation's goodwill, excluding $84.6 million accounted for under SFAS No. 72, as of June 30, 2002, was $113.1 million. Of this amount, $106.3 million of goodwill was assigned to Personal and Commercial Client Group and $6.8 million was assigned to Private Client Group. As of June 30, 2002, the gross carrying amount and accumulated amortization of the Corporation's amortizable intangible assets were $377.6 million and $143.1 million, respectively. Total amortization expense for the Corporation's intangible assets was $7.6 million for the quarter ended June 30, 2002 and $15.1 million for the six months ended June 30, 2002. Estimated intangible asset amortization expense for the years ending December 31, 2003, 2004, 2005, 2006 and 2007 is $30.2 million, $30.4 million, $30.4 million, $30.6 million and $30.6 million, respectively. -------------------------------------------------------------------------------- 5. OTHER In July 2001, Bankmont acquired First National Bancorp, Inc. and its wholly owned subsidiary, First National Bank of Joliet ("Joliet"). First National Bancorp, Inc. was merged with and into Bankmont, followed by a capital contribution of Joliet stock to the Corporation which resulted in approximately $220 million of incremental capital. The purchase price was $220.3 million. Of this amount, $101.6 million was recorded as goodwill and $50.1 million as a core deposit premium intangible with an expected life of eight years. Under the provisions of SFAS No. 142, goodwill will not be subject to periodic amortization. On the date of acquisition, Joliet had total assets amounting to $1.1 billion, total deposits amounting to $860 million and total liabilities amounting to $1.0 billion. -------------------------------------------------------------------------------- 6. SEGMENT REPORTING 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 Personal and Commercial Client Group, Investment Banking Group, Private Client Group and Emfisys and Corporate Support. Personal and Commercial Client Group comprises community banking, which serves individuals through a Chicagoland retail bank network and small business/lower middle-market banking. The Investment Banking Group is comprised of the Corporation's corporate banking distribution to middle-market companies across the Midwest and nationally in selected specialties and the Corporation's Treasury group, which serves as the Corporation's funding unit, and cash management services. 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). Emfisys is the technology and e-business group that provides information technology planning, strategy and development services, together with transaction-processing capabilities, and real estate operations. Corporate Support includes the corporate units that provide expertise and governance support for the Bank in areas such as law, finance, internal audit, risk management, corporate communications, human resources and learning. Corporate Support also reflects income from bank-owned insurance, inter-group eliminations and residual revenues and expenses, representing the difference between actual amounts incurred and the amounts allocated to operating segments. 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 income before income taxes. 9 -------------------------------------------------------------------------------- Selected segment information is included in the following table:

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11 FINANCIAL REVIEW Harris Bankcorp, Inc. and Subsidiaries -------------------------------------------------------------------------------- SECOND QUARTER 2002 COMPARED WITH SECOND QUARTER 2001 -------------------------------------------------------------------------------- SUMMARY The Corporation had second quarter 2002 net income of $76.3 million, a 24 percent increase from second quarter 2001 earnings of $61.8 million. Cash ROE was 19.17 percent compared to 15.55 percent one year earlier. Cash ROA was 1.21 percent compared to 0.94 percent a year ago. Second quarter net interest income on a fully taxable equivalent basis was $206.3 million, up $12.3 million or 6 percent from $194.0 million in 2001's second quarter. Average earning assets decreased 4 percent to $24.22 billion from $25.33 billion in 2001. Consumer, mortgage and small business lending grew by $1.6 billion or 18 percent of which 7 percent was attributable to the acquisition of First National Bank of Joliet. Net interest margin rose to 3.41 percent from 3.08 percent in the same quarter last year, reflecting the impact of a declining interest rate environment during 2001 and a higher mix of retail loans and deposits. The second quarter provision for loan losses of $26.7 million was up $0.7 million from $26.0 million in the second quarter of 2001. Net charge-offs during the current quarter were $23.9 million compared to $27.1 million in the prior year's quarter. Noninterest income increased $26.8 million or 25 percent to $134.5 million for second quarter 2002 from the same quarter last year. This growth primarily resulted from an increase in net gains from investment securities sales and higher service charges on deposits of $9.6 million of which $1.6 million was contributed by Joliet. Second quarter 2002 noninterest expenses of $195.6 million were up $13.9 million or 8 percent compared to second quarter a year ago. Excluding operating expenses of Joliet acquired in third quarter 2001, expense growth was 2 percent. Income tax expense rose by $11.9 million in the current quarter reflecting substantially greater pretax income. Additional commentary on the matters included in the above summary is provided in the following sections of this report. 12 -------------------------------------------------------------------------------- OPERATING SEGMENT REVIEW PERSONAL AND COMMERCIAL CLIENT GROUP Net income for Personal and Commercial Client Group in the second quarter of 2002 was $32.3 million, up $12.4 million from the second quarter of 2001. Total revenue was $160.9 million, an increase of $29.0 million from $131.9 million from the year-ago quarter. This increase was primarily due to loan volume growth in consumer, mortgage and small business lending as well as growth in retail deposits, higher interest margins and the acquisition of Joliet. Noninterest expense increased $10.7 million or 12 percent to $103.6 million from $92.9 million in second quarter 2001. The increase was primarily due to the acquisition of Joliet and costs in support of increased volume. Income taxes increased by $7.7 million in the current quarter, reflecting higher pretax income. INVESTMENT BANKING GROUP Net income for Investment Banking Group was $35.5 million in second quarter 2002, an increase of $0.9 million or 2 percent from $34.6 million a year ago. Total revenue of $122.4 million decreased by $8.6 million or 7 percent from the second quarter of 2001. This decrease was primarily due to reduced loan volumes and lower bond trading profits offset by higher security gains and fee revenue. Noninterest expense decreased $1.0 million or 2 percent to $51.5 million in the current quarter due to cost containment efforts. Net income was also impacted by a lower loan loss provision of $9.0 million. Income taxes increased by $0.5 million during the quarter, reflecting lower pretax income. PRIVATE CLIENT GROUP Net income for Private Client Group was $6.7 million in second quarter 2002, an increase of $0.7 million or 12 percent from $6.0 million a year ago. Total revenue of $51.9 million decreased by $1.0 million or 2 percent from $52.9 million in second quarter 2001. This decrease in revenue has been affected by the current stock market conditions which have resulted in decreased asset values and a decline in new business opportunities slightly offset by increased net interest margins. Noninterest expense decreased $1.8 million or 8 percent to $40.7 million in the current quarter, primarily due to cost containment efforts. Income taxes increased by $0.1 million during the quarter, reflecting higher pretax income. EMFISYS AND CORPORATE SUPPORT Emfisys and Corporate Support had net income for the first quarter 2002 of $1.8 million, compared to $1.3 million a year ago quarter. Total revenue increased $19.7 million to $5.6 million. The Corporation's overall provision for loan losses was determined in order to maintain the allowance for loan losses at a level sufficient to cover losses inherent in the consolidated loan portfolio. Provisions are allocated to the operating segments based on average historical losses over a complete economic cycle. The differences between the total of the Corporation's business line allocation of provisions and its total required provisions under generally accepted accounting principles are allocated to Corporate Support. Compared with the second quarter of the prior year, the current quarter's provision for loan losses in Corporate Support increased. In 2001, the excess of actual provisions over average historical losses was charged to the operating segments to which they related, rather than to Corporate Support. For further provision information, see the discussion of the Allowance for Possible Loan Losses section on page 20 of this report. Noninterest expense increased by $6.0 million in the current quarter, primarily due to costs associated with business initiatives. Income tax benefits decreased by $1.7 million during the quarter. 13 -------------------------------------------------------------------------------- CONSOLIDATED STATISTICAL SUMMARY Harris Bankcorp, Inc. and Subsidiaries --------------------------------------------------------------------------------

1. FULLY TAXABLE EQUIVALENT ADJUSTMENT Tax-exempt income has been restated to a comparable taxable level. The Federal and state statutory tax rates used for this purpose were 35 percent and 4.8 percent, respectively, in 2002 and 2001. 2. AVERAGE RATE ON SECURITIES AVAILABLE-FOR-SALE Yields on securities classified as available-for-sale are based on amortized cost. 14 -------------------------------------------------------------------------------- NET INTEREST INCOME

Second quarter net interest income on a fully taxable equivalent (FTE) basis was $206.3 million, up 6 percent from $194.0 million in second quarter 2001. The change in net interest income is typically explained by analyzing its two principal components, net interest margin and average earning assets. Net interest margin is annualized net interest income on a FTE basis over average interest earning assets. Average earning assets represent the average volume of assets employed by the Corporation which generate interest income. Net interest margin rose from 3.08 percent in second quarter 2001 to 3.41 percent in the current quarter, reflecting the impact of a declining interest rate environment during 2001 and a higher mix of retail loans and deposits. Wholesale funding declined in 2002 as did noninterest supporting funds. Average earning assets declined 4 percent to $24.22 billion from $25.33 billion in 2001. Average securities available-for-sale decreased $2.02 billion primarily due to declines in U.S. Treasury and Federal agency securities. Average loans rose $497 million, or 3 percent. Installment and real estate mortgage loans were the most significant contributors to the loan growth with respective increases of $845 million and $515 million, partially offset by a decline in commercial loans of $842 million compared to 2001 levels. Average supporting liabilities declined 4 percent due to short-term borrowings and foreign office time deposits declines of $2.24 billion and $977 million, respectively, offset by an increase in savings deposits and certificates of $1.58 billion from 2001 levels. -------------------------------------------------------------------------------- AVERAGE EARNING ASSETS -- NET INTEREST MARGIN

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Noninterest income for the second quarter of 2002 was $134.5 million, an increase of $26.8 million or 25 percent from the second quarter of 2001. Growth in noninterest income primarily resulted from a $14.8 million increase in net gains from sales of investment securities, and higher service charges on deposits amounting to $9.6 million, of which $1.6 million was contributed by Joliet. --------------------------------------------------------------------------------

Second quarter 2002 noninterest expenses of $195.6 million were up $13.9 million or 8% compared to the second quarter of 2001. Excluding operating expenses of Joliet acquired in third quarter 2001, expense growth was 2%. Growth in noninterest expenses primarily resulted from lower levels of reimbursements for services performed on behalf of affiliated companies and higher pension expense. Income tax expense rose $11.9 million in the current quarter, reflecting substantially greater pretax income. 16 -------------------------------------------------------------------------------- CAPITAL POSITION The Corporation's total equity capital at June 30, 2002 was $2.16 billion, compared with $2.20 billion and $2.09 billion at December 31, 2001 and June 30, 2001, respectively. Excluding adjustments for unrealized gains and losses from securities available-for-sale and cash flow hedges, total equity increased $5.1 million from June 30, 2001. During the preceding twelve months, the Corporation declared common and preferred dividends of $392.0 million and $18.0 million, respectively. Common dividends reflect the Corporation's continued strong capital position in addition to declines in average assets, primarily investment portfolio securities and commercial loans. In February 1998, Harris Preferred Capital Corporation, a wholly-owned indirect subsidiary of Harris Trust and Savings Bank ("HTSB"), issued $250 million of noncumulative preferred stock in a public offering. The preferred stock qualifies as Tier 1 capital at both HTSB and the Corporation for U.S. banking regulatory purposes. U.S. banking regulators issued risk-based capital guidelines, based on the international "Basel 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. 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 equal 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 Corporation's Tier 1 and total risk-based capital ratios were 9.02 percent and 12.01 percent, respectively, at June 30, 2002. HTSB's Tier 1 and total risk-based capital ratios were 10.12 percent and 12.55 percent, respectively, at June 30, 2002. Another regulatory capital measure, the Tier 1 leverage ratio, is computed by dividing period-end Tier 1 capital by adjusted quarterly average assets. The Federal Reserve Board established a minimum ratio of 4 percent for most holding companies. The Corporation's and HTSB's Tier 1 leverage ratios were 7.56 percent and 8.99 percent, respectively, for the second quarter of 2002. The Federal Deposit Insurance Corporation Improvement Act of 1991 contains several provisions that establish five capital categories for all FDIC-insured institutions ranging from "well capitalized" to "critically undercapitalized." Based on those regulations effective at June 30, 2002, all of the Corporation's subsidiary banks were designated as "well capitalized," the highest capital category. Capital adequacy guidelines generally restrict the inclusion of intangible assets in Tier 1 capital; however, servicing assets 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 June 30, 2002, the Corporation's intangible assets totaled $348 million, including approximately $312 million of intangibles excluded under capital guidelines. The Corporation's and HTSB's tangible Tier 1 leverage ratios (which exclude all intangibles) were 7.44 percent and 8.88 percent, respectively, for the second quarter of 2002. 17 -------------------------------------------------------------------------------- The following is a summary of the Corporation's capital ratios:

-------------------------------------------------------------------------------- NONPERFORMING ASSETS

Nonperforming assets consist of loans placed on nonaccrual status when collection of principal or 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 earning assets. Nonperforming assets at June 30, 2002 totaled $196 million, or 1.22 percent of total loans, down from $220 million or 1.37 percent of total loans at March 31, 2002 and up from $150 million or 0.97 percent of total loans a year ago. Interest shortfall for the six months ended June 30, 2002 was $7.0 million compared to $5.3 million one year earlier. 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. Impaired loans are measured by the Corporation at the present value of expected future cash flows or, alternatively, at the fair value of collateral. Known losses of principal on these loans have been charged off. Interest income on nonaccrual loans is recognized only at the time cash is received and only if the collection of the entire principal balance is expected. Interest income on restructured loans is accrued according to the most recently agreed upon contractual terms. The average impaired loan balance for the quarter ended June 30, 2002 was $204 million, down from $217 million for the quarter ended March 31, 2002 and up from 18 -------------------------------------------------------------------------------- $128 million for the quarter ended June 30, 2001. The average impaired loan balance for the six months ended June 30, 2002 was $211 million compared to $122 million for the six months ended June 30, 2001.

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The Corporation's provision for loan losses for the current quarter was $26.7 million up 3 percent from $26.0 million in last year's second quarter. On a year-to-date basis, provisions measured $59.4 million, representing a 41 percent rise over the $42.0 million reported for the first six months of 2001. The year-to-date total reflects a peak in net charge-off activity in the first quarter of 2002, which moderated into the second quarter as the economy began to show signs of strengthening and consumer confidence showed gradual improvement. Net charge-offs for the current quarter totaled $23.9 million, or 0.59 percent of average loans annualized, compared to $27.1 million or 0.69 percent of average loans annualized a year ago. While the absolute dollar amount of gross charge-offs rose for second quarter 2002 relative to last year's second quarter, the ratio contracted due to the combined effect of greater recoveries on prior charge-offs for second quarter 2002 and an increase in average loans year over year. On a year-to-date basis, net charge-offs measured $61.8 million or 0.77 percent of average loans annualized, versus $45.6 million one year ago or 0.59 percent of average loans annualized. This reflected the peak in gross charge-off experience for first quarter 2002 due to the deterioration of commercial credit quality over the course of the recession. At June 30, 2002, the allowance for possible loan losses was $290 million, equal to 1.80 percent of loans outstanding, compared to $167 million, or 1.08 percent of total loans one year ago. The allowance's coverage of non-performing loans strengthened from 113 percent at June 30, 2001, to 149 percent at June 30, 2002, despite a $47 million, or 31 percent, rise in non-performing loans relative to one year ago. This was substantially reflective of the impact of a special provision taken in third quarter 2001 to ensure adequate coverage of the expected loss within the portfolio. Relative to first quarter 2002, non-performing loans exhibited a $24 million, or 11 percent, contraction, reflecting the combined impacts of payments received and charge-offs recognized. Management's assessment of the adequacy of the loan loss reserve continues to be based upon a comprehensive and ongoing review of the Corporation's loan portfolio, including assessments of both historical and prospective quantitative and qualitative factors, along with rigorous stress testing of higher risk credits. During the second quarter, the economy appeared to have made the transition from recession into recovery, expanding at a moderate pace through the first half of the year. Economic growth thus far has been uneven, with some major sectors showing signs of improvement, with others softening or remaining weak. While consumers remain heavily leveraged, consumer debt service burdens actually exhibited a decline in the first 20 -------------------------------------------------------------------------------- quarter 2002 due to lower tax rates, thus providing some relief to consumers and relieving a constraint on their spending. The potential for continued and significant disruptions to the capital markets remains a concern due to disclosures of accounting improprieties among prominent corporations and continued uncertainty regarding corporate performance. As a consequence, the Corporation anticipates slow economic growth through the balance of 2002 and into 2003. Based on this economic outlook and the predictable lag in its positive effect, the Corporation expects non-performing loans to remain relatively stable, with some fluctuation around a gradually declining trend line. Management will continue to monitor portfolio quality closely for any divergence from expectations. -------------------------------------------------------------------------------- LIQUIDITY AND SOURCES OF FUNDS 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 needs. 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 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. Some level of liquidity is provided by maintaining assets which mature within a short timeframe 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 34 percent of the Corporation's total assets and amounted to $9.35 billion at June 30, 2002. However, the most important source of liquidity is the ability to raise funds, as required, in a variety of markets using multiple instruments. 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 Bank of Montreal ("BMO") that terminated on December 8, 2001. At that time, the Corporation renewed the $150 million revolving credit agreement, which will expire on December 7, 2002. There were no borrowings under either credit facility in year-to-date 2002 or 2001. The Corporation's average volume of core deposits, consisting of domestic and foreign demand deposits, interest checking deposits, money market accounts, passbook and statement savings accounts, savings certificates and noninterest-bearing time deposits increased from $14.69 billion or 59 percent of total non-equity funding at June 30, 2001 to $16.18 billion or 68 percent of total non-equity funding at June 30, 2002. Passbook and savings accounts experienced the largest growth, up $1.32 billion or 72 percent over June 30, 2001 levels. Savings certificates and money market deposit accounts increased by $264 million or 7 percent and by $344 million or 8 percent over second quarter 2001 levels, respectively. Interest checking deposits increased by $219 million or 16 percent to $1.58 billion. Domestic and foreign demand deposits decreased by $653 million or 20 percent to $2.67 billion. The quarterly average volume of wholesale deposits and short-term borrowings decreased from $10.41 billion or 41 percent of total non-equity funding at June 30, 2001 to $7.47 billion or 32 percent of total non-equity funding at June 30, 2002. Total deposits averaged $19.28 billion in the second quarter of 2002, an increase of $784 million compared to the same quarter last year. Average money market assets in the second quarter of 2002 were $881 million an increase of $452 million from the same quarter last year. These assets represented 4 percent of average earning assets in second quarter 2002. Average money market liabilities decreased 36 percent from $5.79 billion in the same quarter last year to $3.70 billion this quarter. 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 June 30, 2002, $650 million of senior notes were outstanding compared to $985 million at June 30, 2001. 21 -------------------------------------------------------------------------------- FORWARD-LOOKING INFORMATIONThis Report contains certain forward-looking statements and information that are 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," "will," 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. -------------------------------------------------------------------------------- MARKET RISK MANAGEMENT As described in the Corporation's Form 10-K for the year ended December 31, 2001, the Corporation's market risk is composed primarily of interest rate risk. There have been no material changes in market risk or the manner in which the Corporation manages market risk since December 31, 2001. -------------------------------------------------------------------------------- HARRIS BANKCORP, INC. AND SUBSIDIARIES SIX MONTHS ENDED JUNE 30, 2002 COMPARED WITH 2001 The Corporation's earnings for the six months ended June 30, 2002 were $142.0 million. This represented an increase of $16.2 million or 13 percent compared to a year ago. Cash ROE was 17.75 percent, up from 16.12 percent last year. Cash ROA was 1.12 percent compared to 0.96 percent a year ago. Net interest income on a fully taxable equivalent basis was $416.9 million in the current period, an increase of $38.9 million or 10 percent from the 2001 year-to-date period. Average earning assets declined 3 percent to $24.51 billion from $25.30 billion a year ago, although average loans increased by 4 percent or $578 million. Residential mortgages, consumer and small business loans contributed to the loan growth. Net interest margin increased from 3.01 percent in the six months ended June 30, 2001 to 3.42 percent currently. The year-to-date 2002 provision for loan losses of $59.4 million was up $17.4 million from $42.0 million a year ago. Net charge-offs were $61.8 million, an increase of $16.1 million from last year, primarily reflecting an increase in commercial loan write-offs. Noninterest income of $259.8 million increased $38.8 million or 18 percent from the same period last year. Most of this increase resulted from additional net gains from securities sales of $17.2 million and higher service charges on deposits of $19.2 million. Noninterest expense of $400.1 million was $34 million or 9 percent higher than last year. Excluding the impact of the acquisition of First National Bank of Joliet, and a one-time cost associated with the disposition of the Corporation's New York trust subsidiary following sale of the corporate trust business in 2000, noninterest expense rose 2 percent in the six month period ended June 30, 2002. Income tax expense increased $14.8 million, reflecting substantially higher pretax income. 22 -------------------------------------------------------------------------------- OPERATING SEGMENT REVIEW PERSONAL AND COMMERCIAL CLIENT GROUP Net income for Personal and Commercial Client Group in the six month period of 2002 was $62.4 million, up $26.9 million from the year-ago period. Total revenue was $317.9 million, an increase of $66.7 million or 27 percent from $251.2 million in 2001. This increase was primarily due to volume growth in consumer, mortgage and small business lending as well as growth in retail deposits, higher interest margins and the acquisition of Joliet. Noninterest expense of $207.2 million increased $24.1 million from 2001, as a result of the acquisition of Joliet and costs in support of increased volume. Income taxes increased by $16.4 million in the current year, reflecting higher pretax income. INVESTMENT BANKING GROUP Net income for Investment Banking Group was $77.1 million in 2002, a decrease of 1 percent from $77.6 million a year ago. Total revenue of $255.9 million decreased by $15.1 million or 6 percent from 2001 primarily due to reduced loan volumes and lower bond trading profits partially offset by higher security gains and fee revenue. Net income was also impacted by a lower loan loss provision of $9.3 million. Noninterest expense decreased $5.0 million to $103.8 million in the current year due to cost containment efforts. Income taxes decreased by $0.3 million during the year, reflecting slightly lower pretax income. PRIVATE CLIENT GROUP Net income for Private Client Group was $11.9 million in 2002, a decrease of 3 percent from $12.2 million a year ago. Total revenue of $103.2 million decreased $0.2 million from 2001, as increased margins were offset by declining investment management fees. Noninterest expense increased $0.9 million or 1 percent to $83.4 million in the current year, primarily due to the cost of expansion strategies and initiatives. Income taxes decreased $0.8 million during the year, reflecting lower pretax income. EMFISYS AND CORPORATE SUPPORT Emfisys and Corporate Support had a net loss for the six month period of $9.4 million, compared to net income of $0.5 million in 2001. Provision for loan losses increased $27.3 million due to the change to expected loss methodology. The Corporation's overall provision for loan losses was determined in order to maintain the allowance for loan losses at a level sufficient to cover losses inherent in the consolidated loan portfolio. Provisions are allocated to the operating segments based on average historical losses over a complete economic cycle. The differences between the total of the Corporation's business line allocation of provisions and its total required provisions under generally accepted accounting principles are allocated to Corporate Support. Compared with the six month period of the prior year, the current provision for loan losses in Corporate Support increased. In 2001, the excess of actual provisions over average historical losses was charged to the operating segments to which they related, rather than to Corporate Support. For further provision information, see the discussion of the Allowance for Possible Loan Losses section on page 20 of this report. Noninterest expenses increased $14.0 million in the current year. This increase was due to a one-time cost associated with the disposition of the Corporation's New York trust subsidiary following sale of the corporate trust business in 2000 and costs associated with business initiatives. Income tax benefits increased $5.2 million in the current year, reflecting lower pretax income. 23 Harris Bankcorp, Inc. and Subsidiaries -------------------------------------------------------------------------------- HARRIS BANKCORP, INC. 111 West Monroe Street Chicago, Illinois 60603 ------------------------------ HARRIS BANKCORP, INC. EXECUTIVE OFFICERS Alan G. McNally Chairman of the Board and Chief Executive Officer Edward W. Lyman, Jr. Vice Chair of the Board ------------------------------ HARRIS BANKCORP, INC. BOARD OF DIRECTORS Alan G. McNally Chairman of the Board and Chief Executive Officer Edward W. Lyman, Jr. Vice Chair of the Board Pastora San Juan Cafferty Professor University of Chicago School of Social Service Administration Haven E. Cockerham Senior Vice President Human Resources R.R. Donnelley & Sons Company F. Anthony Comper Chairman and Chief Executive Officer Bank of Montreal Susan T. Congalton Managing Director Lupine L.L.C. Wilbur H. Gantz Retired Chairman of the Board and Chief Executive Officer PathoGenesis Corporation James J. Glasser Chairman Emeritus GATX Corporation Dr. Leo M. Henikoff President Emeritus Rush University Richard M. Jaffee Chairman Oil-Dri Corporation of America Charles H. Shaw Chairman The Shaw Company Richard E. Terry Chairman and Chief Executive Officer Peoples Energy Corporation ------------------------------ HARRIS BANKCORP, INC. BANK SUBSIDIARIES HARRIS TRUST AND SAVINGS BANK Chicago, Illinois HARRIS BANK ARGO Summit, Illinois HARRIS BANK ARLINGTON-MEADOWS Rolling Meadows, Illinois HARRIS BANK AURORA, N.A. Aurora, Illinois HARRIS BANK BARRINGTON, N.A. Barrington, Illinois SUBURBAN BANK OF BARRINGTON Barrington, Illinois HARRIS BANK BARTLETT Bartlett, Illinois HARRIS BANK BATAVIA, N.A. Batavia, Illinois HARRIS BANK CARY-GROVE Cary, Illinois HARRIS BANK ELK GROVE, N.A. Elk Grove Village, Illinois HARRIS BANK FRANKFORT Frankfort, Illinois HARRIS BANK GLENCOE - NORTHBROOK, N.A. Glencoe, Illinois HARRIS BANK HINSDALE, N.A. Hinsdale, Illinois HARRIS BANK HOFFMAN-SCHAUMBURG Schaumburg, Illinois HARRIS BANK HUNTLEY Huntley, Illinois HARRIS BANK JOLIET, N.A. Joliet, Illinois HARRIS BANK LIBERTYVILLE Libertyville, Illinois HARRIS BANK MARENGO Marengo, Illinois HARRIS BANK NAPERVILLE Naperville, Illinois HARRIS BANK OAKBROOK TERRACE Oakbrook Terrace, Illinois HARRIS BANK PALATINE, N.A. Palatine, Illinois HARRIS BANK ROSELLE Roselle, Illinois HARRIS BANK ST. CHARLES St. Charles, Illinois HARRIS BANK WESTCHESTER Westchester, Illinois HARRIS BANK WILMETTE, N.A. Wilmette, Illinois HARRIS BANK WINNETKA, N.A. Winnetka, Illinois HARRIS BANK WOODSTOCK Woodstock, Illinois HARRIS TRUST BANK OF ARIZONA Scottsdale, Arizona HARRIS TRUST/BANK OF MONTREAL (FORMERLY HARRIS TRUST COMPANY OF FLORIDA) West Palm Beach, Florida ------------------------------ HARRIS BANKCORP, INC. NON-BANK SUBSIDIARIES HARRIS TRUST COMPANY OF NEW YORK New York, New York HARRIS TRUST COMPANY OF CALIFORNIA Los Angeles, California HARRIS LIFE INSURANCE COMPANY Scottsdale, Arizona HARRIS INVESTMENT MANAGEMENT, INC. Chicago, Illinois HARRIS BANK INTERNATIONAL CORPORATION New York, New York MIDWESTERN HOLDINGS, INC. Chicago, Illinois HARRIS TRADE SERVICES LIMITED Hong Kong HARRIS PREFERRED CAPITAL CORPORATION Chicago, Illinois HARRIS PROCESSING CORPORATION Chicago, Illinois HARRIS CAPITAL HOLDINGS, INC. Dover, Delaware

HARRIS BANKCORP INC 10-Q