Edgar Filing: HARRIS PREFERRED CAPITAL CORP

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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2003
FORM 10-K

ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003

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 (I.R.S. Employer
of incorporation or organization) 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 New York Stock Exchange
A, par value $1.00 per share

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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (229.405 of this chapter) is not contained herein, and
will not be contained to the best of registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [X]

Indicate by check mark whether this registrant is an accelerated filer (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 March
24, 2004 was 1,000. No common equity is held by non-affiliates.

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HARRIS PREFERRED CAPITAL CORPORATION

TABLE OF CONTENTS

PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 7
Item 3. Legal Proceedings........................................... 7
Item 4. Submission of Matters to a Vote of Security Holders......... 7
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 7
Item 6. Selected Financial Data..................................... 8
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 8
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 13
Item 8. Financial Statements and Supplementary Data................. 13
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 13
Item 9A. Controls and Procedures..................................... 13
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 13
Item 11. Executive Compensation...................................... 15
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 15
Item 13. Certain Relationships and Related Transactions.............. 16
Item 14. Principal Accountant Fees and Services...................... 16
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 18
Signatures.................................................................. 19
Exhibit 14 Code of Ethics for Principal Executive and Financial
Officers
Exhibit 21 Subsidiaries
Exhibit 24 Power of Attorney
Exhibit 31.1 Certification of Janine Mulhall pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification of Paul R. Skubic pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

PART I

Forward-Looking Information

Forward-looking statements contained in this Annual Report on Form 10-K
("Report") of Harris Preferred Capital Corporation (the "Company") may include
certain forward-looking information, within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended, including (without limitation) statements with respect
to the Company's expectations, 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 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 statements.

ITEM 1. BUSINESS

General

Harris Preferred Capital Corporation is a Maryland corporation incorporated
on September 24, 1997, pursuant to the Maryland General Corporation Law. The
Company's 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 Harris
Trust and Savings Bank (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. The Company's assets are held in a
Maryland real estate investment trust subsidiary, Harris Preferred Capital
Trust. The Company has elected to be treated as a REIT under the Internal
Revenue Code of 1986 (the "Code"), and will generally not be subject to federal
income tax if it distributes 90% of its adjusted REIT ordinary taxable income
and meets all of the qualifications necessary to be a REIT. All of the shares of
the Company's common stock, par value $1.00 per share (the "Common Stock"), are
owned by Harris Capital Holdings, Inc. ("HCH"), a wholly-owned subsidiary of the
Bank. The Company was formed by the Bank to provide investors with the
opportunity to invest in residential mortgages and other real estate assets and
to provide the Bank with a cost-effective means of raising capital for federal
regulatory purposes.

On February 11, 1998, the Company, through a public offering (the
"Offering"), issued 10,000,000 shares of its 7 3/8% Noncumulative Exchangeable
Preferred Stock, Series A (the "Preferred Shares"), $1.00 par value. The
Offering raised $250 million less $7.9 million of underwriting fees. The
Preferred Shares are traded on the New York Stock Exchange under the symbol "HBC
Pr A". Holders of Preferred Shares are entitled to receive, if declared by the
Company's Board of Directors, noncumulative dividends at a rate of 7 3/8% per
annum of the $25 per share liquidation preference (an amount equivalent to
$1.8438 per share per annum). Dividends on the Preferred Shares, if authorized
and declared, are payable quarterly in arrears on March 30, June 30, September
30 and December 30 of each year. The Preferred Shares may be redeemed for cash
at the option of the Company, in whole or in part, at any time and from time to
time, at the principal amount thereof, plus the quarterly accrued and unpaid
dividends, if any, thereon. The Company may not redeem the Preferred Shares
without prior approval from the Board of Governors of the Federal Reserve System
or the appropriate successor federal regulatory agency.

Each Preferred Share will be automatically exchanged for one newly issued
Bank Preferred Share in the event (i) the Bank becomes less than "adequately
capitalized" under regulations established pursuant to the

Federal Deposit Insurance Corporation Improvement Act of 1991, as amended, (ii)
the Bank is placed into conservatorship or receivership, (iii) the Board of
Governors directs such exchange in writing because, in its sole discretion and
even if the Bank is not less than "adequately capitalized," the Board of
Governors anticipates that the Bank may become less than adequately capitalized
in the near term, or (iv) the Board of Governors in its sole discretion directs
in writing an exchange in the event that the Bank has a Tier 1 risk-based
capital ratio of less than 5%. In the event of an exchange, the Bank Preferred
Shares would constitute a new series of preferred shares of the Bank, would have
the same dividend rights, liquidation preference, redemption options and other
attributes as the Preferred Shares, except that the Bank Preferred Shares would
not be listed on the New York Stock Exchange and would rank pari passu in terms
of cash dividend payments and liquidation preference with any outstanding shares
of preferred stock of the Bank.

Concurrent with the issuance of the Preferred Shares, the Bank contributed
additional capital of $241 million, net of acquisition costs, to the Company.
The Company and the Bank undertook the Offering for two principal reasons: (i)
the qualification of the Preferred Shares as Tier 1 capital of the Bank for U.S.
banking regulatory purposes under relevant regulatory capital guidelines, as a
result of the treatment of the Preferred Shares as a minority interest in a
consolidated subsidiary of the Bank, and (ii) lack of federal income tax on the
Company's earnings used to pay the dividends on the Preferred Shares, as a
result of the Company's qualification as a REIT. On December 30, 1998, the Bank
contributed the common stock of the Company to HCH, a newly-formed and
wholly-owned subsidiary of the Bank. The Bank is an indirect wholly-owned U.S.
subsidiary of Bank of Montreal. The Bank is required to maintain direct or
indirect ownership of at least 80% of the outstanding Common Stock of the
Company for as long as any Preferred Shares are outstanding.

The Company used the Offering proceeds and the additional capital
contributed by the Bank to purchase $356 million of notes (the "Notes") from the
Bank and $135 million of mortgage-backed securities at their estimated fair
value. The Notes are obligations issued by the Bank that are recourse only to
the underlying mortgage loans (the "Securing Mortgage Loans") and were acquired
pursuant to the terms of a loan agreement with the Bank. The principal amount of
the Notes equals approximately 80% of the principal amounts of the Securing
Mortgage Loans.

Business

The Company was formed for the purpose of raising capital for the Bank. One
of the Company's principal business objectives is to acquire, hold, finance and
manage Mortgage Assets. These Mortgage Assets generate interest income for
distribution to stockholders. A portion of the Mortgage Assets of the Company
consists of Notes issued by the Bank that are recourse only to Securing Mortgage
Loans that are secured by real property. The Notes mature on October 1, 2027 and
pay interest at 6.4% per annum. Payments of interest are made to the Company
from payments made on the Securing Mortgage Loans. Pursuant to an agreement
between the Company and the Bank, the Company, through the Bank as agent,
receives all scheduled payments made on the Securing Mortgage Loans, retains a
portion of any such payments equal to the amount due on the Notes and remits the
balance, if any, to the Bank. The Company also retains approximately 80% of any
prepayments of principal in respect of the Securing Mortgage Loans and applies
such amounts as a prepayment on the Notes. The Company has a security interest
in the real property securing the Securing Mortgage Loans and will be entitled
to enforce payment on the loans in its own name if a mortgagor should default.
In the event of such default, the Company would have the same rights as the
original mortgagee to foreclose the mortgaged property and satisfy the
obligations of the Bank out of the proceeds.

The Company may from time to time acquire fixed-rate or variable-rate
mortgage-backed securities representing interests in pools of mortgage loans.
The Bank may have originated a portion of any such mortgage-backed securities by
exchanging pools of mortgage loans for the mortgage-backed securities. The
mortgage loans underlying the mortgage-backed securities will be secured by
single-family residential properties located throughout the United States. The
Company intends to acquire only investment grade mortgage-backed securities
issued by agencies of the federal government or government sponsored agencies,
such as the Federal Home Loan Mortgage Corporation ("FHLMC"), the Federal
National Mortgage Association ("Fannie Mae") and the Government National
Mortgage Association ("GNMA"). The
3

Company does not intend to acquire any interest-only, principal-only or similar
speculative mortgage-backed securities.

The Bank may from time to time acquire or originate both conforming and
nonconforming residential mortgage loans. Conventional conforming residential
mortgage loans comply with the requirements for inclusion in a loan guarantee
program sponsored by either FHLMC or Fannie Mae. Nonconforming residential
mortgage loans are residential mortgage loans that do not qualify in one or more
respects for purchase by Fannie Mae or FHLMC under their standard programs. The
nonconforming residential mortgage loans that the Company purchases will be
nonconforming because they have original principal balances which exceed the
limits for FHLMC or Fannie Mae under their standard programs. The Company
believes that all residential mortgage loans will meet the requirements for sale
to national private mortgage conduit programs or other investors in the
secondary mortgage market. As of December 31, 2003 and 2002 and for each of the
years then ended, the Company did not directly hold any residential mortgage
loans.

The Company may from time to time acquire commercial mortgage loans secured
by industrial and warehouse properties, recreational facilities, office
buildings, retail space and shopping malls, hotels and motels, hospitals,
nursing homes or senior living centers. The Company's current policy is not to
acquire any interest in a commercial mortgage loan if commercial mortgage loans
would constitute more than 5% of the Company's Mortgage Assets at the time of
its acquisition. Unlike residential mortgage loans, commercial mortgage loans
generally lack standardized terms. Commercial real estate properties themselves
tend to be unique and are more difficult to value than residential real estate
properties. Commercial mortgage loans may also not be fully amortizing, meaning
that they may have a significant principal balance or "balloon" payment due on
maturity. Moreover, commercial properties, particularly industrial and warehouse
properties, are generally subject to relatively greater environmental risks than
non-commercial properties, generally giving rise to increased costs of
compliance with environmental laws and regulations. There is no requirement
regarding the percentage of any commercial real estate property that must be
leased at the time the Bank acquires a commercial mortgage loan secured by such
commercial real estate property, and there is no requirement that commercial
mortgage loans have third party guarantees. The credit quality of a commercial
mortgage loan may depend on, among other factors, the existence and structure of
underlying leases, the physical condition of the property (including whether any
maintenance has been deferred), the creditworthiness of tenants, the historical
and anticipated level of vacancies and rents on the property and on other
comparable properties located in the same region, potential or existing
environmental risks, the availability of credit to refinance the commercial
mortgage loan at or prior to maturity and the local and regional economic
climate in general. Foreclosures of defaulted commercial mortgage loans are
generally subject to a number of complicated factors, including environmental
considerations, which are generally not present in foreclosures of residential
mortgage loans. As of December 31, 2003 and 2002 and for each of the years then
ended, the Company did not hold any commercial mortgage loans.

The Company may invest in assets eligible to be held by REITs other than
those described above. In addition to commercial mortgage loans and mortgage
loans secured by multi-family properties, such assets could include cash, cash
equivalents and securities, including shares or interests in other REITs and
partnership interests. At December 31, 2003, the Company held $11.5 million of
short-term money market assets and $230 million of U.S. Treasury securities. At
December 31, 2002, the Company held $20 million of short-term money market
assets and $80 million of U.S. Treasury securities.

The Company intends to continue to acquire Mortgage Assets from the Bank
and/or affiliates of the Bank on terms that are comparable to those that could
be obtained by the Company if such Mortgage Assets were purchased from unrelated
third parties. The Company may also from time to time acquire Mortgage Assets
from unrelated third parties.

The Company intends to maintain a substantial portion of its portfolio in
Bank-secured obligations and mortgage-backed securities. The Company may,
however, invest in other assets eligible to be held by a REIT. The Company's
current policy and the Servicing Agreement (defined below) prohibit the
acquisition of any Mortgage Asset constituting an interest in a mortgage loan
(other than an interest resulting from the acquisition of mortgage-backed
securities), which mortgage loan (i) is delinquent (more than 30 days past

due) in the payment of principal or interest at the time of proposed
acquisition; (ii) is or was at any time during the preceding 12 months (a) on
nonaccrual status or (b) renegotiated due to financial deterioration of the
borrower; or (iii) has been, more than once during the preceding 12 months, more
than 30 days past due in payment of principal or interest. Loans that are on
"nonaccrual status" are generally loans that are past due 90 days or more in
principal or interest. The Company maintains a policy of disposing of any
mortgage loan which (i) falls into nonaccrual status, (ii) has to be
renegotiated due to the financial deterioration of the borrower, or (iii) is
more than 30 days past due in the payment of principal or interest more than
once in any 12 month period. The Company may choose, at any time subsequent to
its acquisition of any Mortgage Assets, to require the Bank (as part of the
Servicing Agreement) to dispose of the mortgage loans for any of these reasons
or for any other reason.

The Bank services the Securing Mortgage Loans and the other mortgage loans
purchased by the Company on behalf of, and as agent for, the Company and is
entitled to receive fees in connection with the servicing thereof pursuant to
the servicing agreement (the "Servicing Agreement"). The Bank receives a fee
equal to 0.25% per annum on the principal balances of the loans serviced.
Payment of such fees is subordinate to payments of dividends on the Preferred
Shares. The Servicing Agreement requires the Bank to service the loans in a
manner generally consistent with accepted secondary market practices, with any
servicing guidelines promulgated by the Company and, in the case of residential
mortgage loans, with Fannie Mae and FHLMC guidelines and procedures. The
Servicing Agreement requires the Bank to service the loans solely with a view
toward the interest of the Company and without regard to the interest of the
Bank or any of its affiliates. The Bank will collect and remit principal and
interest payments, administer mortgage escrow accounts, submit and pursue
insurance claims and initiate and supervise foreclosure proceedings on the loans
it services. The Bank may, with the approval of a majority of the Company's
Board of Directors, as well as a majority of the Company's Independent
Directors, subcontract all or a portion of its obligations under the Servicing
Agreement to unrelated third parties. An "Independent Director" is a director
who is not a current officer or employee of the Company or a current director,
officer or employee of the Bank or of its affiliates. The Bank will not, in
connection with the subcontracting of any of its obligations under the Servicing
Agreement, be discharged or relieved in any respect from its obligations under
the Servicing Agreement. The Company may terminate the Servicing Agreement upon
the occurrence of such events as they relate to the Bank's proper and timely
performance of its duties and obligations under the Servicing Agreement. As long
as any Preferred Shares remain outstanding, the Company may not terminate, or
elect to renew, the Servicing Agreement without the approval of a majority of
the Company's Independent Directors.

The Company entered into an advisory agreement with the Bank (the "Advisory
Agreement") pursuant to which the Bank administers the day-to-day operations of
the Company. The Bank is responsible for (i) monitoring the credit quality of
Mortgage Assets held by the Company, (ii) advising the Company with respect to
the reinvestment of income from and payments on, and with respect to the
acquisition, management, financing and disposition of the Mortgage Assets held
by the Company, and (iii) monitoring the Company's compliance with the
requirements necessary to qualify as a REIT, and other financial and tax-
related matters. The Bank may from time to time subcontract all or a portion of
its obligations under the Advisory Agreement to one or more of its affiliates.
The Bank may, with the approval of a majority of the Company's Board of
Directors, as well as a majority of the Company's Independent Directors,
subcontract all or a portion of its obligations under the Advisory Agreement to
unrelated third parties. The Bank will not, in connection with the
subcontracting of any of its obligations under the Advisory Agreement, be
discharged or relieved in any respect from its obligations under the Advisory
Agreement. The Advisory Agreement is renewed annually. The Company may terminate
the Advisory Agreement at any time upon 60 days' prior written notice. As long
as any Preferred Shares remain outstanding, any decision by the Company either
to renew the Advisory Agreement or to terminate the Advisory Agreement must be
approved by a majority of the Board of Directors, as well as by a majority of
the Company's Independent Directors.

The Advisory Agreement in effect in 2003 and 2002 entitled the Bank to
receive advisory fees of $56,000 and $43,000, respectively. In 2004, advisory
fees of $115,000 have been approved.

The Company may from time to time purchase additional Mortgage Assets out
of proceeds received in connection with the repayment or disposition of Mortgage
Assets, the issuance of additional shares of
5

Preferred Stock or additional capital contributions with respect to the Common
Stock. The Company may also issue additional series of Preferred Stock. However,
the Company may not issue additional shares of Preferred Stock senior to the
Series A Preferred Shares either in the payment of dividends or in the
distribution of assets on liquidation without the consent of holders of at least
67% of the outstanding shares of Preferred Stock at that time or without
approval of a majority of the Company's Independent Directors. The Company does
not currently intend to issue any additional shares of Preferred Stock unless it
simultaneously receives additional capital contributions from HCH or other
affiliates sufficient to support the issuance of such additional shares of
Preferred Stock.

Although the Company does not currently intend to incur any indebtedness in
connection with the acquisition and holding of Mortgage Assets, the Company may
do so at any time (although indebtedness in excess of 25% of the Company's total
stockholders' equity may not be incurred without the approval of a majority of
the Company's Independent Directors). To the extent the Company were to change
its policy with respect to the incurrence of indebtedness, the Company would be
subject to risks associated with leverage, including, without limitation,
changes in interest rates and prepayment risk.

Employees

As of December 31, 2003, the Company had no paid employees. All officers of
the Company were employed by the Bank.

Environmental Matters

In the event that the Company is forced to foreclose on a defaulted
Securing Mortgage Loan to recover its investment in such loan, the Company may
be subject to environmental liabilities in connection with the underlying real
property, which could exceed the value of the real property. Although the
Company intends to exercise due diligence to discover potential environmental
liabilities prior to the acquisition of any property through foreclosure,
hazardous substances or wastes, contaminants, pollutants or sources thereof (as
defined by state and federal laws and regulations) may be discovered on
properties during the Company's ownership or after a sale thereof to a third
party. If such hazardous substances are discovered on a property which the
Company has acquired through foreclosure or otherwise, the Company may be
required to remove those substances and clean up the property. There can be no
assurance that in such a case the Company would not incur full recourse
liability for the entire costs of any removal and clean-up, that the cost of
such removal and clean-up would not exceed the value of the property or that the
Company could recoup any of such costs from any third party. The Company may
also be liable to tenants and other users of neighboring properties. In
addition, the Company may find it difficult or impossible to sell the property
prior to or following any such clean-up. The Company has not foreclosed on any
Securing Mortgage Loans.

Qualification as a REIT

The Company elected to be taxed as a REIT commencing with its taxable year
ended December 31, 1998 and intends to comply with the provisions of the Code
with respect thereto. The Company will not be subject to Federal income tax to
the extent it distributes 90% (95% for years prior to January 1, 2001) of its
adjusted REIT ordinary taxable income to stockholders and as long as certain
assets, income and stock ownership tests are met. For 2003 as well as 2002, the
Company met all Code requirements for a REIT, including the asset, income, stock
ownership and distribution tests. Cash distributions in the amount of $1.8438
per Preferred Share were paid in 2003 and 2002. A cash dividend on common stock
of $2 million was declared on December 2, 2003 to the stockholder of record on
December 15, 2003 and paid on December 31, 2003. A cash dividend on common stock
of $3.090 million was declared on December 4, 2002 to the stockholder of record
on December 15, 2002 and paid on December 27, 2002. In addition, on September
12, 2003 and 2002, the Company paid a cash dividend of $530 thousand and $130
thousand, respectively, on the outstanding common shares to the stockholder of
record on September 3, 2003 and September 4, 2002, respectively. These dividends
completed the 2002 and 2001 REIT tax compliance requirements.

ITEM 2. PROPERTIES

None as of December 31, 2003.

ITEM 3. LEGAL PROCEEDINGS

The Company is not currently involved in any material litigation nor, to
the Company's knowledge is any material litigation currently threatened against
the Company other than routine litigation arising in the ordinary course of
business. See Note 8 to Financial Statements on page 30.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth
quarter of 2003.

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS

HCH presently owns all 1,000 shares of the common stock of the Company,
which are not listed or traded on any securities exchange. On December 2, 2003,
the Company declared $2 million in cash dividends on common stock, which were
paid in December 2003. On December 4, 2002, the Company declared $3.090 million
in cash dividends on common stock, which were paid in December 2002. In
addition, on September 12, 2003 and 2002, the Company paid a cash dividend of
$530 thousand and $130 thousand, respectively, on the outstanding common shares
to the stockholder of record on September 3, 2003, and September 4, 2002,
respectively. These dividends completed the 2002 and 2001 REIT tax compliance
requirements regarding income distributions.

The Preferred Shares are traded on the New York Stock Exchange under the
symbol "HBC Pr A". During 2003 and 2002, the Company declared and paid cash
dividends to preferred stockholders of approximately $18.4 million in each year.
Although the Company declared cash dividends on the Preferred Shares for 2003
and 2002, no assurances can be made as to the declaration of, or if declared,
the amount of, future distributions since such distributions are subject to the
Company's financial condition and capital needs; the impact of legislation and
regulations as then in effect or as may be proposed; economic conditions; and
such other factors as the Board of Directors may deem relevant. Notwithstanding
the foregoing, to remain qualified as a REIT, the Company must distribute
annually at least 90% of its ordinary taxable income to preferred and /or common
stockholders.

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected financial data for the Company and
should be read in conjunction with the Consolidated Financial Statements and
notes thereto and Management's Discussion and Analysis of Financial Condition
and Results of Operations contained in this Report.

FOR THE YEARS ENDED DECEMBER 31
----------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

Statement of Operations Data:
Interest income............................. $ 17,678 $ 19,934 $ 28,715 $ 32,312 $ 31,588
Noninterest income.......................... 4,158 2,677 4,796 257 --
Operating expenses:
Loan servicing fee........................ 70 131 243 373 511
Advisory fees............................. 56 43 35 57 50
General and administrative................ 362 314 300 290 300
-------- -------- -------- -------- --------
Total operating expenses............... 488 488 578 720 861
-------- -------- -------- -------- --------
Net income.................................. 21,348 22,123 32,933 31,849 30,727
Preferred stock dividends................... 18,438 18,438 18,438 18,438 18,438
-------- -------- -------- -------- --------
Net income available to common
stockholder............................... $ 2,910 $ 3,685 $ 14,495 $ 13,411 $ 12,289
======== ======== ======== ======== ========
Basic and diluted net income per common
share..................................... $ 2,910 $ 3,685 $ 14,495 $ 13,411 $ 12,289
======== ======== ======== ======== ========
Distributions per preferred share........... $ 1.8438 $ 1.8438 $ 1.8438 $ 1.8438 $ 1.8438
======== ======== ======== ======== ========
Balance Sheet Data (end of period):
Total assets........................... $494,318 $502,042 $489,342 $489,939 $473,988
======== ======== ======== ======== ========
Total liabilities...................... $ 84 $ 96 $ 100 $ 115 $ 97
======== ======== ======== ======== ========
Total stockholders' equity............. $494,234 $501,946 $489,242 $489,824 $473,891
======== ======== ======== ======== ========
Cash Flows Data:
Operating activities........................ $ 18,046 $ 19,440 $ 28,736 $ 31,638 $ 30,821
======== ======== ======== ======== ========
Investing activities........................ $ 3,120 $ 2,440 $ 4,035 $ (419) $ 10,290
======== ======== ======== ======== ========
Financing activities........................ $(20,968) $(21,658) $(33,084) $(31,662) $(40,470)
======== ======== ======== ======== ========

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion should be read in conjunction with the
Consolidated Financial Statements and notes thereto appearing later in this
Report.

SUMMARY

YEAR ENDED DECEMBER 31, 2003 COMPARED TO DECEMBER 31, 2002

The Company's net income for 2003 was $21.3 million. This represented a
3.5% decrease from 2002 net income of $22.1 million. Earnings decreased
primarily because of reduced interest income on earning assets, partially offset
by increased gains on securities sales from $2.7 million in 2002 to $4.2 million
in 2003.

Interest income on the Notes for 2003 totaled $1.5 million and yielded 6.4%
on $24 million of average principal outstanding compared to $2.8 million and a
6.4% yield on $43 million average principal outstanding for 2002. The decrease
in income was attributable to a reduction in the Note balance because of
customer

payoffs in the Securing Mortgage Loans. The average outstanding balance of the
Securing Mortgage Loans was $29 million for 2003 and $53 million for 2002.
Interest income on securities available-for-sale for 2003 was $14.9 million,
resulting in a yield of 4.6% on an average balance of $326 million compared to
interest income of $15.1 million with a yield of 4.9% on an average balance of
$309 million for 2002. The decrease in interest income on securities
available-for-sale was primarily attributable to a reduction in yield, partially
offset by growth in the investment portfolio. As securities matured or were
sold, proceeds were invested in lower yielding securities as market interest
rates declined. Gains from investment securities sales were $4.2 million in 2003
and $2.7 million in 2002. There were no Company borrowings during either year.

Operating expenses for both of the years ended December 31, 2003 and 2002
totaled $488 thousand. Loan servicing expenses for 2003 totaled $70 thousand, a
decrease of $61 thousand or 47% from 2002. This decrease was attributed to the
reduction in the principal balance of the Notes. Advisory fees for the year
ended December 31, 2003 were $56 thousand compared to $43 thousand for the same
period a year ago, due to higher internal processing, record-keeping and
overhead costs. General and administrative expenses for the same period totaled
$362 thousand, an increase of $48 thousand or 15% from 2002, due to increased
compliance and governance costs.

On December 30, 2003, the Company paid a cash dividend of $0.46094 per
share on the outstanding Preferred Shares to the stockholders of record on
December 15, 2003 as declared on December 2, 2003. On December 30, 2002, the
Company paid a cash dividend of $0.46094 per share on the outstanding Preferred
Shares to the stockholders of record on December 15, 2002 as declared on
December 4, 2002. On a year-to-date basis, the Company declared and paid $18.4
million of dividends to holders of Preferred Shares for 2003 and 2002,
respectively. A cash dividend on common stock of $2.0 million was declared on
December 2, 2003 to the stockholder of record on December 15, 2003 and paid on
December 31, 2003. A cash dividend on common stock of $3.090 million was
declared on December 4, 2002 to the stockholder of record on December 15, 2002
and paid on December 27, 2002. In addition, on September 12, 2003 and September
12, 2002, the Company paid a cash dividend of $530 thousand and $130 thousand,
respectively, on the outstanding common shares to the stockholder of record on
September 3, 2003 and September 4, 2002, respectively. These common share
dividends completed the Company's 2002 and 2001 REIT tax compliance
requirements.

At December 31, 2003 and 2002, there were no Securing Mortgage Loans on
nonaccrual status and there was no allowance for loan losses.

YEAR ENDED DECEMBER 31, 2002 COMPARED TO DECEMBER 31, 2001

The Company's net income for 2002 was $22.1 million. This represented a
$10.8 million or 33% decrease from 2001 net income of $32.9 million. Earnings
decreased primarily because of reduced interest income on earnings assets. In
addition, gains on securities sales declined from $4.8 million in 2001 to $2.7
million in 2002.

Interest income on the Notes for 2002 totaled $2.8 million and yielded 6.4%
on $43 million of average principal outstanding compared to interest income of
$5.2 million and a 6.4% yield on $81 million average principal outstanding for
2001. The decrease in income was attributable to a reduction in the Note balance
because of principal paydowns by customers in the Securing Mortgage Loans. The
average outstanding balance of the Securing Mortgage Loans was $53 million for
2002 and $99 million for 2001. Interest income on securities available-for-sale
for 2002 was $15.1 million, resulting in a yield of 4.9% on an average balance
of $309 million compared to $21.9 million with a yield of 6.1% on an average
balance of $363 million for 2001. The decrease in interest income on securities
available-for-sale was primarily attributable to a reduction in yield. As
securities matured or were sold, proceeds have been invested in lower yielding
securities as a result of declining interest rates. Gains from investment
securities sales were $2.7 million in 2002 and $4.8 million in 2001.

There were no Company borrowings during either year.

Operating expenses for the year ended December 31, 2002 totaled $488
thousand; a decrease of $90 thousand from the year ended December 31, 2001. Loan
servicing expenses for 2002 totaled $131 thousand, a decrease of $112 thousand
or 46% from 2001. This decrease was attributed to the reduction in the

principal balance of the Notes because servicing costs vary directly with their
balances. Advisory fees for the year ended December 31, 2002 were $43 thousand
compared to $35 thousand for the same period a year ago. General and
administrative expenses for the same period totaled $314 thousand, an increase
of $14 thousand or 5% from 2001, as a result of additional reporting and
compliance costs.

On December 30, 2002, the Company paid a cash dividend of $0.46094 per
share on the outstanding Preferred Shares to the stockholders of record on
December 15, 2002 as declared on December 4, 2002. On December 30, 2001, the
Company paid a cash dividend of $0.46094 per share on the outstanding Preferred
Shares to the stockholders of record on December 15, 2001 as declared on
December 4, 2001. On a year-to-date basis, the Company declared and paid $18.4
million of dividends to holders of Preferred Shares for both 2002 and 2001. A
cash dividend on common stock of $3.090 million was declared on December 4, 2002
to the stockholder of record on December 15, 2002 and paid on December 27, 2002.
A cash dividend on common stock of $14.3 million was declared on December 4,
2001 to the stockholder of record on December 15, 2001 and paid on December 31,
2001. In addition, on September 12, 2002 and September 12, 2001, the Company
paid a cash dividend of $130 thousand and $346 thousand, respectively, on the
outstanding common shares to the stockholder of record on September 4, 2002 and
2001, respectively. These dividends completed the Company's 2001 and 2000 REIT
tax compliance requirements.

At December 31, 2002 and 2001, there were no Securing Mortgage Loans on
nonaccrual status and there was no allowance for loan losses.

QUARTER ENDED DECEMBER 31, 2003 COMPARED TO QUARTER ENDED DECEMBER 31, 2002

The Company's net income for the fourth quarter of 2003 was $4.6 million
compared to $4.7 million in the fourth quarter of 2002. Earnings decreased
primarily because of reduced interest income on earning assets offset by gains
on sales of securities.

Fourth quarter 2003 interest income on the Notes totaled $282 thousand and
yielded 6.4% on $18 million of average principal outstanding compared to
interest income of $550 thousand and a 6.4% yield on $34 million average
principal outstanding for the fourth quarter of 2002. The decrease in income was
attributable to a reduction in the Note balance because of principal paydowns by
customers in the Securing Mortgage Loans. The average outstanding balance of the
Securing Mortgage Loans for the fourth quarter of 2003 and 2002 was $22 million
and $42 million, respectively. Interest income on securities available-for-sale
for the current quarter was $3.1 million resulting in a yield of 4.6% on an
average balance of $265 million, compared to interest income of $3.9 million
with a yield of 4.1% on an average balance of $379 million for the same period a
year ago. The decrease in interest income is primarily attributable to the
reduction in the investment portfolio of mortgage-backed securities, partially
offset by the increased investment in U.S. Treasury securities.

There were no Company borrowings during the fourth quarter of 2003 or 2002.

Fourth quarter 2003 operating expenses totaled $179 thousand, an increase
of $4 thousand from the fourth quarter of 2002. Loan servicing expenses totaled
$13 thousand, a decrease of $13 thousand or 50% from the prior year's fourth
quarter, attributed to the reduction in the principal balance of the Notes.
Advisory fees for the fourth quarter of 2003 were $26 thousand compared to $8
thousand in the prior year's fourth quarter, due to increased costs for
processing, recordkeeping and administration. General and administrative
expenses totaled $140 thousand in the current quarter, essentially unchanged
from fourth quarter 2002.

ALLOWANCE FOR LOAN LOSSES

The Company does not currently maintain an allowance for loan losses due to
the over-collateralization of the Securing Mortgage Loans and the prior and
expected credit performance of the collateral pool.

CONCENTRATIONS OF CREDIT RISK

A majority of the collateral underlying the Securing Mortgage Loans is
located in Illinois and Arizona. The financial viability of customers in these
states is, in part, dependent on the states' economies. The
10

collateral may be subject to a greater risk of default than other comparable
loans in the event of adverse economic, political or business developments or
natural hazards that may affect such region and the ability of property owners
in such region to make payments of principal and interest on the underlying
mortgages. The Company's maximum risk of accounting loss, should all customers
in Illinois and Arizona fail to perform according to contract terms and all
collateral prove to be worthless, was approximately $12 million and $2 million,
respectively at December 31, 2003 and $21 million and $6 million, respectively,
at December 31, 2002.

INTEREST RATE RISK

The Company's income consists primarily of interest payments on the
Mortgage Assets it holds. If there is a decline in interest rates during a
period of time when the Company must reinvest payments of interest and principal
with respect to its Mortgage Assets, the Company may find it difficult to
purchase additional Mortgage Assets that generate sufficient income to support
payment of dividends on the Preferred Shares. Because the rate at which
dividends, if, when and as authorized and declared, are payable on the Preferred
Shares is fixed, there can be no assurance that an interest rate environment in
which there is a decline in interest rates would not adversely affect the
Company's ability to pay dividends on the Preferred Shares.

COMPETITION

The Company does not engage in the business of originating mortgage loans.
While the Company will acquire additional Mortgage Assets, it anticipates that
such Mortgage Assets will be acquired from the Bank and affiliates of the Bank.
Accordingly, the Company does not expect to compete with mortgage conduit
programs, investment banking firms, savings and loan associations, banks, thrift
and loan associations, finance companies, mortgage bankers or insurance
companies in acquiring its Mortgage Assets.

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 liquidity needs are to maintain the current
portfolio size through the acquisition of additional Notes or other qualifying
assets and 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 from repayment of principal balances by
individual mortgages or maturities of securities held for sale on a reinvested
basis. The payment of dividends on the Preferred Shares will be made from
legally available funds, principally 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 and mortgage-backed securities. 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 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 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 Statement of Cash Flows, the primary
sources of funds in addition to $18.0 million provided from operations during
2003 were $14.5 million provided by principal payments received on the Notes and
$743.0 million from the maturities and sales of securities available-for-sale.
In 2002, the primary sources of funds other than $19.4 million provided from
operations were $24.9 million provided by principal payments received on the
Notes and $822.3 million from the maturities of securities

available-for-sale. The primary uses of funds for 2003 were $765.4 million in
purchases of securities available-for-sale and $18.4 and $2.5 million in
preferred stock dividends and common stock dividends paid, respectively. In
2002, the primary uses of funds were $848.2 million in purchases of securities
available-for-sale and $18.4 and $3.2 million in preferred stock dividends and
common stock dividends paid, respectively.

ACCOUNTING PRONOUNCEMENTS

The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," on
January 1, 2003. The Statement requires that a liability for costs associated
with exit or disposal activities is recognized when the liability is incurred,
as defined in Concepts Statement 6. It nullifies Emerging Issues Task Force
("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." The adoption of the Statement was not material to the
Company's financial position or results of operations.

The Company adopted the disclosure requirements of Financial Accounting
Standards Board ("FASB") Interpretation No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"), on December 31, 2002. The recognition and
measurement provisions of FIN 45 were adopted on January 1, 2003. The adoption
of FIN 45 was not material to the Company's financial position or results of
operations.

In December 2003, the FASB issued FASB Interpretation No. 46 (Revised),
"Consolidation of Variable Interest Entities" ("FIN 46R"). FIN 46R replaces FIN
46, which was issued in January 2003. FIN 46R addresses how a business
enterprise should evaluate whether it has a controlling financial interest in an
entity through means other than voting rights and whether it should consolidate
the entity. An entity is subject to FIN 46R and is called a variable interest
entity ("VIE") if it has (1) equity that is insufficient to permit the entity to
finance its activities without additional subordinated financial support from
other parties, or (2) equity investors that cannot make decisions about the
entity's operations, or that do not absorb the expected losses or receive the
expected returns of the entity. A VIE is consolidated by its primary
beneficiary, which is the party involved with the VIE that has a majority
interest in the expected losses or the expected residual returns or both. The
Company does not have an interest in a VIE and is not subject to the provisions
of FIN 46R.

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." The Statement clarifies
accounting for derivative instruments, including embedded derivatives, and
accounting for hedging activities. The Company adopted the Statement on July 1,
2003. The adoption of the Statement did not have a material effect on the
Company's financial position or results of operations.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." The
Statement applies to issuers of financial instruments and establishes standards
for the classification and measurement of freestanding financial instruments
having characteristics of both liabilities and equity. The Company adopted the
Statement on July 1, 2003. The adoption of the Statement did not have a material
effect on the Company's financial position or results of operations.

In December 2003, the FASB issued SFAS No. 132 (revised 2003), "Employers'
Disclosures about Pensions and Other Postretirement Benefits" to improve
financial statement disclosures for defined benefit plans. The Statement
requires additional disclosures, primarily for plan assets and cash flow
requirements. The Company adopted the disclosure requirements of SFAS No. 132 on
December 31, 2003. The adoption of the Statement did not have a material effect
on the Company's financial position or results of operations.

OTHER MATTERS

As of December 31, 2003, the Company believes that it is in full compliance
with the REIT tax rules, and expects to qualify as a REIT under the provisions
of the Code. The Company expects to meet all REIT

requirements regarding the ownership of its stock and anticipates meeting the
annual distribution requirements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

As of December 31, 2003, the Company had $17 million invested in Notes, a
decrease of $14 million from December 31, 2002. The decline was attributable to
customer payoffs in the Securing Mortgage Loans. At December 31, 2003, the
Company held $234 million in mortgage-backed securities compared to $365 million
at December 31, 2002. At December 31, 2003, the Company held $230 million in
U.S. Treasuries compared to $80 million at December 31, 2002. At December 31,
2003, the Company held an investment of $11.5 million in securities purchased
from the Bank under agreement to resell compared to $20 million at December 31,
2002. The Company is subject to exposure for fluctuations in interest rates.
Adverse changes in interest rates could impact negatively the value of
mortgage-backed securities, as well as the levels of interest income to be
derived from these assets.

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 prepayments, repurchases, defaults and liquidations), the
pass-through rate and interest rate fluctuations. Changes in interest rates
could impact 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.

The Company currently has no outstanding borrowings.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Refer to the Index to Consolidated Financial Statements on page 20 for the
required information.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

There have been no disagreements with accountants on any matter of
accounting principles, practices or financial statement disclosure.

On January 27, 2004, the Audit Committee of Harris Preferred Capital
Corporation ("HPCC") dismissed PricewaterhouseCoopers LLP ("PwC") as its
independent accountants effective upon completion of audit services related to
HPCC's December 31, 2003 financial statements.

ITEM 9A. CONTROLS AND PROCEDURES

As of December 31, 2003, Paul R. Skubic, the Chairman of the Board, Chief
Executive Officer and President of the Company, and Janine Mulhall, the Chief
Financial Officer of the Company, evaluated the effectiveness of the disclosure
controls and procedures of the Company and concluded that these disclosure
controls and procedures are effective to ensure that material information
required to be included in this Report has been made known to them in a timely
fashion. There was no change in the Company's internal controls over financial
reporting identified in connection with such evaluations that occurred during
the quarter ended December 31, 2003 that has materially affected or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

The Company's Board of Directors consists of five members. The Company does
not anticipate that it will require any additional employees because it has
retained the Bank to perform certain functions pursuant to the Advisory
Agreement described above. Each officer of the Company currently is also an
officer of the

Bank and/or affiliates of the Bank. The Company maintains corporate records and
audited financial statements that are separate from those of the Bank or any of
the Bank's affiliates. None of the officers, directors or employees of the
Company will have a direct or indirect pecuniary interest in any Mortgage Asset
to be acquired or disposed of by the Company or in any transaction in which the
Company has an interest or will engage in acquiring, holding and managing
Mortgage Assets.

Pursuant to terms of the Preferred Shares, the Company's Independent
Directors will consider the interests of the holders of both the Preferred
Shares and the Common Stock in determining whether any proposed action requiring
their approval is in the best interests of the Company.

The persons who are directors and executive officers of the Company are as
follows:

NAME AGE POSITION AND OFFICES HELD
---- --- -------------------------

Paul R. Skubic.......................................... 55 Chairman of the Board, President
Janine Mulhall.......................................... 42 Chief Financial Officer
Frank M. Novosel........................................ 57 Treasurer, Director
Teresa L. Patton........................................ 56 Vice President of Operations
Margaret M. Sulkin...................................... 45 Assistant Treasurer
Delbert J. Wacker....................................... 72 Director
David J. Blockowicz..................................... 61 Director
Forrest M. Schneider.................................... 56 Director

The following is a summary of the experience of the executive officers and
directors of the Company:

Mr. Skubic has been Vice President and Controller of the Bank and Chief
Accounting Officer for Harris Bankcorp, Inc., and the Bank since 1990. Prior to
joining Harris Bankcorp, Inc., Mr. Skubic was employed by Arthur Andersen & Co.
He is a certified public accountant.

Ms. Mulhall, has been Senior Vice President and Chief Financial Officer of
Harris Bankcorp, Inc. since July 2003. From November 1995 to that time she held
several positions in the Finance area of Harris Bankcorp's parent company, Bank
of Montreal, including most recently Vice President and Chief Accountant. From
1984 to 1995, Ms. Mulhall was with KPMG LLP in Toronto. She is a Canadian
Chartered Accountant.

Mr. Novosel has been a Vice President in the Treasury Group of the Bank
since 1995. Previously, he served as Treasurer of Harris Bankcorp, Inc.,
managing financial planning. Mr. Novosel is a Chartered Financial Analyst and a
member of the Investment Analysts' Society of Chicago.

Ms. Patton has been a Vice President in Residential Mortgages at the Bank
for 16 years and is currently the Director of Secondary Marketing. Prior to this
position she was the Manager of Sales and Delivery for the Residential Mortgage
Division. She currently serves on the Bank's Asset/Liability Committee, and has
been employed by the Bank for over 26 years holding positions in Consumer and
Commercial Banking.

Ms. Sulkin has been a Vice President in the Taxation Department of the Bank
since 1992. Ms. Sulkin has been employed by the Bank since 1984. Prior to
joining the Bank, she was employed by KPMG LLP. She is a certified public
accountant.

Mr. Wacker retired as a partner from Arthur Andersen & Co. in 1987 after 34
years. From July 1988 to November 1990, he was Vice President -- Treasurer,
Parkside Medical Services, a subsidiary of Lutheran General Health System. From
November 1990 to September 1993, he completed various financial consulting
projects for Lutheran General.

Mr. Blockowicz is a certified public accountant and is a partner with
Blockowicz & Del Guidicie LLC. Prior to forming his firm, Mr. Blockowicz was a
partner with Arthur Andersen & Co. through 1990.

Mr. Schneider is President and Chief Executive Officer of Lane Industries,
Inc. Mr. Schneider is a director of Lane Industries and director of General
Binding Corporation. He has been employed by Lane

Industries since 1976. He is a graduate of the University of Illinois where he
received his B.S. and masters degree in finance.

INDEPENDENT DIRECTORS

The terms of the Preferred Shares require that, as long as any Preferred
Shares are outstanding, certain actions by the Company be approved by a majority
of the Company's Independent Directors. Delbert J. Wacker, David J. Blockowicz
and Forrest M. Schneider are the Company's Independent Directors.

If at any time the Company fails to declare and pay a quarterly dividend
payment on the Preferred Shares, the number of directors then constituting the
Board of Directors of the Company will be increased by two at the Company's next
annual meeting and the holders of Preferred Shares, voting together with the
holders of any other outstanding series of Preferred Stock as a single class,
will be entitled to elect two additional directors to serve on the Company's
Board of Directors. Any member of the Board of Directors elected by holders of
the Company's Preferred Shares will be deemed to be an Independent Director for
purposes of the actions requiring the approval of a majority of the Independent
Directors.

AUDIT COMMITTEE

The Board of Directors of the Company has established an audit committee
with an approved Audit Committee Charter, which will review the engagement of
independent accountants and review their independence. The audit committee will
also review the adequacy of the Company's internal accounting controls. The
audit committee is comprised of Delbert J. Wacker, David J. Blockowicz and
Forrest M. Schneider. The Company's Board of Directors has determined that each
member of the audit committee is an audit committee financial expert as defined
in rules of the Securities and Exchange Commission. Each audit committee member
is independent as defined in rules of the New York Stock Exchange.

COMPENSATION OF DIRECTORS AND OFFICERS

The Company pays the Independent Directors of the Company fees for their
services as directors. The Independent Directors receive annual compensation of
$10,000 plus a fee of $750 for each attendance (in person or by telephone) at
each meeting of the Board of Directors or the Audit Committee.

The Company has adopted a code of ethics for its senior officers, which is
filed as Exhibit 14 hereto.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Based on a review of reports filed with respect to the year ended December
31, 2003, the Company believes that all ownership reports were filed on a timely
basis.

ITEM 11. EXECUTIVE COMPENSATION

The Company will not pay any compensation to its officers or employees or
to directors who are not Independent Directors.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

(A) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS

No person owns of record or is known by the Company to own beneficially
more than 5% of the outstanding 7 3/8% Noncumulative Exchangeable Preferred
Stock, Series A.

(B) SECURITY OWNERSHIP OF MANAGEMENT

The following table shows the ownership of 7 3/8% Noncumulative
Exchangeable Preferred Stock, Series A, by the only officers or directors who
own any such shares.

NAME OF AMOUNT OF PERCENT
TITLE OF CLASS BENEFICIAL OWNER BENEFICIAL OWNERSHIP OF CLASS
-------------- ----------------- -------------------- --------

Preferred Stock.................................... Paul R. Skubic 300 Shares .003%
Preferred Stock.................................... Forrest Schneider 2200 Shares .022%

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

(A) TRANSACTIONS WITH MANAGEMENT AND OTHERS

The Bank, through its wholly-owned subsidiary, HCH, indirectly owns
100% of the common stock of the Company.

A substantial portion of the assets of the Company initially consisted
of Notes issued by the Bank. The Notes mature on October 1, 2027 and pay
interest at 6.4% per annum. During 2003, the Company received repayments on
the Notes of $15 million compared to 2002 repayments of $25 million. In
years ended December 31, 2003, 2002 and 2001, the Bank paid interest on the
Notes in the amount of $1.5 million, $2.8 million and $5.2 million,
respectively, to the Company.

The Company purchases U.S. Treasury and Federal agency securities from
the Bank under agreements to resell identical securities. At December 31,
2003, the Company held $11.5 million of such assets and had earned $1.3
million of interest from the Bank during 2003. At December 31, 2002, the
Company held $20 million of such assets and earned $2.1 million of interest
for 2002. The Company receives rates on these assets comparable to the
rates that the Bank offers to unrelated counterparties under similar
circumstances.

The Bank and the Company have entered into a Servicing Agreement and
an Advisory Agreement, the terms of which are described in further detail
on page 5 of this Report. In 2003, the Bank received payments of $70
thousand and $56 thousand, respectively, compared to $131 thousand and $43
thousand for 2002, under the terms of these agreements.

(B) CERTAIN BUSINESS RELATIONSHIPS

Paul R. Skubic, Chairman of the Board of the Company, and all of its
executive officers, Janine Mulhall, Frank M. Novosel, Teresa L. Patton and
Margaret M. Sulkin, are also officers of the Bank.

None.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

AUDIT FEES

For both of the years ended December 31, 2003 and 2002, the Company's
principal accountant billed $72 thousand for the audit of the Company's annual
financial statements and review of financial statements included in Form 10-Q
filings.

AUDIT-RELATED FEES

There were no fees billed for services reasonably related to the
performance of the audit or review of our financial statements outside of those
fees disclosed above under "Audit Fees" for years ended December 31, 2003 and
2002.

TAX FEES AND ALL OTHER FEES

There were no tax fees or other fees billed by the Company's principal
accountants other than those disclosed above for years ended December 31, 2003
and 2002.

PRE-APPROVAL POLICIES AND PROCEDURES

Prior to engaging accountants to perform a particular service, this Board
of Directors obtains an estimate for the service to be performed. All of the
services described above were approved by the Board of Directors in accordance
with its procedures.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) Documents filed with Report:

(1) Financial Statements (See page 20 for a listing of all financial
statements included in Item 8)

(2) Financial Statement Schedules

All schedules normally required by Form 10-K are omitted since they are
either not applicable or because the required information is shown in the
financial statements or notes thereto.

(3) Exhibits:

*3(a)(I) Articles of Incorporation of the Company
*3(a)(ii) Form of Articles of Amendment and Restatement of the Company
establishing the Series A Preferred Shares
*3(b) Bylaws of the Company
*4 Specimen of certificate representing Series A Preferred
Shares
*10(a) Form of Servicing Agreement between the Company and the Bank
*10(b) Form of Advisory Agreement between the Company and the Bank
*10(c) Form of Bank Loan Agreement between the Company and the Bank
*10(d) Form of Mortgage Loan Assignment Agreement between the
Company and the Bank
14 Code of Ethics for Senior Officers
21 Subsidiaries
24 Power of attorney
31.1 Certification of Janine Mulhall pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 Certification of Paul R. Skubic pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

---------------
* Incorporated by reference to the exhibit of the same number filed with the
Company's Registration Statement on Form S-11 (Securities and Exchange
Commission file number 333-40257)

(b) No reports on Form 8-K were filed.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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 24th day of March 2004.

/s/ PAUL R. SKUBIC
----------------------------------------
Paul R. Skubic
Chairman of the Board and President
/s/ JANINE MULHALL
----------------------------------------
Janine Mulhall
Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by Paul R. Skubic, Chairman of the Board and President of
the Company, as attorney-in-fact for the following Directors on behalf of Harris
Preferred Capital Corporation of the 24th day of March 2004.

David J. Blockowicz Forrest M. Schneider
Frank M. Novosel Delbert J. Wacker

Paul R. Skubic
Attorney-In-Fact
Supplemental Information

No proxy statement will be sent to security holders in 2004.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

The following consolidated financial statements are included in Item 8 of
this Annual Report on Form 10-K:

HARRIS PREFERRED CAPITAL CORPORATION

Consolidated Financial Statements

Report of Independent Auditors

Consolidated Balance Sheets

Consolidated Statements of Operations and Comprehensive Income

Consolidated Statements of Changes in Stockholders' Equity

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

HARRIS TRUST AND SAVINGS BANK

Financial Review

Consolidated Financial Statements

Joint Independent Auditors

Report of Independent Auditors

Consolidated Statements of Condition

Consolidated Statements of Income

Consolidated Statements of Comprehensive Income

Consolidated Statements of Changes in Stockholders' Equity

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

All other schedules are omitted since the required information is not
present or is not present in amounts sufficient to require submission of the
schedule or because the information required is included in the consolidated
financial statements and notes hereof.

REPORT OF INDEPENDENT AUDITORS

To the Stockholders and Board of Directors
of Harris Preferred Capital Corporation

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations and comprehensive income, of changes in
stockholders' equity and of cash flows present fairly, in all material respects,
the financial position of Harris Preferred Capital Corporation (the "Company")
and its subsidiary at December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2003 in conformity with accounting principles generally accepted in
the United States of America. These financial statements are the responsibility
of the Company's management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP

February 23, 2004
Chicago, Illinois

HARRIS PREFERRED CAPITAL CORPORATION

CONSOLIDATED BALANCE SHEETS

DECEMBER 31
---------------------
2003 2002
--------- ---------
(IN THOUSANDS, EXCEPT
SHARE DATA)

ASSETS
Cash on deposit with Harris Trust and Savings Bank.......... $ 926 $ 728
Securities purchased from Harris Trust and Savings Bank
under agreement to resell................................. 11,500 20,000
Notes receivable from Harris Trust and Savings Bank......... 16,547 31,078
Securities available-for-sale:
Mortgage-backed........................................... 233,857 365,383
U.S. Treasury............................................. 229,995 79,976
Securing mortgage collections due from Harris Trust and
Savings Bank.............................................. 414 2,930
Other assets................................................ 1,079 1,947
-------- --------
TOTAL ASSETS.............................................. $494,318 $502,042
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses............................................ $ 84 $ 96
-------- --------
Commitments and contingencies............................... -- --
STOCKHOLDERS' EQUITY
7 3/8% Noncumulative Exchangeable Preferred Stock, Series A
($1 par value); liquidation value of $250,000,000 and
20,000,000 shares authorized, 10,000,000 shares issued and
outstanding............................................... 250,000 250,000
Common stock ($1 par value); 1,000 shares authorized, issued
and outstanding........................................... 1 1
Additional paid-in capital.................................. 240,733 240,733
Earnings in excess of distributions......................... 1,230 850
Accumulated other comprehensive income -- net unrealized
gains/(losses) on available-for-sale securities........... 2,270 10,362
-------- --------
TOTAL STOCKHOLDERS' EQUITY................................ 494,234 501,946
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................ $494,318 $502,042
======== ========

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

HARRIS PREFERRED CAPITAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31
----------------------------------
2003 2002 2001
--------- --------- ----------
(IN THOUSANDS, EXCEPT SHARE DATA)

INTEREST INCOME:
Securities purchased from Harris Trust and Savings Bank
under agreement to resell............................. $ 1,266 $ 2,063 $ 1,566
Notes receivable from Harris Trust and Savings Bank...... 1,508 2,776 5,208
Securities available-for-sale:
Mortgage-backed....................................... 14,791 14,693 20,828
U.S. Treasury......................................... 113 402 1,113
--------- --------- ----------
Total interest income............................... 17,678 19,934 28,715
NON-INTEREST INCOME:
Gain on sale of securities............................... 4,158 2,677 4,796
--------- --------- ----------
4,158 2,677 4,796
OPERATING EXPENSES:
Loan servicing fees paid to Harris Trust and Savings
Bank.................................................. 70 131 243
Advisory fees paid to Harris Trust and Savings Bank...... 56 43 35
General and administrative............................... 362 314 300
--------- --------- ----------
Total operating expenses............................ 488 488 578
--------- --------- ----------
Net income................................................. 21,348 22,123 32,933
--------- --------- ----------
Preferred dividends........................................ 18,438 18,438 18,438
--------- --------- ----------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER................. $ 2,910 $ 3,685 $ 14,495
========= ========= ==========
Basic and diluted earnings per common share................ $2,910.00 $3,685.00 $14,495.00
========= ========= ==========
Net income................................................. $ 21,348 $ 22,123 $ 32,933
Other comprehensive income/(loss) -- net unrealized
gains/(losses) on available-for-sale securities.......... (8,092) 12,239 (431)
--------- --------- ----------
Comprehensive income....................................... $ 13,256 $ 34,362 $ 32,502
========= ========= ==========

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

HARRIS PREFERRED CAPITAL CORPORATION

STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001

ACCUMULATED
ADDITIONAL EARNINGS IN OTHER TOTAL
PREFERRED COMMON PAID-IN EXCESS OF COMPREHENSIVE STOCKHOLDERS'
STOCK STOCK CAPITAL DISTRIBUTIONS INCOME (LOSS) EQUITY
--------- ------ ---------- ------------- ------------- -------------
(IN THOUSANDS EXCEPT PER SHARE DATA)

BALANCE AT DECEMBER 31,
2000........................ $250,000 $ 1 $ 240,733 $ 536 $(1,446) $489,824
Net income.................. -- -- -- 32,933 -- 32,933
Other comprehensive loss.... -- -- -- -- (431) (431)
Dividends declared on common
stock ($14,646.00 per
share)................... -- -- -- (14,646) -- (14,646)
Dividends declared on
preferred stock ($1.8438
per share)............... -- -- -- (18,438) -- (18,438)
-------- --- --------- -------- ------- --------
BALANCE AT DECEMBER 31,
2001........................ $250,000 $ 1 $ 240,733 $ 385 $(1,877) $489,242
======== === ========= ======== ======= ========
Net income.................. -- -- -- 22,123 -- 22,123
Other comprehensive
income................... -- -- -- -- 12,239 12,239
Dividends declared on common
stock ($3,220.00 per
share)................... -- -- -- (3,220) -- (3,220)
Dividends declared on
preferred stock ($1.8438
per share)............... -- -- -- (18,438) -- (18,438)
-------- --- --------- -------- ------- --------
BALANCE AT DECEMBER 31,
2002........................ $250,000 $ 1 $ 240,733 $ 850 $10,362 $501,946
======== === ========= ======== ======= ========
Net income.................. -- -- -- 21,348 -- 21,348
Other comprehensive loss.... -- -- -- (8,092) (8,092)
Dividends declared on common
stock ($2,530.00 per
share)................... -- -- -- (2,530) -- (2,530)
Dividends declared on
preferred stock ($1.8438
per share)............... -- -- -- (18,438) -- (18,438)
-------- --- --------- -------- ------- --------
BALANCE AT DECEMBER 31,
2003........................ $250,000 $ 1 $ 240,733 $ 1,230 $ 2,270 $494,234
======== === ========= ======== ======= ========

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

HARRIS PREFERRED CAPITAL CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31
---------------------------------
2003 2002 2001
--------- --------- ---------
(IN THOUSANDS)

OPERATING ACTIVITIES:
Net income.............................................. $ 21,348 $ 22,123 $ 32,933
Adjustments to reconcile net income to net cash provided
by operating activities:
Gain on sale of securities......................... (4,158) (2,677) (4,796)
Net decrease (increase) in other assets............ 868 (2) 614
Net decrease in accrued expenses................... (12) (4) (15)
--------- --------- ---------
Net cash provided by operating activities....... 18,046 19,440 28,736
--------- --------- ---------
INVESTING ACTIVITIES:
Net decrease (increase) in securities purchased from
Harris Trust and Savings Bank under agreement to
resell............................................... 8,500 1,000 (18,000)
Repayments of notes receivable from Harris Trust and
Savings Bank......................................... 14,531 24,884 46,998
Decrease (increase) in securing mortgage collections due
from Harris Trust and Savings Bank................... 2,516 2,423 (2,567)
Purchases of securities available-for-sale.............. (765,405) (848,215) (897,270)
Proceeds from maturities and sales of securities
available-for-sale................................... 742,978 822,348 874,874
--------- --------- ---------
Net cash provided by investing activities....... 3,120 2,440 4,035
--------- --------- ---------
FINANCING ACTIVITIES:
Cash dividends paid on preferred stock.................. (18,438) (18,438) (18,438)
Cash dividends paid on common stock..................... (2,530) (3,220) (14,646)
--------- --------- ---------
Net cash used by financing activities.............. (20,968) (21,658) (33,084)
--------- --------- ---------
Net increase (decrease) in cash on deposit with Harris
Trust and Savings Bank............................... 198 222 (313)
Cash on deposit with Harris Trust and Savings Bank at
beginning of period.................................. 728 506 819
--------- --------- ---------
Cash on deposit with Harris Trust and Savings Bank at
end
of period............................................ $ 926 $ 728 $ 506
========= ========= =========

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

HARRIS PREFERRED CAPITAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND 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
Harris Trust and Savings Bank (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. The Company holds
certain assets through a Maryland real estate investment trust subsidiary,
Harris Preferred Capital Trust. The Company has elected to be a REIT under
sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the
"Code"), and will generally not be subject to Federal income tax to the extent
that it meets all of the REIT requirements in Code Sections 856-860. All of the
1,000 shares of the Company's common stock, par value $1.00 per share (the
"Common Stock"), are owned by Harris Capital Holdings, Inc. ("HCH"), a
wholly-owned subsidiary of the Bank. On December 30, 1998, the Bank transferred
its ownership of the common stock of the Company to HCH. The Bank is required to
maintain direct or indirect ownership of at least 80% of the outstanding Common
Stock of the Company for as long as any 7 3/8% Noncumulative Exchangeable
Preferred Stock, Series A (the "Preferred Shares"), $1.00 par value, is
outstanding. The Company was formed by the Bank to provide investors with the
opportunity to invest in residential mortgages and other real estate assets and
to provide the Bank with a cost-effective means of raising capital for federal
regulatory purposes.

On February 11, 1998, the Company completed an initial public offering (the
"Offering") of 10,000,000 shares of the Company's Preferred Shares, receiving
proceeds of $242,125,000, net of underwriting fees. The Preferred Shares are
traded on the New York Stock Exchange. Concurrent with the issuance of the
Preferred Shares, the Bank contributed additional capital of $250 million to the
Company.

The Company used the proceeds raised from the initial public offering of
the Preferred Shares and the additional capital contributed by the Bank to
purchase $356 million of Notes from the Bank and $135 million of mortgage-backed
securities at their estimated fair value.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

CASH AND CASH EQUIVALENTS

Cash and cash equivalents include cash on deposit with the Bank.

ALLOWANCE FOR POSSIBLE LOAN LOSSES

The allowance for possible loan losses is maintained at a level considered
adequate to provide for potential loan losses. The allowance is increased by
provisions charged to operating expense and reduced by net charge-offs. Known
losses of principal on impaired loans are charged off. The provision for loan
losses is based on past loss experience, management's evaluation of the loan
portfolio securing the Mortgage Assets under current economic conditions and
management's estimate of anticipated, but as yet not specifically identified,
loan losses. Such estimates are reviewed periodically and adjustments, if
necessary, are recorded during the periods in which they become known. At
December 31, 2003 and 2002, no allowance for possible loan losses was recorded
under this policy.

INCOME TAXES

The Company has elected to be taxed as a REIT commencing with its taxable
year ended December 31, 1998 and intends to comply with the provisions of the
Code with respect thereto. The Company does not expect to be subject to Federal
income tax because assets, income distribution and stock ownership tests in Code
Sections 856-860 are met. Accordingly, no provision for income taxes is included
in the accompanying financial statements.
26

The REIT Modernization Act, which took effect on January 1, 2001, modified
certain provisions of the Code, with respect to the taxation of REITs. A key
provision of this tax law change reduced the required level of distributions by
a REIT from 95% to 90% of ordinary taxable income starting in calendar year
2001.

SECURITIES

The Company classifies all securities as available-for-sale, even if the
Company has no current plans to divest. Available-for-sale securities are
reported at fair value with unrealized gains and losses included as a separate
component of stockholders' equity.

Interest income on securities, including amortization of discount or
premium, is included in earnings. Realized gains and losses, as a result of
securities sales, are included in securities gains, with the cost of securities
sold determined on the specific identification basis.

The Company purchases U.S. Treasury and Federal agency securities from the
Bank under agreements to resell identical securities. The amounts advanced under
these agreements represent short-term loans and are reflected as securities
purchased under agreement to resell in the balance sheet. Securities purchased
under agreement to resell totaled $11.5 million at December 31, 2003 compared to
$20 million at December 31, 2002. The securities underlying the agreements are
book-entry securities. Securities are transferred by appropriate entry into the
Company's account with the Bank under a written custodial agreement with the
Bank that explicitly recognizes the Company's interest in these securities.

The Company's investment securities are exposed to various risks such as
interest rate, market and credit. Due to the level of risk associated with
certain investment securities and the level of uncertainty related to changes in
the value of investment securities, it is at least reasonably possible that
changes in risks in the near term would materially affect the carrying value of
investments in securities available-for-sale currently reported in the balance
sheet.

NEW ACCOUNTING PRONOUNCEMENTS

MANAGEMENT'S ESTIMATES

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.

3. NOTES RECEIVABLE FROM THE BANK

On February 11, 1998, proceeds received from the Offering were used in part
to purchase $356 million of Notes at a rate of 6.4%. The Notes are secured by
mortgage loans originated by the Bank. The principal amount of the Notes equals
approximately 80% of the aggregate outstanding principal amount of the Mortgage
Loans. During 2003, the Company received repayments on the Notes of $14.5
million compared to 2002 repayment of $25 million. For years ended December 31,
2003, 2002 and 2001, the Bank paid interest on the Notes in the amount of $1.5
million, $2.8 million and $5.2 million, respectively, to the Company.

The Notes are recourse only to the Securing Mortgage Loans that are secured
by real property. The Notes mature on October 1, 2027. Payments of principal and
interest on the Notes are recorded monthly from payments received on the
Securing Mortgage Loans. The Company has a security interest in the real
property securing the underlying mortgage loans and is entitled to enforce
payment on the Securing Mortgage Loans in its own name if a mortgagor should
default. In the event of default, the Company has the same rights as the
original mortgagee to foreclose the mortgaged property and satisfy the
obligations of the Bank out of the proceeds. The Securing Mortgage Loans are
serviced by the Bank, as agent of the Company.

The Company intends that each mortgage loan securing the Notes will
represent a first lien position and will be originated in the ordinary course of
the Bank's real estate lending activities based on the underwriting standards
generally applied (at the time of origination) for the Bank's own account. The
Company also intends that all Mortgage Assets held by the Company will meet
market standards, and servicing guidelines promulgated by the Company, and
Federal National Mortgage Association ("Fannie Mae") and Federal Home Loan
Mortgage Corporation ("FHLMC") guidelines and procedures.

The balance of Securing Mortgage Loans at December 31, 2003 and 2002 was
$21 million and $39 million, respectively. The weighted average interest rate on
those loans at December 31, 2003 and 2002 was 5.996% and 6.930%, respectively.

None of the Securing Mortgage Loans collateralizing the Notes were on
nonaccrual status at December 31, 2003 or 2002.
28

A majority of the collateral securing the underlying mortgage loans is
located in Illinois and Arizona. The financial viability of customers in these
states is, in part, dependent on those states' economies. The Company's maximum
risk of accounting loss, should all customers in Illinois and Arizona fail to
perform according to contract terms and all collateral prove to be worthless,
was approximately $12 million and $2 million, respectively, at December 31, 2003
and $21 million and $6 million, respectively, as of December 31, 2002.

4. SECURITIES

DECEMBER 31, 2002 DECEMBER 31, 2001
---------------------------------------------- ----------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
--------- ---------- ---------- -------- --------- ---------- ---------- --------
(IN THOUSANDS)

AVAILABLE-FOR-SALE
SECURITIES
Mortgage-backed............. $231,587 $2,665 395 $233,857 $355,018 $10,365 $365,383
U.S. Treasury............... $229,995 $ -- $229,995 $ 79,979 $ -- $3 $ 79,976
-------- ------ ---- -------- -------- ------- -- --------
Total Securities............ $461,582 $2,665 $395 $463,852 $434,997 $10,365 $3 $445,359
======== ====== ==== ======== ======== ======= == ========

Mortgage-backed securities include Government National Mortgage Association
("GNMA") Platinum Certificates. The contractual maturities of the
mortgage-backed securities exceed ten years. 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. The U.S. Treasury
Bills held at December 31, 2003 mature within the next month.

5. COMMON AND PREFERRED STOCK

On February 11, 1998, the Company issued 10,000,000 Preferred Shares,
Series A, at a price of $25 per share pursuant to its Registration Statement on
Form S-11. Proceeds from this issuance, net of underwriting fees, totaled
$242,125,000. The liquidation value of each Preferred Share is $25 plus any
authorized, declared and unpaid dividends. The Preferred Shares are redeemable
at any time at the option of the Company, in whole or in part, at the
liquidation preference thereof, plus the quarterly accrued and unpaid dividends,
if any, to the date of redemption. The Company may not redeem the Preferred
Shares without prior approval from the Board of Governors of the Federal Reserve
System or the appropriate successor federal regulatory agency. Except under
certain limited circumstances, as defined, the holders of the Preferred Shares
have no voting rights. The Preferred Shares are automatically exchangeable for a
new series of preferred stock of the Bank upon the occurrence of certain events.

Holders of Preferred Shares are entitled to receive, if declared by the
Board of Directors of the Company, noncumulative dividends at a rate of 7 3/8%
per annum of the $25 per share liquidation preference (an amount equivalent to
$1.84375 per share per annum). Dividends on the Preferred Shares, if authorized
and declared, are payable quarterly in arrears on March 30, June 30, September
30, and December 30 each year. Dividends paid to the holders of the Preferred
Shares for the years ended December 31, 2003 and 2002 were $18,438,000 in both
years. The allocations of the distributions declared and paid for income tax
purposes for December 31, 2003 and 2002 were 92% of ordinary income and 8% of
capital gain and 90% of ordinary income and 10% of short term capital gain,
respectively.

On December 30, 1998, the Bank contributed the Common Stock of the Company
to HCH. The Bank is required to maintain direct or indirect ownership of at
least 80% of the outstanding Common Stock of the Company for as long as any
Preferred Shares are outstanding. Dividends on Common Stock are paid if and when
authorized and declared by the Board of Directors out of funds legally available
after all preferred dividends have been paid. A Common Stock dividend of $2,000
per common share was declared on December 2, 2003, to the stockholder of record
on December 15, 2003 and paid on December 31, 2003. The allocations of the
distribution declared and paid for income tax purposes were 92% of ordinary
income and 8% of capital gain. A Common Stock dividend of $3,090 per common
share was declared on December 4, 2002, to the stockholder of record on December
15, 2002 and paid on December 27, 2002. The allocations of
29

the distribution declared and paid for income tax purposes were 90% of ordinary
income and 10% of capital gain. In addition, on September 12, 2003 and September
12, 2002, the Company paid a cash dividend of $530 thousand and $130 thousand,
respectively, on the outstanding common shares to the stockholder of record on
September 3, 2003 and September 4, 2002, respectively. These dividends completed
the 2002 and 2001 REIT tax compliance requirements.

6. TRANSACTIONS WITH AFFILIATES

The Company entered into an advisory agreement (the "Advisory Agreement")
with the Bank pursuant to which the Bank administers the day-to-day operations
of the Company. The Bank is responsible for (i) monitoring the credit quality of
Mortgage Assets held by the Company; (ii) advising the Company with respect to
the reinvestment of income from and payments on, and with respect to, the
acquisition, management, financing, and disposition of the Mortgage Assets held
by the Company; and (iii) monitoring the Company's compliance with the
requirements necessary to qualify as a REIT.

The Advisory Agreement in effect in 2003, 2002 and 2001 entitled the Bank
to receive advisory fees of $56,000, $43,000, and $35,000, respectively. For
2004, advisory fees of $115,000 have been approved by the Board of Directors.

The Securing Mortgage Loans are serviced by the Bank pursuant to the terms
of a servicing agreement (the "Servicing Agreement"). The Bank receives a fee
equal to 0.25% per annum on the principal balances of the loans serviced. The
Servicing Agreement requires the Bank to service the mortgage loans in a manner
generally consistent with accepted secondary market practices, and servicing
guidelines promulgated by the Company and with Fannie Mae and FHLMC guidelines
and procedures. In 2003, 2002 and 2001, the Bank received payments of $70
thousand, $131 thousand and $243 thousand, respectively.

The Company purchases U.S. Treasury and Federal agency securities from the
Bank under agreements to resell identical securities. At December 31, 2003, the
Company held $11.5 million of such assets and had earned $1.2 million of
interest from the Bank during 2003. At December 31, 2002, the Company held $20
million of such assets and earned $2.1 million of interest for 2002. At December
31, 2001, the Company held $21 million of such assets and earned $1.6 million of
interest for 2001. The Company receives rates on these assets comparable to the
rates that the Bank offers to unrelated counterparties under similar
circumstances.

7. 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.

8. COMMITMENTS AND CONTINGENCIES

Legal proceedings in which the Company is a defendant may arise in the
normal course of business. At December 31, 2003 and 2002, there was no pending
litigation against the Company.

9. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

The following table sets forth selected quarterly financial data for the
Company:

YEAR ENDED DECEMBER 31, 2003 YEAR ENDED DECEMBER 31, 2002
---------------------------------------- ------------------------------------------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
--------- ------- -------- ------- --------- --------- -------- -------
(IN THOUSANDS EXCEPT PER SHARE DATA)

Total interest
income.............. $ 5,293 $4,779 $ 3,856 $ 3,750 $ 5,945 $ 4,686 $ 4,459 $4,844
Total noninterest
income (loss)....... 2,463 -- 687 1,008 -- 2,695 (17) (1)
Total operating
expenses............ 130 99 80 179 126 101 86 175
--------- ------ -------- ------- --------- --------- -------- ------
Net income............ 7,626 4,680 4,463 4,569 5,819 7,280 4,356 4,668
Preferred dividends... 4,609 4,609 4,609 4,611 4,609 4,609 4,609 4,611
--------- ------ -------- ------- --------- --------- -------- ------
Net income (loss)
available to common
stockholder......... 3,017 71 (146) (32) 1,210 2,671 (253) 57
========= ====== ======== ======= ========= ========= ======== ======
Basic and diluted
income (loss) per
common share........ $3,017.00 $71.00 $(146.00) $(32.00) $1,210.00 $2,671.00 $(253.00) $57.00
========= ====== ======== ======= ========= ========= ======== ======

FINANCIAL STATEMENTS OF HARRIS TRUST AND SAVINGS BANK

The following unaudited financial information and audited financial
statements for Harris Trust and Savings Bank are included because the Preferred
Shares are automatically exchangeable for a new series of preferred stock of the
Bank upon the occurrence of certain events.

HARRIS TRUST AND SAVINGS BANK

CERTAIN INFORMATION REGARDING HARRIS TRUST AND SAVINGS BANK

Harris Trust and Savings Bank ("the Bank") is an Illinois banking operation
located at 111 West Monroe Street, Chicago, Illinois 60603. The Bank is a
wholly-owned subsidiary of Harris Bankcorp, Inc., a multibank holding company
incorporated under the laws of the State of Delaware and headquartered in
Chicago and registered under the Bank Holding Company Act of 1956, as amended.
Harris Bankcorp, Inc. is a wholly-owned subsidiary of Harris Financial Corp.
("HFC") (formerly known as Bankmont Financial Corp.). Harris Bankcorp, Inc. also
owns 27 other banks, 26 in the counties surrounding Chicago and one with
locations in Arizona, Florida and Washington. HFC is a wholly-owned subsidiary
of Bank of Montreal. At December 31, 2003, Harris Bankcorp's assets amounted to
$30.61 billion, with the Bank representing approximately 65 percent of that
total.

The Bank, an Illinois state-chartered bank, has its principal office, 59
domestic branch offices and 107 automated teller machines located in the Chicago
area. The Bank also has offices in Atlanta, Detroit, Los Angeles and San
Francisco; a foreign branch office in Nassau; and an Edge Act subsidiary, Harris
Bank International Corporation ("HBIC"), engaged in international banking and
finance in New York. At December 31, 2003, the Bank had total assets of $19.92
billion, total deposits of $12.74 billion, total loans of $9.57 billion and
equity capital of $1.60 billion.

The Bank provides a broad range of banking and financial services to
individuals and corporations domestically and abroad, including corporate
banking, personal financial services, personal trust services and investment
services. The Bank also offers (i) demand and time deposit accounts; (ii)
various types of loans (including term, real estate, revolving credit facilities
and lines of credit); (iii) sales and purchases of foreign currencies; (iv)
interest rate management products (including swaps, forward rate agreements and
interest rate guarantees); (v) cash management services; (vi) underwriting of
municipal bonds; (vii) financial consulting; and (viii) a wide variety of
personal trust and trust-related services.

Competitors of the Bank include commercial banks, savings and loan
associations, consumer and commercial finance companies, credit unions and other
financial services companies. Based on legislation passed in 1986 that allows
Illinois banks to be acquired by banks or holding companies in states with a
reciprocal law in effect, together with the Federal Interstate Banking
Efficiency Act of 1994 that allows for both interstate banking and interstate
branching in certain circumstances, the Bank believes that the level of
competition will increase in the future.

The Bank is subject to regulation by the Board of Governors of the Federal
Reserve System and the Federal Deposit Insurance Corporation. As a
state-chartered bank, it is also regulated by the Illinois Office of Banks and
Real Estate. These regulatory bodies examine the Bank and supervise numerous
aspects of its business. The Federal Reserve System regulates money and credit
conditions and interest rates in order to influence general economic conditions,
primarily through open market operations in U.S. Government securities, varying
the discount rate on bank borrowings, setting reserve requirements against
financial institution deposits and prescribing minimum capital requirements for
member banks. These policies have a significant influence on overall growth and
distribution of bank loans, investments and deposits, and affect interest rates
charged on loans and earned on investments or paid for time, savings and other
deposits. Board of Governors monetary policies have had a significant effect on
the operating results of commercial banks in the past and this is expected to
continue.

Although primarily focusing on U.S. domestic customers, identifiable
foreign assets accounted for 3 percent of the Bank's total consolidated assets
at December 31, 2003 and foreign net income was approximately 8 percent of the
Bank's consolidated net income for the year then ended. Foreign net income is
generated from three primary sources: (i) lending to foreign banks and other
financial institutions; (ii) time deposits held in foreign banks; and (iii)
foreign exchange trading profits of approximately $5.1 million.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

2003 COMPARED TO 2002

Summary

The Bank's 2003 net income was $117.9 million, down $54.0 million from
2002. Declines in gains from sales of portfolio securities, a higher provision
for loan losses and increased pension costs more than offset increased
noninterest revenue excluding security sales. Return on average common equity
("ROE") for 2003 was 7.43 percent and 11.02 percent in 2002. Return on average
assets ("ROA") was 0.61 percent in 2003 and 0.95 percent in 2002.

Earnings before amortization of goodwill and other valuation intangibles
("cash earnings") were $124.0 million in 2003, a 30 percent decrease compared to
2002. Cash return on average common stockholder's equity ("cash ROE") represents
net income applicable to common stock plus after-tax amortization expense of
goodwill and other valuation intangibles, divided by average common
stockholder's equity less average intangible assets. Cash ROE was 8.76 percent
in 2003 compared to 12.85 percent in 2002.

For 2003, net interest income on a fully taxable equivalent basis of $447.9
million was down 4 percent from 2002. Net interest margin declined from 2.99
percent to 2.70 percent in 2003, reflecting the impact of lower yields in the
investment securities portfolio. Average earning assets increased $1.01 billion
or 6 percent to $16.59 billion in the current year, attributable to an increase
of $990 million in investment securities.

Noninterest income increased $2.2 million to $514.7 million for 2003. Gains
on sales of mortgage loans increased $8.9 million and fees from providing
service to related corporate entities rose $28.5 million. Net gains from sales
of investment securities decreased $35.3 million.

Total noninterest expenses were $690.7 million, up $34.4 million or 5
percent from 2002. Income taxes were $39.3 million, down $28.0 million from
2002, reflecting lower pretax income in 2003.

The provision for loan losses was $103.6 million in 2003 compared to $71.2
million in 2002. Net loan charge-offs during the current year were $75.8 million
compared to $91.6 million in 2002 reflecting lower write-offs in the commercial
loan portfolio.

Nonperforming assets totaled $172 million or 1.79 percent of total loans at
both December 31, 2003 and December 31, 2002. At December 31, 2003, the
allowance for possible loan losses was $235 million or 2.45 percent of total
loans outstanding compared to $207 million or 2.15 percent of loans at the end
of 2002. As a result, the ratio of the allowance for possible loan losses to
nonperforming assets increased from a multiple of 1.2 at December 31, 2002 to
1.4 at December 31, 2003.

At December 31, 2003, the Bank's equity capital amounted to $1.60 billion,
up slightly from $1.58 billion at December 31, 2002. Unrealized securities
gains, net of tax, were $31.0 million at December 31, 2003 compared to $73.0
million at December 31, 2002. In February 1998, Harris Preferred Capital
Corporation, a subsidiary of the Bank, issued $250 million of noncumulative
preferred stock in a public offering (see Note 18 to Financial Statements). The
preferred stock qualifies as Tier 1 capital for U.S. banking regulatory
purposes.

The Bank's regulatory capital leverage ratio was 8.52 percent compared to
8.64 percent one year earlier. Regulators require most banking institutions to
maintain capital leverage ratios of not less than 4.0 percent. At December 31,
2003, the Bank's Tier 1 and total risk-based capital ratios were 10.20 percent
and 12.25 percent, respectively, compared to respective ratios of 10.19 percent
and 12.50 percent at December 31, 2002. The 2003 year-end risk-based capital
ratios substantially exceeded minimum required regulatory ratios of 4.0 percent
and 8.0 percent, respectively.

2002 COMPARED TO 2001

Summary

The Bank's 2002 net income was $171.8 million, up $89.6 million from 2001.
Earnings comparability for 2002 and 2001 was affected by a third quarter 2001
special provision for loan losses of $121 million and a special pretax charge of
$3.2 million in fourth quarter 2001 relating to impairments in the value of
certain equity investments. Excluding the effect of these special charges,
earnings grew 6 percent over the prior year. This increase was attributable to
continued strong business growth in consumer, mortgage and small business loans
and retail deposits, and a reduction in the provision for loan losses and
increased earnings from treasury activities. Return on average common equity
("ROE") for 2002 was 11.02 percent and 10.41 percent in 2001 excluding the
special charges described above. Return on average assets ("ROA") was 0.95
percent in 2002 and 0.80 percent in 2001 excluding the special charges described
above.

Earnings before amortization of goodwill and other valuation intangibles
("cash earnings") were $177.9 million in 2002, a 1 percent increase compared to
2001, excluding the special charges described above. Cash return on average
common stockholder's equity ("cash ROE") represents net income applicable to
common stock plus after-tax amortization expense of goodwill and other valuation
intangibles, divided by average common stockholder's equity less average
intangible assets. Cash ROE was 12.85 percent in 2002 compared to 13.13 percent
in 2001, excluding the special charges.

For 2002, net interest income on a fully taxable equivalent basis of $465.2
million was down 5 percent from 2001. Net interest margin rose from 2.80 percent
to 2.99 percent in 2002, reflecting the impact of a declining rate environment
during the past year. Average earning assets declined $1.85 billion or 11
percent to $15.58 billion in 2002, attributable to a decrease of $1.17 billion
in investment securities and $799 million in average loans.

Noninterest income increased $55.3 million to $512.5 million for 2002.
Excluding the special $3.2 million writedown of equity securities in 2001,
noninterest income increased 11 percent from 2001. Net gains from portfolio
securities increased $25.9 million, service charge fees increased $19.8 million
and trading profits decreased $9.3 million. Inter-corporate service charges
increased $13.2 million. Trust and investment management fees decreased $6.0
million.

Total noninterest expenses were $656.4 million, up $24.1 million or 4
percent from 2001. Income taxes were $67.3 million, up $57.1 million from 2001,
reflecting substantially higher pretax income in 2002.

The provision for loan losses was $71.2 million in 2002 compared to $203.5
million in 2001. Third quarter 2001 results included a $121 million special
provision for loan losses. Net loan charge-offs during the current year were
$91.6 million compared to $95.1 million in 2001 reflecting higher recoveries in
the commercial loan portfolio.

Nonperforming assets at December 31, 2002 totaled $172 million, or 1.79
percent of total loans compared to $205 million or 2.05 percent a year earlier.
At December 31, 2002, the allowance for possible loan losses was $207 million or
2.15 percent of total loans outstanding compared to $227 million or 2.28 percent
of loans at the end of 2001. As a result, the ratio of the allowance for
possible loan losses to nonperforming assets increased slightly from a multiple
of 1.1 at December 31, 2001 to 1.2 at December 31, 2002.

At December 31, 2002, the Bank's equity capital amounted to $1.58 billion,
up slightly from $1.56 billion at December 31, 2001. Unrealized securities
gains, net of tax, were $73.0 million at December 31, 2002 compared to $20.1
million at December 31, 2001. In February 1998, Harris Preferred Capital
Corporation, a subsidiary of the Bank, issued $250 million of noncumulative
preferred stock in a public offering (see Note 18 to Financial Statements). The
preferred stock qualifies as Tier 1 capital for U.S. banking regulatory
purposes.

The Bank's regulatory capital leverage ratio was 8.64 percent compared to
8.23 percent one year earlier. Regulators require most banking institutions to
maintain capital leverage ratios of not less than 4.0 percent. At December 31,
2002, the Bank's Tier 1 and total risk-based capital ratios were 10.19 percent
and 12.50 percent, respectively, compared to respective ratios of 9.80 percent
and 12.26 percent at December 31, 2001. The 2002 year-end risk-based capital
ratios substantially exceeded minimum required regulatory ratios of 4.0 percent
and 8.0 percent, respectively.

JOINT INDEPENDENT AUDITORS

The Board of Directors of Harris Trust and Savings Bank engaged the firms
of KPMG LLP and PricewaterhouseCoopers LLP to serve as joint auditors for each
of the years in the three year period ended December 31, 2003.

The Bank's ultimate parent company, Bank of Montreal ("BMO"), has elected
to appoint two firms of independent public auditors to be auditors of BMO and
all significant subsidiaries. The Bank's independent public auditors reflect the
appointments made by BMO.

INDEPENDENT AUDITORS' REPORT

To the Stockholder and Board
of Directors of Harris Trust and Savings Bank

We have audited the accompanying consolidated statements of condition of
Harris Trust and Savings Bank and Subsidiaries as of December 31, 2003 and 2002,
and the related consolidated statements of income, comprehensive income, changes
in stockholder's equity and cash flows for each of the years in the three year
period ended December 31, 2003. These consolidated financial statements are the
responsibility of Harris Trust and Savings Bank's management. Our responsibility
is to express an opinion on these consolidated financial statements based on our
audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Harris Trust
and Savings Bank and Subsidiaries as of December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the years in the
three year period ended December 31, 2003 in conformity with accounting
principles generally accepted in the United States of America.

As discussed in Note 1 to Financial Statements, Harris Trust and Savings
Bank and Subsidiaries adopted Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets," on January 1, 2002.

/S/ KPMG LLP /S/ PRICEWATERHOUSECOOPERS LLP

Chicago, Illinois
January 23, 2004

FINANCIAL STATEMENTS
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CONDITION

DECEMBER 31
---------------------------
2003 2002
------------ ------------
(IN THOUSANDS EXCEPT SHARE
DATA)

ASSETS
Cash and demand balances due from banks..................... $ 823,615 $ 1,057,254
Money market assets:
Interest-bearing deposits at banks........................ 424,459 417,206
Federal funds sold........................................ 409,425 237,950
Securities available-for-sale (including $4.07 billion and
$4.39 billion of securities pledged as collateral for
repurchase agreements at December 31, 2003 and December
31, 2002, respectively)................................... 6,624,280 5,781,360
Trading account assets...................................... 59,467 42,423
Loans....................................................... 9,573,452 9,607,887
Allowance for possible loan losses.......................... (234,798) (206,999)
----------- -----------
Net loans................................................. 9,338,654 9,400,888
Premises and equipment...................................... 302,975 298,414
Customers' liability on acceptances......................... 44,234 16,168
Bank-owned insurance........................................ 1,035,239 994,185
Loans held for sale......................................... 168,904 149,311
Goodwill and other valuation intangibles.................... 165,978 174,397
Other assets................................................ 522,260 457,462
----------- -----------
TOTAL ASSETS.............................................. $19,919,490 $19,027,018
=========== ===========
LIABILITIES
Deposits in domestic offices -- noninterest-bearing......... $ 4,231,540 $ 3,414,159
-- interest-bearing.............. 7,844,596 6,408,171
Deposits in foreign offices -- noninterest-bearing.......... 49,016 31,383
-- interest-bearing................ 616,889 1,184,571
----------- -----------
Total deposits............................................ 12,742,041 11,038,284
Federal funds purchased..................................... 1,190,839 872,096
Securities sold under agreement to repurchase............... 3,452,567 4,188,688
Short-term borrowings....................................... 10,841 300,694
Short-term senior notes..................................... -- 200,000
Acceptances outstanding..................................... 44,234 16,168
Accrued interest, taxes and other expenses.................. 171,422 153,148
Other liabilities........................................... 230,917 200,286
Minority interest -- preferred stock of subsidiary.......... 250,000 250,000
Preferred stock issued to Harris Bankcorp, Inc.............. 5,000 5,000
Long-term notes -- subordinated............................. 225,000 225,000
----------- -----------
TOTAL LIABILITIES......................................... 18,322,861 17,449,364
----------- -----------
STOCKHOLDER'S EQUITY
Common stock ($10 par value); 10,000,000 shares authorized,
issued and outstanding.................................... 100,000 100,000
Surplus..................................................... 634,944 626,640
Retained earnings........................................... 860,674 803,249
Accumulated other comprehensive income...................... 1,011 47,765
----------- -----------
TOTAL STOCKHOLDER'S EQUITY................................ 1,596,629 1,577,654
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY................ $19,919,490 $19,027,018
=========== ===========

The accompanying notes to the financial statements are an integral part of these
statements.
37

HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31
--------------------------------
2003 2002 2001
-------- -------- ----------
(IN THOUSANDS EXCEPT SHARE DATA)

INTEREST INCOME
Loans....................................................... $470,500 $512,946 $ 726,403
Money market assets:
Deposits at banks......................................... 3,061 2,066 3,537
Federal funds sold and securities purchased under
agreement to resell..................................... 3,655 7,938 13,672
Trading account............................................. 1,672 2,031 3,277
Securities available-for-sale:
U.S. Treasury and federal agency.......................... 163,593 195,336 340,398
State and municipal....................................... 302 24 99
Other..................................................... 2,178 2,243 2,128
-------- -------- ----------
Total interest income................................... 644,961 722,584 1,089,514
-------- -------- ----------
INTEREST EXPENSE
Deposits.................................................... 125,102 162,267 339,445
Short-term borrowings....................................... 50,458 64,262 212,635
Senior notes................................................ 3,722 12,144 33,997
Minority interest -- dividends on preferred stock of
subsidiary................................................ 18,438 18,438 18,438
Long-term notes............................................. 10,452 11,257 13,929
-------- -------- ----------
Total interest expense.................................. 208,172 268,368 618,444
-------- -------- ----------
NET INTEREST INCOME......................................... 436,789 454,216 471,070
Provision for loan losses................................... 103,604 71,220 203,508
-------- -------- ----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES......... 333,185 382,996 267,562
-------- -------- ----------
NONINTEREST INCOME
Trust and investment management fees........................ 84,586 82,829 88,846
Money market and bond trading............................... 9,343 9,347 17,016
Foreign exchange............................................ 5,076 7,155 8,833
Service fees and charges.................................... 112,683 118,635 98,823
Securities gains............................................ 25,953 61,272 35,397
Bank-owned insurance........................................ 43,712 50,713 47,226
Foreign fees................................................ 26,349 24,399 21,305
Syndication fees............................................ 14,168 6,289 6,584
Other....................................................... 192,856 151,869 133,155
-------- -------- ----------
Total noninterest income................................ 514,726 512,508 457,185
-------- -------- ----------
NONINTEREST EXPENSES
Salaries and other compensation............................. 321,170 310,116 293,247
Pension, profit sharing and other employee benefits......... 76,572 61,279 51,328
Net occupancy............................................... 41,964 41,727 34,473
Equipment................................................... 54,586 53,531 53,329
Marketing................................................... 31,217 29,165 34,310
Communication and delivery.................................. 22,963 22,593 19,992
Expert services............................................. 26,733 28,328 25,600
Contract programming........................................ 28,930 29,105 31,479
Other....................................................... 76,337 70,369 64,731
-------- -------- ----------
680,472 646,213 608,489
Amortization of intangibles................................. 10,267 10,151 23,752
-------- -------- ----------
Total noninterest expenses................................ 690,739 656,364 632,241
-------- -------- ----------
Income before income taxes.................................. 157,172 239,140 92,506
Applicable income taxes..................................... 39,301 67,306 10,234
-------- -------- ----------
NET INCOME.................................................. $117,871 $171,834 $ 82,272
======== ======== ==========
BASIC EARNINGS PER COMMON SHARE (based on 10,000,000 average
shares outstanding)
NET INCOME.................................................. $ 11.79 $ 17.18 $ 8.23
======== ======== ==========

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

HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES

CONSOLIDATED STATEMENTS
OF COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31
---------------------------------
2003 2002 2001
--------- --------- ---------
(IN THOUSANDS)

NET INCOME.................................................. $117,871 $171,834 $ 82,272
Other comprehensive (loss) income:
Cash flow hedges:
Cumulative effect of accounting change................. -- -- (7,976)
Net unrealized gain on derivative instruments, net of
tax expense of $21 in 2003, zero in 2002, and $4,684
in 2001.............................................. 35 -- 7,976
Minimum pension liability adjustment net of tax benefit of
$3,161 in 2003, $16,618 in 2002, and zero in 2001...... (4,792) (25,194) --
Unrealized (losses) gains on available-for-sale
securities:
Unrealized holding (losses) gains arising during
period, net of tax (benefit) expense of ($18,194) in
2003, $58,702 in 2002 and $34,589 in 2001............ (26,140) 90,296 52,388
Less reclassification adjustment for gains included in
net income, net of tax expense of $10,096 in 2003,
$23,835 in 2002 and $13,769 in 2001.................. (15,857) (37,437) (21,627)
-------- -------- --------
Other comprehensive (loss) income......................... (46,754) 27,665 30,761
-------- -------- --------
Comprehensive income........................................ $ 71,117 $199,499 $113,033
======== ======== ========

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

HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES

STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY

ACCUMULATED
OTHER
COMPREHENSIVE TOTAL
COMMON RETAINED INCOME STOCKHOLDER'S
STOCK SURPLUS EARNINGS (LOSS) EQUITY
-------- -------- -------- ------------- -------------
(IN THOUSANDS EXCEPT PER SHARE DATA)

BALANCE AT DECEMBER 31, 2000........ $100,000 $613,365 $821,719 $(10,661) $1,524,423
Contribution to capital surplus... -- 4,523 -- -- 4,523
Tax benefit from stock option
exercise....................... -- 2,698 -- -- 2,698
Net income........................ -- -- 82,272 -- 82,272
Dividends -- ($8.40 per common
share)......................... -- -- (84,000) -- (84,000)
Other comprehensive income........ -- -- -- 30,761 30,761
-------- -------- -------- -------- ----------
BALANCE AT DECEMBER 31, 2001........ 100,000 620,586 819,991 20,100 1,560,677
Contribution to capital surplus... -- 5,591 -- -- 5,591
Tax benefit from stock option
exercise....................... -- 463 -- -- 463
Net income........................ -- -- 171,834 -- 171,834
Dividends -- ($18.80 per common
share)......................... -- -- (188,000) -- (188,000)
Dividends -- ($0.115 per preferred
share)......................... -- -- (576) -- (576)
Other comprehensive income........ -- -- -- 27,665 27,665
-------- -------- -------- -------- ----------
BALANCE AT DECEMBER 31, 2002........ 100,000 626,640 803,249 47,765 1,577,654
Contribution to capital surplus... -- 6,086 -- -- 6,086
Tax benefit from stock option
exercise....................... -- 2,218 -- -- 2,218
Net income........................ -- -- 117,871 -- 117,871
Dividends -- ($6.00 per common
share)......................... -- -- (60,000) -- (60,000)
Dividends -- ($0.089 per preferred
share)......................... -- -- (446) -- (446)
Other comprehensive loss.......... -- -- -- (46,754) (46,754)
-------- -------- -------- -------- ----------
BALANCE AT DECEMBER 31, 2003........ $100,000 $634,944 $860,674 $ 1,011 $1,596,629
======== ======== ======== ======== ==========

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

HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31
---------------------------------------
2003 2002 2001
----------- ----------- -----------
(IN THOUSANDS)

OPERATING ACTIVITIES:
Net Income.......................................... $ 117,871 $ 171,834 $ 82,272
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses........................ 103,604 71,220 203,508
Depreciation and amortization, including
intangibles.................................... 67,207 61,892 71,054
Deferred tax expense (benefit)................... 9,487 6,035 (24,783)
Gain on sales of securities...................... (25,953) (61,272) (35,397)
Increase in bank-owned insurance................. (43,054) (47,105) (47,162)
Trading account net cash purchases............... (14,712) (21,486) (25,351)
Decrease in interest receivable.................. 4,839 19,811 70,082
Increase (decrease) in interest payable.......... 7,331 (22,155) (18,506)
(Increase) decrease in loans held for sale....... (19,593) (27,723) 120,683
Other, net....................................... 74,257 14,234 9,850
----------- ----------- -----------
Net cash provided by operating activities........ 281,284 165,285 406,250
----------- ----------- -----------
INVESTING ACTIVITIES:
Net increase in interest-bearing deposits at
banks.......................................... (7,253) (221,483) (54,375)
Net (increase) decrease in Federal funds sold and
securities purchased under agreement to
resell......................................... (171,475) 341,800 (88,675)
Proceeds from sales of securities
available-for-sale............................. 1,539,979 2,678,763 1,898,048
Proceeds from maturities of securities
available-for-sale............................. 4,526,559 7,453,346 7,707,315
Purchases of securities available-for-sale....... (7,031,858) (9,992,242) (8,740,451)
Net (increase) decrease in loans................. (53,809) 246,595 697,425
Proceeds from sale of bank premises.............. -- -- 32,276
Purchases of premises and equipment.............. (53,744) (56,753) (64,985)
Other, net....................................... 152 5,145 --
----------- ----------- -----------
Net cash (used) provided by investing
activities..................................... (1,251,449) 455,171 1,386,578
----------- ----------- -----------
FINANCING ACTIVITIES:
Net increase (decrease) in deposits.............. 1,703,757 (152,576) (1,302,517)
Net (decrease) increase in Federal funds
purchased and securities sold under agreement
to repurchase.................................. (417,378) 637,433 (185,528)
Net decrease in other short-term borrowings...... (289,853) (404,005) (785,031)
Proceeds from issuance of senior notes........... 2,590,000 750,000 2,308,500
Repayment of senior notes........................ (2,790,000) (1,410,000) (1,838,000)
Proceeds from the issuance of preferred stock of
subsidiary..................................... -- -- 5,000
Cash dividends paid on common stock.............. (60,000) (188,000) (84,000)
----------- ----------- -----------
Net cash provided (used) by financing
activities.................................. 736,526 (767,148) (1,881,576)
----------- ----------- -----------
Net decrease in cash and demand balances due from
banks.......................................... (233,639) (146,692) (88,748)
Cash and demand balances due from banks at
January 1...................................... 1,057,254 1,203,946 1,292,694
----------- ----------- -----------
Cash and demand balances due from banks at
December 31.................................... $ 823,615 $ 1,057,254 $ 1,203,946
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest....................................... $ 200,841 $ 290,524 $ 636,949
Income taxes................................... $ 21,263 $ 67,056 $ 69,310

The accompanying notes to the financial statements are an integral part of these
statements.
41

HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES

NOTES TO THE FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION AND NATURE OF OPERATIONS

Harris Trust and Savings Bank is a wholly-owned subsidiary of Harris
Bankcorp, Inc. ("Bankcorp"), a Delaware corporation which is a wholly-owned
subsidiary of Harris Financial Corp. ("HFC") (formerly known as Bankmont
Financial Corp.), a Delaware corporation which is a wholly-owned subsidiary of
Bank of Montreal ("BMO"). Throughout these Notes to Financial Statements, the
term "Bank" refers to Harris Trust and Savings Bank and subsidiaries.

The consolidated financial statements include the accounts of the Bank and
its wholly-owned subsidiaries. Significant intercompany accounts and
transactions have been eliminated. Certain reclassifications were made to
conform prior years' financial statements to the current year's presentation.
See Note 23 to the Financial Statements for additional information on business
combinations and Note 24 for additional information on related party
transactions.

The Bank provides banking, trust and other services domestically and
internationally through the main banking facility, 6 active nonbank subsidiaries
and an Edge Act subsidiary, Harris Bank International Corporation ("HBIC"), in
New York. The Bank provides a variety of financial services to commercial and
industrial companies, financial institutions, governmental units, not-for-profit
organizations and individuals throughout the U.S., primarily the Midwest, and
abroad. Services rendered and products sold to customers include demand and time
deposit accounts and certificates; various types of loans; sales and purchases
of foreign currencies; interest rate management products; cash management
services; underwriting of municipal bonds; and financial consulting.

BASIS OF ACCOUNTING

The accompanying financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and
conform to practices within the banking industry.

FOREIGN CURRENCY AND FOREIGN EXCHANGE CONTRACTS

Assets and liabilities denominated in foreign currencies have been
translated into United States dollars at respective year-end rates of exchange.
Monthly translation gains or losses are computed at rates prevailing at
month-end. There were no material translation gains or losses during any of the
years presented. Foreign exchange trading positions including spot, forwards,
option contracts and swaps are revalued monthly using prevailing market rates.
Exchange adjustments are included with noninterest income in the Consolidated
Statements of Income.

DERIVATIVE FINANCIAL INSTRUMENTS

The Bank uses various interest rate, foreign exchange, equity and commodity
derivative contracts in the management of its risk strategy or as part of its
dealer and trading activities. Interest rate contracts may include futures,
forwards, forward rate agreements, option contracts, caps, floors, collars and
swaps. Foreign exchange contracts may include spot, forwards, futures, option
contracts and swaps. Equity contracts and commodity contracts may include option
contracts and swaps.

All derivative instruments are recognized at fair value in the Consolidated
Statements of Condition. All derivative instruments are designated either as
hedges or as held for trading or non-hedging purposes.

Derivative instruments that are used in the management of the Bank's risk
strategy may qualify for hedge accounting if the derivatives are designated as
hedges and applicable hedge criteria are met. On the date that the Bank enters
into a derivative contract, it designates the derivative as a hedge of the fair
value of a recognized asset or liability or an unrecognized firm commitment, a
hedge of a forecasted transaction or the
42

variability of cash flows that are to be received or paid in connection with a
recognized asset or liability, a foreign currency fair value or cash flow hedge.
Changes in the fair value of a derivative that is highly effective (as defined)
and qualifies as a fair value hedge, along with changes in the fair value of the
underlying hedged item, are recorded in current period earnings. Changes in the
fair value of a derivative that is highly effective (as defined) and qualifies
as a cash flow hedge, to the extent that the hedge is effective, are recorded in
other comprehensive income only until earnings are recognized from the
underlying hedged item. Net gains or losses resulting from hedge ineffectiveness
are recorded in current period earnings. Changes in the fair value of a
derivative that is highly effective (as defined) and qualifies as a foreign
currency hedge are recorded in either current period earnings or other
comprehensive income depending on whether the hedging relationship meets the
criteria for a fair value or cash flow hedge.

The Bank formally documents all hedging relationships at inception of hedge
transactions. The process includes documenting the risk management objective and
strategy for undertaking the hedge transaction and identifying the specific
derivative instrument and the specific underlying asset, liability, firm
commitment or forecasted transaction. The Bank formally assesses, both at
inception and on an ongoing quarterly basis, whether the derivative hedging
instruments have been highly effective in offsetting changes in the fair value
or cash flows of the hedged items and whether the derivatives are expected to
remain highly effective in future periods.

Hedge accounting is discontinued prospectively when the Bank determines
that the hedge is no longer highly effective, the derivative instrument expires
or is sold, terminated or exercised, it is no longer probable that the
forecasted transaction will occur, the hedged firm commitment no longer meets
the definition of a firm commitment, or the designation of the derivative as a
hedging instrument is no longer appropriate.

When hedge accounting is discontinued because a fair value hedge is no
longer highly effective, the derivative instrument will continue to be recorded
on the balance sheet at fair value but the underlying hedged item will no longer
be adjusted for changes in fair value. When hedge accounting is discontinued
because the hedged item in a fair value hedge no longer meets the definition of
a firm commitment, the derivative instrument will continue to be recorded on the
balance sheet at fair value and any asset or liability that was recorded to
recognize the firm commitment will be removed from the balance sheet and
recognized as a gain or loss in current period earnings. When hedge accounting
is discontinued because it is no longer probable that the forecasted transaction
in a cash flow hedge will occur, the gain or loss on the derivative that was in
accumulated other comprehensive income will be recognized immediately in
earnings and the derivative instrument will be marked to market through
earnings. When hedge accounting is discontinued and the derivative remains
outstanding, the derivative may be redesignated as a hedging instrument as long
as the applicable hedge criteria are met under the terms of the new contract.

Derivative instruments that are entered into for risk management purposes
and do not otherwise qualify for hedge accounting are marked to market and the
resulting unrealized gains and losses are recognized in noninterest income in
the period of change.

Derivative instruments that are used as part of the Bank's dealer and
trading activities are marked to market and the resulting unrealized gains and
losses are recognized in noninterest income in the period of change.

IMPACT OF NEW ACCOUNTING STANDARDS

The Bank adopted Statement of Financial Accounting Standards ("SFAS") No.
146, "Accounting for Costs Associated with Exit or Disposal Activities," on
January 1, 2003. The Statement requires that a liability for costs associated
with exit or disposal activities be recognized when the liability is incurred,
as defined in Concepts Statement 6. It nullifies Emerging Issues Task Force
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." The adoption of the Statement was not material to the Bank's
financial position or results of operations.

The Bank adopted the disclosure requirements of Financial Accounting
Standards Board ("FASB") Interpretation No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"), on December 31, 2002. The recognition and
measurement provisions of FIN 45 were adopted on January 1, 2003. The
disclosures are included in Note 11 to the Financial Statements. The adoption of
FIN 45 was not material to the Bank's financial position or results of
operations.

In December 2003, the FASB issued FASB Interpretation No. 46 (Revised),
"Consolidation of Variable Interest Entities" ("FIN 46R"). FIN 46R replaces FIN
46, which was issued in January 2003. FIN 46R addresses how a business
enterprise should evaluate whether it has a controlling financial interest in an
entity through means other than voting rights and whether it should consolidate
the entity. An entity is subject to FIN 46R and is called a variable interest
entity ("VIE") if it has (1) equity that is insufficient to permit the entity to
finance its activities without additional subordinated financial support from
other parties, or (2) equity investors that cannot make decisions about the
entity's operations, or that do not absorb the expected losses or receive the
expected returns of the entity. A VIE is consolidated by its primary
beneficiary, which is the party involved with the VIE that has a majority
interest in the expected losses or the expected residual returns or both. The
Bank does not have an interest in a VIE and is not subject to the provisions of
FIN 46R.

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." The Statement clarifies
accounting for derivative instruments, including embedded derivatives, and
accounting for hedging activities. The Bank adopted the Statement on July 1,
2003. The adoption of the Statement did not have a material effect on the Bank's
financial position or results of operations.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." The
Statement applies to issuers of financial instruments and establishes standards
for the classification and measurement of freestanding financial instruments
having characteristics of both liabilities and equity. The Bank adopted the
Statement on July 1, 2003. The adoption of the Statement did not have a material
effect on the Bank's financial position or results of operations.

In December 2003, the FASB issued SFAS No. 132 (revised 2003), "Employers'
Disclosures about Pensions and Other Postretirement Benefits" to improve
financial statement disclosures for defined benefit plans. The Statement
requires additional disclosures, primarily for plan assets and cash flow
requirements. The Bank adopted the disclosure requirements of SFAS No. 132 on
December 31, 2003.

SECURITIES

The Bank classifies securities as either trading account assets or
available-for-sale. Trading account assets include securities acquired as part
of trading activities and are typically purchased with the expectation of
near-term profit. These assets consist primarily of municipal bonds and U.S.
government securities. All other securities are classified as
available-for-sale, even if the Bank has no current plans to divest.

Trading account assets are reported at fair value with unrealized gains and
losses included in trading account income, which also includes realized gains
and losses from closing such positions. Available-for-sale securities are
reported at fair value with unrealized gains and losses included, on an
after-tax basis, in a separate component of stockholder's equity. Purchase
premiums and discounts are recognized in interest income using the interest
method over the terms of the securities. Realized gains and losses, as a result
of securities sales, are included in securities gains, with the cost of
securities sold determined on the specific identification basis.

LOANS, LOAN FEES AND COMMITMENT FEES

Loans not held for sale are recorded at the principal amount outstanding,
net of unearned income, deferred fees and origination costs. For fair value
hedges that are highly effective, loans designated as the underlying hedged
items are recorded net of changes in fair value attributable to the hedged
risks. Origination

fees collected on commercial loans, loan commitments, mortgage loans and standby
letters of credit, that are not held for sale, are generally deferred and
amortized over the life of the related facility. Other loan-related fees that
are not the equivalent of yield adjustments are recognized as income when
received or earned. At December 31, 2003 and 2002, the Bank's Consolidated
Statements of Condition included approximately $12 million and $15 million,
respectively, of deferred loan-related fees net of deferred origination costs.

In conjunction with its mortgage and commercial banking activities, the
Bank will originate loans with the intention of selling them in the secondary
market. These loans are classified as available-for-sale and are included in
"Other Assets" on the Bank's Consolidated Statements of Condition. The loans are
carried at the lower of allocated cost or current market value, on a portfolio
basis. Deferred origination fees and costs associated with these loans are not
amortized and are included as part of the basis of the loan at time of sale.
Realized gains and unrealized losses are included with other noninterest income.

The Bank engages in the servicing of mortgage loans and acquires mortgage
servicing rights by purchasing or originating mortgage loans and then selling
those loans with servicing rights retained. The rights to service mortgage loans
for others are recognized as separate assets by allocating the total cost of the
mortgage loans to the mortgage servicing rights and the loans (without the
mortgage servicing rights) based on their relative fair values. The capitalized
mortgage servicing rights are amortized in proportion to and over the period of
estimated net servicing income. The capitalized mortgage servicing rights are
periodically evaluated for impairment based on the fair value of those rights.
Fair values are estimated using discounted cash flow analyses. The risk
characteristics of the underlying loans used to stratify capitalized mortgage
servicing rights for purposes of measuring impairment are market interest rates,
loan type and repricing interval.

Commercial and real estate loans are placed on nonaccrual status when the
collection of interest is doubtful or when principal or interest is 90 days past
due, unless the credit is adequately collateralized and the loan is in process
of collection. When a loan is placed on nonaccrual status, all interest accrued
but not yet collected which is deemed uncollectible is charged against interest
income in the current year. Interest on nonaccrual loans is recognized as income
only when cash is received and the Bank expects to collect the entire principal
balance of the loan. Loans are returned to accrual status when all the principal
and interest amounts contractually due are brought current and future payments
are reasonably assured. Interest income on restructured loans is accrued
according to the most recently agreed upon contractual terms.

Commercial and real estate loans are charged off when, in management's
opinion, the loan is deemed uncollectible. Consumer installment loans are
charged off when 120 days past due. Consumer revolving loans are charged off
when 180 days past due. Accrued interest on these loans is recorded to interest
income. Such loans are not normally placed on nonaccrual status.

Commercial loan commitments and letters of credit are executory contracts
and are not reflected on the Bank's Consolidated Statements of Condition. Fees
collected are generally deferred and recognized over the life of the facility.

Impaired loans (primarily commercial credits) are measured based on the
present value of expected future cash flows (discounted at the loan's effective
interest rate) or, alternatively, at the loan's observable market price or the
fair value of supporting collateral. Impaired loans are defined as those where
it is probable that amounts due for principal or interest according to
contractual terms will not be collected. Both nonaccrual and certain
restructured loans meet this definition. Large groups of smaller-balance,
homogeneous loans, primarily residential real estate and consumer installment
loans, are excluded from this definition of impairment. The Bank determines loan
impairment when assessing the adequacy of the allowance for possible loan
losses.

ALLOWANCE FOR POSSIBLE LOAN LOSSES

The allowance for possible loan losses is maintained at a level considered
adequate to provide for estimated loan losses. The allowance is increased by
provisions charged to operating expense and reduced by net charge-offs. Known
losses of principal on impaired loans are charged off. The provision for loan
losses is based on past loss experience, management's evaluation of the loan
portfolio under current economic
45

conditions and management's estimate of losses inherent in the portfolio. Such
estimates are reviewed periodically and adjustments, if necessary, are recorded
during the periods in which they become known.

PREMISES AND EQUIPMENT

Premises and equipment are stated at cost less accumulated depreciation and
amortization. Interest costs associated with long-term construction projects are
capitalized and then amortized over the life of the related asset after the
project is completed. For financial reporting purposes, the provision for
depreciation and amortization is computed on the straight-line basis over the
estimated useful lives of the assets. Estimated useful lives ranges from 3 years
to 39 years.

BANK-OWNED INSURANCE

The Bank has purchased life insurance coverage for certain officers. The
one-time premiums paid for the policies, which coincide with the initial cash
surrender value, are recorded as assets on the Consolidated Statements of
Condition. Increases or decreases in cash surrender value (other than proceeds
from death benefits) are recorded as other income or other expense. Proceeds
from death benefits first reduce the cash surrender value attributable to the
individual policy and any additional proceeds are recorded as other income.

GOODWILL AND OTHER INTANGIBLE ASSETS

The Bank records goodwill and other intangible assets in connection with
the acquisition of assets from unrelated parties or the acquisition of new
subsidiaries. Goodwill that originated prior to July 1, 2001 was amortized on a
straight-line basis through 2001 year-end but discontinued effective January 1,
2002 in connection with the adoption of SFAS No. 142. Goodwill arising
subsequent to July 1, 2001 is not amortized. Goodwill is periodically assessed
for impairment, at least annually. Intangible assets with finite lives are
amortized on either an accelerated or straight-line basis depending on the
character of the acquired asset. Original lives range from 3 to 15 years.
Intangible assets subject to amortization are reviewed for impairment when
events or future assessments of profitability indicate that the carrying value
may not be recoverable. Intangible assets with indefinite useful lives are not
amortized and are reviewed for impairment annually or more frequently if events
indicate impairment.

OTHER ASSETS

Property or other assets received in satisfaction of debt are included in
"Other Assets" on the Bank's Consolidated Statements of Condition and are
recorded at the lower of remaining cost or fair value. Fair values for other
real estate owned generally are reduced by estimated costs to sell. Losses
arising from subsequent write-downs to fair value are charged directly to
expense.

Loans intended to be sold in the secondary market are classified as
available-for-sale and are included in "Loans held for sale" on the Consolidated
Statements of Condition. The loans are carried at lower of allocated cost or
current market value, on a portfolio basis. The Bank has qualifying mortgage
loan commitments that are intended to be sold in the secondary market. These
loan commitments are derivatives and are accounted for at fair value.

RETIREMENT AND OTHER POSTEMPLOYMENT BENEFITS

The Bank has noncontributory defined benefit pension plans covering
virtually all its employees. For its primary plan, the policy of the Bank is to,
at a minimum, fund annually an amount necessary to satisfy the requirements
under the Employee Retirement Income Security Act ("ERISA"), without regard to
prior years' contributions in excess of the minimum. The Bank generally
contributes the maximum allowable under the U.S. Internal Revenue Code.

Postemployment benefits provided to former or inactive employees after
employment but before retirement are accrued if they meet the conditions for
accrual of compensated absences. Otherwise, postemployment benefits are recorded
when expenses are incurred.

INCOME TAXES

Deferred tax assets and liabilities, as determined by the temporary
differences between financial reporting and tax bases of assets and liabilities,
are computed using enacted tax rates and laws. The effect on deferred tax assets
and liabilities of a change in tax rates or law is recognized as income or
expense in the period including the enactment date.

The Bank is included in the consolidated Federal income tax return of HFC.
Income tax return liabilities or benefits for all the consolidated entities are
not materially different than they would have been if computed on a separate
return basis.

MANAGEMENT'S ESTIMATES

The preparation of 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 financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. The areas requiring significant management judgment include provision
and allowance for possible loan losses, income taxes, pension cost,
postemployment benefits, valuation of intangible assets, fair values and
temporary vs. other-than-temporary impairment.

RECLASSIFICATIONS

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

2. SECURITIES

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

DECEMBER 31, 2003 DECEMBER 31, 2002
------------------------------------------------- -------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE COST GAINS LOSSES FAIR VALUE
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
(IN THOUSANDS)

U.S. Treasury......... $2,820,111 $35,934 $4,306 $2,851,739 $2,562,541 $ 92,622 $3 $2,655,160
Federal agency........ 2,790,603 3,844 155 2,794,292 2,677,716 16,318 -- 2,694,034
Mortgage-backed....... 915,825 3,115 1,032 917,908 392,106 12,107 -- 404,213
State and municipal... 28,592 364 -- 28,956 627 -- -- 627
Other................. 31,260 125 -- 31,385 27,287 39 -- 27,326
---------- ------- ------ ---------- ---------- -------- -- ----------
Total securities...... $6,586,391 $43,382 $5,493 $6,624,280 $5,660,277 $121,086 $3 $5,781,360
========== ======= ====== ========== ========== ======== == ==========

The following table summarizes, for available-for-sale securities with
unrealized losses as of December 31, 2003, 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 investment securities that have been in a
continuous unrealized loss position for less than 12 months and those that have
been in a continuous unrealized loss position for 12 or more months. Management
believes that all of the unrealized losses are temporary.

LENGTH OF CONTINUOUS UNREALIZED LOSS POSITION
---------------------------------------------------------------------------
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
----------------------- ----------------------- -----------------------
UNREALIZED UNREALIZED UNREALIZED
FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES
---------- ---------- ---------- ---------- ---------- ----------
(IN THOUSANDS)

U.S. Treasury............................... $ 608,118 $(4,306) $ -- $ -- $ 608,118 $(4,306)
Federal agency.............................. 180,994 (155) -- -- 180,994 (155)
Mortgage-backed............................. 639,820 (1,032) -- -- 639,820 (1,032)
State and municipal......................... -- -- -- -- -- --
Other....................................... -- -- -- -- -- --
---------- ------- ---- -------- ---------- -------
Temporarily impaired
securities-available-for-sale......... $1,428,932 $(5,493) $ -- $ -- $1,428,932 $(5,493)
========== ======= ==== ======== ========== =======

At December 31, 2003 and 2002, available-for-sale and trading account
securities having a carrying amount of $4.07 billion and $4.39 billion,
respectively, were pledged as collateral for certain liabilities, securities
sold under agreement to repurchase, public and trust deposits, trading account
activities and for other purposes where permitted or required by law. The Bank
maintains effective control over the securities sold under agreement to
repurchase and accounts for the transactions as secured borrowings.

The amortized cost and estimated fair value of available-for-sale
securities at December 31, 2003, 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.

DECEMBER 31, 2003
-----------------------
AMORTIZED
COST FAIR VALUE
---------- ----------
(IN THOUSANDS)

Maturities:
Within 1 year............................................. $2,653,123 $2,659,767
1 to 5 years.............................................. 3,414,543 3,446,204
5 to 10 years............................................. 205,710 201,948
Over 10 years............................................. 281,755 284,976
Other securities without stated maturity.................... 31,260 31,385
---------- ----------
Total securities....................................... $6,586,391 $6,624,280
========== ==========

In 2003, 2002 and 2001, proceeds from the sale of securities
available-for-sale amounted to $1.54 billion, $2.68 billion and $1.90 billion,
respectively. Gross gains of $26.5 million and gross losses of $0.5 million were
realized on these sales in 2003, gross gains of $63.0 million and gross losses
of $1.7 million were realized on these sales in 2002 and gross gains of $35.4
million and no gross losses were realized on these sales in 2001. Net unrealized
holding gains on trading securities increased during 2003 from an unrealized
gain of $0.9 million at December 31, 2002 to an unrealized gain of $1.1 million
at December 31, 2003. The increase of $0.2 million has been included in 2003
earnings.

3. LOANS

The following table summarizes loan balances by category:

DECEMBER 31
-----------------------
2003 2002
---------- ----------
(IN THOUSANDS)

Domestic loans:
Commercial, financial, agricultural, brokers and
dealers................................................ $5,043,936 $5,641,852
Real estate construction.................................. 289,364 241,278
Real estate mortgages..................................... 3,260,731 2,854,919
Installment............................................... 930,644 740,414
Foreign loans:
Banks and other financial institutions.................... 29,223 100,488
Other, primarily commercial and industrial................ 19,554 28,936
---------- ----------
Total loans............................................ 9,573,452 9,607,887
Less allowance for possible loan losses..................... 234,798 206,999
---------- ----------
Loans, net of allowance for possible loan losses..... $9,338,654 $9,400,888
========== ==========

Nonaccrual loans, restructured loans and other nonperforming assets are
summarized below:

YEARS ENDED DECEMBER 31
------------------------------
2003 2002 2001
-------- -------- --------
(IN THOUSANDS)

Nonaccrual loans............................................ $171,226 $169,588 $202,320
Restructured loans.......................................... -- -- 2,309
-------- -------- --------
Total nonperforming loans................................... 171,226 169,588 204,629
Other assets received in satisfaction of debt............... 450 1,975 140
-------- -------- --------
Total nonperforming assets............................. $171,676 $171,563 $204,769
======== ======== ========
Gross amount of interest income that would have been
recorded if year-end nonperforming loans had been accruing
interest at their original terms.......................... $ 12,380 $ 8,496 $ 14,306
Interest income actually recognized......................... -- -- --
-------- -------- --------
Interest shortfall........................................ $ 12,380 $ 8,496 $ 14,306
======== ======== ========
90-day past due loans, still accruing interest (all
domestic)................................................. $ 14,865 $ 12,478 $ 13,129
======== ======== ========

At December 31, 2003 and 2002, the Bank had no aggregate public and private
sector outstandings to any single country experiencing a liquidity problem which
exceeded one percent of the Bank's consolidated assets. At December 31, 2003 and
2002 commercial loans with a carrying value of $4.78 billion and $3.74 billion,
respectively, were pledged to secure potential borrowings with the Federal
Reserve.

MORTGAGE SERVICING RIGHTS

The carrying amount of mortgage servicing rights was $16.3 million and
$12.9 million at December 31, 2003 and 2002, respectively. The fair value of
those rights equaled or exceeded the carrying amount at both December 31, 2003
and December 31, 2002. Mortgage servicing rights, included in other assets, of
$11.2 million and $4.5 million were capitalized during 2003 and 2002,
respectively. Amortization expense associated with the mortgage servicing rights
was $7.7 million and $5.9 million in 2003 and 2002, respectively. There were no
direct write-downs in 2003 or 2002. During 2003, impairment of mortgage
servicing rights totaling $0.1 million was recorded in a valuation allowance to
reflect the excess of carrying value over estimated fair value.

4. ALLOWANCE FOR POSSIBLE LOAN LOSSES

The changes in the allowance for possible loan losses are as follows:

YEARS ENDED DECEMBER 31
-------------------------------
2003 2002 2001
-------- --------- --------
(IN THOUSANDS)

Balance, beginning of year.................................. $206,999 $ 227,374 $118,951
-------- --------- --------
Charge-offs................................................. (88,244) (106,650) (98,814)
Recoveries.................................................. 12,439 15,055 3,729
-------- --------- --------
Net charge-offs........................................... (75,805) (91,595) (95,085)
Provisions charged to operations............................ 103,604 71,220 203,508
-------- --------- --------
Balance, end of year........................................ $234,798 $ 206,999 $227,374
======== ========= ========

Details on impaired loans and related allowance are as follows:

IMPAIRED LOANS IMPAIRED LOANS
FOR WHICH THERE FOR WHICH THERE TOTAL
IS A RELATED IS NO RELATED IMPAIRED
ALLOWANCE ALLOWANCE LOANS
--------------- --------------- --------
(IN THOUSANDS)

December 31, 2003
Balance.............................................. $144,064 $27,162 $171,226
Related allowance.................................... 76,913 -- 76,913
-------- ------- --------
Balance, net of allowance............................ $ 67,151 $27,162 $ 94,313
======== ======= ========
December 31, 2002
Balance.............................................. $156,306 $13,282 $169,588
Related allowance.................................... 76,538 -- 76,538
-------- ------- --------
Balance, net of allowance............................ $ 79,768 $13,282 $ 93,050
======== ======= ========

YEARS ENDED DECEMBER 31
------------------------------
2003 2002 2001
-------- -------- --------
(IN THOUSANDS)

Average impaired loans...................................... $181,900 $191,493 $153,920
-------- -------- --------
Total interest income on impaired loans recorded on a cash
basis..................................................... $ -- $ -- $ --
======== ======== ========

5. PREMISES AND EQUIPMENT

Premises and equipment are stated at cost less accumulated depreciation and
amortization. A summary of these accounts is set forth below:

DECEMBER 31
-------------------
2003 2002
-------- --------
(IN THOUSANDS)

Land........................................................ $ 22,855 $ 23,183
Premises.................................................... 209,877 203,089
Equipment................................................... 410,674 385,907
Leasehold improvements...................................... 47,175 41,331
-------- --------
Total..................................................... 690,581 653,510
Accumulated depreciation and amortization................... 387,606 355,096
-------- --------
Premises and equipment................................. $302,975 $298,414
======== ========

Depreciation and amortization expense was $49.4 million in 2003, $46.3
million in 2002 and $48.3 million in 2001.

On December 17, 2001, the Bank closed on the sale of its fifteen story
operations center containing approximately 415,000 gross square feet located at
311 West Monroe Street, Chicago, Illinois, and leased back

approximately 259,000 rentable square feet. The lease ends on December 31, 2011.
The Bank has rights of first offering to lease additional space and options to
extend to December 31, 2026. The remainder of the building was occupied by
third-party tenants. The sale resulted in a realized gain of $1 million and a
deferred gain of $14.0 million and $15.7 million as of December 31, 2003 and
2002, respectively.

In addition, the Bank owns or leases premises at other locations to conduct
branch banking activities.

6. GOODWILL AND OTHER INTANGIBLE ASSETS

The Bank adopted 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. Upon adoption of SFAS No. 142, the Bank had no
goodwill.

The Bank adopted SFAS No. 147, "Acquisitions of Certain Financial
Institutions -- an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9," on October 1, 2002. Under this standard, most
acquisitions of financial institutions are removed from the scope of SFAS No. 72
and Interpretation 9 and are accounted for in accordance with SFAS No. 141,
"Business Combinations," and SFAS No. 142. As such, unidentifiable intangible
assets recognized and amortized in accordance with SFAS No. 72, "Accounting for
Certain Acquisitions of Banking or Thrift Institutions," represent goodwill that
will be accounted for under SFAS No. 142. At adoption date, the Bank had an
unidentifiable intangible asset that, in accordance with SFAS No. 72, was
excluded from the scope of SFAS No. 142 and continued to be amortized through
third quarter 2002. Upon adoption of the Statement, the unidentifiable
intangible asset was reclassified to goodwill and no longer amortized starting
in fourth quarter 2002. Under the transitional requirements of the Statement,
the first three quarters of 2002 were restated to reflect the reversal of
previously amortized goodwill in those quarters. The earnings impact for each of
these three quarters was $2.35 million pretax ($1.4 million after tax).

The Bank's goodwill was subject to the annual impairment test in the fourth
quarter of 2003. The fair value of the reporting unit was estimated using a
valuation technique based on multiples of book value. The test did not identify
potential impairment and no impairment loss was recognized in 2003.

For the years ended December 31, 2003, 2002 and 2001, the Bank's net income
and earnings per share on a proforma basis adjusted to exclude the amortization
of goodwill are included in the following table:

YEARS ENDED DECEMBER 31
--------------------------------
2003 2002 2001
--------- --------- --------
(IN THOUSANDS EXCEPT SHARE DATA)

Net income.................................................. $117,871 $171,834 $82,272
Plus goodwill amortization.................................. -- -- 5,639
-------- -------- -------
Adjusted net income......................................... $117,871 $171,834 $87,911
======== ======== =======
Earnings per common share:
Net income applicable to common stock....................... $ 11.79 $ 17.18 $ 8.23
Plus goodwill amortization.................................. -- -- 0.56
-------- -------- -------
Adjusted net income applicable to common stock.............. $ 11.79 $ 17.18 $ 8.79
======== ======== =======

The carrying value of the Bank's goodwill was $89.3 million at December 31,
2003 and 2002.

Besides goodwill, the Bank did not have any intangible assets not subject
to amortization as of December 31, 2003 and 2002.

As of December 31, 2003, the gross carrying amount and accumulated
amortization of the Bank's amortizable intangible assets are included in the
following table:

GROSS CARRYING ACCUMULATED NET CARRYING
AMOUNT AMORTIZATION VALUE
-------------- ------------ ------------
(IN THOUSANDS)

Branch network......................................... $145,000 $(72,500) $72,500
Other.................................................. 5,724 (1,569) 4,155
-------- -------- -------
Total finite life intangibles........................ $150,724 $(74,069) $76,655
======== ======== =======

Total amortization expense for the Bank's intangible assets was $10.3
million and $10.2 million in 2003 and 2002, respectively.

Estimated intangible asset amortization expense for the years ending
December 31, 2004, 2005, 2006, 2007 and 2008 is $10.4 million per year.

7. DEPOSITS

The following table summarizes deposit balances by category:

INCREASE (DECREASE)
DECEMBER 31 2003 VS. 2002
------------------------- --------------------
2003 2002 AMOUNT %
----------- ----------- ------------ -----
(DOLLARS IN THOUSANDS)

Demand deposits.................................. $ 4,231,540 $ 3,414,159 $ 817,381 24
Interest-bearing checking deposits............... 146,441 116,564 29,877 26
Money market accounts............................ 2,094,733 1,855,870 238,863 13
Statement savings accounts....................... 1,799,684 1,607,760 191,924 12
Savings certificates............................. 1,477,743 1,797,894 (320,151) (18)
Other time deposits.............................. 2,325,995 1,030,083 1,295,912 126
Deposits in foreign offices...................... 665,905 1,215,954 (550,049) (45)
----------- ----------- ----------
Total deposits................................. $12,742,041 $11,038,284 $1,703,757 15
=========== =========== ==========

Certificates of deposit in denominations exceeding $100,000 issued by
domestic offices totaled $2.8 billion at December 31, 2003. Total interest
expense on domestic office certificates of deposit of $100,000 or more amounted
to approximately $51 million, at both December 31, 2003 and December 31, 2002.
Virtually all time deposits in foreign offices were in denominations exceeding
$100,000.

The remaining maturity of certificates of deposit as of December 31, 2003
is as follows:

Certificates of Deposit

(IN MILLIONS)

Maturities:
2004...................................................... $2,115
2005...................................................... 198
2006...................................................... 45
2007...................................................... 623
2008...................................................... 1,011
Thereafter................................................ 429
------
Total.................................................. $4,421
======

8. SECURITIES PURCHASED UNDER AGREEMENT TO RESELL AND SECURITIES SOLD UNDER
AGREEMENT TO REPURCHASE

At various times the Bank enters into purchases of U.S. Treasury and
Federal agency securities under agreements to resell identical securities. The
amounts advanced under these agreements represent short-term loans and are
reflected as receivables in the Consolidated Statements of Condition. There were
no securities purchased under agreement to resell outstanding at December 31,
2003 and December 31, 2002. The

securities underlying the agreements are book-entry securities. Securities are
transferred by appropriate entry into the Bank's account with Bank of New York
through the Federal Reserve Bank of New York under a written custodial agreement
with Bank of New York that explicitly recognizes the Bank's interest in these
securities.

The Bank also enters into sales of U.S. Treasury and Federal agency
securities under agreements to repurchase identical securities. The amounts
received under these agreements represent short-term borrowings and are
reflected as liabilities in the Consolidated Statements of Condition. Securities
sold under agreement to repurchase totaled $3.45 billion and $4.19 billion at
December 31, 2003 and 2002, respectively. Securities sold under agreement to
repurchase are transferred via book-entry to the counterparty, if transacted
with a financial institution or a broker-dealer, or are delivered to customer
safekeeping accounts. The Bank monitors the market value of these securities and
adjusts the level of collateral for repurchase agreements, as appropriate. The
Bank maintains effective control over the securities sold under agreement to
repurchase and accounts for the transactions as secured borrowings.

Securities Purchased Under Agreement to Resell

2003 2002
---------- ----------
(DOLLARS IN THOUSANDS)

Amount outstanding at end of year........................... $ -- $ --
Highest amount outstanding as of any month-end during the
year...................................................... $350,375 $405,063
Daily average amount outstanding during the year............ $ 65,847 $ 7,598
Daily average annualized rate of interest................... 0.53% 1.62%
Average rate of interest on amount outstanding at end of
year...................................................... -- --

Securities Sold Under Agreement to Repurchase

2003 2002
---------- ----------
(DOLLARS IN THOUSANDS)

Amount outstanding at end of year........................... $3,452,567 $4,188,688
Highest amount outstanding as of any month-end during the
year...................................................... $4,821,309 $4,188,688
Daily average amount outstanding during the year............ $4,164,402 $3,125,430
Daily average annualized rate of interest................... 1.04% 1.52%
Average rate of interest on amount outstanding at end of
year...................................................... 0.91% 1.19%

9. SENIOR NOTES AND LONG-TERM NOTES

The following table summarizes the Bank's long-term notes:

DECEMBER 31
-------------------
2003 2002
-------- --------
(IN THOUSANDS)

Floating rate subordinated note to Bankcorp due March 31,
2005...................................................... $ 50,000 $ 50,000
Floating rate subordinated note to Bankcorp due December 1,
2006...................................................... 50,000 50,000
Fixed rate 6 1/2% subordinated note to Bankcorp due December
27, 2007.................................................. 60,000 60,000
Fixed rate 7 5/8% subordinated note to Bankcorp due June 27,
2008...................................................... 15,000 15,000
Fixed rate 7 1/8% subordinated note to Bankcorp due June 30,
2009...................................................... 50,000 50,000
-------- --------
Total..................................................... $225,000 $225,000
======== ========

All of the Bank notes are unsecured obligations, ranking on a parity with
all unsecured and subordinated indebtedness of the Bank and are not subject to
redemption prior to maturity at the election of the debtholders. The interest
rate on the floating rate notes reprices semiannually and floats at 50 basis
points above 180 day London Interbank Offering Rate ("LIBOR"). At year-end 2003,
180 day LIBOR was 1.22 percent.

Scheduled principal payments on long-term notes are as follows:
2004 -- $0.0 million; 2005 -- $50.0 million; 2006 -- $50.0 million;
2007 -- $60.0 million; 2008 -- $15.0 million; thereafter -- $50.0 million.

The Bank offers to institutional investors from time to time, unsecured
short-term and medium-term bank notes in an aggregate principal amount of up to
$1.5 billion outstanding at any time. The term of each note could range from 14
days to 15 years. These senior notes are subordinated to deposits and rank pari
passu with all other unsecured senior indebtedness of the Bank. As of December
31, 2003, there were no senior short-term notes outstanding. As of December 31,
2002, $200 million of senior short-term notes were outstanding with original
maturities of 64 days (remaining maturities of 22 days) and stated interest
rates of 1.33 percent.

10. FAIR VALUE OF FINANCIAL INSTRUMENTS

Generally accepted accounting principles require the disclosure of
estimated fair values for both on and off-balance-sheet financial instruments.
The Bank's fair values are based on quoted market prices when available. For
financial instruments not actively traded, such as certain loans, deposits,
off-balance-sheet transactions and long-term borrowings, fair values have been
estimated using various valuation methods and assumptions. Although management
used its best judgment in estimating these values, there are inherent
limitations in any estimation methodology. In addition, accounting
pronouncements require that fair values be estimated on an item-by-item basis,
thereby ignoring the impact a large sale would have on a thin market and
intangible values imbedded in established lines of business. Therefore, the fair
value estimates presented herein are not necessarily indicative of the amounts
the Bank could realize in an actual transaction. The fair value estimation
methodologies employed by the Bank were as follows:

The carrying amounts for cash and demand balances due from banks along with
short-term money market assets and liabilities reported on the Bank's
Consolidated Statements of Condition were considered to be the best estimates of
fair value for these financial instruments. Fair values of trading account
assets and available-for-sale securities were based on quoted market prices.

A variety of methods were used to estimate the fair value of loans. Changes
in estimated fair value of loans reflect changes in credit risk and general
interest rates which have occurred since the loans were originated. Fair values
of floating rate loans, including commercial, broker dealer, financial
institution, construction, charge card, consumer and home equity, were assumed
to be the same as carrying value since the loans' interest rates automatically
reprice to market. Fair values of residential mortgages were based on current
prices for securities backed by similar loans. For long-term fixed rate loans,
including consumer installment and commercial mortgage loans, fair values were
estimated based on the present value of future cash flows with current market
rates as discount rates. Additionally, management considered appraisal values of
collateral when nonperforming loans were secured by real estate.

The fair values of customers' liability on acceptances and acceptances
outstanding approximate carrying value due to the short-term nature of these
assets and liabilities and the generally negligible credit losses associated
with them.

The fair values of accrued interest receivable and payable approximate
carrying values due to the short-term nature of these assets and liabilities.

The fair values of bank-owned insurance investments approximate carrying
value, because upon liquidation of these investments the Bank would receive the
cash surrender value which equals carrying value.

The fair values of demand deposits, savings accounts, interest-bearing
checking deposits and money market accounts were the amounts payable on demand
at the reporting date, or the carrying amounts. The fair value of time deposits
was estimated using a discounted cash flow calculation with current market rates
offered by the Bank as discount rates.

The fair value of senior notes approximates carrying value because the
average maturity on these notes is less than one year.

The fair value of minority interest -- preferred stock of subsidiary
(Harris Preferred Capital Corporation) approximates carrying value as the
preferred stock has a liquidation preference that equals book value.

The fair value of long-term notes was determined using a discounted cash
flow calculation with current rates available to the Bank for similar debt as
discount rates.

The fair values of credit facilities approximates their carrying value
(i.e. deferred income) of estimated cost that would be incurred to induce third
parties to assume these commitments.

The estimated fair values of the Bank's financial instruments at December
31, 2003 and 2002 are presented in the following table. See Note 11 to Financial
Statements for additional information regarding fair values of off-balance-sheet
financial instruments.

DECEMBER 31
-----------------------------------------------------
2003 2002
------------------------- -------------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
----------- ----------- ----------- -----------
(IN THOUSANDS)

ASSETS
Cash and demand balances due from
banks.................................. $ 823,615 $ 823,615 $ 1,057,254 $ 1,057,254
Money market assets:
Interest-bearing deposits at banks..... 424,459 424,459 417,206 417,206
Federal funds sold and securities
purchased under agreement to
resell.............................. 409,425 409,425 237,950 237,950
Securities available-for-sale............ 6,624,280 6,624,280 5,781,360 5,781,360
Trading account assets................... 59,467 59,467 42,423 42,423
Loans, net of unearned income and
allowance for possible loan losses..... 9,338,654 9,364,083 9,400,888 9,455,610
Customers' liability on acceptances...... 44,234 44,234 16,168 16,168
Accrued interest receivable.............. 71,811 71,811 76,649 76,649
Loans held for sale...................... 168,904 168,904 149,311 149,311
Bank-owned insurance..................... 1,035,239 1,035,239 994,185 994,185
----------- ----------- ----------- -----------
Total on-balance-sheet financial
assets............................ $19,000,088 $19,025,517 $18,173,394 $18,228,116
=========== =========== =========== ===========
LIABILITIES
Deposits:
Demand deposits........................ $ 8,301,415 $ 8,301,415 $ 6,988,180 $ 6,988,180
Time deposits.......................... 4,440,626 4,455,398 4,050,104 4,080,992
Federal funds purchased.................. 1,190,839 1,190,839 872,096 872,096
Securities sold under agreement to
repurchase............................. 3,452,567 3,452,567 4,188,688 4,188,688
Short-term borrowings.................... 10,841 10,841 300,694 300,694
Acceptances outstanding.................. 44,234 44,234 16,168 16,168
Accrued interest payable................. 23,251 23,251 15,920 15,920
Short-term notes -- senior............... -- -- 200,000 200,000
Minority interest -- preferred stock of
subsidiary............................. 250,000 250,000 250,000 250,000
Preferred stock issued to Harris
Bankcorp, Inc.......................... 5,000 5,000 5,000 5,000
Long-term notes -- subordinated.......... 225,000 243,571 225,000 237,173
----------- ----------- ----------- -----------
Total on-balance-sheet financial
liabilities....................... $17,943,773 $17,977,116 $17,111,850 $17,154,911
=========== =========== =========== ===========
OFF-BALANCE-SHEET CREDIT FACILITIES
(POSITIVE POSITIONS/(OBLIGATIONS))
Loan commitments......................... $ (11,239) $ (11,239) $ (13,957) $ (13,957)
Standby letters of credit................ (1,126) (1,126) (854) (854)
Commercial letters of credit............. -- -- (44) (44)
----------- ----------- ----------- -----------
Total off-balance-sheet credit
facilities........................ $ (12,365) $ (12,365) $ (14,855) $ (14,855)
=========== =========== =========== ===========

11. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

The Bank utilizes various financial instruments with off-balance-sheet risk
in the normal course of business to meet its customers' financing and risk
management needs. The Bank's major categories of financial

instruments with off-balance-sheet risk include credit facilities, financial
guarantees and various securities-related activities.

Credit Facilities

Credit facilities with off-balance-sheet risk include commitments to extend
credit and commercial letters of credit.

Commitments to extend credit are contractual agreements to lend to a
customer as long as contract terms have been met. They generally require payment
of a fee and have fixed expiration dates. The Bank's commitments serve both
business and individual customer needs, and include commercial loan commitments,
home equity lines, commercial real estate loan commitments and mortgage loan
commitments. The maximum potential amount of undiscounted future payments the
Bank could be required to make is represented by the total contractual amount of
commitments, which was $8.3 billion and $8.0 billion at December 31, 2003 and
2002, respectively. Since only a portion of commitments will ultimately be drawn
down, the Bank does not expect to provide funds for the total contractual
amount. Risks associated with certain commitments are reduced by participations
to third parties, which at December 31, 2003, totaled $944 million and at
December 31, 2002, totaled $667 million.

Commercial letters of credit are commitments to make payments on behalf of
customers when letter of credit terms have been met. Maximum risk of accounting
loss is represented by total commercial letters of credit outstanding of $46
million at December 31, 2003 and $41 million at December 31, 2002.

Credit risks associated with all of these facilities are mitigated by
reviewing customers' creditworthiness on a case-by-case basis, obtaining
collateral, limiting loans to individual borrowers, setting restrictions on
long-duration maturities and establishing stringent covenant terms outlining
performance expectations which, if not met, may cause the Bank to terminate the
contract. Credit risks are further mitigated by monitoring and maintaining
portfolios that are well-diversified.

Collateral is required to support certain of these credit facilities when
they are drawn down and may include equity and debt securities, commodities,
inventories, receivables, certificates of deposit, savings instruments, fixed
assets, real estate, life insurance policies and memberships on national or
regional stock and commodity exchanges. Requirements are based upon the risk
inherent in the credit and are more stringent for firms and individuals with
greater default risks. The Bank monitors collateral values and appropriately
perfects its security interest. Periodic evaluations of collateral adequacy are
performed by Bank personnel.

The fair value of credit facilities (i.e. deferred income) is approximately
equal to their carrying value of $12.4 million at December 31, 2003 and $14.9
million at December 31, 2002.

Financial Guarantees

Financial guarantees with off-balance-sheet risk include standby letters of
credit, loans sold with recourse and written put options.

Standby letters of credit are unconditional commitments that guarantee the
obligation of a customer to a third party should that customer default. They are
issued to support financial and performance-related obligations including
brokers' margin maintenance, industrial revenue bond repayment, debt repayment,
construction contract performance and trade agreement performance. The Bank's
maximum risk of accounting loss for these items is represented by the total
commitments outstanding of $2.76 billion at December 31, 2003 and $2.66 billion
at December 31, 2002. Risks associated with standby letters of credit are
reduced by participations to third parties which totaled $948 million at
December 31, 2003 and $881 million at December 31, 2002. In most cases, these
commitments expire within three years without being drawn upon.

The Bank has sold mortgage loans with limited recourse. The recourse
provisions require the Bank to reimburse the buyer, based on pre-determined
rates, upon the occurrence of certain credit-related events. The maximum amount
payable under the recourse provisions is $7.0 million at December 31, 2003. The
carrying amount of the recourse liability is $1.3 million at December 31, 2003.

Written put options are contracts that provide the buyer the right (but not
the obligation) to sell a financial instrument at a specified price, either
within a specified period of time or on a certain date. The Bank writes put
options, providing the buyer the right to require the Bank to buy the specified
assets per the contract terms. The maximum amount payable for the written put
options is equal to their notional amount of $864.7 million at December 31,
2003. The fair value of the related derivative liability is $4.3 million at
December 31, 2003.

Securities Activities

The Bank's securities activities that have off-balance-sheet risk include
municipal bond underwriting and short selling of securities.

Through its municipal bond underwriting activities, the Bank commits to buy
and offer for resale newly issued bonds. The Bank is exposed to market risk
because it may be unable to resell its inventory of bonds profitably as a result
of unfavorable market conditions. In syndicate arrangements, the Bank is
obligated to fulfill syndicate members' commitments should they default. The
syndicates of which the Bank was a member had underwriting commitments totaling
$47 million at December 31, 2003 and $37 million at December 31, 2002.

Security short selling, defined as selling of securities not yet owned,
exposes the Bank to off-balance-sheet market risk because the Bank may be
required to buy securities at higher prevailing market prices to cover its short
positions. The Bank had no short position at December 31, 2003 or 2002.

12. DERIVATIVE FINANCIAL INSTRUMENTS

The Bank utilizes various derivative financial instruments in the normal
course of business to a) meet its customers' financing and risk management
needs, b) reduce its own risk exposure, and c) produce fee income and trading
profits. Fair values of derivative financial instruments are based on market
prices of comparable instruments, pricing models using year-end rates and
counterparty credit ratings.

All derivative instruments are recognized at fair value in the Consolidated
Statements of Condition. All derivative instruments are designated either as
hedges or held for trading or non-hedging purposes.

The Bank uses various interest rate, foreign exchange, equity, and
commodity derivative contracts as part of its dealer and trading activities or
in the management of its risk strategy. Interest rate contracts may include
futures, forwards, forward rate agreements, option contracts, caps, floors,
collars and swaps. Foreign exchange contracts may include spot, futures,
forwards, option contracts and swaps. Equity contracts and commodity contracts
may include options and swaps. The Bank enters into derivative contracts with
BMO to facilitate a more efficient use of combined resources and to better serve
customers. See Note 24 for additional information on related party transactions.

At December 31, 2003, the Bank recorded, for dealer and trading activities
and for risk management activities that do not otherwise qualify for hedge
accounting, the fair value of derivative instrument assets of $112.3 million in
other assets and derivative instrument liabilities of $92.7 million in other
liabilities. At December 31, 2002, the Bank recorded the fair value of
derivative instrument assets of $147.2 million in other assets and derivative
instrument liabilities of $151.9 million in other liabilities. These amounts
reflect the netting of certain derivative instrument assets and liabilities when
the conditions in FASB Interpretation ("FIN") No. 39, "Offsetting of Amounts
Related to Certain Contracts," have been met.

Dealer and Trading Activity

Interest Rate Contracts

As dealer, the Bank serves customers seeking to manage interest rate risk
by entering into contracts as counterparty to their (customer) transactions. In
its trading activities, the Bank uses interest rate contracts to profit from
expected future market movements.

These contracts may create exposure to both credit and market risk.
Replacement risk, the primary component of credit risk, is the risk of loss
should a counterparty default following unfavorable market movements and is
measured as the Bank's cost of replacing contracts at current market rates. The
Bank manages credit risk by establishing credit limits for customers and
products through an independent corporate-wide credit review process and by
continually monitoring exposure against those limits to ensure they are not
exceeded. Credit risk is, in many cases, further mitigated by the existence of
netting agreements that provide for netting of contractual receivables and
payables in the event of default or bankruptcy. Netting agreements apply to
situations where the Bank is engaged in more than one outstanding derivative
transaction with the same counterparty and also has a legally enforceable master
netting agreement with that counterparty.

Market risk is the potential for loss arising from potential adverse
changes in underlying market factors, including interest and foreign exchange
rates. The Bank manages market risk through the imposition of integrated
value-at-risk limits and an active, independent monitoring process.

Value-at-risk methodology is used for measuring the market risk of the
Bank's trading positions. This statistical methodology uses recent market
volatility to estimate the maximum daily trading loss that the Bank would expect
to incur, on average, 99 percent of the time. The model also measures the effect
of correlation among the various trading instruments to determine how much risk
is eliminated by offsetting positions.

Futures and forward contracts are agreements in which the Bank is obligated
to make or take delivery, at a specified future date, of a specified instrument,
at a specified price or yield. Futures contracts are exchange traded and,
because of exchange requirements that gains and losses be settled daily, create
negligible exposure to credit risk.

Forward rate agreements are arrangements between two parties to exchange
amounts, at a specified future date, based on the difference between an agreed
upon interest rate and reference rate applied to a notional principal amount.
These agreements enable purchasers and sellers to fix interest costs and
returns.

Options are contracts that provide the buyer the right (but not the
obligation) to purchase or sell a financial instrument, at a specified price,
either within a specified period of time or on a certain date. Interest rate
guarantees (caps, floors and collars) are agreements between two parties that,
in general, establish for the purchaser a maximum level of interest expense or a
minimum level of interest revenue based on a notional principal amount for a
specified term. Options and interest rate guarantees written create exposure to
market risk. As a writer of interest rate options and guarantees, the Bank
receives a premium at the outset of the agreement and bears the risk of an
unfavorable change in the price of the financial instrument underlying the
option or interest rate guarantee. Options and interest rate guarantees
purchased create exposure to credit risk and, to the extent of the premium paid
or unrealized gain recognized, market risk.

Interest rate swaps are contracts involving the exchange of interest
payments based on a notional amount for a specified period. Most of the Bank's
activity in swaps is as intermediary in the exchange of interest payments
between customers, although the Bank also uses swaps to manage its own interest
rate exposure (see discussion of risk management activity).

Foreign Exchange Contracts

The Bank is a dealer in foreign exchange ("FX") contracts. FX contracts may
create exposure to market and credit risk, including replacement risk and
settlement risk. Credit risk is managed by establishing limits for customers
through an independent corporate-wide credit approval process and continually
monitoring exposure against those limits. In addition, both settlement and
replacement risk are reduced through netting
58

by novation, agreements with counterparties to offset certain related
obligations. Market risk is managed through establishing exposure limits by
currency and monitoring actual exposure against those limits, entering into
offsetting positions, and closely monitoring price behavior.

The Bank and BMO combine their U.S. FX revenues. Under this arrangement, FX
net profit is shared by the Bank and BMO in accordance with a specific formula
set forth in the agreement. This agreement expires on April 2, 2004, but may be
extended at that time. Either party may terminate the arrangement at its option.
FX revenues are reported net of expenses. Net gains (losses) from dealer/trading
foreign exchange contracts, for the years ended December 31, 2003 and December
31, 2002, totaled $5.1 million and $7.2 million, respectively, of net profit
under the aforementioned agreement with BMO.

At December 31, 2003, approximately 95 percent of the Bank's gross notional
positions in foreign currency contracts are represented by seven currencies:
Eurodollar, Canadian dollars, British pounds, Australian dollar, Swedish krona,
Japanese yen and the Mexican peso.

Foreign exchange contracts include spot, futures, forwards, options and
swaps that enable customers to manage their foreign exchange risk. Spot, future
and forward contracts are agreements to exchange currencies at a future date, at
a specified rate of exchange. Foreign exchange option contracts give the buyer
the right and the seller an obligation (if the buyer asserts his right) to
exchange currencies during a specified period (or on a certain date in the case
of "European" options) at a specified exchange rate. Cross currency swap
contracts are agreements to exchange principal denominated in two different
currencies at the spot rate and to repay the principal at a specified future
date and exchange rate.

Equity Contracts

The Bank enters into equity contracts that enable customers to manage the
risk associated with equity price fluctuations. Equity contracts include options
and swaps.

Commodity Contracts

The Bank enters into commodity contracts that enable customers to manage
the risk associated with commodity price fluctuations. Commodity contracts
include options and swaps.

Risk Management Activity

In addition to its dealer and trading activities, the Bank uses interest
rate contracts, primarily swaps, and foreign exchange contracts to reduce the
level of financial risk inherent in mismatches between the interest rate
sensitivities and foreign currency exchange rate fluctuations of certain assets
and liabilities. For non-trading risks, market risk is controlled by actively
managing the asset and liability mix, either directly through the balance sheet
or with off-balance sheet derivative instruments. Measures also focus on
interest rate exposure gaps and sensitivity to rate changes.

The Bank has an interest rate risk management strategy that incorporates
the use of derivative instruments to minimize significant unplanned fluctuations
in earnings that may be caused by interest rate volatility. The Bank manages
interest rate sensitivity by modifying the repricing or maturity characteristics
of certain fixed rate assets so that net interest margin is not adversely
affected, on a material basis, by movements in interest rates. As a result of
interest rate fluctuations, fixed rate assets will appreciate or depreciate in
market value. The effect of the unrealized appreciation or depreciation will
generally be offset by the gains or losses on the derivative instruments.

The Bank has a foreign currency risk management strategy that incorporates
the use of derivative instruments to minimize significant unplanned fluctuations
in earnings that may be caused by foreign currency exchange rate fluctuations.
Certain assets and liabilities are denominated in foreign currency, creating
exposure to changes in exchange rates. The Bank uses cross currency interest
rate swaps and foreign exchange forward contracts to hedge the risk.

Risk management activities include the following derivative transactions
that qualify for hedge accounting.

Fair Value Hedges

The Bank uses interest rate swaps to alter the character of 1) revenue
earned on certain long-term, fixed rate loans and available-for-sale securities
and 2) interest paid on certain long-term, fixed rate deposits. Interest rate
swaps convert the loans, securities and deposits from fixed rate to variable
rate. Interest rate swap contracts generally involve the exchange of fixed and
variable rate interest payments between two parties, based on a common notional
amount and maturity date.

For fair value hedges, as of December 31, 2003 the Bank recorded the fair
value of derivative instrument assets and liabilities of $10.7 million and $23.9
million, respectively, in other assets and other liabilities. For fair value
hedges, as of December 31, 2002 the Bank recorded the fair value of derivative
instrument liabilities of $14.9 million in other liabilities. Net losses
recorded for the year-to-date periods ended December 31, 2003 and December 31,
2002 representing the ineffective portion of the fair value hedges were not
material to the consolidated financial statements of the Bank. Gains or losses
resulting from hedge ineffectiveness are recorded in noninterest income.

Cash Flow Hedges

The Bank uses interest rate swaps to reduce the variability associated with
future interest payments on floating-rate, prime-based loans. Interest rate
swaps convert the expected cash flows on the loans from variable to fixed.
Changes in the fair value of the swaps are recorded in other comprehensive
income.

For cash flow hedges, as of December 31, 2003 the fair value of the
derivative instrument asset was recorded in other assets and was not material to
the consolidated financial statements of the Bank. No hedge ineffectiveness was
recorded to earnings for the year ended December 31, 2003. The unrealized gain
(loss) in accumulated other comprehensive income related to the interest rate
swap is reclassified to earnings in the same period that the interest on the
floating-rate loans affects earnings. The amount expected to be reclassified to
earnings over the next twelve months is not expected to be material to the
consolidated financial statements of the Bank. There were no cash flow hedges in
2002.

Risk management activities also include the following derivative
transactions that do not otherwise qualify for hedge accounting.

Foreign exchange contracts are used to stabilize any currency exchange rate
fluctuation for certain senior notes and certain loans. The derivative
instruments, primarily cross currency interest rate swaps and to a lesser extent
forward contracts, do not qualify for hedge accounting and are accounted for at
fair value.

The Bank has qualifying mortgage loan commitments that are intended to be
sold in the secondary market. These loan commitments are derivatives and are
accounted for at fair value. The Bank enters into forward sales of
mortgage-backed securities to minimize its exposure to interest rate volatility.
These forward sales of mortgage-backed securities are also derivatives and are
accounted for at fair value.

13. CONCENTRATIONS OF CREDIT RISK IN FINANCIAL INSTRUMENTS

The Bank had one major concentration of credit risk arising from financial
instruments at December 31, 2003 and 2002. This concentration was the Midwest
geographic area. This concentration exceeded 10 percent of the Bank's total
credit exposure, which is the total potential accounting loss should all
customers fail to perform according to contract terms and all collateral prove
to be worthless.

Midwestern Geographic Area

A majority of the Bank's customers are located in the Midwestern region of
the United States, defined here to include Illinois, Indiana, Iowa, Michigan,
Minnesota, Missouri, Ohio and Wisconsin. The Bank provides credit to these
customers through a broad array of banking and trade financing products
including

commercial loans, commercial loan commitments, commercial real estate loans,
consumer installment loans, mortgage loans, home equity loans and lines, standby
and commercial letters of credit and banker's acceptances. The financial
viability of customers in the Midwest is, in part, dependent on the region's
economy. Corporate customers headquartered in the region and serving a national
or international market are not included in this concentration because their
business is broad-based and not dependent on the region's economy. The Bank's
maximum risk of accounting loss, should all customers making up the Midwestern
concentration fail to perform according to contract terms and all collateral
prove to be worthless, was approximately $14.0 billion or 50 percent of the
Bank's total credit exposure at December 31, 2003 and $13.4 billion or 50
percent of the Bank's total credit exposure at December 31, 2002.

The Bank manages this exposure by continually reviewing local market
conditions and customers, adjusting individual and industry exposure limits
within the region and by obtaining or closely monitoring collateral values. See
Note 11 to Financial Statements for information on collateral supporting credit
facilities.

14. EMPLOYEE BENEFIT PLANS

The Bank has noncontributory defined benefit pension plans covering
virtually all its employees as of December 31, 2003. Most of the employees
participating in retirement plans were included in one primary plan ("primary
plan") during the three-year period ended December 31, 2003. The plan is a
multiple-employer plan covering the Bank's employees as well as persons employed
by certain affiliated entities.

Certain employees participating in the primary plan are also covered by a
supplemental unfunded retirement plan. The purpose of this plan is to extend
full retirement benefits to individuals without regard to statutory limitations
for qualified funded plans.

Effective January 1, 2002, the plan's benefit formula for new employees was
changed to an account-based formula from a final average pay formula. The
account-based benefit formula is based upon eligible pay, age and length of
service. Prior to January 1, 2002, the plan's benefit formula was a final
average pay formula, based upon length of service and an employee's highest
qualifying compensation during five consecutive years of active employment less
an estimated Social Security benefit. For employees who were employed as of
December 31, 2001 and leave the Corporation on or after January 1, 2002,
benefits are calculated two ways: under the account-based formula for service
beginning January 1, 2002 and under the final average pay formula for all
service. This group of employees will receive the greater benefit.

The policy for this plan is to have the participating entities, at a
minimum, fund annually an amount necessary to satisfy the requirements under
ERISA, without regard to prior years' contributions in excess of the minimum.
The Bank generally contributes the maximum allowable under the U.S. Internal
Revenue Code. For 2003, 2002 and 2001, cumulative contributions were less than
the amounts recorded as primary plan pension expense for financial reporting
purposes. For 2004, the estimated pension contribution is $13.9 million. The
total consolidated pension expense of the Bank, including the supplemental
unfunded retirement plan (excluding settlement losses and curtailment gains),
for 2003, 2002, and 2001 was $22.2 million, $11.7 million and $7.1 million,
respectively. The qualified pension accumulated benefit obligation for 2003,
2002, and 2001 was $263.6 million, $233.3 million and $200.3 million,
respectively.

In addition to pension benefits, the Bank provides medical care benefits
for retirees (and their dependents) who have attained age 55 and have at least
10 years of service. The Bank also provides medical care benefits for disabled
employees and widows of former employees (and their dependents). The Bank
provides these medical care benefits through a self-insured plan. Under the
terms of the plan, the Bank contributes to the cost of coverage based on
employees' length of service. Cost sharing with plan participants is
accomplished through deductibles, coinsurance and out-of-pocket limits. Funding
for the plan largely comes from the general assets of the Bank supplemented by
contributions to a trust fund created under Internal Revenue Code Section
401(h).

FASB Staff Position No. 106-1, Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement, and Modernization Act of
2003, permitted employers either to recognize the Medicare Prescription Drug,
Improvement, and Modernization Act of 2003 (the Act) immediately as of the

December 8, 2003, enactment date or to defer recognition until FASB issues
further guidance. Specific authoritative guidance on the accounting is pending
and guidance, when issued, could require the sponsor to change previously
reported information. The deferral was elected by the Bank for 2003 and
accordingly, measures of the accumulated postretirement benefit obligation or
net periodic postretirement benefit cost in the financial statements or
accompanying notes do not reflect the effects of the Act.

Settlement losses amounting to $2.6 million for the supplemental unfunded
retirement plan were recognized in 2003.

The following tables set forth the change in benefit obligation and plan
assets for the pension and postretirement medical care benefit plans for the
Bank:

PENSION BENEFITS POSTRETIREMENT MEDICAL BENEFITS
-------------------------------- ---------------------------------
2003** 2002** 2001** 2003** 2002** 2001**
--------- --------- -------- --------- --------- ---------
(IN THOUSANDS)

CHANGE IN BENEFIT OBLIGATION*
Benefit obligation at beginning of
year............................ $ 311,566 $ 248,377 $224,002 $ 44,361 $ 38,389 $ 32,933
Service cost...................... 13,867 10,871 8,812 1,569 1,259 1,280
Interest cost..................... 19,239 18,451 16,419 2,917 2,799 2,471
Plan Amendments................... -- 1,585 4,033 -- -- --
Acquisitions/transfers............ -- -- 94 -- -- --
Curtailment (gain) or loss........ -- -- -- -- -- --
Benefits paid (net of participant
contributions).................. (42,600) (19,065) (13,035) (2,227) (2,863) (2,003)
Actuarial (gain) or loss.......... 38,863 51,347 8,052 7,549 4,777 3,708
--------- --------- -------- -------- -------- --------
Benefit obligation at end of
year............................ $ 340,935 $ 311,566 $248,377 $ 54,169 $ 44,361 $ 38,389
========= ========= ======== ======== ======== ========
CHANGE IN PLAN ASSETS
Fair value of plan assets at
beginning of year............... $ 210,844 $ 236,956 $246,912 $ 24,406 $ 25,962 $ 25,209
Actual return on plan assets...... 38,180 (14,316) (1,361) 7,001 (3,579) (1,463)
Acquisitions/transfers............ -- -- 1,192 -- -- --
Employer contribution............. 8,861 7,269 3,248 -- 2,023 2,216
Benefits paid..................... (42,600) (19,065) (13,035) -- -- --
--------- --------- -------- -------- -------- --------
Fair value of plan assets at end
of year***...................... $ 215,285 $ 210,844 $236,956 $ 31,407 $ 24,406 $ 25,962
========= ========= ======== ======== ======== ========
Funded Status..................... $(125,650) $(100,722) $(11,421) $(22,762) $(19,955) $(12,427)
Contributions made between
measurement date (September 30)
and end of year................. -- -- -- -- -- --
Unrecognized actuarial (gain) or
loss............................ 131,102 117,006 29,580 7,506 5,079 (5,589)
Unrecognized transition (asset) or
obligation...................... -- -- (85) 15,641 17,392 19,143
Unrecognized prior service cost... 2,836 2,556 691 1,015 1,184 1,354
--------- --------- -------- -------- -------- --------
Net amount at year-end............ $ 8,288 $ 18,840 $ 18,765 $ 1,400 $ 3,700 $ 2,481
========= ========= ======== ======== ======== ========
AMOUNTS RECOGNIZED IN THE
STATEMENT OF CONDITION CONSIST
OF:
Prepaid benefit cost.............. $ -- $ -- $ 18,765 $ 1,400 $ 3,700 $ 2,481
Accrued benefit liability......... (44,313) (25,528) -- -- -- --
Intangible asset.................. 2,836 2,556 -- -- -- --
Accumulated other comprehensive
income (gross of tax)........... 49,765 41,812 -- -- -- --
--------- --------- -------- -------- -------- --------
Net amount recognized at
year-end........................ $ 8,288 $ 18,840 $ 18,765 $ 1,400 $ 3,700 $ 2,481
========= ========= ======== ======== ======== ========
Other comprehensive income
attributable to change in
additional minimum liability
(gross of tax).................. $ 7,953 $ 41,812 $ -- $ -- $ -- $ --

COMPONENTS OF NET PERIODIC BENEFIT
COST
Service cost...................... $ 13,867 $ 10,871 $ 8,812 $ 1,569 $ 1,259 $ 1,280
Interest cost..................... 19,239 18,451 16,419 2,917 2,799 2,471
Expected return on plan assets.... (17,591) (21,778) (20,066) (1,953) (2,077) (2,017)
Amortization of prior service
cost............................ (279) (280) (745) 169 169 169
Amortization of transition (asset)
or obligation................... -- (85) (313) 1,751 1,751 1,751
Amortization of actuarial (gain)
or loss......................... 4,638 -- (75) -- (233) (548)
--------- --------- -------- -------- -------- --------
Net periodic benefit cost......... $ 19,874 $ 7,179 $ 4,032 $ 4,453 $ 3,668 $ 3,106
========= ========= ======== ======== ======== ========

---------------

* Benefit obligation is projected for Pension Benefits and accumulated for
Postretirement Medical Benefits.

** Plan assets and obligation measured as of September 30.

*** The actual allocation of plan assets by category are as follows:

2003 2002 2001
---- ---- ----

Pension:
Equity securities........................................... 73% 67% 69%
Fixed income securities..................................... 27% 33% 31%
Postretirement Medical:
Equity securities........................................... 73% 66% 69%
Fixed income securities..................................... 27% 34% 31%

Investment objectives include the achievement of a total account return
(net of fees) which meets or exceeds over a long time horizon the expected
return on plan assets, the inflation rate as measured by the Consumer Price
Index, and the median performance in a comparable manager universe. The return
on asset assumption is based upon management's review of the current rate
environment, historical trend analysis and the mix of asset categories
represented in the Plan's portfolio. The performance benchmark includes the
asset classes of equities and fixed income securities. Plan asset and liability
studies are presented to the Investment Committee periodically. The current
portfolio target allocation is as follows:

U.S. large capitalization equities.......................... 35%
U.S. small capitalization equities.......................... 10%
International equities...................................... 15%
Emerging market equities.................................... 5%
Market bonds................................................ 25%
High yield bonds............................................ 10%
---
100%

POSTRETIREMENT
PENSION BENEFITS MEDICAL BENEFITS
------------------ ------------------
2003 2002 2001 2003 2002 2001
---- ---- ---- ---- ---- ----

WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31
Discount rate*........................................ 6.00% 6.75% 7.50% 6.00% 6.75% 7.50%
Expected return on plan assets........................ 8.00% 9.00% 9.00% 8.00% 8.00% 8.00%
Rate of compensation increase......................... 4.50% 5.50% 5.50% N/A N/A N/A

---------------

* Discount rates are used to determine service costs for the subsequent year.

For measurement purposes, a 10 percent annual rate of increase for pre 65
and a 12 percent annual rate of increase for post 65 in the per capita cost of
covered health care benefits was assumed for 2003. The rate will

be graded down to 5.0 percent for pre 65 and 5.5 percent for post 65 in 2013 and
2012, respectively, and remain level thereafter.

Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A one-percentage-point change in
assumed health care cost trend rates would have the following effects:

1-PERCENTAGE 1-PERCENTAGE
POINT INCREASE POINT DECREASE
-------------- --------------
(IN THOUSANDS)

Effect on total of service and interest cost components..... $ 892 $ (694)
Effect on postretirement benefit obligation................. $8,389 $(6,753)

The following table sets forth the status of the supplemental unfunded
retirement plan:

SUPPLEMENTAL UNFUNDED
RETIREMENT BENEFITS
------------------------------
2003 2002 2001
-------- -------- --------
(IN THOUSANDS)

CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year..................... $ 25,544 $ 23,750 $ 19,258
Service cost................................................ 1,132 2,273 1,320
Interest cost............................................... 1,075 1,398 1,049
Settlement (gain) or loss................................... 1,546 -- --
Plan amendments/merger...................................... -- -- (3,990)
Benefits paid (net of participant contributions)............ (180) (239) (385)
Settlement payments......................................... (10,872) -- --
Actuarial (gain) or loss.................................... (4,294) (1,638) 6,498
-------- -------- --------
Benefit obligation at end of year........................... $ 13,951 $ 25,544 $ 23,750
======== ======== ========
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year.............. $ -- $ -- $ --
Actual return on plan assets................................ -- -- --
Employer contribution....................................... 11,052 239 385
Benefits paid............................................... (11,052) (239) (385)
-------- -------- --------
Fair value of plan assets at end of year.................... $ -- $ -- $ --
======== ======== ========
Funded Status............................................... $(13,951) $(25,544) $(23,750)
Contributions made between measurement date (September 30)
and end of year........................................... 916 -- 45
Unrecognized actuarial (gain) or loss....................... 3,325 8,020 10,274
Unrecognized transition (asset) or obligation............... -- 12 25
Unrecognized prior service cost............................. (2,978) (2,880) (2,711)
-------- -------- --------
Prepaid (accrued) benefit cost.............................. $(12,688) $(20,392) $(16,117)
======== ======== ========
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost................................................ $ 1,132 $ 2,273 $ 1,320
Interest cost............................................... 1,075 1,398 1,049
Expected return on plan assets.............................. -- -- --
Amortization of prior service cost.......................... 97 170 415
Amortization of transition (asset) or obligation............ 13 10 99
Recognized actuarial (gain) or loss......................... 53 664 208
-------- -------- --------
Net periodic benefit cost................................... $ 2,370 $ 4,515 $ 3,091
======== ======== ========
Additional (gain) or loss recognized due to:
Settlement................................................ $ 2,597 $ -- $ --
WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31:
Discount rate............................................... 5.25% 5.50% 6.00%
Rate of compensation increase............................... 4.50% 5.70% 5.70%

The Bank has a defined contribution plan that is available to virtually all
employees. Effective January 1, 2002, the Bank amended the plan to enhance the
401(k) matching contribution and discontinue the profit sharing contribution.
The matching contribution is based on the amount of eligible employee
contributions. The profit sharing contribution was based on the annual financial
performance of the Bank relative to predefined targets. The Bank's total expense
for this plan was $9.4 million, $9.3 million and $7.8 million in 2003, 2002 and
2001, respectively.

15. STOCK OPTIONS

The Bank has two primary stock-based compensation plans, an options program
and a performance incentive plan. The option plans are accounted for under the
fair value based method of accounting and are described below.

Harris Bankcorp Stock Option Program

The Harris Bankcorp Stock Option Program was established under the Bank of
Montreal Stock Option Plan for certain designated executives and other employees
of the Bank and affiliated companies in order to provide incentive to attain
long-term strategic goals and to attract and retain services of key employees.

The Bank has two types of option plans. The Fixed Stock Option Plan
consists of standard stock options with a ten-year term which are exercisable
only during the second five years of their term, assuming cumulative performance
goals are met. The Performance Based Option Plan consists of standard and
performance conditioned stock options with a ten-year term and a four-year
vesting period, which are exercisable twenty-five percent per annum. The
standard options may be exercised at any time once vested. The
performance-conditioned options may be exercised provided the BMO shares trade
at fifty percent over the price of the stock at date of grant for twenty
consecutive days, after the vesting date. The stock options are exercisable for
BMO common stock equal to the market price on the date of grant. The
compensation expense related to this program totaled $5.8 million, $5.6 million
and $4.5 million in 2003, 2002 and 2001, respectively.

The following table summarizes the stock option activity for 2003, 2002 and
2001 and provides details of stock options outstanding at December 31, 2003:

2003 2002 2001
-------------------------- --------------------------- ---------------------------
WTD. AVG. WTD. AVG. WTD. AVG.
OPTIONS SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
------- --------- -------------- ---------- -------------- ---------- --------------

Outstanding at beginning
of year................ 3,994,491 $33.32 3,609,059 $34.30 2,702,246 $39.22
Granted.................. -- -- 425,300 26.18 1,160,300 22.70
Exercised................ (470,448) 34.25 (76,115) 30.44 (133,307) 26.94
Forfeited, cancelled..... -- -- -- -- (90,700) 38.07
Transferred.............. (101,859) 26.18 36,247 13.15 (29,480) 50.36
Expired.................. -- -- -- -- -- --
--------- ---------- ----------
Outstanding at end of
year................... 3,422,184 33.40 3,994,491 33.32 3,609,059 34.30
========= ========== ==========
Options exercisable at
year-end............... 2,432,304 $35.70 1,552,213 $35.51 810,731 $34.63
Weighted-average fair
value of options
granted during the
year................... N/A $ 5.27 $ 3.55

---------------

N/A -- There were no stock options granted during fiscal 2003.

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------- ------------------------------------
NUMBER WTD. AVG. NUMBER
RANGE OF OUTSTANDING REMAINING WTD. AVG. EXERCISABLE WTD. AVG.
EXERCISE PRICES DECEMBER 31, 2003 CONTRACTUAL LIFE EXERCISE PRICE DECEMBER 31, 2003 EXERCISE PRICE
--------------- ------------------- ---------------- -------------- ------------------- --------------

$22-30 1,629,894 7.77 years $23.66 790,553 $23.61
34-42 1,072,397 5.37 37.27 1,072,397 37.27
46-54 719,893 6.46 49.70 569,354 49.53
--------- ---------
22-54 3,422,184 6.74 33.40 2,432,304 35.70
========= =========

The fair value of the stock options granted has been estimated using the
Rolle-Geske Model with the following assumptions:

2003 2002 2001
---- ------ ------

Risk-free interest rate..................................... N/A 4.80% 5.50%
Expected life, in years..................................... N/A 7.0 7.0
Expected volatility......................................... N/A 23.44% 23.29%
Compound annual dividend growth............................. N/A 8.39% 9.21%
Estimated fair value per option (US $)...................... N/A $ 5.27 $ 3.55

---------------

N/A -- There were no stock options granted during fiscal 2003.

Mid-Term Incentive Plan

The Bank maintains the Mid-Term Incentive Plan which was established in
January 2000. The plan is intended to enhance the Bank's ability to attract and
retain high quality employees and to provide a strong incentive to employees to
achieve BMO's governing objective of maximizing value for its shareholders.

During 2003 the Bank was party to an agreement made between BMO and a third
party to assume the obligation related to the 2003 Mid-Term Inventive Plan. The
Bank's share of the payment was $14.5 million. A similar agreement was entered
into in 2002 related to the 2002 Mid-Term Incentive Plan for a payment of $8.0
million. These amounts will be recorded as compensation expense over the three
year performance cycle of the plan on a straight-line basis. Any future payments
required under these plans will be the responsibility of the third party.

Payouts under the plan to participants depend on the achievement of
specific performance criteria that are set at the grant date. The right to
receive distributions under the plan vest and are paid out after three years
based on various factors including the BMO share price. Compensation expense for
this plan totaled $20.5 million, $10.6 million and $6.8 million in 2003, 2002
and 2001, respectively.

16. LEASE EXPENSE AND OBLIGATIONS

Rental expense for all operating leases was $16.6 million in 2003, $15.9
million in 2002 and $13.6 million in 2001. These amounts include real estate
taxes, maintenance and other rental-related operating costs of $6.2 million,
$6.6 million and $2.9 million for 2003, 2002 and 2001, respectively, paid under
net lease arrangements. Lease commitments are primarily for office space.

Minimum rental commitments as of December 31, 2003 for all noncancelable
operating leases are as follows:

(IN THOUSANDS)

2004........................................................ $10,000
2005........................................................ 9,251
2006........................................................ 8,965
2007........................................................ 7,725
2008........................................................ 6,086
2009 and thereafter......................................... 16,885
-------
Total minimum future rentals.............................. $58,912
=======

Occupancy expenses for 2003, 2002 and 2001 have been reduced by $17
million, $17 million and $15 million, respectively, for rental income from
leased premises.

17. INCOME TAXES

The 2003, 2002 and 2001 applicable income tax expense (benefit) were as
follows:

FEDERAL STATE TOTAL
-------- ------- --------
(IN THOUSANDS)

2003: Current.............................................. $ 31,116 $(1,302) $ 29,814
Deferred............................................. 8,374 1,113 9,487
-------- ------- --------
Total............................................. $ 39,490 $ (189) $ 39,301
======== ======= ========
2002: Current.............................................. $ 58,791 $ 2,480 $ 61,271
Deferred............................................. 5,247 788 6,035
-------- ------- --------
Total............................................. $ 64,038 $ 3,268 $ 67,306
======== ======= ========
2001: Current.............................................. $ 38,271 $(3,254) $ 35,017
Deferred............................................. (23,860) (923) (24,783)
-------- ------- --------
Total............................................. $ 14,411 $(4,177) $ 10,234
======== ======= ========

Deferred tax assets (liabilities) are comprised of the following at
December 31, 2003, 2002 and 2001:

DECEMBER 31
------------------------------
2003 2002 2001
-------- -------- --------
(IN THOUSANDS)

Deferred tax assets:
Allowance for possible loan losses..................... $ 91,977 $ 83,194 $ 95,253
Deferred expense and prepaid income.................... 13,155 13,554 13,037
Deferred employee compensation......................... 19,110 16,605 7,865
Other assets........................................... 882 16,697 11,641
-------- -------- --------
Gross deferred tax assets............................ 125,124 130,050 127,796
-------- -------- --------
Deferred tax liabilities:
Depreciable assets..................................... (40,650) (43,608) (31,197)
Other liabilities...................................... (18,684) (11,165) (15,386)
-------- -------- --------
Gross deferred tax liabilities....................... (59,334) (54,773) (46,583)
-------- -------- --------
Deferred tax assets.................................... 65,790 75,277 81,213
The tax effect of fair value adjustments on
available-for-sale securities, minimum pension liabilities
and hedging transactions recorded directly to
stockholder's equity...................................... (76) (31,507) (13,258)
-------- -------- --------
Net deferred tax assets..................................... $ 65,714 $ 43,770 $ 67,955
======== ======== ========

At December 31, 2003 and 2002, the respective deferred tax assets of $65.8
million and $75.3 million included $59.3 million and $67.7 million for Federal
taxes and $6.5 million and $7.6 million for state taxes, respectively.
Management believes that the realization of the recognized net deferred tax
asset is more likely than not based on existing carryback ability and
expectations as to future taxable income.

Total income tax expense of $39.3 million for 2003, $67.3 million for 2002
and $10.2 million for 2001 reflects effective tax rates of 25.0 percent, 28.2
percent, and 11.1 percent, respectively. The reconciliation between actual tax
expense and the amount determined by applying the federal statutory rate of 35
percent to income before income taxes were as follows:

YEARS ENDED DECEMBER 31
---------------------------------------------------------------------
2003 2002 2001
--------------------- --------------------- ---------------------
PERCENT OF PERCENT OF PERCENT OF
PRETAX PRETAX PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
-------- ---------- -------- ---------- -------- ----------
(DOLLARS IN THOUSANDS)

Computed tax expense........... $ 55,010 35.0% $ 83,699 35.0% $ 32,377 35.0%
Increase (reduction) in income
tax expense due to:
Tax-exempt income from loans
and investments net of
municipal interest expense
disallowance.............. (563) (0.4) (567) (0.2) (891) (1.0)
Bank-owned insurance......... (15,253) (9.7) (17,709) (7.4) (16,507) (17.8)
Equity ownership in
securitization trust...... -- -- -- -- (278) (0.3)
State income taxes........... (123) (0.1) 2,124 0.9 (2,715) (2.9)
Other, net................... 230 0.2 (241) (0.1) (1,752) (1.9)
-------- ---- -------- ---- -------- -----
Actual tax expense............. $ 39,301 25.0% $ 67,306 28.2% $ 10,234 11.1%
======== ==== ======== ==== ======== =====

The tax expense from net gains on security sales amounted to $10.1 million,
$23.8 million, and $13.8 million in 2003, 2002 and 2001, respectively.

18. REGULATORY CAPITAL

The Bank, as a state-member bank, must adhere to the capital adequacy
guidelines of the Federal Reserve Board ("the Board"), which are not
significantly different than those published by other U.S. banking regulators.
The guidelines specify minimum ratios for Tier 1 capital to risk-weighted assets
of 4 percent and total regulatory capital to risk-weighted assets of 8 percent.

Risk-based capital guidelines define total capital to consist primarily of
Tier 1 (core) and Tier 2 (supplementary) capital. In general, Tier 1 capital is
comprised of stockholder's equity, including certain types of preferred stock,
less goodwill and certain other intangibles. Core capital must comprise at least
50 percent of total capital. Tier 2 capital basically includes subordinated debt
(less a discount factor during the five years prior to maturity), other types of
preferred stock and the allowance for possible loan losses. The portion of the
allowance for possible loan losses includable in Tier 2 capital is limited to
1.25 percent of risk-weighted assets.

The Board also requires an additional measure of capital adequacy, the Tier
1 leverage ratio, which is evaluated in conjunction with risk-based capital
ratios. The Tier 1 leverage ratio is computed by dividing period-end Tier 1
capital by adjusted quarterly average assets. The Board established a minimum
ratio of 3 percent applicable only to the strongest banking organizations
having, among other things, excellent asset quality, high liquidity, good
earnings and no undue interest rate risk exposure. Other institutions are
expected to maintain a minimum ratio of 4 percent.

The Federal Deposit Insurance Corporation Improvement Act of 1991 contains
prompt corrective action provisions that established five capital categories for
all Federal Deposit Insurance Corporation ("FDIC")-insured institutions ranging
from "well capitalized" to "critically undercapitalized." Classification within
a category is based primarily on the three capital adequacy measures. An
institution is considered "well capitalized" if its capital level significantly
exceeds the required minimum levels, "adequately capitalized" if it meets the
minimum levels, "undercapitalized" if it fails to meet the minimum levels,
"significantly undercapitalized" if it is significantly below the minimum levels
and "critically undercapitalized" if it has a ratio of tangible equity to total
assets of 2 percent or less.

Noncompliance with minimum capital requirements may result in regulatory
corrective actions that could have a material effect on the Bank's financial
statements. Depending on the level of noncompliance, regulatory corrective
actions may include the following: requiring a plan for restoring the
institution to an acceptable capital category, restricting or prohibiting
certain activities and appointing a receiver or conservator for the institution.

As of December 31, 2003, the most recent notification from the FDIC
categorized the Bank as "well capitalized" under the regulatory framework for
prompt corrective action. Management is not aware of any conditions or events
since December 31, 2003 that have changed the capital category of the Bank.

At December 31, 2003 the Bank had $255 million of minority interest in
preferred stock of subsidiaries including $250 million noncumulative,
exchangeable Series A preferred stock with dividends payable at the rate of
7 3/8% per annum. The Bank also had a total of $5 million of preferred stock
with cumulative dividends payable at the rate of LIBOR plus 100 basis points
adjusted as of the first business day of the calendar quarter that the record
date falls. During both 2003 and 2002, $19 million of dividends were paid on the
preferred stock. All issues of preferred stock qualify as Tier 1 capital for the
Bank under U.S. banking regulatory guidelines.

The following table summarizes the Bank's risk-based capital ratios and
Tier 1 leverage ratio for the past two years as well as the minimum amounts and
ratios as per capital adequacy guidelines and FDIC prompt corrective action
provisions.

TO BE WELL CAPITALIZED
FOR CAPITAL ADEQUACY UNDER PROMPT CORRECTIVE
ACTUAL PURPOSES ACTION PROVISIONS
-------------------- ---------------------- ------------------------
CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
---------- ------- ------------ ------- ------------- --------
(IN THOUSANDS)

As of December 31, 2003:
Total Capital to Risk-
Weighted Assets....... $1,980,042 12.25% $ $1,293,089 $ 8.00% $ $1,616,361 $ 10.00%
Tier 1 Capital to Risk-
Weighted Assets....... $1,649,198 10.20% $ $ 646,744 $ 4.00% $ $ 970,116 $ 6.00%
Tier 1 Capital to Average
Assets................ $1,649,198 8.52% $ $ 774,271 $ 4.00% $ $ 967,839 $ 5.00%
As of December 31, 2002:
Total Capital to Risk-
Weighted Assets....... $1,928,809 12.50% $ $1,234,438 $ 8.00% $ $1,543,047 $ 10.00%
Tier 1 Capital to Risk-
Weighted Assets....... $1,572,465 10.19% $ $ 617,258 $ 4.00% $ $ 925,887 $ 6.00%
Tier 1 Capital to Average
Assets................ $1,572,465 8.64% $ $ 727,993 $ 4.00% $ $ 909,991 $ 5.00%

19. INVESTMENTS IN SUBSIDIARIES AND STATUTORY RESTRICTIONS

Harris Trust and Savings Bank's investment in the combined net assets of
its wholly-owned subsidiaries was $792 million and $787 million at December 31,
2003 and 2002, respectively.

Provisions of both Illinois and Federal banking laws place restrictions
upon the amount of dividends that can be paid to Bankcorp by its bank
subsidiaries. Illinois law requires that no dividends may be paid in an amount
greater than the net profits then on hand, reduced by certain loan losses (as
defined). In addition to these restrictions, Federal Reserve member banking
subsidiaries require prior approval of Federal banking authorities if dividends
declared by a subsidiary bank, in any calendar year, will exceed its net profits
(as defined in the applicable statute) for that year, combined with its retained
net profits, as so defined, for the preceding two years. Based on these and
certain other prescribed regulatory limitations, the Bank could have declared,
without regulatory approval, $100 million of dividends at December 31, 2003.
Actual dividends paid, however, would be subject to prudent capital maintenance.
Cash dividends paid to Bankcorp by the Bank amounted to $60 million and $188
million in 2003 and 2002, respectively.

The Bank is required by the Federal Reserve Act to maintain reserves
against certain of its deposits. Reserves are held either in the form of vault
cash or balances maintained with the Federal Reserve Bank. Required reserves are
essentially a function of daily average deposit balances and statutory reserve
ratios prescribed by type of deposit. During 2003 and 2002, daily average
reserve balances of $279 million and $266 million, respectively, were required
for the Bank. At year-end 2003 and 2002, balances on deposit at the Federal
Reserve Bank totaled $164 million and $211 million, respectively.

20. CONTINGENT LIABILITIES

Harris Trust and Savings Bank and certain 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
Bank's financial position or results of operations.

21. OTHER COMPREHENSIVE INCOME

The following table summarizes the components of other comprehensive income
(loss) shown in stockholder's equity:

TOTAL
MINIMUM UNREALIZED ACCUMULATED
UNREALIZED GAINS PENSION GAIN ON OTHER
ON AVAILABLE-FOR- LIABILITY DERIVATIVE COMPREHENSIVE
SALE SECURITIES ADJUSTMENT INSTRUMENTS INCOME
------------------ ---------- ----------- -------------
(IN THOUSANDS)

Balance at December 31, 2001.............. $20,100 $ -- $-- $20,100
======= ======== === =======
Balance at December 31, 2002.............. $72,959 $(25,194) $-- $47,765
======= ======== === =======
Balance at December 31, 2003.............. $30,962 $(29,986) $35 $ 1,011
======= ======== === =======

22. FOREIGN ACTIVITIES (BY DOMICILE OF CUSTOMER)

Income and expenses identifiable with foreign and domestic operations are
summarized in the table below:

FOREIGN DOMESTIC CONSOLIDATED
-------- ----------- ------------
(IN THOUSANDS)

2003
Total operating income.................................. $ 17,790 $ 1,141,897 $ 1,159,687
Total expenses.......................................... 1,594 1,000,921 1,002,515
-------- ----------- -----------
Income before taxes..................................... 16,196 140,976 157,172
Applicable income taxes................................. 6,437 32,864 39,301
-------- ----------- -----------
Net income.............................................. $ 9,759 $ 108,112 $ 117,871
======== =========== ===========
Identifiable assets at year-end......................... $523,206 $19,396,284 $19,919,490
======== =========== ===========
2002
Total operating income.................................. $ 18,305 $ 1,216,787 $ 1,235,092
Total expenses.......................................... 2,978 992,974 995,952
-------- ----------- -----------
Income before taxes..................................... 15,327 223,813 239,140
Applicable income taxes................................. 6,092 61,214 67,306
-------- ----------- -----------
Net income.............................................. $ 9,235 $ 162,599 $ 171,834
======== =========== ===========
Identifiable assets at year-end......................... $559,259 $18,467,759 $19,027,018
======== =========== ===========
2001
Total operating income.................................. $ 22,701 $ 1,523,998 $ 1,546,699
Total expenses.......................................... 9,302 1,444,891 1,454,193
-------- ----------- -----------
Income before taxes..................................... 13,399 79,107 92,506
Applicable income taxes................................. 5,325 4,909 10,234
-------- ----------- -----------
Net income.............................................. $ 8,074 $ 74,198 $ 82,272
======== =========== ===========
Identifiable assets at year-end......................... $228,741 $19,507,430 $19,736,171
======== =========== ===========

Determination of rates for foreign funds generated or used are based on the
actual external costs of specific interest-bearing sources or uses of funds for
the periods. Internal allocations for certain unidentifiable income and expenses
were distributed to foreign operations based on the percentage of identifiable
foreign income to total income. As of December 31, 2003, 2002 and 2001,
identifiable foreign assets accounted for 3 percent, 3 percent and 1 percent,
respectively, of total consolidated assets.

23. BUSINESS COMBINATIONS/INTANGIBLES

At December 31, 2003 and 2002, intangible assets, including goodwill
resulting from business combinations, amounted to $166 million and $174 million,
respectively. Amortization of these intangibles amounted to $10.3 million in
2003, $10.2 million in 2002 and $23.8 million in 2001. The decrease in the 2002
amortization is primarily due to the Bank's adoption of SFAS No. 147,
"Acquisitions of Certain Financial Institutions-an amendment of FASB Statements
No. 72 and 144 and FASB Interpretation No. 9," on October 1, 2002 (see Note 6).

24. RELATED PARTY TRANSACTIONS

During 2003, 2002 and 2001, the Bank engaged in various transactions with
BMO and its subsidiaries. These transactions included the payment and receipt of
service fees and occupancy expenses; purchasing and selling Federal funds;
repurchase and reverse repurchase agreements; short-term borrowings; interest
rate and foreign exchange rate contracts. The purpose of these transactions was
to facilitate a more efficient use of combined resources and to better serve
customers. Fees for these services were determined in accordance with applicable
banking regulations. During 2003, 2002 and 2001, the Bank received from BMO
approximately

$17.3 million, $20.8 million and $24.9 million, respectively, primarily for
trust services, data processing and other operations support provided by the
Bank. The Bank made payments to BMO of approximately $32.0 million, $27.3
million and $32.1 million in 2003, 2002 and 2001, respectively.

At December 31, 2003, derivative contracts with BMO represent $49.4 million
and $102.1 million of unrealized gains and unrealized losses, respectively. At
December 31, 2002, derivative contracts with BMO represented $20.3 million and
$136.7 million of unrealized gains and unrealized losses, respectively.

The Bank and BMO combine their U.S. foreign exchange activities. Under this
arrangement, the Bank and BMO share FX net profit in accordance with a specific
formula set forth in the agreement. This agreement expires in April 2004 but may
be extended at that time. Either party may terminate the arrangement at its
option. FX revenues are reported net of expenses. 2003, 2002 and 2001 foreign
exchange revenues included $5.1 million, $7.2 million and $8.8 million of net
profit, respectively, under this agreement.

On July 3, 2003, the Bank issued a $1.0 billion certificate of deposit
("CD") to a subsidiary of BMO, BMO (Barbados) Limited. The certificate matures
June 30, 2008 and bears a 2.84 percent fixed rate of interest, payable
quarterly. On August 28, 2003, the Bank issued a $427.7 million CD to BMO
(Barbados) Limited. The certificate matures March 31, 2009 and bears a 4.30
percent fixed rate of interest, payable semi-annually. On September 22, 2003,
the Bank issued a $570 million CD to BMO (Barbados) Limited. The certificate
matures September 24, 2007 and bears a 3.28 percent fixed rate of interest,
payable quarterly. Interest expense recognized on these CD's in 2003 was $25.4
million.