Edgar Filing: HARRIS PREFERRED CAPITAL CORP

10-Q

United States

Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

Quarterly Report under Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2011

Commission file number 1-13805

Harris Preferred Capital Corporation

(Exact name of registrant as specified in its charter)


Maryland		# 36-4183096
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

111 West Monroe Street, Chicago, Illinois		60603
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (312) 461-2121

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Name of each exchange on

which registered

7 3/8% Noncumulative Exchangeable

Preferred Stock, Series A, par value

$1.00 per share

New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T(232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether this registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	x	Smaller reporting company	¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

The number of shares of Common Stock, $1.00 par value, outstanding on November 14, 2011 was 1,180. No common equity is held by nonaffiliates.

Harris Preferred Capital Corporation

TABLE OF CONTENTS


Part I	FINANCIAL INFORMATION

Item 1.	Financial Statements:
	Consolidated Balance Sheets	1
	Consolidated Statements of Income and Comprehensive Income	2
	Consolidated Statements of Changes in Stockholders’ Equity	3
	Consolidated Statements of Cash Flows	4
	Notes to Consolidated Financial Statements	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	24

Item 4T.	Controls and Procedures	24

Part II	OTHER INFORMATION

Item 6.	Exhibits	25

Signatures		26

Harris Preferred Capital Corporation

Consolidated Balance Sheets


	Sept 30, 2011		December 31, 2010			Sept 30, 2010
	(unaudited)		(audited)			(unaudited)
	(in thousands, except share data)
Assets
Cash on deposit with BMO Harris Bank N.A.	$	1,309	$	525		$	649
Securities purchased from BMO Harris Bank N.A. under agreement to resell		24,000		23,500			12,500

Total cash and cash equivalents	$	25,309	$	24,025		$	13,149

Notes receivable from BMO Harris Bank N.A.		2,835		3,369			3,422
Securities available-for-sale, at fair value
Mortgage-backed		447,092		516,911			512,370
U.S. Treasury Bills		115,000		40,000			61,999
Other assets		1,306		1,781			1,798

Total assets	$	591,542	$	586,086		$	592,738

Liabilities and Stockholders’ Equity
Accrued expenses	$	38	$	114		$	41
Accrued taxes payable and deferred tax liabilities		1,778		1,144			1,625

Total liabilities	$	1,816	$	1,258		$	1,666

Stockholders’ Equity
7 3/8% Noncumulative Exchangeable Preferred Stock, Series A ($1 par value); liquidation value of $250,000; 20,000,000 shares authorized; 10,000,000 shares issued and outstanding	$	250,000	$	250,000		$	250,000
Common stock ($1 par value); 5,000 shares authorized; 1,180 issued and outstanding		1		1			1
Additional paid-in capital		320,733		320,733			320,733
Earnings in excess of (less than) distributions		1,295		(255	)		(293	)
Accumulated other comprehensive income — net unrealized gains on available-for-sale securities		17,697		14,349			20,631

Total stockholders’ equity	$	589,726	$	584,828		$	591,072

Total liabilities and stockholders’ equity	$	591,542	$	586,086		$	592,738

The accompanying notes are an integral part of these financial statements.

Harris Preferred Capital Corporation

Consolidated Statements of Income

and Comprehensive Income

(Unaudited)


	Quarter Ended September 30,					Nine Months Ended September 30,
	2011		2010			2011		2010
	(in thousands)					(in thousands)
Interest income:
Securities purchased from BMO Harris Bank N.A. under agreement to resell	$	5	$	23		$	37	$	61
Notes receivable from BMO Harris Bank N.A.		43		55			148		168
Securities available-for-sale:
Mortgage-backed		4,026		4,981			13,227		15,388
U.S. Treasury Bills		1		3			2		7

Total interest income	$	4,075	$	5,062		$	13,414	$	15,624


Noninterest income:
Gain on sale of securities	$	1,258	$	—		$	4,328	$	—

Total income	$	5,333	$	5,062		$	17,742	$	15,624


Operating expenses:
Loan servicing fees paid to BMO Harris Bank N.A.	$	2	$	3		$	7	$	8
Advisory fees paid to BMO Harris Bank N.A.		38		34			106		136
General and administrative		60		24			255		232

Total operating expenses	$	100	$	61		$	368	$	376


Income before income taxes	$	5,233	$	5,001		$	17,374	$	15,248
Applicable state income taxes		498		365			1,650		1,113

Net Income	$	4,735	$	4,636		$	15,724	$	14,135
Preferred stock dividends		4,609		4,609			13,827		13,827

Net income available to common stockholder	$	126	$	27		$	1,897	$	308

Basic and diluted earnings per common share	$	107	$	23		$	1,608	$	261

Net income	$	4,735	$	4,636		$	15,724	$	14,135
Other comprehensive income:
Available-for-sale securities:
Unrealized holding gains/ (losses) arising during the period, net of deferred state taxes		4,936		(1,210	)		7,265		8,274
Less reclassification adjustment for realized gains included in net income		1,139		—			3,917		—

Comprehensive income	$	8,532	$	3,426		$	19,072	$	22,409

The accompanying notes are an integral part of these financial statements.

Harris Preferred Capital Corporation

Consolidated Statements of Changes in Stockholders’ Equity

(Unaudited)


	Nine Months Ended September 30
	2011			2010
	(in thousands)

Balance at January 1	$	584,828		$	582,490
Net income		15,724			14,135
Other comprehensive income		3,348			8,274
Dividends on common stock		(347	)		—
Dividends (preferred stock $0.46094 per share)		(13,827	)		(13,827	)

Balance at September 30	$	589,726		$	591,072

The accompanying notes are an integral part of these financial statements.

Harris Preferred Capital Corporation

Consolidated Statements of Cash Flows

(Unaudited)


	Nine Months Ended September 30,
	2011			2010
	(in thousands)
Operating Activities:
Net income	$	15,724		$	14,135

Adjustments to reconcile net income to net cash provided by operating activities:
Gain on sale of securities		(4,328	)		—
Decrease in other assets		475			87
Decrease in accrued expenses		(76	)		(70	)
Increase in accrued taxes payable and deferred taxes		634			652

Net cash provided by operating activities	$	12,429		$	14,804

Investing Activities:
Repayments of notes receivable from BMO Harris Bank N.A.	$	534		$	162
Purchases of securities available-for-sale		(339,837	)		(288,466	)
Proceeds from maturities/redemptions of securities available-for-sale		284,819			277,560
Proceeds from sales of securities available-for-sale		57,513			—

Net cash provided by (used in) investing activities	$	3,029		$	(10,744	)

Financing Activities:
Cash dividends paid on preferred stock	$	(13,827	)	$	(13,827	)
Cash dividends paid on common stock		(347	)		—

Net cash used in financing activities	$	(14,174	)	$	(13,827	)

Net decrease in cash and cash equivalents with BMO Harris Bank N.A.	$	1,284		$	(9,767	)
Cash and cash equivalents with BMO Harris Bank N.A. at beginning of period		24,025			22,916

Cash and cash equivalents with BMO Harris Bank N.A. at end of period	$	25,309		$	13,149

The accompanying notes are an integral part of these financial statements.

Harris Preferred Capital Corporation

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.	Basis of Presentation

Harris Preferred Capital Corporation (the “Company”) is a Maryland corporation whose principal business objective is to acquire, hold, finance and manage qualifying real estate investment trust (“REIT”) assets (the “Mortgage Assets”), consisting of a limited recourse note or notes (the “Notes”) issued by BMO Harris Bank N.A., formerly known as Harris N.A. (the “Bank”) secured by real estate mortgage assets (the “Securing Mortgage Loans”) and other obligations secured by real property, as well as certain other qualifying REIT assets, primarily U.S. treasury securities and securities collateralized with real estate mortgages. The Company holds its assets through a Maryland real estate investment trust subsidiary, Harris Preferred Capital Trust. Harris Capital Holdings, Inc., owns 100% of the Company’s common stock. The Bank owns all common stock outstanding issued by Harris Capital Holdings, Inc.

The accompanying consolidated financial statements have been prepared by management from the books and records of the Company. These statements reflect all adjustments and disclosures which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented and should be read in conjunction with the notes to financial statements included in the Company’s 2010 Form 10-K. Certain reclassifications were made to conform prior years’ financial statements to the current year’s presentation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission.

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Recent Accounting Pronouncements

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring”, in April 2011. The standard clarifies the existing guidance on a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring is a troubled debt restructuring. The Company’s adoption of this standard during the third quarter 2011, had no impact on the Company’s financial position or results of operations.

The FASB issued ASU No. 2011-03, “Reconsideration of Effective Control for Repurchase Agreements” in April 2011. The ASU removes from the assessment of effective control the criterion requiring a transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and the collateral maintenance implementation guidance related to that criterion. The ASU is effective for the first interim or annual period beginning on or after December 15, 2011 and is to be applied prospectively to new transactions or modifications of existing transactions that occur on or after the effective date. Repurchase transactions entered into by the Company are accounted for as secured borrowings; therefore, the adoption of this ASU, effective January 1, 2012, is not expected to have an impact on the Company’s consolidated financial position or results of operations.

The FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” in May 2011. The ASU attempts to clarify the FASB’s intent about the application of existing fair value measurement requirements and changes certain principles or requirements for measuring fair value or for disclosing information about fair value measurements. The ASU’s

amendments will result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs and are effective for the first interim or annual period beginning on or after December 15, 2011. The adoption of this ASU by the Company, effective January 1, 2012, will result in additional fair value measurement disclosures, but is not expected to have a material impact on the consolidated financial position or results of operations.

The FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income” in June 2011. The ASU addresses the presentation of comprehensive income and provides entities with the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The provisions of this ASU, which are effective for the first interim or annual period beginning on or after December 15, 2011, do not change the items that must be reported in other comprehensive income, when an item of other comprehensive income must be reclassified to net income, the presentation of the tax effects on other comprehensive income or how earnings per share is calculated or presented. Since this ASU addresses financial statement presentation only, its adoption, effective January 1, 2012 will not impact the Company’s consolidated financial position or results of operations.

2.	Commitments and Contingencies

Legal proceedings in which the Company is a defendant may arise in the normal course of business. There is no pending litigation against the Company at September 30, 2011.

3. Securities

The amortized cost and estimated fair value of securities available-for-sale were as follows:


	September 30, 2011
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
	(in thousands)
Available-for-Sale Securities
Residential mortgage-backed	$	427,539	$	19,553	$	—	$	447,092
U.S. Treasury Bills		115,000		—		—		115,000

Total Securities	$	542,539	$	19,553	$	—	$	562,092


	December 31, 2010
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
	(in thousands)
Available-for-Sale Securities
Residential mortgage-backed	$	501,435	$	17,439	$	1,963	$	516,911
U.S. Treasury Bills		40,000		—		—		40,000

Total Securities	$	541,435	$	17,439	$	1,963	$	556,911


	September 30, 2010
	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
	(in thousands)
Available-for-Sale Securities
Residential mortgage-backed	$	490,115	$	22,289	$	34	$	512,370
U.S. Treasury Bills		61,999		—		—		61,999

Total Securities	$	552,114	$	22,289	$	34	$	574,369

The Company classifies all securities as available-for-sale. Available-for-sale securities are reported at fair value with unrealized gains and losses included as a separate component of stockholders’ equity. At September 30, 2011, net unrealized gains on available-for-sale securities were $19.5 million compared to $15.5 million of net unrealized gains on December 31, 2010 and $22.2 million of net unrealized gains at September 30, 2010.

In making a determination of temporary vs. other-than-temporary impairment of an investment, a major consideration of management is whether the Company will be able to collect all amounts due according to the contractual terms of the investment. Such a determination involves estimation of the outcome of future events as well as knowledge and experience about past and current events. Factors considered include the following: whether the fair value is significantly below cost and whether the decline is attributable to specific adverse conditions in an industry or geographic area; the period of time the decline in fair value has existed; if an outside rating agency has downgraded the investment; if dividends have been reduced or eliminated; if scheduled interest payments have not been made and finally, whether the financial condition of the issuer has deteriorated. In addition, it may be necessary for the Company to demonstrate its ability and intent to hold a debt security to maturity.

The following tables summarize residential mortgage-backed securities with unrealized losses, the amount of the unrealized loss and the related fair value of the securities with unrealized losses. The unrealized losses have been further segregated by mortgage-backed securities that have been in a continuous unrealized loss position for less than 12 months and those that have been in an unrealized loss position for greater than 12 months. As of September 30, 2011, there were no securities in an unrealized loss position. As of December 31, 2010 and September 30, 2010 there were no securities that were in an unrealized loss position for 12 or more months. Management believes that all of the unrealized losses, caused by interest rate increases on investments in mortgage-backed securities, are temporary. The contractual cash flows of these securities are guaranteed directly by a U.S. government-sponsored enterprise. It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company has the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired. There was a $1.1 million reclassification adjustment for the three month period ended September 30, 2011. There was a $3.9 million reclassification adjustment for realized securities gains to other comprehensive income for the nine month period ended September 30, 2011. There were no reclassification adjustments to other comprehensive income during the three or nine month periods ended September 30, 2010.


	December 31, 2010
	Length of Continuous Unrealized Loss Position
	Less than 12 months				12 months or longer				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(in thousands)
Residential mortgage-backed	$	79,133	$	1,963	$	—	$	—	$	79,133	$	1,963

Total	$	79,133	$	1,963	$	—	$	—	$	79,133	$	1,963


	September 30, 2010
	Length of Continuous Unrealized Loss Position
	Less than 12 months				12 months or longer				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(in thousands)
Residential mortgage-backed	$	18,155	$	34	$	—	$	—	$	18,155	$	34

Total	$	18,155	$	34	$	—	$	—	$	18,155	$	34

The amortized cost and estimated fair value of total available-for-sale securities as of September 30, 2011, 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.


	September 30, 2011
	(in thousands)
	Amortized Cost		Fair Value
Maturities:
Within 1 year	$	115,000	$	115,000
1 to 5 years		4,434		4,563
5 to 10 years		76,769		82,315
Over 10 years		346,336		360,214

Total	$	542,539	$	562,092

4. Fair Value Measurements

Fair value represents the estimate of the proceeds to be received, or paid in the case of a liability, in a current transaction between willing parties. ASC 820 establishes a fair value hierarchy to categorize the inputs used in valuation techniques to measure fair value. Inputs are either observable or unobservable in the marketplace. Observable inputs are based on market data from independent sources and unobservable inputs reflect the reporting entity’s assumptions about market participant assumptions used to value an asset or liability. Level 1 includes quoted prices in active markets for identical instruments. Level 2 includes quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in inactive markets; and model-derived valuations using observable market information for significant inputs. Level 3 includes valuation techniques where one or more significant inputs are unobservable. Financial instruments are classified according to the lowest level input that is significant to their valuation. A financial instrument that has a significant unobservable input along with significant observable inputs may still be classified Level 3.

The Company has investments in U.S. Treasury securities that are classified as Level 1, and has U.S. government sponsored residential mortgage-backed securities that are classified in Level 2 of the fair value hierarchy. External vendors typically use pricing models to determine fair values for the securities. Standard market inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets and additional market reference data.

The valuations of assets that are measured at fair value on a recurring basis at September 30, 2011, December 31, 2010 and September 30, 2010 are presented in the following table.


	Fair Value		Fair Value Measurements Using
	September 30, 2011		Level 1		Level 2		Level 3
			(in thousands)
Available-for-sale securities
Residential mortgage-backed	$	447,092	$	—	$	447,092	$	—
U.S. Treasury		115,000		115,000		—		—

	$	562,092	$	115,000	$	447,092	$	—


	Fair Value		Fair Value Measurements Using
	December 31, 2010		Level 1		Level 2		Level 3
			(in thousands)
Available-for-sale securities
Residential mortgage-backed	$	516,911	$	—	$	516,911	$	—
U.S. Treasury		40,000		40,000		—		—

	$	556,911	$	40,000	$	516,911	$	—


	Fair Value		Fair Value Measurements Using
	September 30, 2010		Level 1		Level 2		Level 3
			(in thousands)
Available-for-sale securities
Residential mortgage-backed	$	512,370	$	—	$	512,370	$	—
U.S. Treasury		61,999		61,999		—		—

	$	574,369	$	61,999	$	512,370	$	—

5. Fair Value of Financial Instruments

FASB ASC 825, “Financial Instruments”, requires the disclosure of estimated fair values for both on and off-balance-sheet financial instruments. The Company’s fair values are based on quoted market prices when available. For financial instruments not actively traded, such as Notes receivable from BMO Harris Bank N.A., fair values have been estimated using various valuation methods and assumptions. The fair value estimates presented herein are not necessarily indicative of the amounts the Company could realize in an actual transaction. The fair value estimation methodologies employed by the Company were as follows:

Fair value was assumed to equal carrying value for cash on deposit with the Bank, securities purchased from BMO Harris Bank N.A. under agreement to resell and accrued interest receivable which is included in other assets, due to their short term nature.

The fair value of notes receivable from BMO Harris Bank N.A. was estimated using a discounted cash flow calculation utilizing current market rates offered by BMO Harris Bank N.A. as the discount rates.

The fair value of securities available-for-sale and the methods used to determine fair value are provided in Notes 3 and 4 to the Consolidated Financial Statements.

The estimated fair values of the Company’s financial instruments at September 30, 2011, December 31, 2010 and September 30, 2010 are presented in the following table.


	September 30, 2011				December 31, 2010				September 30, 2010
	Carrying Value		Fair Value		Carrying Value		Fair Value		Carrying Value		Fair Value
	(in thousands)				(in thousands)				(in thousands)
Assets
Cash on deposit with BMO Harris Bank N.A.	$	1,309	$	1,309	$	525	$	525	$	649	$	649
Securities purchased from BMO Harris Bank N.A. under agreement to resell		24,000		24,000		23,500		23,500		12,500		12,500
Notes receivable from BMO Harris Bank N.A.		2,835		4,965		3,369		4,758		3,422		5,426
Securities available-for-sale		562,092		562,092		556,911		556,911		574,369		574,369
Other assets		1,306		1,306		1,781		1,781		1,798		1,798

Total on-balance-sheet financial assets	$	591,542	$	593,672	$	586,086	$	587,475	$	592,738	$	594,742

Operating Segment

The Company’s operations consist of monitoring and evaluating the investments in mortgage assets. Accordingly, the Company operates in only one segment. The company has no external customers and transacts most of its business with the Bank.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Information

The statements contained in this Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding the Company’s expectation, intentions, beliefs or strategies regarding the future. Forward-looking statements include the Company’s statements regarding tax treatment as a real estate investment trust, liquidity, provision for loan losses, capital resources and investment activities. In addition, in those and other portions of this document, the words “anticipate,” “believe,” “estimate,” “expect,” “intend” and other similar expressions, as they relate to the Company or the Company’s management, are intended to identify forward-looking statements. Such statements reflect the current views of the Company with respect to future events and are subject to certain risks, uncertainties and assumptions. It is important to note that the Company’s actual results could differ materially from those described herein as anticipated, believed, estimated or expected. Among the factors that could cause the results to differ materially are the risks discussed in Item 1A. “Risk Factors” in the Company’s 2010 Form 10-K and in the “Risk Factors” section included in the Company’s Registration Statement on Form S-11 (File No. 333-40257), with respect to the Preferred Shares declared effective by the Securities and Exchange Commission on February 5, 1998. The Company assumes no obligation to update any such forward-looking statement.

Results of Operations

Third Quarter 2011 Compared with Third Quarter 2010

The Company’s net income for the third quarter of 2011 was $4.7 million, compared to $4.6 million from the third quarter of 2010.

Interest income on securities purchased from BMO Harris Bank N.A. under agreement to resell for the third quarter of 2011 was $5 thousand, on an average balance of $84 million, with an annualized yield of 0.02%. During the same period in 2010, the interest income on securities purchased from BMO Harris Bank N.A. under agreement to resell was $23 thousand, on an average balance of $60 million, with an annualized yield of 0.15%. The Federal Funds rate at September 30, 2011 was .06% compared to the Federal Fund rate at September 30, 2010 of .19%. Third quarter 2011 interest income on the Notes receivable from BMO Harris Bank N.A. totaled $43 thousand and yielded 6.1% on $2.8 million of average principal outstanding for the quarter compared to $55 thousand and a 6.4% yield on $3.4 million average principal outstanding for third quarter 2010. The decrease in income was attributable to a reduction in the Notes receivable from BMO Harris Bank N.A. balance because of customer payoffs in the Securing Mortgage Loans. At September 30, 2011 and 2010, there were no Securing Mortgage Loans on nonaccrual status. Interest income on securities available-for-sale for the current quarter was $4.0 million resulting in a yield of 3.38% on an average balance of $476 million, compared to $5.0 million with a yield of 3.96% on an average balance of $504 million for the same period a year ago. Virtually all income in the current quarter was attributable to the residential mortgage-backed security portfolio. Market yields on these types of securities are expected to decline.

There were no Company borrowings during the third quarter 2011 or 2010.

Gains from mortgage-backed investment securities sales for the quarter ended September 30, 2011 were $1.3 million. There were no investment securities sales for the same period a year ago.

Third quarter 2011 operating expenses totaled $100 thousand, an increase of $39 thousand or 64% from the third quarter of 2010. General and administrative expenses totaled $60 thousand, an increase of $36 thousand over the same period in 2010 primarily caused by adjustments to insurance costs that lowered such costs by approximately $30 thousand in the prior quarter ended September 30, 2010. Advisory fees for the third quarter 2011 were $38 thousand compared to $34 thousand for the same period in 2010. There was an increase in tax expense of $133 thousand for the quarter ended September 30, 2011 due to an increase in the Illinois statutory tax rate from 7.3% in 2010 to 9.5% in 2011.

On September 30, 2011, the Company paid a cash dividend of $0.46094 per share on outstanding Preferred Shares to the stockholders of record on September 15, 2011 as declared on August 31, 2011. On August 31, 2011 the Company paid a cash dividend of $347 thousand on the outstanding common shares to the common stockholder of record on August 31, 2011. On September 30, 2010, the Company paid a cash dividend of $0.46094 per share on outstanding Preferred Shares to the stockholders of record on September 15, 2010 as declared on September 1, 2010.

The National Bank Act requires all national banks, including the Bank, to obtain prior approval from the OCC if dividends declared by the national bank (including subsidiaries of the national bank (except for dividends paid by such subsidiary to the national bank)) in any calendar year, will exceed its net income for that year, combined with its retained income (as defined in the applicable regulations) for the preceding two years. These provisions apply to a national bank and its subsidiaries on a consolidated basis, notwithstanding the earnings of any subsidiary on a stand-alone basis. Beginning in 2009, the Bank no longer had sufficient capacity to declare and pay dividends without prior regulatory approval of the OCC. As a result, the Company, as an indirect subsidiary of the Bank, became subject to the provisions relating to dividend approval and the Bank had to receive prior approval from the OCC before the Company declared dividends on the Preferred Shares. Prior approval from the OCC was received for the dividend declaration in August 2011. Because the Bank’s third quarter 2011 earnings were sufficient to eliminate the need for OCC approval of dividends on the Preferred Shares that may be declared by the Company’s Board of Directors in the fourth quarter ending December 31, 2011, the Company was not required to obtain permission from the OCC for such a declaration. The need to request similar approvals from the OCC for subsequent quarters will be determined by the Bank’s earnings for those future periods. There is no assurance that the Bank and the Company will not be subject to the requirement to receive prior regulatory approvals for Preferred Shares dividend payments in the future or that, if required, such approvals will be obtained. At this time the Company has no reason to expect that such approvals, if required, will not be received.

Nine Months Ended September 30, 2011 compared with September 30, 2010

The Company’s net income for the nine months ended September 30, 2011 was $15.7 million. This represented a $1.6 million or 11.2% increase from earnings for the nine months ended September 30, 2010. Earnings increased primarily due to gains on sales of mortgage-backed securities in the first nine months of 2011.

Interest income on securities purchased under agreement to resell for the nine months ended September 30, 2011 was $37 thousand on an average balance of $72 million, with a yield of 0.07%. During the same period in 2010, the interest income on securities purchased under agreements to resell was $61 thousand, on an average balance of $64 million, with a yield of 0.13%. The Federal Funds rate at September 30, 2011 was .06% compared to the Federal Fund rate at September 30, 2010 of 0.15%. Interest income on the Notes receivable from BMO Harris Bank N.A. for the nine months ended September 30, 2011 totaled $148 thousand, yielding 6.3% on $3.2 million of average principal outstanding compared to $168 thousand, yielding 6.4% on $3.5 million of average principal outstanding for the nine months ended September 30, 2010. The decrease in income was attributable to a reduction in the Notes receivable from BMO Harris Bank N.A. balance resulting from customer payoffs on the Securing Mortgage Loans. Interest income on securities available-for-sale for the nine months ended September 30, 2011 was $13.2 million resulting in a yield of 3.6% on an average balance of $490 million, compared to $15.4 million resulting in a yield of 4.1% on an average balance of $498 million for the nine months ended September 30, 2010. The decrease in interest income from available-for-sale securities is primarily attributable to maturities in the portfolio of mortgaged-backed securities with reinvestment in similar securities at a lower yield. There were no Company borrowings during either period.

Gains from mortgage-backed investment securities sales were $4.3 million for the nine months ended September 30, 2011. There were no investment securities sales for the same period a year ago.

Operating expense for the nine months ended September 30, 2011 totaled $368 thousand, a decrease of $8 thousand or 2.1% from the same period a year ago. Advisory fees for the nine months ended September 30, 2011 were $106 thousand compared to $136 thousand for the same period a year ago primarily due to a reduction in

internal costs related to expenses of administering the Company’s activities. General and administrative expenses totaled $255 thousand, an increase of $23 thousand or 10% from the same period in 2010 as a result of increased processing costs and an adjustment lowering insurance costs in the same period in 2010.

Liquidity Risk Management

The objective of liquidity management is to ensure the availability of sufficient cash flows to meet all of the Company’s financial commitments. In managing liquidity, the Company takes into account various legal limitations placed on a REIT.

The Company’s principal asset management requirements are to maintain the current earning asset portfolio size through the acquisition of additional Notes or other qualifying assets in order to pay dividends to its stockholders after satisfying obligations to creditors. The acquisition of additional Notes or other qualifying assets is funded with the proceeds obtained as a result of repayment of principal balances of individual Securing Mortgage Loans or maturities or sales of securities. The payment of dividends on the Preferred Shares is made from legally available funds, arising from operating activities of the Company. The Company’s cash flows from operating activities principally consist of the collection of interest on the Notes, mortgage-backed securities and other earning assets. The Company does not have and does not anticipate having any material capital expenditures.

In order to remain qualified as a REIT, the Company must distribute annually at least 90% of its adjusted REIT ordinary taxable income, as provided for under the Internal Revenue Code, to its common and preferred stockholders. The Company currently expects to distribute dividends annually equal to 90% or more of its adjusted REIT ordinary taxable income.

The Company anticipates that cash and cash equivalents on hand and the cash flow from the Notes and mortgage-backed and U.S. treasury securities (including potential gains from sales of securities) will provide adequate liquidity for its operating, investing and financing needs including the capacity to continue preferred dividend payments on an uninterrupted basis.

As presented in the accompanying Consolidated Statements of Cash Flows, the primary sources of funds in addition to $12.4 million provided from operations during the nine months ended September 30, 2011, were $342.3 million from the maturities and sales of securities available-for-sale. In the prior period ended September 30, 2010, the primary sources of funds other than $14.1 million from operations were $277.6 million from the maturities of securities available-for-sale. The primary uses of funds for the nine months ended September 30, 2011 were $339.8 million for purchases of securities available-for-sale, $13.8 million in preferred stock dividends paid and $347 thousand in common stock dividends paid. For the prior year’s nine months ended September 30, 2010, the primary uses of funds were $288.5 million for purchases of securities available-for-sale and $13.8 million in preferred stock dividends paid.

Market Risk Management

The Company’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 Company manages market risk since December 31, 2010.

Tax Matters

As of September 30, 2011, the Company believes that it is in full compliance with the REIT federal tax rules, and expects to qualify as a REIT under the provisions of the Internal Revenue Code. The Company expects to meet all REIT requirements regarding the ownership of its stock and anticipates meeting the annual distribution requirements. Beginning January 1, 2009, Illinois requires a “captive” REIT to increase its state taxable income by the amount of dividends paid. Under this law, a “captive” REIT includes a REIT of which 50% of the voting power or value of the beneficial interest or shares is owned by a single person. Management believes that the Company would be classified as a “captive” REIT under Illinois law, in light of the fact that (1) all of the

Company’s outstanding common shares are held by Harris Capital Holdings, Inc. a wholly owned subsidiary of BMO Harris Bank N.A. and (2) the Company’s Common Stock represent more than 50% of the voting power of the Company’s equity securities and (3) the Common Stock is not listed for trading on an exchange. Management believes that the state tax expense to be incurred by the Company in future years should not have a material adverse effect upon the Company’s ability to declare and pay future dividends on the preferred shares. The current Illinois statutory tax rate is 9.5%, effective January 1, 2011. The prior year’s rate was 7.3%. This belief is based upon the ownership interest of the Company, whereby any tax expense incurred is expected to primarily reduce the net earnings available to the holder of the Company’s Common Stock. For the third quarter of 2011, $498 thousand of Illinois income tax was recorded compared to $365 thousand in the third quarter of 2010. For the year-to-date period ended September 30, 2011 the income tax expense was $1.7 million compared to $1.1 million or the same period in 2010.

Financial Statements of BMO Harris Bank N.A.

The following unaudited financial information for the Bank is included because the Company’s Preferred Shares are automatically exchangeable for a new series of preferred stock of the Bank upon the occurrence of certain events.

BMO HARRIS BANK N.A. AND SUBSIDIARIES (formerly Harris N.A. and Subsidiaries)

FINANCIAL REVIEW

Third Quarter 2011 Compared with Third Quarter 2010

Summary

On July 5, 2011, Bank of Montreal completed its acquisition of Milwaukee-based Marshall and Ilsley Corporation (“M&I”). At the time of the acquisition, the legal entities that merged with and into Harris N.A. included M&I Marshall & Ilsley Bank, M&I Bank N.A. and The Harris Bank, N.A. (a subsidiary of BMO Bankcorp, Inc.). At the time of these mergers, Harris N.A. changed its name to BMO Harris Bank N.A. (Note 1)

For the third quarter 2011, BMO Harris Bank N.A. and subsidiaries (the “Bank”) reported net income attributable to common stockholder of $160.5 million, an increase of $155.3 million from third quarter 2010 earnings of $5.2 million, mainly due to the significant increase in the size of the entity from the acquisition of M&I. Excluding the results of M&I as well as related costs for restructuring and integration, the Bank would have reported a net loss attributable to common stockholder of $13.4 million.

Net interest income was $807.8 million in the current quarter, up $583.5 million from a year ago, largely due to the additional net interest income associated with M&I. Excluding this net interest income, net interest income would have declined $17.3 million or 7.7 percent as lower earnings on loans were partially offset by a reduction in the cost of borrowings. Average earning assets increased to $82.4 billion in the third quarter of 2011 from $41.5 billion in 2010. This reflects the addition of $33.9 billion from M&I and an increase in lower-yielding interest bearing deposits placed at the Federal Reserve Bank ($7.1 billion) partially offset by a decrease in the Bank’s legacy loan balances ($1.3 billion). Net interest margin for the quarter was 3.93 percent, an increase of 172 basis points from 2.21 percent in the third quarter of 2010. The higher margin reflects $285.3 million related to the purchased loan portfolio discount amortization and higher yield on the M&I portfolio partially offset by reduced yields on the legacy loan portfolio and securities available-for-sale as well as the increase in the level of low-yielding interest bearing deposits placed at the Federal Reserve Bank. The margin was also favorably affected by reduced interest cost on long-term notes payable.

Provision for loan losses for the third quarter 2011 was $183.3 million, an increase of $145.5 million from $37.8 million in the third quarter 2010, mainly attributable to $132.0 million related to the M&I portfolio and $16.6 million of provision for loan losses related to loans associated with the acquisition of certain assets and liabilities of Rockford, IL based AMCORE Bank, N.A. (“Amcore”) from the Federal Deposit Insurance

Corporation (“FDIC”) on April 23, 2010 (Note 1), partially offset by the release of $28.0 million of general reserves of the legacy company. Net loan charge-offs during the quarter were $63.0 million compared to $64.9 million in the same period last year mainly due to lower commercial chare-offs. 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.

Noninterest income for the third quarter 2011 of $213.6 million reflects the addition of $101.9 million of fees and other income from M&I. Excluding this additional revenue, noninterest income decreased $28.8 million or 20.5 percent from a year ago driven by lower trading revenue ($20.5 million) and charge card income ($5.3 million) plus a reduction in the FDIC indemnification asset associated with the Amcore acquisition ($9.2 million) partially offset by higher net equity securities gains ($2.4 million) and other than temporary impairment on securities recorded in the prior year quarter ($4.7 million).

Third quarter 2011 noninterest expenses were $612.9 million, which reflects the addition of $223.9 million of operating expense, $36.1 million of integration costs, $23.6 million of intangible amortization, and $21.2 million of restructuring charges related to the M&I acquisition. Excluding these costs, expenses were down $19.7 million or 6.0 percent from the third quarter 2010 driven by lower marketing costs ($8.1 million), professional fees ($5.0 million) and provisioning for off balance sheet credit risk ($7.6 million). Income tax expense increased $70.6 million from the third quarter of 2010 due to increase in pre-tax income between periods. The tax benefit recorded a year ago exceeded pre-tax earnings primarily due to the benefit of certain tax exempt loans and investments as well as bank owned life insurance.

Nonperforming loans at September 30, 2011 totalled $957 million or 1.87 percent of total loans, up from $916 million or 4.00 percent of total loans at December 31, 2010 and $838 million or 3.60 percent a year earlier, primarily attributable to higher Harris legacy non-performing commercial loans. No M&I nonperforming loans are recorded as of September 30, 2011 as purchased impaired loans are not considered impaired per US GAAP. Nonperforming loans as a percentage of total loans decreased from last year attributable to higher total loans as a result of the acquisition of $29 billion M&I loan portfolio. At September 30, 2011, the allowance for loan losses was $837.9 million, equal to 1.64 percent of loans outstanding compared to $721.9 million or 3.16 percent of loans outstanding and $691.9 million or 2.97 percent of loans outstanding at December 31, 2010 and September 30, 2010, respectively. Coverage of nonperforming loans by the allowance for loan losses increased from 83 percent at September 30, 2010 to 88 percent at September 30, 2011, largely due to the addition of $117 million M&I allowance. At December 31, 2010, the ratio was 81 percent. Ratios reflect the fair value adjustments recorded on the M&I loan portfolio at the time of acquisition and the merger of The Harris Bank N.A. into the Bank effective July 5^th.

At September 30, 2011, total stockholders’ equity amounted to $13.8 billion, up $8.5 billion from December 31, 2010, largely due to the M&I acquisition, effected through the issuance of stock and capital contribution from BMO. Return on equity was 4.92 percent in the current quarter, compared to 0.41 percent in last year’s third quarter. Return on assets was 0.69 percent compared to 0.05 percent a year ago. The Bank did not declare any dividends on common stock in either the current quarter or in the year-ago quarter.

At September 30, 2011, Tier 1 capital of the Bank amounted to $8.6 billion, up $4.1 billion from a year ago, while risk-weighted assets increased by $33.6 billion to $62.1 billion. The Bank’s September 30, 2011 Tier 1 and total risk-based capital ratios were 13.81 percent and 16.24 percent compared to respective ratios of 15.98 percent and 17.87 percent at December 31, 2010 and 15.66 percent and 17.53 percent at September 30, 2010. The regulatory Tier 1 leverage capital ratio was 9.71 percent for the third quarter of 2011 compared to 9.64 percent at year-end 2010 and 10.07 percent a year ago. The Bank’s capital ratios significantly exceed the prescribed regulatory minimum for “well-capitalized” banks.

Nine Months Ended September 30, 2011 Compared with Nine Months Ended September 30, 2010

Summary

For the nine months ended September 30, 2011, the Bank reported net income attributable to common stockholder of $121.5 million, an increase of $96.2 million from earnings of $25.3 million for the same period last year, mainly due to the additional earnings from M&I, net of integration and restructuring costs. Excluding the M&I related activity, the Bank would have reported a net loss attributable to common stockholder of $41.3 million driven by lower revenue and higher provision for loan losses partially offset by a decline in expense. The results also include the impact associated with the Amcore acquisition in April 2010. Return on equity was 2.11 percent in the current year, compared to 0.76 percent for first nine months of last year. Return on assets was 0.25 percent compared to 0.08 percent a year ago.

Net interest income was $1,224.8 million, up $539.9 million from a year ago due to the additional revenue associated with M&I. Excluding this revenue, net interest income was down $60.8 million or 8.9 percent as reduced loan income and interest on securities available for sale were partially offset by reduced interest costs on deposits and long-term notes payable. Net interest margin increased to 2.86 percent in 2011 from 2.33 percent in the same period in 2010, reflecting amortization of $285.3 million related to the purchased loan portfolio discount and higher yield on the M&I portfolio partially offset by reduced yields on the legacy loan portfolio as spreads continued to decline despite an increase in earning assets. Average earning assets of $58.1 billion increased $17.7 billion driven by $11.4 billion related to the M&I acquisition and a $6.8 billion increase in lower-yielding Federal Reserve Bank deposits.

Year-to-date 2011, provision for loan losses was $325.2 million compared to $223.7 million in 2010. This is primarily attributable to the additional provisions for loan losses related to the M&I portfolio and loans purchased in the Amcore acquisition. Net charge-offs decreased to $216.1 million from $230.2 million in the prior year, reflecting a lower level of consumer write-downs.

Noninterest income was $507.3 million, up $54.1 million or 11.9 percent from a year ago. This reflects the addition of $101.9 million of fees and other income from M&I and higher net equity securities gains ($19.3 million) and Trust fees ($9.0 million) partially offset by a reduction in the FDIC indemnification asset related to the Amcore acquisition ($30.5 million) and lower trading revenue ($25.4 million), charge card income ($12.4 million) and service charges and fees ($11.2 million).

Noninterest expenses were $1,257.7 million, an increase of $361.7 million or 40.4 percent. Excluding the additional $223.9 million of operating expense, $53.1 million of integration costs, $23.6 million of intangible amortization, and $21.2 million of restructuring charges associated with the M&I acquisition, expenses increased $40.0 million or 4.5% mainly due to higher salaries and employee benefits ($27.6 million), information processing, database and network fees ($10.7 million) and professional fees ($4.6 million). Partially offsetting these increases were lower marketing costs ($7.1 million). Income tax expense increased $34.4 million from the first nine months of 2010 primarily due to the increase in pre-tax income between periods.

BMO HARRIS BANK N.A. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CONDITION


		September 30 2011			December 31 2010			September 30 2010
		(Unaudited)			(Audited)			(Unaudited)
		(In thousands except share data)
Assets
Cash and demand balances due from banks		$	1,335,932		$	737,227		$	717,224
Money market assets:
Interest-bearing deposits at banks ($15.7 billion, $14.1 billion and $10.4 billion held at Federal Reserve Bank at September 30, 2011, December 31, 2010 and September 30, 2010, respectively)			16,744,392			15,015,453			11,065,012
Federal funds sold and securities purchased under agreement to resell			1,676,622			1,255,313			150,849

Total cash and cash equivalents		$	19,756,946		$	17,007,993		$	11,933,085
Securities available-for-sale, at fair value			11,243,748			5,689,293			5,794,874
Trading account assets and derivative instruments			818,176			1,161,940			1,298,648
Loans, net of unearned income			51,159,171			22,880,126			23,293,870
Allowance for loan losses			(837,863	)		(721,888	)		(691,899	)

Net loans		$	50,321,308		$	22,158,238		$	22,601,971
Loans held for sale			96,075			29,915			8,799
Premises and equipment, net			1,008,827			550,750			536,523
Bank-owned insurance			2,616,114			1,373,099			1,364,969
Goodwill and other intangible assets, net			3,332,441			909,883			917,344
Deferred tax asset, net			2,389,430			268,577			253,018
Other assets			2,622,757			1,423,948			1,552,389

Total assets		$	94,205,822		$	50,573,636		$	46,261,620

Liabilities
Deposits in domestic offices	— noninterest-bearing	$	22,305,219		$	9,265,697		$	9,227,633
	— interest-bearing (includes $1.7 billion, $1.3 billion and $1.2 billion measured at fair value at September 30, 2011, December 31, 2010 and September 30, 2010, respectively)		47,530,469			23,443,770			22,062,398
Deposits in foreign offices	— noninterest-bearing		2,002,059			2,718,059			—
	— interest-bearing		483,811			1,518,884			1,475,984

Total deposits		$	72,321,558		$	36,946,410		$	32,766,015
Federal funds purchased			261,965			131,251			109,574
Securities sold under agreement to repurchase			440,466			864,918			1,206,380
Short-term borrowings			376,092			1,427,794			762,530
Short-term senior notes			81,909			—			—
Accrued interest, taxes and other			459,325			203,161			200,112
Accrued pension and post-retirement			52,067			27,172			19,429
Other liabilities			1,553,657			648,587			832,911
Long-term notes — senior/unsecured			1,100,000			2,446,500			2,446,500
Long-term notes — senior/secured			2,375,000			2,375,000			2,375,000
Long-term notes — subordinated			1,369,961			200,000			200,000

Total liabilities		$	80,392,000		$	45,270,793		$	40,918,451

Stockholders’ Equity
Common stock ($10 par value); authorized 60,430,512 shares; issued and outstanding 50,430,512 at September 30, 2011 and 20,256,027 at December 31, 2010 and September 30, 2010		$	504,305		$	202,560		$	202,560
Surplus			11,326,706			3,364,727			3,359,197
Retained earnings			1,743,415			1,621,915			1,641,781
Accumulated other comprehensive loss			(30,892	)		(136,359	)		(110,424	)

Stockholder’s equity before noncontrolling interest in subsidiaries		$	13,543,534		$	5,052,843		$	5,093,114
Noncontrolling interest in subsidiaries			270,288			250,000			250,055

Total stockholders’ equity		$	13,813,822		$	5,302,843		$	5,343,169

Total liabilities and stockholders’ equity		$	94,205,822		$	50,573,636		$	46,261,620

The accompanying notes to consolidated financial statements are an integral part of these statements.

BMO HARRIS BANK N.A. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Quarter Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
	(In thousands)
Interest Income
Loans	$	849,950		$	267,516		$	1,336,293		$	812,310
Money market assets:
Deposits at banks		12,414			8,158			33,731			20,571
Federal funds sold and securities purchased under agreements to resell		152			47			481			131
Trading account assets		1,708			2,248			4,362			7,995
Securities available-for-sale:
U.S. Treasury and federal agency		28,014			10,814			46,977			39,113
State and municipal		11,474			12,356			33,914			36,914
Other		3,068			2,759			11,303			8,701

Total interest income	$	906,780		$	303,898		$	1,467,061		$	925,735

Interest Expense
Deposits	$	71,956		$	47,202		$	156,439		$	137,756
Short-term borrowings		403			1,393			1,760			4,991
Short-term senior notes		367			—			367			—
Long-term notes — senior/unsecured		14,445			23,618			58,713			69,312
Long-term notes — senior/secured		6,210			6,920			18,758			27,532
Long-term notes — subordinated		5,559			419			6,221			1,250

Total interest expense	$	98,940		$	79,552		$	242,258		$	240,841

Net Interest Income	$	807,840		$	224,346		$	1,224,803		$	684,894
Provision for loan losses		183,302			37,808			325,226			223,697

Net Interest Income after Provision for Loan Losses	$	624,538		$	186,538		$	899,577		$	461,197

Noninterest Income
Trust and investment management fees	$	29,190		$	28,282		$	92,407		$	83,361
Net money market and bond trading (loss) income, including derivative activity		(28,281	)		2,898			(5,736	)		28,038
Foreign exchange trading gains (losses), net		4,627			(685	)		6,576			3,531
Service charges and fees		88,690			48,220			179,384			148,833
Charge card income		31,410			27,251			83,074			85,999
Equity securities gains, net		2,091			1,994			18,694			6,082
Net securities gains, other than trading		18,507			2,907			25,133			5,237
Other-than-temporary impairment on securities		—			(4,741	)		(1,062	)		(4,872	)
Bank-owned insurance		22,164			11,042			43,666			34,179
Letter of credit fees		9,913			4,901			20,144			16,494
Net gains on loans held for sale		8,484			4,188			19,672			11,855
Other		26,798			14,220			25,324			34,453

Total noninterest income	$	213,593		$	140,477		$	507,276		$	453,190

Noninterest Expenses
Salaries and other compensation	$	220,426		$	117,677		$	452,147		$	329,034
Pension and other employee benefits		46,781			23,543			113,741			79,507
Net occupancy		46,797			28,662			100,229			79,276
Equipment		32,836			18,902			67,675			57,533
Marketing		22,916			22,717			54,410			49,926
Communication and delivery		15,047			9,679			33,343			25,427
Professional fees		42,456			32,204			104,950			81,267
Information processing, database and network fees		11,772			10,537			37,174			26,490
FDIC insurance		22,857			11,143			43,376			34,912
Intercompany services, net		30,051			(1,120	)		28,389			(3,956	)
Visa indemnification reversal		—			—			(2,200	)		(2,800	)
Charge card expense		5,218			6,270			17,565			20,572
(Reversal) provision for off-balance sheet credit losses		(6,556	)		6,808			5,889			9,614
Restructuring		21,183			—			21,183			—
Other real estate expense		11,518			1,484			15,402			3,979
Amortization of intangibles		28,438			6,935			42,955			19,177
Other		61,117			32,330			121,500			86,078

Total noninterest expenses	$	612,857		$	327,771		$	1,257,728		$	896,036

Income (loss) before income tax expense (benefit)	$	225,274		$	(756	)	$	149,125		$	18,351
Applicable income tax expense (benefit)		59,970			(10,609	)		13,573			(20,801	)

Net income	$	165,304		$	9,853		$	135,552		$	39,152
Less: noncontrolling interest in subsidiaries		4,833			4,609			14,052			13,828

Net Income Available for Common Stockholder	$	160,471		$	5,244		$	121,500		$	25,324

The accompanying notes to consolidated financial statements are an integral part of these statements.

BMO HARRIS BANK N.A. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)


	Quarter Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
	(In thousands)
Net income	$	165,304		$	9,853		$	135,552		$	39,152
Other comprehensive income (loss):
Cash flow hedges:
Net unrealized gain (loss) on derivative instruments, net of tax expense (benefit) for the quarter of $2,164 in 2011 and ($3,199) in 2010 and net of tax expense (benefit) for the year-to-date period of $10,755 in 2011 and ($20,378) in 2010		4,018			(5,942	)		19,976			(37,847	)
Reclassification adjustment for realized loss included in net income, net of tax benefit for the quarter of $203 in 2011 and $637 in 2010 and net of tax benefit for the year-to-date period of $1,097 in 2011 and $1,575 in 2010		378			1,183			2,036			2,926
Pension and postretirement medical benefit plans:
Net (loss) gain and net prior service cost included in net income, net of tax benefit for the quarter of $0 in 2011 and $6 in 2010 and net of tax expense for the year-to-date period of $143 in 2011 and $1,423 in 2010		—			(406	)		267			4,223
Reclassification adjustment for amortization included in net income, net of tax benefit for the quarter of $1,348 in 2011 and $684 in 2010 and net of tax benefit for the year-to-date period of $4,042 in 2011 and $2,052 in 2010		2,501			1,271			7,506			3,812
Available-for-sale securities:
Unrealized holding gain arising during the period, net of tax expense for the quarter of $42,451 in 2011 and $7,426 in 2010 and net of tax expense for the year-to-date period of $51,698 in 2011 and $5,190 in 2010		75,749			12,738			94,196			16,763
Reclassification adjustment for realized gain included in net income, net of tax expense for the quarter of $7,083 in 2011 and $979 in 2010 and net of tax expense for the year-to-date period of $8,203 in 2011 and $1,749 in 2010		(14,071	)		(1,819	)		(18,514	)		(3,249	)

Other comprehensive income (loss)	$	68,575		$	7,025		$	105,467		$	(13,372	)

Comprehensive income	$	233,879		$	16,878		$	241,019		$	25,780
Comprehensive income related to noncontrolling interest in subsidiaries		4,834			4,609			14,052			13,828

Comprehensive income available for common stockholder	$	229,045		$	12,269		$	226,967		$	11,952

The accompanying notes to consolidated financial statements are an integral part of these statements.

BMO HARRIS BANK N.A. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)


	Common Stock		Surplus		Retained Earnings		Accumulated Other Comprehensive Loss			Noncontrolling Interest in Subsidiaries			Total Stockholders’ Equity
	(In thousands)
Balance at December 31, 2010	$	202,560	$	3,364,727	$	1,621,915	$	(136,359	)	$	250,000		$	5,302,843
Stock option exercise		—		722		—		—			—			722
Tax benefit from stock option exercise		—		6,612		—		—			—			6,612
Net income		—		—		121,500		—			14,052			135,552
Dividends — preferred stock of subsidiary		—		—		—		—			(14,052	)		(14,052	)
Other comprehensive income		—		—		—		105,467			—			105,467
Issuance of common stock and contribution to capital surplus		301,745		7,954,645		—		—			20,288			8,256,390

Balance at September 30, 2011	$	504,305	$	11,326,706	$	1,743,415	$	(30,892	)	$	270,288		$	13,793,534

Balance at December 31, 2009	$	178,010	$	2,390,207	$	1,616,457	$	(97,052	)	$	250,000		$	4,337,622
Stock option exercise		—		540		—		—			—			540
Net income		—		—		25,324		—			13,828			39,152
Dividends — preferred stock of subsidiary		—		—		—		—			(13,828	)		(13,828	)
Noncontrolling interest of acquiree		—		—		—		—			55			55
Other comprehensive loss		—		—		—		(13,372	)		—			(13,372	)
Issuance of common stock and contribution to capital surplus		24,550		968,450		—		—			—			993,000

Balance at September 30, 2010	$	202,560	$	3,359,197	$	1,641,781	$	(110,424	)	$	250,055		$	5,343,169

The accompanying notes to consolidated financial statements are an integral part of these statements.

BMO Harris Bank N.A. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)


	Nine Months Ended September 30
	2011			2010
	(in thousands)
Cash Flows from Operating Activities:
Net income available for common stockholder	$	121,500		$	25,324
Noncontrolling interest in subsidiaries		14,052			13,828

Net income	$	135,552		$	39,152
Adjustments to determine net cash flows provided by (used in) operating activities:
Provision for loan losses		325,226			223,697
Depreciation and amortization, including intangibles		142,881			81,817
Deferred tax expense (benefit)		13,738			(5,952	)
Tax expense from stock options exercise		6,865			—
Other-than-temporary impairment on securities		1,062			4,872
Net gains on securities, other than trading		(25,133	)		(5,237	)
Net equity investment gains		(18,694	)		(1,994	)
Increase in bank-owned insurance		(32,919	)		(25,312	)
Net decrease in trading securities		695,198			113,938
Decrease (increase) in accrued interest receivable		12,217			(112	)
Increase in prepaid expenses		(150,275	)		(88,394	)
Increase in accrued interest payable		61,577			211
Net decrease (increase) in accrued tax receivable		5,931			(80,101	)
Decrease in other accrued expenses		(35,010	)		(37,573	)
Net change in pension and post retirement benefits		36,853			(28,482	)
Origination of loans held for sale		(598,485	)		(526,378	)
Proceeds from sale of loans held for sale		551,997			559,408
Net gains on loans held for sale		(19,672	)		(11,855	)
Net gains on sale of premises and equipment		(264	)		(788	)
Net (decrease) increase in foreign exchange contracts		(8,903	)		19,080
Recoveries on charged-off loans		54,776			53,777
Net (decrease) increase in marked to market hedging derivatives		(39,709	)		31,745
Visa indemnification reversal		(2,200	)		(2,800	)
Other, net		349,751			176,810

Net cash (used in) provided by operating activities	$	1,462,360		$	489,529

Cash Flows from Investing Activities:
Proceeds from sales of securities available-for-sale	$	1,965,459		$	514,900
Proceeds from maturities of securities available-for-sale		4,277,472			3,027,567
Purchases of securities available-for-sale		(6,135,168	)		(3,417,861	)
Net decrease in loans		1,877,687			1,381,149
Net proceeds from FDIC loss sharing agreement		50,251			—
Proceeds from loans sold to affiliates		—			273,522
Purchases of premises and equipment		(141,427	)		(70,234	)
Proceeds from sales of premises and equipment		891			10,250
Increase (decrease) in cash due to acquisitions, net of cash received		2,617,652			191,663

Net cash (used in) provided by investing activities	$	4,512,817		$	1,910,956

Cash flows from Financing Activities:
Net decrease in deposits	$	(272,194	)	$	(740,471	)
Net (decrease) increase in deposits measured at fair value		479,166			478,886
Net decrease in Federal funds purchased and securities sold under agreement to repurchase		(293,738	)		(1,332,635	)
Net (decrease) increase in other short-term borrowings		(1,223,567	)		45,480
Net increase in short-term senior notes		81,909			—
Repayment of long-term notes — senior/unsecured		(1,346,500	)		—
Repayment of long-term notes — senior/secured		—			(137,409	)
Proceeds of long-term notes — subordinated		(3,237,941	)		—
Repayment of long-term notes — subordinated		—			(92,750	)
Net proceeds from stock options exercise		722			540
Excess tax expense from stock options exercise		(253	)		(189	)
Capital contributions		2,600,000			993,000
Cash dividends paid on preferred stock		(13,828	)		(13,828	)

Net cash provided by (used in) financing activities	$	(3,226,224	)	$	(799,376	)

Net increase in cash and cash equivalents	$	2,748,953		$	1,601,109
Cash and cash equivalents at January 1		17,007,993			10,331,975

Cash and cash equivalents at September 30	$	19,756,946		$	11,933,084

The accompanying notes to consolidated financial statements are an integral part of these statements.

BMO HARRIS BANK N.A. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

BMO Harris Bank N.A., formerly Harris N.A., (the “Bank” or “BHB”) is a wholly-owned subsidiary of BMO Bankcorp, Inc., formerly Harris Bankcorp, Inc., (“Bankcorp”), a wholly-owned subsidiary of BMO Financial Corp., formerly Harris Financial Corp., (“BFC”), a wholly-owned U.S. subsidiary of Bank of Montreal (“BMO”). The consolidated financial statements of the Bank include the accounts of the Bank and its wholly-owned subsidiaries. Significant inter-company accounts and transactions have been eliminated.

On July 5, 2011, BMO completed the acquisition of all outstanding voting shares of Milwaukee-based Marshall & Ilsley Corporation (“M&I”) for consideration of approximately $4.3 billion paid in BMO common shares, with fractional entitlements to BMO common shares paid in cash. Prior to the completion of the transaction, BFC purchased M&I’s Troubled Asset Relief Program preferred shares and warrants from the U.S. Treasury for approximately $1.7 billion. Immediately upon acquisition, M&I merged with and into BFC, and M&I Marshall and Ilsley Bank and M&I Bank N.A. merged with and into the Bank. In addition, The Harris Bank N.A. (a subsidiary of Bankcorp) merged with and into the Bank. At this time, Harris N.A. changed its name to BMO Harris Bank N.A. The Bank assumed approximately $46.1 billion in assets, including approximately $30.4 billion in loans, and $35.2 billion in deposits from M&I. The Bank recorded goodwill of $1.9 billion, a core deposit intangible of $483.9 million and a customer relationship intangible of $70.1 million. The results of operations for M&I Marshall and Ilsley Bank and M&I Bank N.A. have been included in the Bank’s consolidated financial statements since July 5, 2011. This acquisition substantially increased the Bank’s assets, geographic presence, scope of operations and customer base. The results of the Bank have been restated to reflect the merger of The Harris Bank N.A. into BMO Harris Bank N.A.

On April 23, 2010, the Bank acquired certain assets and liabilities of Rockford, Illinois-based, AMCORE from the FDIC for $221.5 million. The Bank assumed approximately $2.5 billion in assets, including approximately $2.1 billion in loans, and $2.2 billion in deposits. The Bank recorded a core deposit intangible of $21.1 million to be amortized over 10 years on an accelerated basis and a customer relationship intangible of $1.3 million to be amortized over 13 years on an accelerated basis. The acquisition includes a loss share agreement with the FDIC which provides for reimbursement from the FDIC for 80% of losses incurred on covered assets, including loans and other real estate owned, subsequent to acquisition date. An indemnification asset estimated at a fair value of $427.5 million was recorded at acquisition based on the present value of expected cash flows to be received from the FDIC for loss reimbursements covered by the agreement. The Bank recorded goodwill of $84.6 million which is expected to be deductible for tax purposes. As part of the acquisition, the Bank obtained the option to purchase certain AMCORE branches after the close of the transaction. The Bank increased the purchase price by $19.9 million as a result of exercising the option to purchase certain of these branches. Acquisition costs of $6.2 million were recorded to noninterest expense for the year ended December 31, 2010. The acquisition provides the Bank with an opportunity to expand its branch network into communities in northern Illinois and southern Wisconsin. The results of AMCORE’s operations have been included in the Bank’s consolidated financial statements since April 23, 2010.

The interim consolidated financial statements have been prepared by management from the books and records of the Bank, 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. Events occurring subsequent to the date of the balance sheet have been evaluated for potential recognition or disclosure in the consolidated financial statements.

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. Certain reclassifications were made to conform prior year’s financial statements to the current year’s presentation.

2. Contingent Liabilities and Litigation

BMO Harris Bank N.A. and certain of its subsidiaries are party to legal proceedings in the ordinary course of their businesses. While there is inherent difficulty in predicting the outcome of these proceedings, management does not expect the outcome of any of these proceedings, individually or in the aggregate, to have a material adverse effect on the Bank’s consolidated financial position or results of operations.

3. Cash Flows

In the Consolidated Statements of Cash Flows, cash and cash equivalents include cash and demand balances due from banks, interest-bearing deposits at banks and federal funds sold and securities purchased under agreement to resell. Cash interest payments for the nine months ended September 30 totaled $180.9 million and $245.0 million in 2011 and 2010, respectively. Cash income tax refunds received for the nine months ended September 30, 2011 and 2010 totaled $10.1 million and $4.0 million, respectively.

4. Visa Indemnification Charge

BHB was a member of Visa U.S.A. Inc. (“Visa U.S.A.”) and in 2007 received shares of restricted stock in Visa, Inc. (“Visa”) as a result of its participation in the global restructuring of Visa U.S.A., Visa Canada Association, and Visa International Service Association in preparation for an initial public offering by Visa. BHB and other Visa U.S.A. member banks are obligated to share in potential losses resulting from certain indemnified litigation involving Visa that has been settled.

A member bank such as BHB is also required to recognize the contingent obligation to indemnify Visa under Visa’s bylaws (as those bylaws were modified at the time of the Visa restructuring on October 3, 2007) for potential losses arising from the other indemnified litigation that has not yet settled at its estimated fair value. BHB is not a direct party to this litigation and does not have access to any specific, non-public information concerning the matters that are the subject of the indemnification obligations. While the estimation of any potential losses is highly judgmental, as of December 31, 2007, BHB recorded a liability and corresponding charge of $34 million (pretax) for the remaining litigation.

The initial public offering (IPO) occurred on March 25, 2008 followed by a mandatory partial redemption of Harris’ restricted stock in Visa that took place in two parts: exchange for cash and funding of the covered litigation escrow account. During the first quarter of 2008, BHB received $37.8 million in cash in conjunction with the mandatory partial redemption which was recognized as an equity security gain in the Consolidated Statements of Operations since there was no basis in the stock. In addition, Visa funded the U.S. litigation escrow account with IPO proceeds. Harris’ share of the U.S. litigation escrow account funding was $17 million which was recognized as a reversal to the litigation reserve and as a decrease to noninterest expense.

In March 2011, October 2010, June 2010, July 2009 and December 2008, BHB recorded decreases to noninterest expense of $2.2 million, $4.7 million, $2.8 million, $3.0 million and $6.3 million, respectively, as a reduction in the Visa litigation reserve to reflect Visa’s use of a portion of the Bank’s restricted Visa stock to fund the escrow account available to settle certain litigation matters. Visa’s funding of amounts required beyond the current escrow, if any, will be obtained via additional mandatory redemptions of restricted shares. As of September 30, 2011, December 31, 2010 and September 30, 2010, the recorded reserve relating to the Visa litigation matter included in the Consolidated Statements of Condition was $5.1 million, $7.2 million and $12.0 million, respectively.

5. Other-than-temporary impairment

During the nine months ended September 30, 2011, the Bank recorded other-than-temporary impairment of $0.5 million on auction rate securities and $0.6 million on CRA investments. During the nine months ended

September 30, 2010, the Bank recorded other-than-temporary impairment of $4.8 million. Of this amount, $4.0 million was recorded on auction rate securities, $0.6 million on municipal bonds and $0.2 million on CRA investments. The entire amount of the impairment in all periods was related to credit deterioration.

6. Recent accounting standards

The FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”, in July 2010. This ASU amended ASC 310-10-50, “Receivables — Overall — Disclosure”, in order to expand the requirements for separate reporting and disclosure of allowances for credit losses and the policies for managing credit exposures. The standard requires companies to significantly increase disclosures about the credit quality of financing receivables and the credit reserves held against them. The additional disclosures include aging of past due receivables, credit quality information such as credit risk scores or external credit agency ratings and the modification of financing receivables. Further disaggregation of information by certain classification of the total portfolio will also be required. The objective of enhancing these disclosures is to improve financial statement users’ understanding of (1) the nature of an entity’s credit risk associated with its financing receivables and (2) the entity’s assessment of that risk in estimating its allowance for credit losses as well as changes in the allowance and the reasons for those changes. The disclosures will be effective for the Bank for the annual reporting period ending December 31, 2011. The Bank does not expect the adoption of this standard to impact its financial position or results of operations.

The FASB issued ASU 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring”, in April 2011. The standard clarifies the existing guidance on a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring is a troubled debt restructuring. The amendment will be effective for the Bank for the annual reporting period ending December 31, 2012. The Bank does not expect the adoption of this standard to materially impact its financial position or results of operations.

The FASB issued ASU 2011-05, “Comprehensive Income,” in June 2011. The standard eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. It requires companies to present reclassification adjustments from other comprehensive income to net income in the statements of net income and other comprehensive income. The amendment will be effective for the Bank for the annual reporting period ending December 31, 2012. The Bank does not expect the adoption of this standard to materially impact its financial position or results or operations.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

See “Liquidity Risk Management” and “Market Risk Management” under Management’s Discussion and Analysis of Financial Condition and Results of Operations on page 12.

The following table stratifies the Company’s available-for-sale securities by maturity date (dollars in thousands):


	Oct 1, 2011 to Dec. 31, 2011			Year Ending December 31,									Thereafter			Total			Fair Value at
	Oct 1, 2011 to Dec. 31, 2011			2012		2013			2014		2015		Thereafter			Total			September 30, 2011
Residential mortgage-backed
Amortized cost	$	—		$	—	$	4,434		$	—	$	—	$	423,105		$	427,539		$	447,092
Average Yield		—			—		4.00	%		—		—		3.90	%		3.94	%		—

U.S. Treasury Bills
Amortized cost	$	115,000		$	—	$	—		$	—	$	—	$	—		$	115,000		$	115,000
Average Yield		0.07	%		—		—			—		—		—			0.07	%		—

At September 30, 2011, the Company’s investments held in mortgage-backed securities are secured by adjustable and fixed interest rate residential mortgage loans. The yield to maturity on each security depends on, among other things, the price at which each such security is purchased, the rate and timing of principal payments (including prepayment rates as well as default rates, which in turn would impact the value and yield to maturity of the Company’s mortgage-backed securities. These investments are guaranteed by the Federal National Mortgage Association, (“FNMA”) or Federal Home Loan Mortgage Corporation (“Freddie Mac”) and none of the underlying loan collateral is represented by sub-prime mortgages.

Item 4T. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

Harris Preferred Capital Corporation’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the Company’s disclosure controls and procedures as of September 30, 2011. Based on this evaluation, management has concluded that the disclosure controls and procedures are effective to provide reasonable assurance that the information required to be disclosed by the Company in the reports filed under the Securities Exchange Act of 1934, as amended is (i) recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission’s rules and forms, and (ii) accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer , as appropriate to allow timely decisions regarding required disclosure.

(b) Changes in Internal Controls over Financial Reporting

There were no changes in internal controls over financial reporting that occurred during the quarter ended September 30, 2011 that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.

Part II. OTHER INFORMATION

Items 1, 1A, 2, 3, 4 and 5 are being omitted from this Report because such items are not applicable to the reporting period.

None

Item 6. Exhibits


31.1		Certification of Pamela C. Piarowski pursuant to rule 13a-14(a)

31.2		Certification of Paul R. Skubic pursuant to rule 13a-14(a)

32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS*		XBRL Instance Document

101.SCH*		XBRL Taxonomy Extension Schema Document

101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB*		XBRL Taxonomy Extension Label Linkbase Document

101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document

XBRL information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934, and is not subject to liability under those sections, is not part of any registration statement or prospectus to which it relates and is not incorporated or deemed to be incorporated by reference into any registration statement, prospectus or other document.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, Harris Preferred Capital Corporation has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on the 14th day of November 2011.

/s/ PAUL R. SKUBIC

Paul R. Skubic

Chairman of the Board and President and CEO

(Principal Executive Officer)

/s/ PAMELA C. PIAROWSKI

Pamela C. Piarowski

Chief Financial Officer and Chief Accounting Officer

(Principal Financial and Accounting Officer)

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