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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934, FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999, OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934, FOR THE TRANSITION PERIOD FROM N/A TO ____________ .
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COMMISSION FILE NUMBER 0-16533
SOVEREIGN BANCORP, INC.
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(Exact name of Registrant as specified in its charter)
PENNSYLVANIA 23-2453088
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(State or other jurisdiction of incorporation or (I.R.S. Employer
organization) Identification No.)
1130 BERKSHIRE BOULEVARD, WYOMISSING, PENNSYLVANIA 19610
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(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER: (610) 320-8400
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock (without par value)
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(Title of class)
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 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. [ ]
The aggregate market value of the shares of Common Stock of the Registrant
held by nonaffiliates of the Registrant was $1,635,601,921 at March 29, 2000. As
of March 29, 2000, the Registrant had 225,600,265 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's definitive Proxy Statement to be used in connection with
its 2000 Annual Meeting of Shareholders is incorporated herein by reference in
response to Part III hereof.
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FORWARD-LOOKING STATEMENTS
Sovereign Bancorp, Inc. ("Sovereign") may from time to time make
"forward-looking statements," including statements contained in Sovereign's
filings with the Securities and Exchange Commission (including this Annual
Report on Form 10-K and the Exhibits thereto), in its reports to shareholders
(including its 1999 Annual Report) and in other communications by Sovereign,
which are made in good faith by Sovereign, pursuant to the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include statements with respect to
Sovereign's vision, mission, strategies, goals, beliefs, plans, objectives,
expectations, anticipations, estimates, intentions, financial condition, results
of operations, future performance and business of Sovereign, including: (i)
statements relating to Sovereign's expectations and goals with respect to (a)
growth in earnings per share; (b) return on equity; (c) return on assets; (d)
efficiency ratio; (e) tier 1 leverage ratio; (f) annualized net charge-offs and
other asset quality measures; (g) fee income as a percentage of total revenue;
(h) tangible equity to assets; (i) book value and tangible book value per share;
(j) loan and deposit portfolio compositions, (ii) statements preceded by,
followed by or that include the words "may," "could," "should," "pro forma,"
"looking forward," "would," "believe," "expect," "anticipate," "estimate," "
intend," "plan," or similar expressions, and (iii) statements relating to some
or all of the foregoing which assume the successful completion of the three
staggered closings with respect to its FleetBoston acquisition, the successful
conversion of FleetBoston operating systems, and the retention of former
FleetBoston employees and customers. Although we believe that the expectations
reflected in our forward-looking statements are reasonable, these
forward-looking statements involve risks and uncertainties which are subject to
change based on various important factors (some of which, in whole or in part,
are beyond Sovereign's control). The following factors, among others, could
cause Sovereign's financial performance to differ materially from the goals,
plans, objectives, intentions and expectations forecasts and projections (and
underlying assumptions) expressed in such forward-looking statements: (1) the
strength of the United States economy in general and the strength of the
regional and local economies in which Sovereign conducts operations; (2) the
effects of, and changes in, trade, monetary and fiscal policies and laws,
including interest rate policies of the Board of Governors of the Federal
Reserve System; (3) inflation, interest rate, market and monetary fluctuations;
(4) the timely development of competitive new products and services by Sovereign
and the acceptance of such products and services by customers; (5) the
willingness of customers to substitute competitors' products and services and
vice versa; (6) the success of Sovereign in meeting the conditions for
regulatory approval for each of its three staggered closings with respect to its
FleetBoston acquisition; (7) the impact of changes in financial services' laws
and regulations and the application of such laws and regulations (including laws
concerning taxes, capital, liquidity, proper accounting treatment, securities
and insurance); (8) technological changes; (9) changes in consumer spending and
savings habits; (10) the impact of the FleetBoston acquisition and other
acquisitions of Sovereign, including the success of Sovereign in fully
realizing, within the expected time frame, earnings enhancements from such
pending or completed acquisitions, including, without limitation, the earnings
enhancements expected from the acquisition of approximately $12.0 billion in
deposits, $9.1 billion in loans, and 285 branches from FleetBoston; (11)
Sovereign's ability to complete the FleetBoston acquisition and related systems
conversions, and Sovereign's ability to retain FleetBoston customers and
employees; (12) changes in the amount, mix, yield, quality, and other
characteristics of the deposits and loans Sovereign expects to assume and
acquire from FleetBoston; (13) changes in the timing and structure of the
FleetBoston acquisition and related transactions and other changed facts and
circumstances resulting from the passage of time; (14) unanticipated regulatory
or judicial proceedings; (15) unanticipated changes in asset quality; and (16)
the success of Sovereign at managing the risks involved in the foregoing.
Sovereign cautions that the foregoing list of important factors is not
exclusive, and neither such list nor any such forward-looking statement takes
into account the impact that any future acquisition may have on Sovereign and
any such forward-looking statement. Sovereign does not undertake to update any
forward-looking statement, whether written or oral, that may be made from time
to time by or on behalf of Sovereign.
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PART I
ITEM 1. BUSINESS.
GENERAL
Sovereign Bancorp, Inc. ("Sovereign") is a Pennsylvania business
corporation and is the holding company for Sovereign Bank. Sovereign is
headquartered in Philadelphia, Pennsylvania and Sovereign Bank is headquartered
in Wyomissing, Pennsylvania, a suburb of Reading, Pennsylvania.
Sovereign Bank was created in 1984 under the name Penn Savings Bank, F.S.B.
through the merger of two financial institutions with market areas primarily in
Berks and Lancaster counties, Pennsylvania. Sovereign Bank assumed its current
name on December 31, 1991.
Sovereign was incorporated by Sovereign Bank in 1987. Since then, Sovereign
has completed 24 acquisitions with assets totaling approximately $15 billion
through December 31, 1999, and expanded its markets throughout eastern
Pennsylvania, central New Jersey and northern Delaware. Sovereign also serves
customers throughout New York and several New England states. At December 31,
1999, Sovereign had consolidated assets, deposits and stockholders' equity of
approximately $26.6 billion, $11.7 billion and $1.8 billion, respectively and
306 community banking offices. Based on assets at December 31, 1999, Sovereign
is the largest thrift holding company and the third largest bank headquartered
in Pennsylvania.
On June 30, 1999, Sovereign acquired Peoples Bancorp, Inc. ("Peoples"), a
$1.4 billion bank holding company headquartered in Lawrenceville, New Jersey
whose principal operating subsidiary operated 14 community banking offices in
Mercer, Burlington and Ocean counties, New Jersey. This transaction was
accounted for as a purchase.
On June 15, 1999, Sovereign acquired The Network Companies ("Network"), a
$50 million privately held specialty leasing company headquartered in Commack,
New York. Network provides financing for the purchase or lease of equipment and
specialty vehicles plus other specialty products for businesses throughout the
United States. This acquisition was accounted for as a purchase.
On September 3, 1999, Sovereign entered into a purchase and assumption
agreement with FleetBoston Financial to acquire branch banking offices located
in Connecticut, Massachusetts, New Hampshire and Rhode Island, and related
deposit liabilities, loans and other assets associated with the business of
those branches. On February 28, 2000, Sovereign and FleetBoston Financial agreed
to restructure certain terms of the agreement. Sovereign will purchase
approximately $12 billion of deposits, $9 billion of loans and 285 community
banking offices. The acquisition, which results in the creation of Sovereign
Bank New England, the third largest bank in New England, includes the following:
the former Fleet Bank community banking franchise in eastern Massachusetts; the
entire former BankBoston community banking franchise in Rhode Island; and select
community banking offices of Fleet Bank in southern New Hampshire and BankBoston
in Connecticut. In addition, Sovereign is acquiring a substantial portion of the
middle market and small business-lending groups from Fleet Bank in Massachusetts
and New Hampshire, and from BankBoston in Rhode Island and Connecticut. The
acquisition includes the purchase of fully functioning business units, with the
necessary management, relationship officers, support staffs, and other
infrastructure for the acquired loans and deposits to be fully serviced. For
additional information with respect to the Sovereign Bank New England
Acquisition see part II, Item 7 "Management Discussion and Analysis of Financial
Condition and Results of Operations" hereof.
Sovereign's primary business consists of attracting deposits from its
network of community banking offices, located throughout eastern and
northcentral Pennsylvania, New Jersey and northern Delaware, and originating
commercial, consumer and residential mortgage loans in those communities.
Sovereign also serves customers throughout New York and several New England
States.
Sovereign operates in a heavily regulated environment. Changes in laws and
regulations affecting it and its subsidiaries may have an impact on its
operations. See "Business--Supervision and Regulation."
For additional information with respect to Sovereign's business activities,
see Part II, Item 7 "Management's Discussion and Analysis of Financial Condition
and Results of Operations" hereof.
SUBSIDIARIES
Sovereign has six wholly-owned subsidiaries: Sovereign Bank, Sovereign
Delaware Investment Corporation, Sovereign Delaware Escrow Company, Sovereign
Capital Trust I, Sovereign Capital Trust II, and ML Capital Trust I. Sovereign
Delaware Investment Corporation is a Delaware corporation whose
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primary purpose is to purchase and hold certain investment securities. Sovereign
Delaware Escrow Company is a Delaware corporation created expressly for holding
in escrow the proceeds of the debt and equity issuances to finance the Sovereign
Bank New England transaction. Sovereign Capital Trust I and Sovereign Capital
Trust II are special-purpose statutory trusts, created expressly for the
issuance of preferred capital securities, which solely holds subordinated
debentures of Sovereign. ML Capital Trust I is a special-purpose statutory trust
created expressly for the issuance of preferred capital securities.
Sovereign Bank has the following wholly-owned subsidiaries: Main Line
Abstract Corporation, 1130 Abstract, Inc., 201 Associates, Inc., First Lancaster
Financial Corp., Sovereign Trust Company, and Sovereign REIT Holdings, Inc. Main
Line Abstract Corporation and 1130 Abstract Inc. are Pennsylvania corporations
whose primary functions are to act as title insurance agencies and abstract
companies. 201 Associates, Inc. is a Delaware corporation whose primary purpose
is to hold certain investment securities. First Lancaster Financial Corp. is a
Pennsylvania corporation whose primary function is to act as a holding company
for Sovereign Annuity Corp. and The Sovereign Agency, Inc. Sovereign Annuity
Corp. is a New Jersey corporation whose primary purpose is to market investment
securities, mutual funds and insurance annuities. The Sovereign Agency, Inc. is
a New Jersey corporation whose primary purpose is to market insurance products.
The Sovereign Trust Company is a New Jersey corporation whose primary function
is to perform trust services. Sovereign REIT Holdings, Inc. is a Delaware
corporation whose primary purpose is to act as a holding company for Sovereign
Real Estate Investment Trust ("REIT"). Sovereign REIT is a Delaware business
trust whose primary purpose is to invest in and manage certain real estate
assets.
Federal regulations generally permit federally-chartered savings
institutions to invest up to 2% of assets in the capital stock of, and make
secured and unsecured loans to, certain types of subsidiary service
corporations. At December 31, 1999, Sovereign Bank was authorized to have a
maximum investment of approximately $507.0 million in such subsidiaries,
pursuant to applicable federal regulations. As of such date, Sovereign Bank had
a total investment of $46.7 million in subsidiary service corporations, which
excludes 201 Associates, Inc., Sovereign Trust Company, and Sovereign REIT
Holdings, Inc., as they are considered to be operating subsidiaries for purposes
of this test.
EMPLOYEES
At December 31, 1999, Sovereign had 3,923 full-time and 573 part-time
employees. None of these employees are represented by a collective bargaining
agent, and Sovereign believes it enjoys good relations with its personnel.
COMPETITION
Sovereign experiences substantial competition in attracting and retaining
deposits and in lending funds. The primary factors in competing for deposits are
the ability to offer attractive rates and the convenience of office locations.
Direct competition for deposits comes primarily from other thrift institutions
and commercial banks. Competition for deposits also comes from money market
mutual funds, corporate and government securities, and credit unions. The
primary factors in the competition for loans are interest rates, loan
origination fees and the range of products and services offered. Competition for
origination of real estate loans normally comes from other thrift institutions,
commercial banks, mortgage bankers, mortgage brokers and insurance companies.
ENVIRONMENTAL LAWS
Environmentally related hazards have become a source of high risk and
potentially unlimited liability for financial institutions relative to their
loans. Environmentally contaminated properties owned by an institution's
borrowers may result in a drastic reduction in the value of the collateral
securing the institution's loans to such borrowers, high environmental clean up
costs to the borrower affecting its ability to repay the loans, the
subordination of any lien in favor of the institution to a state or federal lien
securing clean up costs, and liability to the institution for clean up costs if
it forecloses on the contaminated property or becomes involved in the management
of the borrower. To minimize this risk, Sovereign Bank may require an
environmental examination of and report with respect to the property of any
borrower or prospective borrower if circumstances affecting the property
indicate a potential for contamination, taking into consideration the potential
loss to the institution in relation to the burdens to the borrower. Such
examination must be performed by an engineering firm experienced in
environmental risk studies and acceptable to the institution, and the costs of
such examinations and reports are the responsibility of the borrower. These
costs may be substantial and may deter a prospective borrower from entering into
a loan transaction with Sovereign
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Bank. Sovereign is not aware of any borrower who is currently subject to any
environmental investigation or clean up proceeding which is likely to have a
material adverse effect on the financial condition or results of operations of
Sovereign Bank.
SUPERVISION AND REGULATION
General. Sovereign is a "savings and loan holding company" registered with
the Office of Thrift Supervision ("OTS") under the Home Owners' Loan Act
("HOLA") and as such, Sovereign is subject to OTS regulation, examination,
supervision and reporting. The deposits of Sovereign Bank are insured by the
Federal Deposit Insurance Corporation ("FDIC"). The FDIC manages two funds: the
Savings Association Insurance Fund ("SAIF") and the Bank Insurance Fund ("BIF").
These funds are required to be separately maintained and not combined. The
majority of Sovereign Bank's deposits are subject to the FDIC's SAIF deposit
insurance assessment rate; however, certain deposits which Sovereign acquired
from other institutions are subject to the FDIC's BIF deposit insurance
assessment rate. See "Insurance of Deposit Accounts" below. Sovereign Bank is
required to file reports with the OTS describing its activities and financial
condition and is periodically examined to test compliance with various
regulatory requirements. Sovereign Bank is also subject to examination by the
FDIC. Such examinations are conducted for the purpose of protecting depositors
and the insurance fund and not for the purpose of protecting holders of equity
or debt securities of Sovereign or Sovereign Bank. Sovereign Bank is a member of
the Federal Home Loan Bank ("FHLB") of Pittsburgh, which is one of the twelve
regional banks comprising the FHLB system. Sovereign Bank is also subject to
regulation by the Board of Governors of the Federal Reserve System with respect
to reserves maintained against deposits and certain other matters. Except as
described herein, Sovereign's management is not aware of any current
recommendations by regulatory authorities that would have a material effect on
Sovereign's operations, capital resources or liquidity.
Holding Company Regulation. The HOLA prohibits a registered savings and
loan holding company from directly or indirectly acquiring control, including
through an acquisition by merger, consolidation or purchase of assets, of any
savings association (as defined in HOLA to include a federal savings bank) or
any other savings and loan holding company, without prior OTS approval.
Generally, a savings and loan holding company may not acquire more than 5% of
the voting shares of any savings association unless by merger, consolidation or
purchase of assets. Certain regulations of the OTS describe standards for
control under the HOLA. See "Control of Sovereign" below.
Federal law empowers the Director of the OTS to take substantive action
when the Director determines that there is reasonable cause to believe that the
continuation by a savings and loan holding company of any particular activity
constitutes a serious risk to the financial safety, soundness or stability of a
savings and loan holding company's subsidiary savings institution. The Director
of the OTS has oversight authority for all holding company affiliates, not just
the insured institution. Specifically, the Director of the OTS may, as
necessary, (i) limit the payment of dividends by the savings institution; (ii)
limit transactions between the savings institution, the holding company and the
subsidiaries or affiliates of either; (iii) limit any activities of the savings
institution that might create a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the savings institution. Any such
limits would be issued in the form of a directive having the legal efficacy of a
cease and desist order.
Control of Sovereign. Under the Savings and Loan Holding Company Act and
the related Change in Bank Control Act (the "Control Act"), individuals,
corporations or other entities acquiring Sovereign common stock may, alone or
"in concert" with other investors, be deemed to control Sovereign and thereby
Sovereign Bank. If deemed to control Sovereign, such person or group will be
required to obtain OTS approval to acquire Sovereign's common stock and will be
subject to certain ongoing reporting procedures and restrictions under federal
law and regulations. Under the regulations, ownership of 25% of the capital
stock of Sovereign will be deemed to constitute "control," and ownership of more
than 10% of the capital stock may also be deemed to constitute "control" if
certain other control factors are present. It is possible that even lower levels
of ownership of such securities could constitute "control" under the
regulations. As of December 31, 1999, no individual corporation or other entity
owned more than 10% of Sovereign's capital stock.
Regulatory Capital Requirements. OTS regulations require savings
associations to maintain a minimum tangible capital ratio of not less than 2.0%,
a minimum core capital, or "leverage" ratio of not less than 3% and a minimum
risk-based capital ratio (based upon credit risk) of not less than 8%. These
standards are the same as the capital standards that are applicable to other
insured depository institutions, such as banks. Federal banking agencies are
required to ensure that their risk-based capital guidelines take adequate
account
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of interest rate risk, concentration of credit risk and risks of non-traditional
activities. In August 1995, the federal banking agencies, including the OTS,
issued a rule modifying their then-existing risk-based capital standards to
provide for consideration of interest rate risk when assessing the capital
adequacy of an institution. This new rule implements the first step of a
two-step process by explicitly including a depository institution's exposure to
declines in the value of its capital due to changes in interest rates as one
factor that the banking agencies will consider in evaluating an institution's
capital adequacy. The new rule does not establish a measurement framework for
assessing an institution's interest rate risk exposure level. Examiners will use
data collected by the banking agencies to determine the adequacy of an
individual institution's capital in light of interest rate risk. Examiners will
also consider historical financial performance, earnings exposure to interest
rate movements and the adequacy of internal interest rate risk management, among
other things. This case-by-case approach for assessing an institution's capital
adequacy for interest rate risk is transitional. The second step of the federal
banking agencies' interest rate risk regulation will be to establish an explicit
minimum capital charge for interest rate risk, based on measured levels of
interest rate risk exposure. The banking agencies may implement this second step
at some future date.
The federal banking agencies, including the OTS, also adopted final rules
relating to concentration of credit risk and risks of non-traditional activities
effective on January 17, 1995. The agencies declined to adopt a quantitative
test for concentrations of credit risk and, instead, provided that such risk
would be considered in addition to other risks in assessing an institution's
overall capital adequacy. Institutions with higher concentration of credit risk
will be required to maintain greater levels of capital. Similarly, the federal
agencies incorporated the evaluation of the risks of non-traditional activities
into the overall assessment of capital adequacy. The agencies also indicated
that proposed rules regarding specific types of non-traditional activities will
be promulgated from time to time.
Under the Federal Deposit Insurance Act ("FDIA"), insured depository
institutions must be classified in one of five defined categories
(well-capitalized, adequately-capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized). Under OTS regulations, an
institution will be considered "well-capitalized" if it has (i) a total
risk-based capital ratio of 10% or greater, (ii) a Tier 1 risk-based capital
ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv) is not
subject to any order or written directive to meet and maintain a specific
capital level. An "adequately-capitalized" institution is one that has (i) a
total risk-based capital ratio of 8% or greater, (ii) a Tier 1 risk-based
capital ratio of 4% or greater, (iii) a leverage ratio of 4% or greater (or 3%
or greater in the case of a bank with the highest composite regulatory
examination rating) and (iv) does not meet the definition of a well-capitalized
institution. An institution will be considered (A) "undercapitalized" if it has
(i) a total risk-based capital ratio of less than 8% (ii) a Tier 1 risk-based
capital ratio of less than 4% or (iii) a leverage ratio of less than 4% (or 3%
in the case of an institution with the highest regulatory examination rating);
(B) "significantly undercapitalized" if the institution has (i) a total
risk-based capital ratio of less than 6% (ii) a Tier 1 risk-based capital ratio
of less than 3% or (iii) a leverage ratio of less than 3%; and (C) "critically
undercapitalized" if the institution has a ratio of tangible equity to total
assets of equal to or less than 2%. The OTS may, under certain circumstances,
reclassify a "well-capitalized" institution as "adequately-capitalized" or
require an "adequately-capitalized" or "undercapitalized" institution to comply
with supervisory actions as if it were in the next lower category. Such a
reclassification could be made if the OTS determines that the institution is in
an unsafe or unsound condition (which could include unsatisfactory examination
ratings). A savings institution's capital category is determined with respect to
its most recent thrift financial report filed with the OTS. In the event an
institution's capital deteriorates to the undercapitalized category or below,
the FDIA and OTS regulations prescribe an increasing amount of regulatory
intervention, including the adoption by the institution of a capital restoration
plan, a guarantee of the plan by its parent holding company and the placement of
a hold on increases in assets, number of branches and lines of business.
If capital has reached the significantly or critically undercapitalized
levels, further material restrictions can be imposed, including restrictions on
interest payable on accounts, dismissal of management and (in critically
undercapitalized situations) appointment of a receiver or conservator.
Critically undercapitalized institutions generally may not, beginning 60 days
after becoming critically undercapitalized, make any payment of principal or
interest on their subordinated debt. All but well-capitalized institutions are
prohibited from accepting brokered deposits without prior regulatory approval.
Pursuant to the FDIA and OTS regulations, savings associations which are not
categorized as well-capitalized or adequately-capitalized are restricted from
making capital distributions which include cash dividends, stock redemptions or
repurchases, cash-out mergers, interest payments on certain convertible debt and
other transactions charged to the capital
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account of a savings association. At December 31, 1999, Sovereign Bank met the
criteria to be classified as "well-capitalized."
Standards for Safety and Soundness. The federal banking agencies adopted,
effective in August 1995, certain operational and managerial standards for
depository institutions, including internal audit system components, loan
documentation requirements, asset growth parameters, and compensation standards
for officers, directors and employees. The implementation or enforcement of
these guidelines has not had a material adverse effect on Sovereign's results of
operations.
Insurance of Accounts and Regulation by the FDIC. Sovereign Bank is a
member of the Savings Association Insurance Fund, which is administered by the
FDIC. Deposits are insured up to the applicable limits by the FDIC and such
insurance is backed by the full faith and credit of the United States
government. As insurer, the FDIC imposes deposit insurance premiums and is
authorized to conduct examinations of, and to require reporting by, FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious risk
to the Savings Association Insurance Fund or Bank Insurance Fund. The FDIC also
has the authority to initiate enforcement actions against savings institutions,
after giving the Office of Thrift Supervision an opportunity to take such
action, and may terminate an institution's deposit insurance if it determines
that the institution has engaged in unsafe or unsound practices or is in an
unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, institutions classified as
well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier I
or core capital to risk-weighted assets ("Tier 1 risk-based capital") of at
least 6% and a risk-based capital ratio of at least 10%) and considered healthy
pay the lowest premium while institutions that are less than adequately
capitalized (i.e., core or Tier I risk-based capital ratios of less than 4% of a
risk-based capital ratio of less than 8%) and considered of substantial
supervisory concern pay the highest premium. Risk classification of all insured
institutions is made by the FDIC for each semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semi-annual
basis, if it determines that the reserve ratio of the Savings Association
Insurance Fund will be less than the designated reserve ratio of 1.25% of
Savings Association Insurance Fund insured deposits. In setting these increased
assessments, the FDIC must seek to restore the reserve ratio to that designated
reserve level, or such higher reserve ratio as established by the FDIC. The FDIC
may also impose special assessments on Savings Association Insurance Fund
members to repay amounts borrowed from the United States Treasury or for any
other reason deemed necessary by the FDIC.
The current premium schedule for Savings Association Insurance Fund insured
institutions ranges from 0 to 27 basis points per $100 of deposits. Sovereign
Bank is in the category of institutions that pay no deposit insurance premiums.
However, all insured institutions are required to pay a Financing Corporation
assessment, in order to fund the interest on bonds issued to resolve thrift
failures in the 1980s. The current rate for Savings Association Insurance Fund
insured institutions is 5.9 basis points for each $100 in domestic deposits,
while Bank Insurance Fund insured institutions pay an assessment equal to 1.2
basis points for each $100 in domestic deposits. After January 1, 2000, the
Financing Corporation assessments for Savings Association Insurance Fund and
Bank Insurance Fund insured institutions will be the same. These assessments,
which may be revised based upon the level of Bank Insurance Fund and Savings
Association Insurance Fund deposits, will continue until the bonds mature in the
year 2017.
New Legislation. Landmark legislation in the financial services area was
signed into law by the President on November 12, 1999. The Gramm-Leach-Bliley
Act dramatically changes certain banking laws that have been in effect since the
early part of the 20th century. The most radical changes are that the separation
between banking and the securities businesses mandated by the Glass-Steagall Act
has now been removed, and the provisions of any state law that prohibits
affiliation between banking and insurance entities have been preempted.
Accordingly, the new legislation now permits firms engaged in underwriting and
dealing in securities, and insurance companies, to own banking entities, and
permits bank holding companies (and in some cases, banks) to own securities
firms and insurance companies. As Sovereign is a savings and loan holding
company, many of the provisions of the new legislation do not apply to it. The
new law does change the status of Sovereign, however, in that Sovereign can no
longer become part of a non-financial group of companies, as it could under
prior law. Sovereign is still permitted to acquire non-financial companies,
however.
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The new legislation also makes a number of additions and revisions to
numerous federal laws that affect the business of banking. For example, there is
now a federal law on privacy with respect to customer information held by banks.
The federal banking regulators are authorized to adopt rules regarding privacy
for customer information. Banks must establish a disclosure policy for
non-public customer information, disclose the policy to their customers, and
give their customers the opportunity to object to non-public information being
disclosed to a third party. The new law also requires any CRA agreement entered
into between a bank and a community group to be disclosed, with both the bank
and the group receiving any grants from the bank detailing the amount of funding
provided and what it was used for. The new law also requires a bank's policy on
fees for transactions at ATM machines by non-customers to be conspicuously
posted on the ATM. A number of other provisions affecting other general
regulatory requirements for banking institutions were also adopted.
ITEM 2. PROPERTIES.
Sovereign Bank is the owner of a five-story office building in Wyomissing,
Berks County, Pennsylvania. The building is used as Sovereign Bank's executive
offices and operations center.
Sovereign Bank has 315 branch and loan production offices. Sovereign owns
162 of these offices and leases 153. Sovereign Bank also leases several other
facilities throughout its market area to support its various administrative
functions.
ITEM 3. LEGAL PROCEEDINGS.
Sovereign is not involved in any pending legal proceedings other than
non-material legal proceedings occurring in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.
Certain information, including principal occupation during the past five
years, relating to the principal executive officers of Sovereign, as of March
29, 2000, is set forth below:
Richard E. Mohn--Age 68. Mr. Mohn was elected the Chairman of the
Board of Sovereign on April 24, 1995. Mr. Mohn became Chairman of the Board
of Sovereign Bank in November 1989. He is the retired Chairman of Cloister
Spring Water Company, Lancaster, Pennsylvania, a bottler and distributor of
spring water.
Jay S. Sidhu--Age 48. Mr. Sidhu has served as President and Chief
Executive Officer of Sovereign since November 21, 1989. Prior thereto, Mr.
Sidhu served as Treasurer and Chief Financial Officer of Sovereign. Mr.
Sidhu is also President and Chief Executive Officer of Sovereign Bank.
Prior to becoming President and Chief Executive Officer of Sovereign Bank
on March 28, 1989, Mr. Sidhu served as Vice Chairman and Chief Operating
Officer of Sovereign Bank.
Lawrence M. Thompson, Jr.--Age 47. Mr. Thompson serves as Chief
Administrative Officer and Secretary of Sovereign and Chief Operating
Officer and Secretary of Sovereign Bank. Mr. Thompson was hired as
Sovereign Bank's General Counsel and Secretary in 1984. He was promoted to
Vice President in 1985. In April 1986, he became Sovereign Bank's Senior
Vice President for legal affairs and administration. In January 1990, he
became Group Executive Officer--Lending and in June 1995, he became Chief
Administrative Officer of Sovereign and Sovereign Bank. Mr. Thompson became
Chief Operating Officer of Sovereign Bank in November 1996.
Dennis S. Marlo--Age 57. Mr. Marlo was appointed Chief Financial
Officer and Treasurer of Sovereign on May 19, 1998. Mr. Marlo joined
Sovereign in February 1998 as the President of the Pennsylvania Division of
Sovereign Bank. Prior thereto, Mr. Marlo served as President and Chief
Executive Officer of ML Bancorp, a predecessor company of Sovereign.
7
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
Sovereign's common stock is traded in the over-the-counter market and is
quoted on the National Association of Securities Dealers Automated Quotation
System ("NASDAQ") National Market System under the symbol "SVRN." At March 29,
2000, the total number of holders of Sovereign's common stock was 17,098.
The high and low bid prices reported on the NASDAQ National Market system
for Sovereign's common stock for 1999, adjusted to reflect all stock dividends
and splits, were $26.250 and $7.000 and for 1998 were $22.188 and $9.000,
respectively.
During 1999, Sovereign paid a cash dividend of $.021 per share in the first
quarter, $.026 per share in the second quarter, $.027 per share in the third
quarter and $.024 per share in the fourth quarter. During 1998, Sovereign paid a
cash dividend of $.020 per share in the first quarter, $.023 per share in the
second quarter, $.020 per share in the third quarter and $.021 per share in the
fourth quarter. During 1997, Sovereign paid a cash dividend of $.037 per share
in the first quarter, $.038 in the second quarter, $.036 in the third quarter
and $.017 in the fourth quarter. These per share amounts have been adjusted to
reflect all stock dividends and stock splits.
For certain limitations on the ability of Sovereign Bank to pay dividends
to Sovereign, see part I, Item 1 "Business--Supervision and
Regulation--Regulatory Capital Requirements" and Note 12 at Item 8 "Financial
Statements and Supplementary Data" hereof.
8
ITEM 6. SELECTED FINANCIAL DATA.
SELECTED FINANCIAL DATA(1)
AT OR FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------
1999 1998 1997 1996 1995
----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Balance Sheet Data
Total assets................................ $26,607,112 $21,913,873 $17,655,455 $15,298,690 $13,082,579
Loans....................................... 14,226,540 11,285,840 11,324,122 9,595,495 7,591,107
Allowance for loan losses................... (132,986) (133,802) (116,823) (73,847) (67,515)
Investment securities....................... 10,392,263 8,502,082 5,372,713 5,012,118 4,695,805
Deposits.................................... 11,719,646 12,322,716 9,515,294 8,660,684 8,548,888
Borrowings.................................. 12,663,138 7,902,239 6,863,643 5,599,109 3,566,857
Stockholders' equity........................ 1,821,495 1,204,068 1,047,795 889,751 843,733
Summary Statement of Operations
Total interest income....................... $ 1,607,329 $ 1,355,371 $ 1,178,777 $ 1,016,826 $ 838,261
Total interest expense...................... 992,673 861,759 746,695 629,860 518,483
----------- ----------- ----------- ----------- -----------
Net interest income......................... 614,656 493,612 432,082 386,966 319,778
Provision for loan losses................... 30,000 27,961 41,125 22,685 13,119
----------- ----------- ----------- ----------- -----------
Net interest income after provision for loan
losses.................................... 584,656 465,651 390,957 364,281 306,659
Other income................................ 130,342 105,181 48,688 63,379 42,908
Other expenses(2)........................... 446,384 359,626 269,783 289,773 199,647
----------- ----------- ----------- ----------- -----------
Income before income taxes.................. 268,614 211,206 169,862 137,887 149,920
Income tax provision........................ 89,315 74,751 67,324 47,509 51,051
----------- ----------- ----------- ----------- -----------
Net income.................................. $ 179,299 $ 136,455 $ 102,538 $ 90,378 $ 98,869
=========== =========== =========== =========== ===========
Share Data(3)
Common shares outstanding at end of period
(in thousands)............................ 225,470 159,727 141,218 134,000 130,762
Preferred shares outstanding at end of
period (in thousands)..................... -- -- 1,996 2,000 2,000
Basic earnings per share(4)................. $ 1.02 $ .88 $ .70 $ .63 $ .68
Diluted earnings per share(4)............... $ 1.01 $ .85 $ .66 $ .59 $ .66
Book value per share at end of period(5).... $ 8.08 $ 7.54 $ 7.42 $ 6.64 $ 6.45
Common share price at end of period......... $ 7 29/64 $ 14 1/4 $ 1 75/16 $ 9 1/8 $ 6 11/16
Dividends per common share(6)............... $ 0.098 $ .084 $ .114 $ .140 $ .119
Selected Financial Ratios
Dividend payout ratio(7).................... 9.7% 9.9% 17.3% 23.7% 18.0%
Return on average assets.................... .75% .70% .63% .63% .83%
Return on average equity.................... 13.20% 12.42% 10.92% 10.34% 12.60%
Equity to assets............................ 6.85% 5.49% 5.93% 5.82% 6.45%
- ------------------
(1) All selected financial data has been restated to reflect those acquisitions
which have been accounted for under the pooling-of-interests method of
accounting.
(2) Other expenses for the year ended December 31, 1999 include special charges
related to merger and other integration expenses of $30.8 million. See
Reconciliation of Net Income to Operating Earnings in Part II, Item 7
"Management's Discussion and Analysis" hereof.
(3) All per share data have been adjusted to reflect all stock dividends and
stock splits.
(4) The 1998 and 1997 results include the merger-related charges of $33.5
million (after-tax) and $36.7 million (after-tax), respectively, resulting
from Sovereign's acquisitons during 1998 and 1997. Excluding the
merger-related charges, basic earnings per share and diluted earnings per
share were $1.10 and $1.06, respectively, for 1998 and $.97 and $.89,
respectively, for 1997. The 1996 results include the non-recurring SAIF
assessment of $24.9 million (after-tax). Excluding the non-recurring SAIF
assessment, basic earnings per share and diluted earnings per share for 1996
were $.81 and $.76, respectively.
(5) Book value is calculated using equity divided by common shares.
(6) The higher dividend rate in prior periods is the result of acquisitions
which were accounted for as a pooling-of-interests.
(7) The dividend payout ratio is calculated using dividends per common share
divided by diluted earnings per share.
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General. Sovereign reported cash earnings for 1999 of $231 million, or
$1.34 per share, up from $188 million and $1.17 per share in 1998. This
represents an increase in cash earnings of 23% and a 15% increase in cash
earnings per share. Operating earnings for 1999 were $202 million, an increase
of 19% from 1998 operating earnings of $170 million. Operating earnings per
share for 1999 was $1.18, an increase of 11% over 1998 operating earnings per
share of $1.06. Net income for 1999 was $179 million or $1.01 per share. Net
income for 1998 was $136 million or $.85 per share. On an operating basis,
return on average equity and return on average assets were 15.51% and .85%,
respectively, for 1999 compared to 15.47% and .87%, respectively, for 1998.
Operating earnings exclude the following special charges for 1999 and 1998:
merger-related and integration charges related to acquisitions, as well as the
impact on net interest income and shares outstanding from the early issuance of
certain debt and equity instruments issued to finance Sovereign's pending New
England retail banking and middle market lending acquisition from FleetBoston
("Sovereign Bank New England"). Special charges were $23.0 million after tax for
the year ended December 31, 1999 and $33.5 million after tax for the year ended
1998.
Cash earnings are operating earnings excluding amortization of intangible
assets and ESOP-related expense.
A reconciliation of net income to operating earnings is presented below:
RECONCILIATION OF NET INCOME TO OPERATING EARNINGS
(Dollars in thousands, except per share data -- all amounts are after tax)
YEAR-ENDED DECEMBER 31,
-----------------------------------
TOTAL PER SHARE
------------------- -------------
1999 1998 1999 1998
-------- -------- ----- -----
Net income as reported.................................... $179,299 $136,455 $1.01 $0.85
Net negative carry on escrowed bond proceeds(1)........... 3,123 -- 0.02 --
Merger-related and integration costs recorded during the
period.................................................. 20,576 33,533 0.12 0.21
Expense on convertible trust preferred securities
("PIERS")(1)............................................ 2,125 -- 0.01 --
Assumed income from reinvestment of net proceeds of common
equity and PIERS(1)..................................... (2,827) -- (0.02) --
Impact of additional shares outstanding for 1999 common
and PIERS securities offerings(2)....................... -- -- 0.04 --
-------- -------- ----- -----
Operating earnings(2)..................................... $202,296 $169,988 $1.18 $1.06
======== ======== ===== =====
Cash earnings(2).......................................... $231,467 $188,177 $1.34 $1.17
======== ======== ===== =====
- ------------------
(1) As part of the agreement to purchase Sovereign Bank New England, Sovereign
was required to raise $1.8 billion of debt or equity capital by December 15,
1999. Substantially all of the funds were required to be escrowed with
limited ability to reinvest the proceeds between the closing of the
financing and the assumption of the FleetBoston branches. Consequently, the
excess of interest expense and trust preferred expense over income earned on
the raised capital has resulted in a net reduction in net income of $3.7
million ($2.4 million after-tax) for the year ended December 31, 1999,
comprised of the following components: a) a net negative impact of $4.7
million ($3.1 million after-tax) to net interest income; b) $3.1 million
($2.1 million after-tax) of expense associated with PIERS issued in
November, 1999; c) an assumed $4.4 million ($2.8 million after-tax) of
income from the re-investment of the proceeds of the Trust Preferred
Securities and the common stock offerings in November, 1999.
(2) Operating earnings per share and cash earnings per share are calculated
using weighted average shares of 172 million, which excludes the average
effect of the 43.8 million shares issued in the November, 1999 offering.
10
All per share amounts presented in Management's Discussion and Analysis of
Financial Condition and Results of Operations have been adjusted to reflect all
stock dividends and stock splits.
Acquisitions. Sovereign's financial results for 1999 include the following
significant events: (For additional information with respect to Sovereign's 1999
acquisition activity, see Note 2 in the "Notes to Consolidated Financial
Statements" hereof).
Network. On June 15, 1999, Sovereign acquired The Network Companies
("Network"), a privately held specialty leasing company headquartered in
Commack, New York. The acquisition was accounted for as a purchase and had total
assets of approximately $50 million.
Peoples. On June 30, 1999, Sovereign acquired Peoples Bancorp, Inc.
("Peoples"), a $1.4 billion bank holding company headquartered in Lawrenceville,
New Jersey whose principal operating subsidiary operated 14 community banking
offices in Mercer, Burlington and Ocean counties, New Jersey. The transaction
added loans, deposits, and equity to Sovereign of approximately $503 million,
$515 million, and $291 million, respectively.
Sovereign Bank New England. On September 3, 1999, Sovereign entered into a
purchase and assumption agreement with FleetBoston Financial to acquire branch
banking offices located in Connecticut, Massachusetts, New Hampshire and Rhode
Island, and related deposit liabilities, loans and other assets associated with
the business of those branches. On February 28, 2000, Sovereign and FleetBoston
Financial agreed to restructure certain terms of the agreement. Sovereign will
purchase approximately $12 billion of deposits, $9 billion of loans and 285
community banking offices. The acquisition, which results in the creation of
Sovereign Bank New England, the third largest bank in New England, includes the
following: the former Fleet Bank community banking franchise in eastern
Massachusetts; the entire former BankBoston community banking franchise in Rhode
Island; and select community banking offices of Fleet Bank in southern New
Hampshire and BankBoston in Connecticut. In addition, Sovereign is acquiring a
substantial portion of the middle market and small business-lending groups from
Fleet in Massachusetts and New Hampshire, and from BankBoston in Rhode Island
and Connecticut. The acquisition includes the purchase of fully functioning
business units, with the necessary management, relationship officers, support
staffs, and other infrastructure for the acquired loans and deposits to be fully
serviced.
ACQUISITION TIMETABLE
DATE DIVESTED UNITS DEPOSITS BRANCHES LOANS
---- -------------- ------------ -------- ------------
March 24, 2000......... Rhode Island, Connecticut (BankBoston) $4.0 billion 90 $3.2 billion
June 16, 2000.......... Eastern Mass (Fleet) $4.0 billion 86 $3.5 billion
July 21, 2000.......... Central Mass, New Hampshire (Fleet) $4.0 billion 109 $2.4 billion
In February, 2000, Sovereign received approval from the Office of Thrift
Supervision for the transaction subject to certain conditions at each
acquisition date. Total potential consideration for the consumer and banking
franchise is 12% of acquired deposits, or approximately $1.4 billion. Sovereign
will pay approximately $1.1 billion as the purchases are completed according to
the above schedule. Sovereign will pay the remaining $340 million in periodic
installments between January 2001 and October 2001 if FleetBoston complies with
its non-compete obligations under the agreement. Sovereign paid a non-refundable
deposit of $200 million to FleetBoston in connection with the acquisition, and
their obligation to close each of the acquisitions is unconditional.
Sovereign raised approximately $1.8 billion of debt and equity in November
and December, 1999, to finance the acquisition. See Liquidity and Capital
Resources for a more complete description of these financings.
11
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
Net Interest Income. Net interest income for 1999 was $615 million
compared to $494 million for 1998. This growth represents an increase of 24% and
was primarily due to an internal commercial and consumer loan growth, recent
acquisitions, an increase in average balances in investment securities available
for sale and growth in core deposits. Net interest margin -- operating basis
(net interest income adjusted to eliminate the negative impact from escrowed
financing proceeds relating to the pending acquisition of Sovereign Bank New
England, divided by average interest-earning assets -- see Reconciliation of Net
Income to Operating Earnings) was 2.88% for 1999 compared to 2.79% for 1998.
Interest on interest-earning deposits was $4.7 million for 1999 compared to
$7.4 million for 1998. The average balance of interest-earning deposits was
$15.2 million with an average yield of 31.12%for 1999 compared to an average
balance of $56.4 million with an average yield of 13.12%for 1998. The high
yields on interest-earning deposits were the result of a contractual arrangement
whereby a third-party vendor performed check processing and reconcilement
functions for Sovereign's disbursement accounts. Under the agreement, the vendor
is required to pay Sovereign interest on disbursed funds during the two to three
day float period, effectively producing interest income with no corresponding
asset balance. This agreement will continue to favorably impact the yield on
Sovereign's interest-earning deposits in future years.
Interest on investment securities available-for-sale was $544 million for
1999 compared to $284 million for 1998. The average balance of investment
securities available-for-sale was $8.1 billion with an average yield of 6.85%for
1999 compared to an average balance of $4.3 billion with an average yield of
6.75% for 1998. The increase in the average balance of investment securities
available-for-sale was due to Sovereign's realignment of its investment
portfolio, and an active decision by management to increase balance sheet
flexibility by placing more investments into available-for-sale.
Interest on investment securities held-to-maturity was $99.8 million for
1999 compared to $182 million for 1998. The average balance of investment
securities held-to-maturity was $1.4 billion with an average yield of 6.94% for
1999 compared to an average balance of $2.5 billion with an average yield of
7.22% for 1998. The decrease in the yield at year end, and the majority of the
year-end balance, is associated with the escrowed proceeds from the November
offerings related to the FleetBoston acquisition.
Interest and fees on loans were $959 million for 1999 compared to $881
million for 1998. The average balance of net loans was $12.4 billion with an
average yield of 7.77% for 1999 compared to an average balance of $11.1 billion
with an average yield of 7.94% for 1998. The increases in average loan volume
were primarily the result of Sovereign's significant progress during the year in
increasing its emphasis in commercial and consumer lending. The increases in
volume were offset slightly by an overall decrease in rates.
Interest on total deposits was $428 million for 1999 compared to $440
million for 1998. The average balance of total deposits was $12.0 billion with
an average cost of 3.57% for 1999 compared to an average balance of $10.7
billion with an average cost of 4.11% for 1998. The increase in the average
balance and the decrease in the average cost of deposits was primarily the
result of Sovereign's emphasis on attracting lower-cost core deposits from small
and medium size corporations, governmental units and consumers, and the
CoreStates branch acquisition in September 1998.
12
Interest on total borrowings was $565 million for 1999 compared to $421
million for 1998. The average balance of total borrowings was $10.3 billion with
an average cost of 5.47% for 1999 compared to an average balance of $7.4 billion
with an average cost of 5.69% for 1998. The increase in the average balance was
the result of both balance sheet growth and funding requirements needed in
anticipation of the pending acquisition of assets and liabilities from
FleetBoston. The decrease in the average cost of borrowings was due to a higher
proportion of short-term borrowings in the current year versus prior year, and a
slight overall decrease in interest rates.
Table 1 presents a summary of Sovereign's average balances, the yields
earned on average assets and the cost of average liabilities and stockholders'
equity for the years indicated (in thousands):
TABLE 1: NET INTEREST MARGIN
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------
1999 1998
--------------------------------- ---------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE
----------- ---------- ------ ----------- ---------- ------
Interest-earning assets:
Interest-earning deposits.... $ 15,170 $ 4,721 31.12% $ 56,389 $ 7,397 13.12%
Investment securities
available-for-sale(1)...... 8,079,731 543,631 6.85 4,336,872 284,392 6.75
Investment securities
held-to-maturity........... 1,440,894 99,813 6.94 2,530,143 182,499 7.22
Net loans(2)(3).............. 12,379,295 959,164 7.77 11,105,400 881,083 7.94
----------- ---------- ----- ----------- ---------- -----
Total interest-earning
assets..................... 21,915,090 1,607,329 7.39 18,028,804 1,355,371 7.57
Non-interest-earning
assets..................... 2,027,003 -- -- 1,589,937 -- --
----------- ---------- ----- ----------- ---------- -----
Total assets............. $23,942,093 $1,607,329 6.76% $19,618,741 1,355,371 6.96
=========== ---------- ----- =========== ---------- -----
Interest-bearing liabilities:
Deposits:
Demand deposit and NOW
accounts................. $ 2,607,000 $ 21,851 .84 $ 1,712,730 $ 16,387 .96
Savings accounts........... 2,246,127 58,333 2.60 2,126,149 62,694 2.95
Money market accounts...... 1,288,581 50,246 3.90 1,173,889 45,055 3.84
Certificates of deposit.... 5,836,785 297,625 5.10 5,688,568 316,164 5.56
----------- ---------- ----- ----------- ---------- -----
Total deposits........... 11,978,493 428,055 3.57 10,701,336 440,300 4.11
Total borrowings............. 10,330,125 564,618 5.47 7,404,186 421,459 5.69
----------- ---------- ----- ----------- ---------- -----
Total interest-bearing
liabilities . . 22,308,618 992,673 4.45 18,105,522 861,759 4.76
Non-interest-bearing
liabilities................ 274,858 -- -- 414,719 -- --
----------- ---------- ----- ----------- ---------- -----
Total liabilities........ 22,583,476 992,673 4.40 18,520,241 861,759 4.65
Stockholders' equity......... 1,358,617 -- -- 1,098,500 -- --
----------- ---------- ----- =========== ---------- -----
Total liabilities and
stockholders' equity... $23,942,093 $ 992,673 4.15 $19,618,741 $ 861,759 4.39
=========== ---------- ----- =========== ---------- -----
Net interest net spread(4)... 2.62% 2.56%
===== =====
Net interest income/net
interest margin(5)......... $ 614,656 2.86% $ 493,612 2.79%
========== ===== ========== =====
Net interest margin-operating
basis(6)................... 2.88% 2.79%
----- -----
Ratio of interest-earning
assets to interest-bearing
liabilities................ .98x 1.00x
===== =====
YEAR ENDED DECEMBER 31,
---------------------------------
1997
---------------------------------
AVERAGE YIELD/
BALANCE INTEREST RATE
----------- ---------- ------
Interest-earning assets:
Interest-earning deposits.... $ 32,261 $ 5,392 16.71%
Investment securities
available-for-sale(1)...... 1,566,975 102,123 6.77
Investment securities
held-to-maturity........... 3,902,940 279,900 7.18
Net loans(2)(3).............. 10,138,964 791,362 7.82
----------- ---------- -----
Total interest-earning
assets..................... 15,641,140 1,178,777 7.57
Non-interest-earning
assets..................... 689,618 -- --
----------- ---------- -----
Total assets............. $16,330,758 $1,178,777 7.25
=========== ---------- -----
Interest-bearing liabilities:
Deposits:
Demand deposit and NOW
accounts................. $ 1,157,372 $ 7,967 .69
Savings accounts........... 1,946,404 58,974 3.03
Money market accounts...... 834,933 33,719 4.04
Certificates of deposit.... 5,069,113 278,153 5.49
----------- ---------- -----
Total deposits........... 9,007,822 378,813 4.21
Total borrowings............. 6,164,004 367,882 5.97
----------- ---------- -----
Total interest-bearing
liabilities . . 15,171,826 746,695 4.92
Non-interest-bearing
liabilities................ 220,047 -- --
----------- ---------- -----
Total liabilities........ 15,391,873 746,695 4.85
Stockholders' equity......... 938,885 -- --
=========== ---------- -----
Total liabilities and
stockholders' equity... $16,330,758 $ 746,695 4.57
=========== ---------- -----
Net interest net spread(4)... 2.68%
=====
Net interest income/net
interest margin(5)......... $ 432,082 2.79%
========== =====
Net interest margin-operating
basis(6)................... 2.79%
-----
Ratio of interest-earning
assets to interest-bearing
liabilities................ 1.03x
=====
- ------------------
(1) The tax equivalent adjustments for the years ended December 31, 1999, 1998
and 1997 were $9.7 million, $8.1 million and $3.9 million, respectively, and
are based on an effective tax rate of 35%.
(2) Amortization of net fees of $10.4 million, $2.6 million and $4.8 million for
the years ended December 31, 1999, 1998 and 1997, respectively, are included
in interest income. Average loan balances include non-accrual loans and
loans held for sale.
(3) The tax equivalent adjustments for the years ended December 31, 1999, 1998
and 1997, were $2.5 million, $1.1 million and $1.0 million, respectively,
and are based on an effective tax rate of 35%.
(4) Represents the difference between the yield on total assets and the cost of
total liabilities and stockholders' equity.
(5) Represents tax equivalent net interest income divided by average
interest-earning assets.
(6) Represents net interest margin adjusted to eliminate the negative impact
from escrowed financing proceeds relating to the pending acquisition of
Sovereign Bank New England. Sovereign was required to raise $1.8 billion of
debt and equity capital by December 15, 1999. Substantially all of the
proceeds were required to be escrowed with limited ability to reinvest
between closing of the financings and the assumption of the FleetBoston
branches.
13
Table 2 presents, prior to any tax equivalent adjustments, the relative
contribution of changes in volumes and changes in rates to changes in net
interest income for the periods indicated. The change in interest income and
interest expense attributable to the combined impact of both volume and rate has
been allocated proportionately to the change due to volume and the change due to
rate (in thousands):
TABLE 2: VOLUME/RATE ANALYSIS
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
1999 VS. 1998 1998 VS. 1997
INCREASE/(DECREASE) INCREASE/(DECREASE)
------------------------------ ------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
-------- -------- -------- -------- -------- --------
Interest-earning assets:
Interest-earning deposits.............. $ (5,407) $ 2,731 $ (2,676) $ 4,033 $ (2,028) $ 2,005
Investment securities
available-for-sale................... 245,439 13,800 259,239 180,520 1,749 182,269
Investment securities
held-to-maturity..................... (78,567) (4,119) (82,686) (98,450) 1,049 (97,401)
Net loans(1)........................... 101,069 (22,988) 78,081 75,432 14,289 89,721
-------- --------
Total interest-earning assets............ 251,958 176,594
-------- --------
Interest-bearing liabilities:
Deposits............................... 52,548 (64,793) (12,245) 71,219 (9,732) 61,487
Borrowings............................. 166,549 (23,390) 143,159 74,017 (20,440) 53,577
-------- --------
Total interest-bearing liabilities....... 130,914 115,064
-------- --------
Net change in net interest income........ $ 43,437 $ 77,607 $121,044 $ 16,299 $ 45,231 $ 61,530
======== ======== ======== ======== ======== ========
- ------------------
(1) Includes non-accrual loans and loans held for sale.
Provision for Loan Losses. The provision for loan loss expense is based
upon credit loss experience and on estimation of losses inherent in the current
loan portfolio. The provision for loan losses for 1999 was $30.0 million
compared to $28.0 million for 1998.
Over the last few years, through several strategic acquisitions and
internal restructuring initiatives, Sovereign has diversified its lending
efforts and increased its emphasis on providing its customers with small
business loans and an expanded line of commercial and consumer products, such as
asset-based lending and automobile loans. As a result of the increased risk
inherent in these loan products, and as Sovereign continues to place emphasis on
commercial and consumer lending in future years, management will regularly
evaluate its loan portfolio and record additional loan loss allowance as is
necessary. Historically, Sovereign's additions to its loan loss allowance
(through income statement charges and acquisition accounting) have been
sufficient to absorb the incremental credit risk in its loan portfolio. During
1998, Sovereign established an initial loan loss allowance of $20.5 million
related to $725 million of loans acquired in connection with its CoreStates
branch acquisition. Excluding charge-offs of $7.0 million incurred as part of an
accelerated disposition of non-performing residential loans during the second
and fourth quarters of 1999, as shown in Table 3 on the next page, the 1999 loan
loss provision is in excess of net charge-offs.
Sovereign's net charge-offs for 1999 were $35.6 million and consisted of
charge-offs of $55.0 million and recoveries of $19.4 million. This compares to
1998 net charge-offs of $33.6 million consisting of charge-offs of $46.3 million
and recoveries of $12.7 million. The ratio of net loan charge-offs to average
loans, including loans held for sale, was .29% for 1999, compared to .30% for
1998 and .18% for 1997. Commercial loan net charge-offs as a percentage of
average commercial loans were .11% for 1999, compared to .14% for 1998 and .14%
for 1997. Consumer loan net charge-offs as a percentage of average consumer
loans were .48% for 1999, compared to .80% for 1998 and .55% for 1997.
Residential real estate mortgage loan net charge-offs as a percentage of average
residential mortgage loans, including loans held for sale, were .23% for 1999,
.08% for 1998, and .11% for 1997. Sovereign's increased level of consumer and
commercial loan charge-offs in 1998 was primarily related to Sovereign's
acquisition activity during the two preceding years and principally the result
of higher indirect automobile loan charge-offs, substantially all of which are
related to Sovereign's acquisition of Fleet Financial Group, Inc.'s ("Fleet")
Auto Finance Division ("Fleet Auto") during 1997. The increased level of
residential mortgage loan net charge-offs were the result of the $7.0 million
accelerated net charge-offs previously described. In Sovereign's experience, a
strategy that involves the accelerated resolution of certain problem assets is
more appropriate than a long-term workout approach.
14
Table 3 presents the activity in the allowance for loan losses for the
years indicated (in thousands):
TABLE 3: RECONCILIATION OF THE ALLOWANCE FOR LOAN LOSSES
DECEMBER 31,
--------------------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- ------- -------
Allowance, beginning of year.................... $133,802 $116,823 $ 73,847 $67,515 $64,611
Charge-offs:
Residential(1)................................ 14,038 6,223 8,869 11,016 9,546
Commercial.................................... 4,659 3,220 3,687 5,846 2,563
Consumer...................................... 36,326 36,887 11,628 2,079 962
-------- -------- -------- ------- -------
Total charge-offs........................... 55,023 46,330 24,184 18,941 13,071
-------- -------- -------- ------- -------
Recoveries:
Residential................................... 1,629 1,134 1,040 1,376 923
Commercial.................................... 1,429 839 2,264 133 201
Consumer...................................... 16,350 10,715 2,079 363 227
-------- -------- -------- ------- -------
Total recoveries............................ 19,408 12,688 5,383 1,872 1,351
-------- -------- -------- ------- -------
Charge-offs, net of recoveries.................. 35,615 33,642 18,801 17,069 11,720
Provision for loan losses....................... 30,000 27,961 41,125 22,685 13,119
Acquired allowance and other additions(2)....... 4,799 22,660 20,652 716 1,505
-------- -------- -------- ------- -------
Allowance, end of year.......................... $132,986 $133,802 $116,823 $73,847 $67,515
======== ======== ======== ======= =======
Charge-offs, net of recoveries to average total
loans......................................... .285% .300% .184% .193% .159%
======== ======== ======== ======= =======
- ------------------
(1) The 1999 residential charge-offs include $7.0 million of charge-offs
incurred as part of accelerated dispositions of non-performing residential
loans sold during the second and fourth quarters of 1999.
(2) For 1999, acquired allowance relate entirely to Sovereign's June 1999
acquisition of Peoples Bancorp, Inc. For 1998, acquired allowance and other
additions include $20.5 million of loan loss allowance established in
connection with the CoreStates branch acquisition. For 1997, acquired
allowance and other additions represent $22.0 million of loan loss allowance
established as part of the Fleet Auto acquisition, partially off-set by net
charge-offs of $2.7 million related to First State for the three-month
period ended December 31, 1996 resulting from the differing fiscal year end
of First State.
Sovereign's policy for charging off loans varies with respect to the
category of loans and specific circumstances surrounding each loan under
consideration. Consumer loans are generally charged off when deemed to be
uncollectible or 120 days past due, whichever comes first. Charge-offs of
commercial loans and residential real estate mortgage loans are made on the
basis of management's ongoing evaluation of non-performing loans.
Other Income. Total other income was $130 million for 1999 compared to
$105 million for 1998. Several factors contributed to the increase in other
income as discussed below.
Retail banking fees were $49.2 million for 1999 compared to $31.1 million
for 1998. This increase was primarily due to an increase in the number of
Sovereign's transaction accounts and active fee collection efforts due in part
to customer relationships acquired in the CoreStates and Peoples' acquisitions.
Mortgage banking revenues were $29.9 million for 1999 compared to $28.2
million for 1998. At December 31, 1999, Sovereign serviced $10.2 billion of its
own loans and $5.7 billion of loans for others. This compares to $9.2 billion of
its own loans and $6.7 billion of loans for others at December 31, 1998.
Loan fees and service charges were $8.9 million for 1999 compared to $7.1
million for 1998. Loan fees and service charges relate primarily to Sovereign's
non-residential loan portfolios, and the growth period to period is the result
of growth in the commercial and consumer loan portfolios due to internal growth
and acquisitions.
15
Net gains on sales of loans and investment securities were $4.3 million for
1999 compared to $19.8 million for 1998, which included net investment security
gains of $3.7 million and $15.8 million, and net gains on sales of loans of $0.6
million and $4.0 million in 1999 and 1998, respectively. This decrease was in
part due to a net gain of $2.8 million resulting from the sale of Sovereign's
credit card portfolio during the second quarter of 1998, and gains on sales of
investment securities available-for-sale during 1998.
Income from bank-owned life insurance ("BOLI") was $22.8 million for 1999
compared to $12.6 million for 1998. This increase was primarily due to an
additional investment in BOLI, which was made during the first quarter of 1999.
General and Administrative Expenses. Total general and administrative
expenses were $393 million for 1999 compared to $327 million. Included in 1998
total general and administrative expenses were $49.9 million of merger-related
charges. The increase in general and administrative expenses for 1999 was
primarily due to Sovereign's overall franchise growth (including the full year
impact of the CoreStates branch acquisition completed September 4, 1998, and
inclusion of the Peoples acquisition from June 30, 1999), $30.8 million of
merger, integration and other charges related to Sovereign's recent and pending
acquisitions, and start-up costs related to the formation of Sovereign's Capital
Markets Group and 1stwebbankdirect.com during the fourth quarter of 1999. The
remaining increase in expenses are related to Sovereign's Year 2000 and other
technology initiatives, and expansion in its corporate banking business line
during the year. Included in 1998 total general and administrative expenses were
$49.9 million of merger-related charges. Sovereign's efficiency ratio (all
operating general and administrative expenses as a percentage of net interest
income and recurring non-interest income) for 1999 was 48.6% compared to 46.6%
for 1998.
Other Operating Expenses. Total other operating expenses were $53.5
million for 1999 compared to $32.3 million for 1998. Other operating expenses
included amortization of goodwill and other intangible assets of $38.0 million
for 1999 compared to $20.6 million for 1998, Trust Preferred Securities expense
of $15.4 million for 1999 compared to $12.5 million for 1998, and other net real
estate owned ("OREO") losses of $95,000 for 1999 compared to net OREO gains of
$804,000 for 1998. This increase in amortization expense for goodwill and other
intangible assets is due to Sovereign's September 1998 CoreStates branch
acquisition. Trust Preferred Securities expense increased due to the issuance of
additional securities in November.
Income Tax Provision. The income tax provision was $89.3 million for 1999
compared to $74.8 million for 1998. The effective tax rate for 1999 was 33.2%
compared to 35.4% for 1998. The effective tax rate for 1999 includes the effect
of Sovereign's increased investment in BOLI during the first quarter of 1999.
For additional information with respect to Sovereign's income taxes, see Note 15
in the "Notes to Consolidated Financial Statements" hereof.
FINANCIAL CONDITION
Loan Portfolio. Sovereign's loan portfolio at December 31, 1999 was $14.2
billion compared to $11.3 billion at December 31, 1998. Sovereign's loan
portfolio has increased as a result of strong originations during the year.
With its increased focus on non-residential lending and Sovereign's
acquisition activity over the past few years, at December 31, 1999, Sovereign's
total loan portfolio included $4.1 billion of commercial loans and $4.5 billion
of consumer loans, including $2.0 billion of outstanding home equity loans
secured primarily by second mortgages on owner-occupied one-to-four family
residential properties and $1.9 billion of auto loans. This compares to $2.3
billion of commercial loans and $3.8 billion of consumer loans, including $1.8
billion of outstanding home equity loans and $1.5 billion of auto loans, at
December 31, 1998. Additionally, at December 31, 1999, Sovereign has extended
$1.0 billion and $572 million of unused commitments for commercial loans and
home equity lines of credit, respectively. At December 31, 1999, Sovereign's
total loan portfolio included $5.6 billion of first mortgage loans secured
primarily by liens on owner-occupied one-to-four family residential properties
compared to $5.1 billion at December 31, 1998.
Over the past few years, Sovereign has increased its emphasis on commercial
and consumer loan originations evidenced by $3.2 billion of commercial loans
closed during 1999, compared to $1.3 billion of
16
commercial loans closed during 1998. This increase was due to strong business
loan demand in Sovereign's market area resulting from a strong regional economy,
recent bank mergers affecting the region, significant staffing increases in
Sovereign's commercial banking unit, and Sovereign's recent acquisitions.
Sovereign closed $2.3 billion of consumer loans during 1999 compared to
$2.0 billion of consumer loans for 1998. This increase was primarily the result
of home equity loan originations of approximately $492 million and indirect auto
loan originations of approximately $735 million during 1999.
Total production of first mortgage loans was $2.9 billion in 1999 of which
$1.6 billion were fixed rate and sold in the secondary market. This compares to
first mortgage loan closings of $2.1 billion and $1.9 billion of fixed rate
loans sold for 1998.
Table 4 presents the composition of Sovereign's loan portfolio by type of
loan and by fixed and variable rates at the dates indicated (in thousands):
TABLE 4: COMPOSITION OF LOAN PORTFOLIO
AT DECEMBER 31,
--------------------------------------------------------------------------------------------
1999 1998 1997 1996
--------------------- --------------------- --------------------- --------------------
BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT
----------- ------- ----------- ------- ----------- ------- ---------- -------
Residential real
estate loans........ $ 5,623,295 39.5% $ 5,113,537 45.3% $ 6,634,271 58.6% $7,381,820 76.9%
Residential
construction
loans............... 59,264 .4 62,536 .6 137,367 1.2 136,436 1.4
----------- ----- ----------- ----- ----------- ----- ---------- -----
Total Residential
Loans............. 5,682,559 39.9 5,176,073 45.9 6,771,638 59.8 7,518,256 78.3
----------- ----- ----------- ----- ----------- ----- ---------- -----
Commercial real
estate loans........ 1,516,953 10.7 887,938 7.9 664,943 5.9 511,071 5.3
Commercial loans..... 1,690,744 11.8 717,440 6.4 356,517 3.1 262,840 2.7
Automotive floor plan
loans............... 730,623 5.2 578,147 5.1 279,757 2.5 -- --
Multi-family loans... 137,019 1.0 115,195 1.0 115,570 1.0 109,774 1.2
----------- ----- ----------- ----- ----------- ----- ---------- -----
Total Commercial
Loans............. 4,075,339 28.7 2,298,720 20.4 1,416,787 12.5 883,685 9.2
----------- ----- ----------- ----- ----------- ----- ---------- -----
Home equity loans.... 1,957,945 13.8 1,750,883 15.5 1,050,304 9.3 800,559 8.3
Auto loans........... 1,936,980 13.6 1,510,676 13.4 1,553,318 13.7 73,393 .8
Loans to automotive
lessors............. 288,636 2.0 252,856 2.2 267,033 2.3 -- --
Student loans........ 249,279 1.8 256,744 2.3 190,440 1.7 211,358 2.2
Credit cards......... -- -- -- -- 54,887 .5 82,798 .9
Other................ 35,802 .2 39,888 .3 19,715 .2 25,446 .3
----------- ----- ----------- ----- ----------- ----- ---------- -----
Total Consumer
Loans............. 4,468,642 31.4 3,811,047 33.7 3,135,697 27.7 1,193,554 12.5
----------- ----- ----------- ----- ----------- ----- ---------- -----
Total Loans......... $14,226,540 100.0% $11,285,840 100.0% $11,324,122 100.0% $9,595,495 100.0%
=========== ===== =========== ===== =========== ===== ========== =====
Total Loans with:(1)
Fixed rates......... $ 8,707,951 61.2 $ 5,798,158 51.4% $ 4,548,951 40.2% $2,180,356 22.7%
Variable rates...... 5,518,589 38.8 5,487,682 48.6 6,775,171 59.8 7,415,139 77.3
----------- ----- ----------- ----- ----------- ----- ---------- -----
Total Loans....... $14,226,540 100.0% $11,285,840 100.0% $11,324,122 100.0% $9,595,495 100.0%
=========== ===== =========== ===== =========== ===== ========== =====
AT DECEMBER 31,
--------------------
1995
--------------------
BALANCE PERCENT
---------- -------
Residential real
estate loans........ $6,059,064 79.8%
Residential
construction
loans............... 116,110 1.6
---------- -----
Total Residential
Loans............. 6,175,174 81.4
---------- -----
Commercial real
estate loans........ 358,334 4.7
Commercial loans..... 166,712 2.2
Automotive floor plan
loans............... -- --
Multi-family loans... 130,819 1.7
---------- -----
Total Commercial
Loans............. 655,865 8.6
---------- -----
Home equity loans.... 648,033 8.5
Auto loans........... 14,267 .2
Loans to automotive
lessors............. -- --
Student loans........ 14,232 .2
Credit cards......... 32,274 .4
Other................ 51,262 .7
---------- -----
Total Consumer
Loans............. 760,068 10.0
---------- -----
Total Loans......... $7,591,107 100.0%
========== =====
Total Loans with:(1)
Fixed rates......... $1,896,384 25.0%
Variable rates...... 5,694,723 75.0
---------- -----
Total Loans....... $7,591,107 100.0%
========== =====
- ------------------
(1) Loan totals do not reflect the impact of off-balance sheet interest rate
swaps used for interest rate risk management as discussed in "Management's
Discussion and Analysis--Asset and Liability Management."
17
Table 5 presents the contractual maturity of Sovereign's commercial loans
at December 31, 1999 (in thousands):
TABLE 5: LOAN MATURITY SCHEDULE
AT DECEMBER 31, 1999, MATURING
------------------------------------------------------
IN ONE YEAR AFTER ONE YEAR AFTER
OR LESS FIVE YEARS FIVE YEARS TOTAL
----------- -------------- ---------- ----------
Commercial real estate loans................ $164,561 $ 491,530 $ 860,862 $1,516,953
Commercial loans............................ 656,954 582,022 451,768 1,690,744
Automotive floor plans loans................ 129,596 509,191 91,836 730,623
Multi-family loans.......................... 1,571 35,345 100,103 137,019
-------- ---------- ---------- ----------
Total..................................... $952,682 $1,618,088 $1,504,569 $4,075,339
======== ========== ========== ==========
Loans with:
Fixed rates............................... $327,493 $ 880,465 $ 935,920 $2,143,878
Variable rates............................ 625,189 737,623 568,649 1,931,461
-------- ---------- ---------- ----------
Total.................................. $952,682 $1,618,088 $1,504,569 $4,075,339
======== ========== ========== ==========
Sovereign's recent strategic acquisitions, coupled with expanded
origination capacity, accelerated Sovereign's transition in becoming a Super
Community Bank by increasing consumer and commercial loans to 60% of total loans
in 1999, up from 54% in 1998. Commercial loan credit quality remains strong and
the commercial loan division's growing portfolio is regularly examined for
quality by an experienced internal credit review team. Larger commercial loans
are allocated loan loss allowance based upon individual asset risk assessments.
Credit Risk Management. Extending credit exposes Sovereign to credit risk,
which is the risk that the principal balance of a loan and any related interest
will not be collected due to the inability of the borrower to repay the loan.
Sovereign manages credit risk in the loan portfolio through adherence to
consistent standards, guidelines and limitations established by the Board of
Directors. Written loan policies establish underwriting standards, lending
limits and other standards or limits as deemed necessary and prudent. Various
approval levels, based on the amount of the loan and whether the loan is secured
or unsecured, have also been established. Loan approval authority ranges from
the individual loan officer to the Board of Directors' Loan Committee.
The Loan Review group conducts ongoing, independent reviews of the lending
process to ensure adherence to established policies and procedures, monitors
compliance with applicable laws and regulations, provides objective measurement
of the risk inherent in the loan portfolio, and ensures that proper
documentation exists. The results of these periodic reviews are reported to the
Asset Review Committee, and to the Board of Directors of both Sovereign and
Sovereign Bank. In response to Sovereign's increased emphasis on commercial and
consumer lending, Sovereign has added to its loan review group by hiring loan
review officers with significant commercial and consumer experience. Sovereign
also maintains a watch list for certain loans identified as requiring a higher
level of monitoring by management because of one or more factors, such as
economic conditions, industry trends, nature of collateral, collateral margin,
payment history, or other factors.
The following discussion summarizes the underwriting policies and
procedures for the major categories within the loan portfolio and address
Sovereign's strategies for managing the related credit risk.
Commercial Loans. Credit risk associated with commercial loans is
primarily influenced by prevailing and expected economic conditions and the
level of underwriting risk Sovereign is willing to assume. To manage credit risk
when extending commercial credit, Sovereign focuses on both assessing the
borrower's ability to repay and on obtaining sufficient collateral. Commercial
and industrial loans are generally secured by the borrower's assets and by
personal guarantees. Commercial Real Estate loans are originated primarily
within the Pennsylvania, New Jersey, and New England market areas and are
secured by developed real
18
estate at conservative loan-to-values and often by a guarantee of the borrower.
Management closely monitors the composition and quality of the total commercial
loan portfolio to ensure that significant credit concentrations by borrower or
industry do not exist.
Consumer Loans. Credit risk in the direct consumer loan portfolio is
controlled by strict adherence to conservative underwriting standards that
consider debt to income levels and the creditworthiness of the borrower and, if
secured, collateral values. In the home equity loan portfolio, combined
loan-to-value ratios are generally limited to 80% or credit insurance is
purchased to limit exposure. Other credit considerations may warrant higher
combined loan-to-value ratios for approved loans. The portion of the consumer
portfolio which is secured by real estate, vehicles, deposit accounts or
government guarantees comprises 93% of the entire portfolio.
Residential Loans. Sovereign originates fixed rate and adjustable rate
residential mortgage loans which are secured by the underlying 1-4 family
residential property. At December 31, 1999 and 1998, residential loans accounted
for 40% and 46% respectively, of the total loan portfolio. This decrease was the
outcome of Sovereign's increased emphasis on commercial and consumer lending.
Credit risk exposure in this area of lending is minimized by the evaluation of
the creditworthiness of the borrower, including debt-to-equity ratios, credit
scores, and adherence to underwriting policies that emphasize conservative
loan-to-value ratios of generally no more than 80%. Residential mortgage loans
granted in excess of the 80% loan-to-value ratio criterion are generally insured
by private mortgage insurance, unless otherwise guaranteed or insured by the
Federal, state or local government. Sovereign also utilizes underwriting
standards which comply with those of the Federal Home Loan Mortgage Corporation
("FHLMC") or the Federal National Mortgage Association ("FNMA"). Credit risk is
further reduced since a portion of Sovereign's fixed rate mortgage loan
production and all of its sub-prime mortgage loan production is sold to
investors in the secondary market without recourse.
Collections. Sovereign closely monitors delinquencies as another means of
maintaining high asset quality. Collection efforts begin within 15 days after a
loan payment is missed by attempting to contact all borrowers and to offer a
variety of loss mitigation alternatives. If these attempts fail, Sovereign will
proceed to gain control of any and all collateral in a timely manner in order to
minimize losses. While liquidation and recovery efforts continue, officers
continue to work with the borrowers, if appropriate, to recover all monies owed
to Sovereign. Sovereign monitors delinquency trends at 30, 60, and 90 days past
due. These trends are discussed at the monthly Committee meetings. Minutes from
these meetings are submitted to the Board of Directors of Sovereign Bank.
Approximately $168 million, or 1.18%, of the loans in the loan portfolio at
December 31, 1999, were 30 to 89 days delinquent, compared to $231 million, or
2.05% of portfolio loans, at December 31, 1998. Sovereign also maintains a watch
list for loans identified as requiring a higher level of monitoring by
management because of one or more factors, such as economic conditions, industry
trends, nature of collateral, collateral margin, payment history or other
factors.
Non-Performing Assets. At December 31, 1999, Sovereign's non-performing
assets were $84 million compared to $116 million at December 31, 1998.
Non-performing assets as a percentage of total assets was .32% at December 31,
1999 compared to .53% at December 31, 1998. This decrease, both in dollars and
as a percent of total assets, is a result in part of the aforementioned
non-performing asset sales in the second and fourth quarters of 1999 and an
active non-performing loan management program. At December 31, 1999, 47% of
non-performing assets consisted of loans related to real estate or OREO. Another
4% of non-performing assets consist of indirect auto loans and other repossessed
assets. Indirect auto loans delinquent in excess of 120 days carry an allowance
allocation of 100%. Repossessed autos carry an allowance allocation of 50%. The
remainder of Sovereign's non-performing assets consist principally of consumer
loans, many of which are secured by collateral. Sovereign places all loans 90
days or more delinquent (except auto loans and loans guaranteed by the
government or secured by deposit accounts) on non-performing status. Sovereign's
auto loans continue to accrue interest until they are 120 days delinquent, at
which time they are placed on non-accrual status and a 100% allowance allocation
is assigned.
19
Table 6 presents the composition of non-performing assets at the dates
indicated (in thousands):
TABLE 6: NON-PERFORMING ASSETS
AT DECEMBER 31,
---------------------------------------------------
1999 1998 1997 1996 1995
------- -------- -------- -------- --------
Non-accrual loans:
Past due 90 days or more as to interest or
principal:
Real estate related............................. $36,510 $ 63,258 $ 65,930 $ 78,715 $81,571
Other........................................... 36,923 33,297 22,368 19,671 11,721
Past due less than 90 days as to interest or
principal:
Real estate related............................. -- -- 555 639 3,884
Other........................................... -- -- -- 160 739
------- -------- -------- -------- --------
Total non-accrual loans............................. 73,433 96,555 88,853 99,185 97,915
Other............................................... 1,978 3,404 6,524 -- --
Restructured loans.................................. 3,755 141 327 1,561 3,772
------- -------- -------- -------- --------
Total non-performing loans.......................... 79,166 100,100 95,704 100,746 101,687
Other real estate owned and other repossessed
assets:
Residential real estate owned..................... 2,344 12,147 11,299 13,669 9,988
Commercial real estate owned...................... 1,223 665 710 4,380 11,676
Other repossessed assets.......................... 1,762 2,772 -- -- --
------- -------- -------- -------- --------
Total other real estate owned and other repossessed
assets............................................ 5,329 15,584 12,009 18,049 21,664
------- -------- -------- -------- --------
Total non-performing assets......................... $84,495 $115,684 $107,713 $118,795 $123,351
======= ======== ======== ======== ========
Past due 90 days or more as to interest or principal
and accruing interest(1).......................... $10,238 $ 9,975 $ 7,053 $ 16,722 $ 2,299
Non-performing assets as a percentage of total
assets............................................ .32% .53% .61% .78% .94%
Non-performing loans as a percentage of total
loans............................................. .56 .89 .85 1.05 1.34
Non-performing assets as a percentage of total loans
and other real estate owned....................... .65 1.08 1.01 1.41 1.65
Allowance for loan losses as a percentage of total
non-performing assets............................. 152.4 111.5 103.7 58.5 53.5
Allowance for loan losses as a percentage of total
non-performing loans.............................. 162.7 128.9 116.7 69.0 65.0
- ------------------
(1) Non-performing assets past due 90 days or more as to interest or principal
and accruing interest include government guaranteed student loans of $8.3
million, $6.6 million, $6.7 million and $10.5 million at December 31, 1999,
1998, 1997, and 1996 respectively, and also included are auto loans past due
between 90 and 120 days of $1.9 million, and $3.4 million at December 31,
1999 and 1998, respectively.
Impaired Loans. At December 31, 1999 and 1998, the gross recorded
investment in impaired loans totaled $108 million and $63.3 million,
respectively. The increase in the investment in impaired loans at December 31,
1999 compared to December 31, 1998 was primarily the result of Sovereign's
recent balance sheet transformation strategy which places more emphasis on
building the commercial and consumer loan portfolios. Along with higher yields,
these loan types also bring greater risk of impairment, especially as the
portfolio becomes more seasoned. Sovereign classifies all commercial loans that
are greater than 90 days delinquent on non-accrual status, and classifies
certain criticized loans as impaired. Impaired loans includes a significant
portion of potential problem loans discussed in a following paragraph. These are
primarily commercial loans that have been classified internally but are not
necessarily 90 days delinquent.
Gross interest income for the years ended December 31, 1999, 1998 and 1997
would have increased by approximately $5.0 million, $9.5 million and $7.5
million, respectively, had Sovereign's period end non-accruing and restructured
loans been current in accordance with their original terms and outstanding
throughout the period. Interest income recorded on these loans for the years
ended December 31, 1999, 1998, and 1997 was $2.1 million, $3.3 million and $2.4
million, respectively.
20
Potential problem loans (consisting of loans for which management has
doubts as to the ability of such borrowers to comply with present repayment
terms, although not currently classified as non-performing loans) amounted to
approximately $95.9 million at December 31, 1999 and consisted principally of
commercial loans.
Allowance for Loan Loss. The adequacy of Sovereign's allowance for loan
losses is regularly evaluated. Management's evaluation of the adequacy of the
allowance to absorb potential loan losses takes into consideration the risks
inherent in the loan portfolio, past loan loss experience, specific loans which
have loss potential, geographic and industry concentrations, delinquency trends,
economic conditions, the level of originations and other relevant factors.
Management also considers loan quality, changes in the size and character of the
loan portfolio, consultation with regulatory authorities, amount of
non-performing loans, delinquency trends, economic conditions and industry
trends when determining the allowance. At December 31, 1999, Sovereign's loan
delinquencies (all loans greater than 30 days delinquent) as a percentage of
total loans was 1.79% compared to 2.95% at December 31, 1998. This decrease was
primarily attributable to Sovereign's business decision to accelerate the
disposition of certain non-performing residential mortgage loans, as well as
improved collections efforts for its loan portfolio. Overall, management
believes delinquencies, charge-offs and non-performing statistics are improved
compared to previous years because of changes in Sovereign's underwriting and
credit monitoring process during 1999, and the fact in the current year versus
prior year, a larger percentage of Sovereign's loan portfolio (primarily
indirect and commercial loans) represents internally generated loans that were
underwritten using Sovereign's own underwriting policy. At December 31, 1998,
Sovereign's loan portfolio was 46% residential, 34% consumer and 20% commercial.
At December 31, 1999, Sovereign's loan portfolio was 40% residential, 31%
consumer and 29% commercial. Along with higher yields, management believes this
shift in loan composition brings higher inherent risk.
Table 7 summarizes Sovereign's allocation of the allowance for loan losses
for allocated and unallocated allowances by loan type, and the percentage of
each loan type of total portfolio loans (in thousands):
TABLE 7: ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
AT DECEMBER 31,
------------------------------------------------------------------------------------
1999 1998 1997 1996
------------------- ------------------- ------------------- ------------------
% OF % OF % OF % OF
LOANS TO LOANS TO LOANS TO LOANS TO
TOTAL TOTAL TOTAL TOTAL
AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
-------- -------- -------- -------- -------- -------- ------- --------
Allocated allowances:
Commercial loans............. $ 58,784 29% $ 38,354 20% $ 30,793 12% $21,091 9%
Residential real estate
mortgage loans............. 19,535 40 22,427 46 36,351 60 25,835 78
Consumer loans............... 43,455 31 48,083 34 24,300 28 10,274 13
Unallocated allowances......... 11,212 n/a 24,938 n/a 25,379 n/a 16,647 n/a
-------- -------- -------- -------
Total allowance for loan
losses....................... $132,986 100% $133,802 100% $116,823 100% $73,847 100%
======== === ======== === ======== === ======= ===
AT DECEMBER 31,
------------------
1995
------------------
% OF
LOANS TO
TOTAL
AMOUNT LOANS
------- --------
Allocated allowances:
Commercial loans............. $13,753 9%
Residential real estate
mortgage loans............. 23,968 81
Consumer loans............... 6,748 10
Unallocated allowances......... 23,046 n/a
-------
Total allowance for loan
losses....................... $67,515 100%
======= ===
Sovereign maintains an allowance for loan losses sufficient to absorb
inherent losses in the loan portfolio. As discussed in Credit Management,
Sovereign believes the current allowance to be at a level adequate to cover such
inherent losses. At December 31, 1999, the Company's total allowance was $133.0
million.
The Company's total allowance at year-end equated to approximately 3.2
times the average charge-offs for the last three years and 4.5 times the average
net charge-offs for the same three-year period. Because historical charge-offs
are not necessarily indicative of future charge-off levels, the Company also
gives consideration to other risk indicators when determining the appropriate
allowance level.
The allowance for loan losses consists of two elements: (i) an allocated
allowance, which is comprised of allowances established on specific loans, and
class allowances based on historical loan loss experience and current trends,
and (ii) unallocated allowances based on both general economic conditions and
other risk
21
factors in the Company's individual markets and portfolios, and to account for a
level of imprecision in management's estimation process.
The specific allowance element of the allocated allowance is based on a
regular analysis of criticized loans where internal credit ratings are below a
predetermined classification. This analysis is performed at the relationship
manager level, and periodically reviewed by the loan review department. The
specific allowance established for these criticized loans is based on a careful
analysis of related collateral value, cash flow considerations and, if
applicable, guarantor capacity.
The class allowance element of the allocated allowance is determined by an
internal loan grading process in conjunction with associated allowance factors.
These class allowance factors are updated annually and are based primarily on
actual historical loss experience, consultation with regulatory authorities, and
peer groups loss experience. While this analysis is conducted annually, the
Company has the ability to revise the class allowance factors whenever necessary
in order to address improving or deteriorating credit quality trends or specific
risks associated with a given loan pool classification.
Regardless of the extent of the Company analysis of customer performance,
portfolio evaluations, trends or risk management processes established, certain
inherent, but undetected losses are probable within the loan portfolio. This is
due to several factors including inherent delays in obtaining information
regarding a customer's financial condition or changes in their unique business
conditions; the judgmental nature of individual loan evaluations, collateral
assessments and the interpretation of economic trends; volatility of economic or
customer-specific conditions affecting the identification and estimation of
losses for larger non-homogeneous credits; and the sensitivity of assumptions
utilized to establish allocated allowances for homogeneous groups of loans among
other factors. The Company maintains an unallocated allowance to recognize the
existence of these exposures. These other risk factors are continuously reviewed
and revised by management where conditions indicate that the estimates initially
applied are different from actual results.
A comprehensive analysis of the allowance for loan losses is performed by
the Company on a quarterly basis. In addition, a review of allowance levels
based on nationally published statistics is conducted on an annual basis. The
Company has an Asset Review Committee, which has the responsibility of affirming
allowance methodology and assessing the general and specific allowance factors
in relation to estimated and actual net charge-off trends. This Committee is
also responsible for assessing the appropriateness of the allowance for loan
losses for each loan pool classification at Sovereign.
Residential Portfolio. The allowance for the residential mortgage
portfolio decreased from $22.4 million at December 31, 1998 to $19.5 million at
December 31, 1999. The decrease was due primarily to the aforementioned sale of
the non-performing loan portfolio during 1999, which enhanced the overall
performance of the remaining portfolio.
Consumer Portfolio. The allowance for the consumer loan portfolio
decreased from $48.1 million at December 31, 1998 to $43.5 million at December
31, 1999, and is due to management's continual assessment of the credit quality
of the consumer portfolio. Specifically, during 1999, the Company enhanced its
underwriting and credit monitoring processes related to its indirect auto
portfolio, which has resulted in a decrease in delinquencies outstanding to
2.23% of the December 31, 1999 portfolio from 4.95% of the December 31, 1998
portfolio. Charge-offs related to the indirect portfolio were .90% of the
portfolio, down from 1.69% in 1998. Additionally, as acquired consumer
portfolios continued to season and were exposed to Sovereign's credit monitoring
and collection processes, Sovereign could accurately monitor loss statistics and
the Company determined that the general reserve factors associated with such
portfolios could be reduced.
Commercial Portfolio. The portion of the allowance for loan losses related
to the Commercial portfolio has increased $20.4 million, or 35%, to $58.8
million at December 31, 1999. This increase is primarily attributable to the
significant growth in the commercial loan portfolio.
22
Unallocated Allowance. The decrease in the unallocated allowance versus
the prior year is related to the Company's ability to reallocate the unallocated
allowance to the various portfolios as a result of management's enhancement of
its credit analysis, and favorable delinquency and non-performing statistics.
Investment Securities. Sovereign's investment portfolio is concentrated in
mortgage-backed securities and collateralized mortgage obligations issued by
federal agencies or private label issues. The private label issues have ratings
of "AAA" by Standard and Poor's and Fitch at the date of issuance. The classes
are backed by single-family residential loans which are primary residences
geographically dispersed throughout the United States. Sovereign purchases
classes which are senior positions backed by subordinate classes. The
subordinate classes absorb the losses and must be completely eliminated before
any losses flow through the senior positions. Sovereign's strategy is to
purchase classes which have an average life of four years or less. The effective
duration of the total investment portfolio at December 31, 1999 was 3.6 years.
Investment Securities Available-for-Sale. Securities expected to be held
for an indefinite period of time are classified as available-for-sale and are
carried at fair value, with unrealized gains and losses reported as a separate
component of stockholders' equity, net of estimated income taxes. Decisions to
purchase or sell these securities are based on economic conditions including
changes in interest rates, liquidity, and asset/liability management strategies.
For additional information with respect to the amortized cost and estimated fair
value of Sovereign's investment securities available-for-sale, see Note 4 in the
"Notes to Consolidated Financial Statements" hereof.
The actual maturities of mortgage-backed securities available-for-sale will
differ from contractual maturities because borrowers may have the right to put
or repay obligations with or without put or prepayment penalties.
Table 8 presents the book value, expected maturities and yields of
Sovereign's investment securities available-for-sale at December 31, 1999 (in
thousands):
TABLE 8: INVESTMENT AND MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE
AT DECEMBER 31, 1999, DUE
-----------------------------------------------------------------------------
AFTER 10
IN ONE YEAR ONE YEAR/ FIVE YEARS/ YEARS/
OR LESS FIVE YEARS TEN YEARS NO MATURITY TOTAL
----------- ---------- ----------- ----------- ----------
Investment Securities:
U.S. Treasury and government agency
securities....................... $ 34,812 $ 41,209 $ -- $ -- $ 76,021
5.18% 5.12% 5.15%
Corporate securities............... -- -- 36,597 193,737 230,334
7.76% 8.47% 8.36%
Asset-backed securities............ 137,309 365,421 122,888 38,506 664,124
6.85% 6.84% 6.90% 6.45% 6.83%
Equities........................... -- -- -- 20,753 20,753
2.66% 2.66%
FHLB stock......................... -- -- -- 524,397 524,397
6.50% 6.50%
Agency preferred stock............. -- -- -- 429,628 429,628
7.88% 7.88%
Municipal securities............... -- 715 1,520 29,944 32,179
4.87% 5.33% 5.07% 5.08%
Mortgage-backed Securities:
U.S. government agency
passthroughs..................... 33,135 186,642 102,696 135,894 458,367
7.16% 7.01% 6.85% 6.75% 6.91%
Non-agency passthroughs............ 205,943 1,263,993 563,193 522,854 2,555,983
6.83% 6.81% 6.78% 6.75% 6.79%
Collateralized mortgage
obligations...................... 281,309 1,625,889 637,457 493,771 3,038,426
6.58% 6.58% 6.60% 6.58% 6.58%
-------- ---------- ---------- ---------- ----------
Total investment and mortgage-backed
securities available-for-sale...... $692,508 $3,483,869 $1,464,351 $2,389,484 $8,030,212
======== ========== ========== ========== ==========
Weighted average yield............... 6.67% 6.70% 6.74% 6.94% 6.77%
======== ========== ========== ========== ==========
23
Investment Securities Held-to-Maturity. Securities that Sovereign has the
intent and ability to hold to maturity are classified as held-to-maturity and
reported at amortized cost. This portfolio is primarily comprised of U.S.
Treasury and government agency securities; corporate debt securities;
mortgage-backed securities issued by FHLMC, FNMA, the Government National
Mortgage Association ("GNMA"), and private issuers; and collateralized mortgage
obligations. For additional information with respect to the amortized cost and
estimated fair value of Sovereign's investment securities held-to-maturity, see
Note 4 in the "Notes to Consolidated Financial Statements" hereof.
The actual maturities of the mortgage-backed securities held-to-maturity
will differ from contractual maturities because borrowers may have the right to
call or repay obligations with or without call or prepayment penalties.
Table 9 presents the book value, expected maturity and yields of
Sovereign's investment securities held-to-maturity at December 31, 1999 (in
thousands):
TABLE 9: INVESTMENT AND MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY
AT DECEMBER 31, 1999, DUE
---------------------------------------------------------------------------
IN ONE YEAR ONE YEAR/ FIVE YEARS/ AFTER
OR LESS FIVE YEARS TEN YEARS TEN YEARS TOTAL
----------- ---------- ----------- --------- ----------
Investment Securities:
U.S. Treasury and government agency
securities......................... $ 1,137 $ 2,968 $ 509 $ 193 $ 4,807
6.22% 6.91% 6.70% 6.94% 6.73%
Corporate securities(1).............. 1,289,567 2,503 32,783 1,974 1,326,827
6.02% 8.99% 10.25% 10.25% 6.14%
Municipal securities................. 646 1,861 426 342 3,275
3.69% 5.06% 6.22% 6.80% 5.12%
Mortgage-backed Securities:
U.S. government agency
passthroughs....................... 105,734 273,405 79,441 41,286 499,866
7.28% 7.29% 7.32% 7.36% 7.30%
Non-agency passthroughs.............. 14,558 31,893 5,117 751 52,319
6.00% 6.12% 6.37% 6.74% 6.12%
Collateralized mortgage
obligations........................ 136,621 265,168 48,158 25,010 474,957
6.45% 6.71% 6.56% 6.74% 6.62%
---------- -------- -------- ------- ----------
Total investment and mortgage-backed
securities held-to-maturity.......... $1,548,263 $577,798 $166,434 $69,556 $2,362,051
========== ======== ======== ======= ==========
Weighted Average Yield................. 6.14% 6.96% 7.64% 7.21% 6.48%
========== ======== ======== ======= ==========
- ------------------
(1) Corporate securities maturing in one year or less represents commercial
paper obligations held in escrow pending completion of the Sovereign Bank
New England acquisition. See LIQUIDITY AND CAPITAL RESOURCES for a more
complete discussion of the financings completed to fund the acquisition and
the escrow requirements of certain of the agreements.
Table 10 presents the book value of investment securities by obligation
(dollars in thousands):
TABLE 10: INVESTMENT SECURITIES BY OBLIGOR
AT DECEMBER 31,
------------------------------------
1999 1998 1997
---------- ---------- ----------
Investment securities available-for-sale:
U.S. Treasury and government agency securities........... $ 964,016 $ 660,649 $ 932,126
State and municipal securities........................... 32,179 35,046 --
Other securities......................................... 7,034,017 5,966,732 1,024,136
---------- ---------- ----------
Total investment securities available-for-sale........... $8,030,212 $6,662,427 $1,956,262
========== ========== ==========
Investment securities held-to-maturity:
U.S. Treasury and government agency securities........... $ 504,673 $ 732,754 $1,090,677
State and municipal securities........................... 3,275 8,064 2,302
Other securities......................................... 1,854,103 1,098,837 2,323,472
---------- ---------- ----------
Total investment securities held-to-maturity............. $2,362,051 $1,839,655 $3,416,451
========== ========== ==========
24
Table 11 presents the securities of single issuers (other than obligations
of the United States and its political subdivisions, agencies and corporations)
having an aggregate book value in excess of 10% of Sovereign's stockholders'
equity which were held by Sovereign at December 31, 1999 (in thousands):
TABLE 11: INVESTMENT SECURITIES OF SINGLE ISSUERS
AT DECEMBER 31, 1999
------------------------------
AMORTIZED COST FAIR VALUE
-------------- ----------
Cendant Mortgage............................................ $ 487,580 $ 478,740
CMSI........................................................ 242,859 236,486
Countrywide Home Loans, Inc................................. 617,291 590,863
First Nationwide Trust...................................... 282,217 264,059
G.E. Capital Mortgage Servicing, Inc........................ 853,456 822,066
Norwest Asset Securities Corporation........................ 846,824 799,073
PNC Mortgage Securities Corporation......................... 1,172,930 1,113,071
Residential Asset Securitization Trust...................... 345,923 332,828
Residential Funding Corporation............................. 855,186 828,141
Structured Asset Securities Corporation..................... 429,064 405,685
---------- ----------
Total..................................................... $6,133,330 $5,871,012
========== ==========
Other Assets. At December 31, 1999, premises and equipment, net of
accumulated depreciation, was $119 million compared to $98.5 million at December
31, 1998. This increase was primarily attributable to Sovereign's acquisitions
of Peoples and Network during the second quarter of 1999. Total goodwill and
other intangible assets at December 31, 1999 were $434 million compared to $426
million at December 31, 1998. This increase was also attributable to Sovereign's
acquisitions of Peoples and Network, which added approximately $45 million of
goodwill and other intangibles to Sovereign's balance sheet. Sovereign's
increase in other assets during 1999 was primarily attributable to the purchase
of $150 million of BOLI during the year, and associated $23 million of earnings
on the entire $413 million BOLI portfolio.
Deposits. Deposits are attracted from within Sovereign's primary market
area through the offering of various deposit instruments including demand and
NOW accounts, money market accounts, savings accounts, certificates of deposit
and retirement savings plans. Total deposits at December 31, 1999 were $11.7
billion compared to $12.3 billion at December 31, 1998.
Table 12 presents the composition of Sovereign's deposits at the dates
indicated (in thousands):
TABLE 12: DEPOSIT PORTFOLIO COMPOSITION
AT DECEMBER 31,
-----------------------------------------------------------------------
1999 1998 1997
---------------------- ---------------------- ---------------------
% OF % OF % OF
BALANCE DEPOSITS BALANCE DEPOSITS BALANCE DEPOSITS
----------- -------- ----------- -------- ---------- --------
Demand deposit and NOW accounts....... $ 2,667,731 22.8% $ 2,385,686 19.4% $1,334,852 14.0%
Savings accounts...................... 2,142,708 18.3 2,295,448 18.6 1,900,334 20.0
Money market accounts................. 1,345,325 11.5 1,545,634 12.5 916,788 9.6
Retail certificates of deposit........ 4,708,057 40.2 5,172,196 42.0 4,673,467 49.1
----------- ----- ----------- ----- ---------- -----
Total retail deposits............... 10,863,821 92.8 11,398,964 92.5 8,825,441 92.7
Jumbo certificates of deposit......... 855,825 7.2 923,752 7.5 689,853 7.3
----------- ----- ----------- ----- ---------- -----
Total deposits...................... $11,719,646 100.0% $12,322,716 100.0% $9,515,294 100.0%
=========== ===== =========== ===== ========== =====
Borrowings. Sovereign utilizes borrowings as a source of funds for its
asset growth and its asset/liability management. Collateralized advances are
available from the Federal Home Loan Bank of Pittsburgh ("FHLB") provided
certain standards related to creditworthiness have been met. Another source of
funds for Sovereign is reverse repurchase agreements. Reverse repurchase
agreements are short-term obligations collateralized by investment securities.
25
Total borrowings at December 31, 1999 were $12.7 billion, of which $6.9
billion were short-term, compared to total borrowings of $7.9 billion, of which
$3.9 billion were short-term, at December 31, 1998. The increase in FHLB
advances is principally due to loan growth during the period being funded by
borrowings. The increase in other borrowings is due to $700 million senior notes
and $500 million senior secured credit facility, issued in November and
December, 1999, in anticipation of the acquisition of Sovereign Bank New
England. See the following Liquidity and Capital Resources section for a more
complete description of these debt instruments.
Table 13 presents information regarding Sovereign's borrowings at the dates
indicated (in thousands):
TABLE 13: BORROWINGS
AT DECEMBER 31,
--------------------------------------------------------------------------------------
1999 1998 1997
-------------------------- --------------------------- ---------------------------
WEIGHTED WEIGHTED WEIGHTED
BALANCE AVERAGE RATE BALANCE AVERAGE RATE BALANCE AVERAGE RATE
----------- ------------ ---------- -------------- ---------- --------------
Securities sold under
repurchase
agreements.......... $ 584,553 4.69% $ 655,540 5.46% $1,150,093 5.70%
FHLB advances......... 10,484,904 5.43 6,901,505 5.14 5,525,399 5.93
Other borrowings...... 1,593,681 10.74 345,194 8.19 189,442 5.90
----------- ----- ---------- ---- ---------- ----
Total borrowings.... $12,663,138 6.06% $7,902,239 5.30% $6,864,934 5.94%
=========== ===== ========== ==== ========== ====
Through the use of interest rate swaps, $200 million of the FHLB advances
at December 31, 1999 have been effectively converted from variable rate
obligations to fixed rate obligations. An additional $1.1 billion of borrowings
have been protected from upward repricing through the use of interest rate caps.
LIQUIDITY AND CAPITAL RESOURCES
Sovereign Bank is required under applicable federal regulations to maintain
specified levels of "liquid" investments in cash and U.S. Treasury securities
and other qualifying investments. Regulations currently in effect require
Sovereign Bank to maintain liquid assets of not less than 4% of its net
withdrawable accounts plus short-term borrowings. These levels are changed from
time to time by the Office of Thrift Supervision (OTS) to reflect economic
conditions. Sovereign Bank's liquidity ratio for December 1999 was 42.6%.
Sovereign's primary financing sources are deposits obtained in its own
market area and borrowings in the form of securities sold under repurchase
agreements and advances from the FHLB. While the majority of Sovereign's
certificate of deposit accounts are expected to mature within a one year period,
historically, the retention rate has been approximately 70%. If a significant
portion of maturing certificates would not renew at maturity, the impact on
Sovereign's operations and liquidity would be minimal due to cash flows produced
by Sovereign's investment portfolio which approximate $100 million per month.
Sovereign Bank can also borrow from the FHLB, subject to required
collateralization. Other sources of funds include operating activities,
repayments of principal on investment securities, repayment of principal on
loans and other investing activities. Sovereign also maintains strong
relationships with numerous investment banking firms, and has the ability to
access the capital markets through a variety of products and structures, should
liquidity or capital needs arise.
Sovereign raised $1.8 billion of debt and equity in November and December 1999,
to finance its pending acquisition of Sovereign Bank New England. Components of
these financings were as follows:
COMMON STOCK: 43.8 million shares of common stock were issued on November
15, 1999 resulting in net proceeds to Sovereign of $331.5 million.
26
PIERS UNITS: 5.75 million units of Trust Preferred Income Equity Redeemable
Securities (PIERS) on November 15, 1999, resulting in net proceeds to Sovereign
of $278.3 million, $91.5 million of which has been allocated to the value of the
warrants and is treated as original issue discount. The original issue discount
is accreted into Trust Preferred Securities expense over the life of the unit
resulting in an effective yield of 11.74%. Each PIERS unit consists of:
A preferred security issued by Sovereign Capital Trust II (the Trust),
having a stated liquidation amount of $50, representing an undivided
beneficial ownership interest in the Trust, which assets consist solely of
debentures issued by Sovereign. Distributions are payable quarterly
beginning February 15, 2000 at an annual rate of 7.5% of the stated
liquidation value; and
A warrant to purchase, subject to antidilution adjustments, 5.3355
shares of Sovereign common stock at any time prior to November 20, 2029.
SENIOR NOTES: $200 million of 10.25% notes due May 15, 2004, and $500
million of 10.5% notes due November 15, 2006, on November 15, 1999 resulting in
net proceeds to Sovereign of $681.3 million. The senior notes are unsecured
senior obligations of Sovereign and rank equally with all existing and future
senior indebtedness.
SENIOR SECURED CREDIT FACILITY: $500 million floating rate senior secured
credit facility resulting in net proceeds to Sovereign of $485.5 million on
December 16, 1999. The senior secured credit facility is secured primarily by
the stock of Sovereign Bank, which is wholly owned by Sovereign Bancorp. The
senior facility will mature on the date six months prior to the maturity date of
the 10.25% senior notes, but in no event later than June 30, 2003. The facility
amortizes in quarterly installments in the following annual percentages of
principal: 2000-5%, $25 million; 2001-15%, $75 million; 2002-40%, $200 million;
and 2003-40%, $200 million with mandatory prepayments occurring if Sovereign's
cash flow exceeds predetermined levels. Interest is calculated, at the option of
the borrower, at LIBOR plus 3.5%, or the sum of a) the highest of (i) lender's
base rate, (ii) .50% over lender's three month CD rate, or (iii) .50% over the
Federal Funds Effective Rate, plus b) 2.50%.
An amount sufficient to pay principal, premium and accrued interest of the
Senior Notes and the Senior Secured Credit Facility is presently being held in
escrow pending the completion of the final closing of the Sovereign Bank New
England transaction. If the final closing does not occur, the amount in escrow
plus accrued and unpaid interest will be refunded to investors. At December 31,
1999, investment securities held-to-maturity includes $1.3 billion of commercial
paper of commercial obligors as required under the escrow agreements.
On May 15, 1998, Sovereign redeemed all outstanding shares of its 6 1/4%
Cumulative Convertible Preferred Stock, Series B.
Cash and cash equivalents decreased $160 million for 1999. Net cash used by
operating activities was $23.6 million for 1999. Net cash used by investing
activities for 1999 was $3.6 billion consisting primarily of purchases of
mortgage-backed securities, partially offset by proceeds from sales, repayments
and maturities of investment securities and sales of loans. Net cash provided by
financing activities for 1999 was $3.5 billion which was primarily attributable
to an increase in long-term and short-term borrowings, offset somewhat by a
decrease in retail and jumbo certificates of deposit.
At December 31, 1999, Sovereign Bank was classified as well-capitalized and
was in compliance with all capital requirements. For a detailed discussion on
regulatory capital requirements, see Note 12 in the "Notes to Consolidated
Financial Statements" hereof. The following table sets forth the capital ratios
of Sovereign Bancorp and Sovereign Bank and the current regulatory requirements
at December 31, 1999:
WELL
SOVEREIGN SOVEREIGN MINIMUM CAPITALIZED
BANCORP(1) BANK REQUIREMENT REQUIREMENT
---------- --------- ----------- -----------
Tangible capital to tangible assets................ 6.28% 8.20% 2.00% None
Leverage (core) capital to tangible assets......... 7.52 8.20 3.00 5.00%
Leverage (core) capital to risk-adjusted assets.... 11.72 13.69 4.00 6.00
Risk-based capital to risk-adjusted assets......... 14.89 14.55 8.00 10.00
- ------------------
(1) OTS capital regulations do not apply to thrift holding companies. Sovereign
Bancorp ratios are computed using quarterly average tangible assets, which
is consistent with the method used by bank holding companies.
27
ASSET AND LIABILITY MANAGEMENT
The objective of Sovereign's asset and liability management is to identify,
measure and manage its interest rate risk in order to produce consistent
earnings that are not contingent upon favorable trends in interest rates.
Sovereign manages its assets and liabilities to attain a stable net interest
margin across a wide spectrum of interest rate environments. This is attained by
monitoring the levels of interest rates, the relationships between the rates
earned on assets and the rates paid on liabilities, the absolute amount of
assets and liabilities which reprice or mature over similar periods, off-balance
sheet positions and the effect of all these factors on the estimated level of
net interest income.
Sovereign measures interest rate risk utilizing three tools: net interest
income simulation analysis in multiple interest rate environments, instantaneous
parallel interest rate shocks and lastly, gap analysis, which is a schedule
measuring the difference between assets, liabilities and off-balance sheet
positions which will mature or reprice within specific terms. Income simulation
considers not only the impact of changing market interest rates on forecasted
net income, but also other factors, such as yield curve relationships, the
volume and mix of assets and liabilities, customer preferences and general
market conditions.
Sovereign manages the impact to net interest income in a +/- 200 basis
point instantaneous rate shock environment to be within a 10% variance.
Sovereign estimates that if interest rates decline by 200 basis points, net
interest income would decrease by $75.9 million, or 7.6%, for 1999 as compared
to $52.4 million, or 8.5%, for 1998. Conversely, if interest rates increase by
200 basis points, net interest income would decrease by $98.1 million, or 9.6%,
for 1999 as compared to $22.1 million, or 3.6%, for 1998.
Sovereign generally manages the one-year interest rate gap within a +/- 10%
range. A positive gap position implies that the bank is asset sensitive, which
could cause net interest income to decrease if interest rates fall. Conversely,
a negative gap position implies that the bank is liability sensitive, which
could cause net interest income to decrease if interest rates rise. Sovereign
estimates that the cumulative one-year gap position was a negative 17.8% and a
positive 5.7% at December 31, 1999 and 1998, respectively. The negative position
at December 31, 1999, is a result of positioning for the Sovereign Bank New
England acquisition in 2000.
Pursuant to its interest rate risk management strategy, Sovereign enters
into off-balance sheet transactions which involve interest rate exchange
agreements (swaps, caps and floors) for interest rate risk management purposes.
Sovereign's objective in managing its interest rate risk is to provide
sustainable levels of net interest income while limiting the impact that changes
in interest rates have on net interest income.
Interest rate swaps are generally used to convert fixed rate assets and
liabilities to variable rate assets and liabilities and vice versa. Sovereign
utilizes interest rate swaps that have a high degree of correlation to the
related financial instrument. At December 31, 1999, Sovereign's principal
off-balance sheet transactions were to convert liabilities from fixed rate to
floating rate to reduce the cost of funds.
Interest rate caps are generally used to limit the exposure from the
repricing and maturity of liabilities and interest rate floors are generally
used to limit the exposure from the repricing and maturity of assets. Interest
rate caps and floors are also used to limit the exposure created by other
interest rate swaps. In certain cases, interest rate caps and floors are
simultaneously bought and sold to create a range of protection against changing
interest rates while limiting the cost of that protection.
As part of its mortgage banking strategy, Sovereign originates fixed rate
residential mortgages. It sells the majority of these loans to FHLMC, FNMA and
private investors. The loans are exchanged for cash or marketable fixed rate
mortgage-backed securities which are generally sold. This helps insulate
Sovereign from the interest rate risk associated with these fixed rate assets.
Sovereign uses forward sales, cash sales and options on mortgage-backed
securities as a means of hedging loans in the mortgage pipeline which are
originated for sale.
Sovereign's primary funding source is deposits obtained in its own
marketplace. Deposit programs at Sovereign are priced to meet management's
asset/liability objectives, while taking into account the rates available on
lending opportunities and also considering the cost of alternative funding
sources. Borrowings are a significant funding source for Sovereign and have
primarily been in the form of securities sold under repurchase agreements and
advances from the FHLB. Since borrowings are not subject to the market
constraints to which deposits are, Sovereign uses borrowings to add flexibility
to its interest rate risk position.
28
Table 14 presents the amounts of interest-earning assets and
interest-bearing liabilities that are assumed to mature or reprice during the
periods indicated at December 31, 1999, and their related average yields and
costs. Adjustable and floating rate loans and securities are included in the
period in which interest rates are next scheduled to adjust rather than the
period in which they mature (in thousands):
TABLE 14: GAP ANALYSIS
AT DECEMBER 31, 1999 REPRICING
-----------------------------------------------------------------
0-3 4 MONTHS YEAR 2
MONTHS -1 YEAR & OVER TOTAL
------------ ------------ ------------ -----------
Interest-earning assets:
Investment securities(1)(2)............... $ 2,304,250 $ 860,211 $ 7,247,040 $10,411,501
6.17% 7.19% 7.10% 6.90%
Loans(3).................................... 3,842,973 3,488,219 6,957,273 14,288,465
8.34% 7.95% 7.77% 7.97%
------------ ------------ ------------ -----------
Total interest-earning assets............... 6,147,223 4,348,430 14,204,313 24,699,966
7.53% 7.80% 7.43% 7.52%
Non-interest-earning assets................. -- -- 1,907,146 1,907,146
------------ ------------ ------------ -----------
Total assets................................ $ 6,147,223 $ 4,348,430 $ 16,111,459 $26,607,112
7.53% 7.80% 6.55% 6.98%
Interest-bearing liabilities:
Deposits(4)............................... $ 3,873,342 $ 3,317,566 $ 4,528,738 $11,719,646
4.49% 4.72% 2.05% 3.61%
Borrowings.................................. 7,763,274 1,395,377 3,504,487 12,663,138
5.90% 5.31% 6.43% 5.98%
------------ ------------ ------------ -----------
Total interest-bearing liabilities.......... 11,636,616 4,712,943 8,033,225 24,382,784
5.43% 4.90% 3.95% 4.84%
Non-interest-bearing liabilities............ -- -- 402,833 402,833
Stockholders' equity........................ -- -- 1,821,495 1,821,495
------------ ------------ ------------ -----------
Total liabilities and stockholders'
equity.................................... $ 11,636,616 $ 4,712,943 $ 10,257,553 $26,607,112
5.43% 4.90% 3.08% 4.43%
------------ ------------ ------------ -----------
Excess assets (liabilities) before effect of
off-balance sheet positions............... $ (5,489,393) $ (364,513) $ 5,853,906
------------ ------------ ------------
To total assets......................... (20.63)% (1.37)% 22.00%
============ ============ ============
Cumulative excess assets (liabilities)
before effect of off-balance sheet
positions................................. $ (5,489,393) $ (5,853,906) $ --
============ ============ ============
To total assets......................... (20.63)% (22.00)%
Effect of off-balance sheet positions on
assets and liabilities.................... $ 1,047,700 $ 77,300 $ (1,125,000)
------------ ------------ ------------
Excess assets (liabilities) after effect of
off-balance sheet positions............... $ (4,441,693) $ (287,213) $ 4,728,906
============ ============ ============
To total assets......................... (16.69)% (1.08)% 17.77%
Cumulative excess assets (liabilities) after
off-balance sheet positions............... $ (4,441,693) $ (4,728,906) $ --
============ ============ ============
To total assets......................... (16.69)% (17.77)%
- ------------------
(1) Includes interest-earning deposits.
(2) Investment securities include market rate prepayment and repayment
assumptions.
(3) Loan balances include annual prepayment and repayment assumptions between 7%
and 35% initially with gradual slowing thereafter. Loan balances are
presented net of deferred loan fees and include loans held for sale and the
allowance for loan losses.
(4) Savings, NOW, money market and demand deposit accounts have been assumed to
decay at an annual rate of 14.6%.
29
Table 15 presents selected quarterly consolidated financial data (in
thousands, except per share data):
TABLE 15: SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA
THREE MONTHS ENDED
---------------------------------------------------------------------------------------
DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
1999 1999 1999 1999 1998 1998 1998 1998
-------- --------- -------- -------- -------- --------- -------- --------
Total interest income........... $445,902 $ 415,954 $377,444 $368,028 $357,631 $ 341,768 $331,860 $324,112
Total interest expense.......... 280,315 254,086 230,036 228,236 224,915 220,521 212,828 203,495
-------- --------- -------- -------- -------- --------- -------- --------
Net interest income............. 165,587 161,868 147,408 139,792 132,716 121,247 119,032 120,617
Provision for loan losses....... 7,500 7,500 7,500 7,500 7,000 7,001 7,200 6,760
-------- --------- -------- -------- -------- --------- -------- --------
Net interest income after
provision..................... 158,087 154,368 139,908 132,292 125,716 114,246 111,832 113,857
-------- --------- -------- -------- -------- --------- -------- --------
Gain on sale of loans and
investment securities......... (2,196) (299) 3,362 3,408 7,455 6,262 3,075 3,052
Other income.................... 31,993 35,250 29,928 28,896 24,421 19,484 22,118 19,314
Other expenses(1)............... 148,722 103,843 98,445 95,369 93,397 74,164 70,282 71,851
Merger-related charges(2)....... -- -- -- -- -- 10,860 -- 39,072
-------- --------- -------- -------- -------- --------- -------- --------
Income before income taxes...... 39,162 85,476 74,753 69,227 64,195 54,968 66,743 25,300
Income tax provision............ 9,939 29,488 25,974 23,914 20,524 20,178 23,849 10,200
-------- --------- -------- -------- -------- --------- -------- --------
Net income...................... $ 29,223 $ 55,988 $ 48,779 $ 45,313 $ 43,671 $ 34,790 $ 42,894 $ 15,100
======== ========= ======== ======== ======== ========= ======== ========
Net income before special
charges(1).................... $ 52,220 $ 55,988 $ 48,779 $ 45,313 $ 43,671 $ 42,781 $ 42,894 $ 40,941
======== ========= ======== ======== ======== ========= ======== ========
Net income applicable to common
stock......................... $ 52,220 $ 55,988 $ 48,779 $ 45,313 $ 43,671 $ 34,790 $ 42,894 $ 13,604
======== ========= ======== ======== ======== ========= ======== ========
Basic earnings per
share(3)(4)................... $ 0.14 $ 0.31 $ 0.31 $ 0.28 $ .27 $ .22 $ .29 $ .10
Diluted earnings per
share(3)(4)................... 0.14 0.31 0.30 0.28 .27 .22 .27 .09
Operating basic earnings per
share(3)(5)................... 0.29 0.31 0.31 0.28 .27 .27 .29 .27
Operating diluted earnings per
share(3)(5)................... 0.29 0.31 0.30 0.28 .27 .26 .27 .26
Market prices(3)
High.......................... 92 3/64 12 7/8 17 1/2 14 9/16 14 7/16 18 1/4 22 3/16 18 15/16
Low........................... 7 3/16 9 3/32 11 5/8 11 15/16 9 12 16 5/16 14 15/16
Dividends per common
share(3)(6)................... 0.024 0.027 0.026 0.021 .021 .020 .023 .020
- ------------------
(1) Other expenses for the quarter ended December 31, 1999 includes special
charges related to merger-related and other integration charges of $30.8
million. See "Reconciliation of Net Income to Operating Earnings" on page 19
of Management's Discussion and Analysis.
(2) Reflects merger charges of $10.9 million ($7.8 million after-tax) related to
the acquisitions of Carnegie and First Home during the three-month period
ended September 30, 1998. Reflects merger charges of $39.1 million ($25.5
million after-tax) related to the acquisition of ML Bancorp during the
three-month period ended March 31, 1998.
(3) All per share data have been adjusted to reflect all stock dividends and
stock splits.
(4) Results for the three-month periods ended September 30, 1998, and March 31,
1998 include the merger-related charges described in Note 1 above.
(5) Results for the three-month periods ended September 30, 1998, and March 31,
1998 exclude the merger-related charges described in Note 1 above.
(6) The higher dividend rate in prior periods is the result of acquisitions
which were accounted for as a pooling-of-interests.
30
Pending Accounting Pronouncements. In June 1999, The Financial Accounting
Standards Board ("FASB") issued SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities--Deferral of the Effective Date of FASB
Statement No. 133", which delays the effective date of SFAS No. 133.
Accordingly, SFAS No. 133, shall be effective for all fiscal years beginning
after June 15, 2000. SFAS No. 133 requires the recognition of all derivatives on
the balance sheet at fair value. Derivatives that are not hedges must be
adjusted to fair value as a component of income. If the derivative is a hedge,
depending on the nature of the hedge, changes in the fair value of derivatives
will either be off-set against the change in fair value of the hedged assets,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings. Sovereign expects to adopt SFAS No. 133 effective
January 1, 2001. Management reduced its off-balance sheet positions during 1999
so that the adoption of SFAS No. 133 will not have a material impact on the
financial condition of the company.
The Year 2000 Computer Issue. The Year 2000 ("Y2K") computer issue refers
to concerns about the inability of many computers, computer based systems,
related software, and other electronic devices (collectively "computer systems")
to process dates accurately after 1999. Sovereign initiated a project in 1998 to
update its computer systems to be Y2K compliant, and to monitor the compliance
status of computer systems of its outside service providers. Accordingly,
contingency plans were developed for any process determined to be mission
critical to Sovereign.
Sovereign has experienced no significant internal Y2K related problems
internally or with outside service providers. All known remediation and other
critical projects throughout the Company have been completed and no material
future Y2K related problems or expenses are expected. General and Administrative
expense includes $5.7 million and $6.5 million of Y2K remediation expense at
December 31, 1999 and 1998, respectively.
31
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
Net Income. Net operating income for the year ended December 31, 1998 was
$170 million. This represents an increase of 22% over net operating income of
$139 million reported for 1997. Operating earnings per share was $1.06 for 1998,
which represents an increase of 19% over 1997 operating earnings per share of
$.89. On an operating basis, return on average equity and return on average
assets were 15.47% and .87%, respectively, for 1998 compared to 14.83% and .85%,
respectively, for 1997. See Reconciliation of Operating Earnings to Net Income
for a detailed explanation of amounts excluded from operating earnings. For
additional information with respect to Sovereign's merger-related charges, see
Note 2 in the "Notes to Consolidated Financial Statements" hereof. All per share
amounts presented in Management's Discussion and Analysis of Financial Condition
and Results of Operations have been calculated based on average diluted shares
outstanding and have been adjusted to reflect all stock dividends and stock
splits.
Net income for the year ended December 31, 1998, including the impact of
the merger-related charges, was $136 million or $.85 per share. Net income for
the year ended December 31, 1997, including the impact of the merger-related
charges, was $103 million or $.66 per share.
Net Interest Income. Net interest income for 1998 was $494 million
compared to $432 million for 1997. This represents an increase of 14% and was
primarily due to an increase in average balances resulting from internal growth
and acquisitions during the period.
Interest on interest-earning deposits was $7.4 million for 1998 compared to
$5.4 million for 1997. The average balance of interest-earning deposits was
$56.4 million with an average yield of 13.12% for 1998 compared to an average
balance of $32.3 million with an average yield of 16.71% for 1997. The high
yields on interest-earning deposits were the result of a contractual arrangement
whereby a third-party vendor performed check processing and reconcilement
functions for Sovereign's disbursement accounts. Under the agreement, the vendor
is required to pay Sovereign interest on disbursed funds during the two to three
day float period, effectively producing interest income with no corresponding
asset balance.
Interest on investment securities available-for-sale was $284 million for
1998 compared to $102 million for 1997. The average balance of investment
securities available-for-sale was $4.3 billion with an average yield of 6.75%
for 1998 compared to an average balance of $1.6 billion with an average yield of
6.77% for 1997. The increase in the average balance of investment securities
available-for-sale was due to favorable market conditions which have created
opportunities for Sovereign to realign its investment portfolio and an active
decision by management to increase balance sheet flexibility by placing more
investments into available-for-sale.
Interest on investment securities held-to-maturity was $182 million for
1998 compared to $280 million for 1997. The average balance on investment
securities held-to-maturity was $2.5 billion with an average yield of 7.22% for
1998 compared to an average balance of $3.9 billion with an average yield of
7.18% for 1997.
Interest and fees on loans were $881 million for 1998 compared to $791
million for 1997. The average balance of net loans was $11.1 billion with an
average yield of 7.94% for 1998 compared to an average balance of $10.1 billion
with an average yield of 7.82% for 1997. The increases in average balance and
average yield were primarily the result of continued growth in Sovereign's
commercial lending and auto finance divisions, Sovereign's acquisition of 93
CoreStates branch offices, which added approximately $725 million of higher
yielding commercial and consumer loans to Sovereign's loan portfolio, as well as
planned run-off of lower yielding residential loans.
Interest on total deposits was $440 million for 1998 compared to $379
million for 1997. The average balance of total deposits was $10.7 billion with
an average cost of 4.11% for 1998 compared to an average balance of $9.0 billion
with an average cost of 4.21% for 1997. The increase in the average balance and
the decrease in the average cost of deposits was primarily the result of
Sovereign's acquisition of approximately $2.2 billion of low cost deposits from
the CoreStates branch acquisition and strong internal core deposit growth during
1998.
32
Interest on total borrowings was $421 million for 1998 compared to $368
million for 1997. The average balance of total borrowings was $7.4 billion with
an average cost of 5.69% for 1998 compared to an average balance of $6.2 billion
with an average cost of 5.97% for 1997. The increase in the average balance and
the decrease in the average cost of borrowings was the result of balance sheet
growth being partially funded by borrowings and generally lower borrowing rates
in 1998 compared to 1997.
Provision for Loan Losses. The provision for loan losses was $28.0 million
for 1998 compared to $41.1 million for 1997. The higher loan loss provision for
1997 included $24.9 million of reserves recorded as part of the merger charges
related to Sovereign's acquisitions of First State and Bankers during 1997.
These additional reserves were added as a result of Sovereign's conservative
approach with respect to an aggressive workout plan for certain non-performing
assets acquired from First State and Bankers. Excluding these merger-related
charges, Sovereign's loan loss provision for 1998 increased 73% from 1997
levels. In addition, during 1998, Sovereign established an initial loan loss
allowance of $20.5 million related to $725 million of loans acquired in
connection with its Core States branch acquisition, and during 1997, Sovereign
established an initial loan loss allowance of $22.0 million in connection with
its acquisition of Fleet Financial Group Inc.'s ("Fleet") Automobile Finance
Division ("Fleet Auto").
Sovereign's net charge-offs for 1998 were $33.6 million and consisted of
charge-offs of $46.3 million and recoveries of $12.7 million. This compares to
1997 net charge-offs of $18.8 million consisting of charge-offs of $24.2 million
and recoveries of $5.4 million. The ratio of net loan charge-offs to average
loans, including loans held for sale, was .30% for 1998, compared to .18% for
1997 and .19% for 1996. Commercial loan net charge-offs as a percentage of
average commercial loans were .14% for 1998, compared to .14% for 1997 and .85%
for 1996. The higher figure for 1996 was due to charge-offs related to a pool of
non-performing loans charged-off by First State, a predecessor institution
acquired by Sovereign, previous to its 1997 acquisition that was accounted for
as a pooling-of-interests. Consumer loan net charge-offs as a percentage of
average consumer loans were .80% for 1998, compared to .55% for 1997 and .18%
for 1996. Residential real estate mortgage loan net charge-offs as a percentage
of average residential mortgage loans, including loans held for sale, were .08%
for 1998, .11% for 1997 and .13% for 1996. Sovereign's increased level of
consumer and commercial loan charge-offs in 1998 was primarily related to
Sovereign's acquisition activity over the past two years. Although commercial
and consumer lending will typically result in higher net charge-off levels than
residential lending, historically, it has also resulted in higher income
potential.
Other Income. Total other income was $105 million for 1998 compared to
$48.7 million for 1997. Several factors contributed to the increase in other
income as discussed below.
Retail banking fees were $31.1 million for 1998 compared to $23.9 million
for 1997. This increase was primarily the result of an increase in the number of
Sovereign's transaction accounts and a larger retail customer base over the last
year.
Mortgage banking revenues were $28.2 million for 1998 compared to $23.9
million for 1997. This increase was primarily due to internal restructuring and
management enhancements made to this business unit during 1998 and a favorable
external environment.
Loan fees and service charges were $7.1 million for 1998 compared to $3.5
million for 1997. This increase was directly attributable to the full year
effect of fees earned on Sovereign's auto loan portfolio which was acquired in
September 1997. Loan fees and service charges result primarily from Sovereign's
loan servicing portfolio. At December 31, 1998, Sovereign serviced $9.2 billion
of its own loans and $6.7 billion of loans for others. This compares to $9.3
billion of its own loans and $6.4 billion of loans for others at December 31,
1997.
Gains on sales of loans and investment securities were $19.8 million for
1998 compared to losses of $7.2 million for 1997, which included investment
security net gains (losses) of $15.8 million and $(9.2) million, and net gains
on sales of loans of $4.0 million and $2.0 million in 1998 and 1997,
respectively. This increase was in part due to a net gain of $2.8 million
resulting from the sale of Sovereign's credit card portfolio during the second
quarter of 1998. The remaining increase was the result of gains on sales of
investment securities available-for-sale during 1998 and a $10.3 million
(pre-tax) loss on the liquidation of $750 million of investments including
certain held-to-maturity securities in conjunction with the Bankers
33
acquisition during the third quarter of 1997. This sale was completed in
accordance with the provisions of Statement of Financial Accounting standard
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" to maintain Sovereign's pre-merger interest rate risk position.
Sovereign recognized $12.6 million from its investment in BOLI, which was
made during the first quarter of 1998.
Miscellaneous income was $6.4 million for 1998 compared to $4.5 million for
1997. This increase was primarily due to increased inter-change income resulting
from growth in the number and transaction volume of Sovereign's debit cards over
the last year.
General and Administrative Expenses. Total general and administrative
expenses were $327 million for 1998 compared to $244 million for 1997.
Sovereign's efficiency ratio (all general and administrative expenses as a
percentage of net interest income and recurring non-interest income) for 1998
was 46.6% compared to 46.1% for 1997. The increase in general and administrative
expenses during 1998 was primarily due to Sovereign's overall franchise growth,
as well as special systems-related charges. These special systems-related
charges include Sovereign's conversion to a new commercial bank data processing
system and its Year 2000 initiatives.
Other Operating Expenses. Total other operating expenses were $32.3
million for 1998 compared to $25.6 million for 1997. Other operating expenses
included amortization of goodwill and other intangible assets of $20.6 million
for 1998 compared to $13.2 million for 1997, Trust Preferred Securities expense
of $12.5 million for 1998 compared to $11.7 million for 1997, and other net real
estate owned ("OREO") gains of $804,000 for 1998 compared to net OREO losses of
$767,000 for 1997.
Income Tax Provision. The income tax provision was $74.8 million for 1998
compared to $67.3 million for 1997. The effective tax rate for 1998 was 35.4%
compared to 39.6% for 1997. The effective tax rates for 1998 and 1997 include
the effect of certain non-deductible expenses incurred in conjunction with
Sovereign's acquisitions during each of these years.
34
TO OUR STOCKHOLDERS:
FINANCIAL STATEMENTS
Sovereign Bancorp, Inc. ("Sovereign") is responsible for the preparation,
integrity and fair presentation of its published financial statements as of
December 31, 1999, and for the year then ended. The consolidated financial
statements of Sovereign have been prepared in accordance with generally accepted
accounting principles and, as such, include some amounts that are based on
judgments and estimates of management.
INTERNAL CONTROLS OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining effective
internal control over financial reporting presented in conformity with generally
accepted accounting principles and regulatory reporting. The system contains
monitoring mechanisms, and actions are taken to correct deficiencies identified.
There are inherent limitations in the effectiveness of any system of
internal control, including the possibility of human error and the circumvention
or overriding of controls. Accordingly, even effective internal control can
provide only reasonable assurance with respect to financial statement
preparation. Further, because of changes in conditions, the effectiveness of
internal control may vary over time.
Management assessed Sovereign's internal control structure over financial
reporting presented in conformity with generally accepted accounting principles
and regulatory reporting as of December 31, 1999. This assessment was based on
criteria for effective internal control over financial reporting described in
"Internal Control -- Integrated Framework" issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, management
believes that Sovereign maintained effective internal control over financial
reporting presented in conformity with generally accepted accounting principles
and regulatory reporting as of December 31, 1999.
COMPLIANCE WITH LAWS AND REGULATIONS
Management is also responsible for compliance with the federal and state
laws and regulations concerning dividend restrictions and federal laws and
regulations concerning loans to insiders designated by the Office of Thrift
Supervision as safety and soundness laws and regulations.
Management assessed compliance by Sovereign Bank with the designated laws
and regulations relating to safety and soundness. Based on this assessment,
management believes that Sovereign Bank complied, in all significant respects,
with the designated laws and regulations related to safety and soundness for the
year ended December 31, 1999.
/s/ JAY S. SIDHU /s/ DENNIS S. MARLO /s/ MARK R. MCCOLLOM
---------------- ------------------- --------------------
Jay S. Sidhu Dennis S. Marlo Mark R. McCollom
President and Treasurer and Chief Accounting Officer
Chief Executive Officer Chief Financial Officer
ITEM 7A. MANAGEMENT'S DISCUSSION OF MARKET RISK
Incorporated by reference from Part II, Item 7 "Management's Discussion and
Analysis of Financial Conditions and Results of Operations--Asset and Liability
Management" hereof.
35
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders,
Sovereign Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of Sovereign
Bancorp, Inc. as of December 31, 1999 and 1998, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1999. These financial statements
are the responsibility of the management of Sovereign. Our responsibility is to
express an opinion on these financial statements based on our audits. We did not
audit the 1997 financial statements of ML Bancorp, Inc., Carnegie Bancorp, or
First Home Bancorp Inc., which combined statements reflect combined net interest
income constituting 21.1% of the related consolidated financial statement totals
for the year ended December 31, 1997. Those statements were audited by other
auditors whose reports have been furnished to us, and our opinion, insofar as it
relates to data included for ML Bancorp, Inc., Carnegie Bancorp and First Home
Bancorp Inc., for 1997, is based solely on the reports of the other auditors.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 and the reports of other
auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Sovereign Bancorp,
Inc. at December 31, 1999 and 1998, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.
/s/ ERNST & YOUNG LLP
January 24, 2000
except for Note 22, as to which
the date is February 28, 2000
Philadelphia, Pennsylvania
36
SOVEREIGN BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
YEAR ENDED DECEMBER 31,
----------------------------
1999 1998
----------- -----------
Assets
Cash and amounts due from depository institutions......... $ 373,996 $ 471,074
Interest-earning deposits................................. 19,238 82,650
Loans held for sale (fair value approximates $62,439 and
$297,414).............................................. 61,925 296,930
Investment securities available-for-sale.................. 8,030,212 6,662,427
Investment securities held-to-maturity (fair value
approximates $2,367,025 and $1,860,583)................ 2,362,051 1,839,655
Loans..................................................... 14,226,540 11,285,840
Allowance for loan losses................................. (132,986) (133,802)
Premises and equipment.................................... 119,201 98,491
Other real estate owned and other repossessed assets...... 5,329 15,584
Accrued interest receivable............................... 164,720 147,441
Goodwill and other intangible assets...................... 434,078 425,925
Other assets.............................................. 942,808 721,658
----------- -----------
Total Assets......................................... $26,607,112 $21,913,873
=========== ===========
Liabilities
Deposits.................................................. $11,719,646 $12,322,716
Borrowings
Short-term............................................. 6,902,414 3,922,352
Long-term.............................................. 5,760,724 3,979,887
Advance payments by borrowers for taxes and insurance..... 28,222 27,655
Other liabilities......................................... 58,265 328,145
----------- -----------
Total Liabilities.................................... 24,469,271 20,580,755
----------- -----------
Corporation-obligated mandatorily redeemable capital
securities of subsidiary trusts holding solely
subordinated debentures of Sovereign Bancorp, Inc.
("Trust Preferred Securities")......................... 316,346 129,050
----------- -----------
Stockholders' Equity
Preferred stock; no par value; $50 liquidation preference;
7,500,000 shares authorized; 0 shares issued and
outstanding............................................ -- --
Common stock; no par value; 400,000,000 shares authorized;
issued 230,647,896 and 164,146,353..................... 1,251,583 649,341
Warrants.................................................. 91,500 --
Unallocated common stock held by the Employee Stock
Ownership Plan (4,793,792 shares and 4,340,572 shares
at cost)............................................... (33,841) (26,892)
Treasury stock (383,875 shares and 78,626 shares at
cost).................................................. (3,595) (1,086)
Accumulated other comprehensive income.................... (210,932) 18,120
Retained earnings......................................... 726,780 564,585
----------- -----------
Total Stockholders' Equity........................... 1,821,495 1,204,068
----------- -----------
Total Liabilities and Stockholders' Equity........... $26,607,112 $21,913,873
=========== ===========
See accompanying notes to consolidated financial statements.
37
SOVEREIGN BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
YEAR ENDED DECEMBER 31,
------------------------------------------
1999 1998 1997
---------- ---------- ----------
Interest Income:
Interest on interest-earning deposits............... $ 4,721 $ 7,397 $ 5,392
Interest and dividends on investment securities
available-for-sale............................... 543,631 284,392 102,123
Interest and dividends on investment securities
held-to-maturity................................. 99,813 182,499 279,900
Interest and fees on loans.......................... 959,164 881,083 791,362
---------- ---------- ----------
Total interest income.......................... 1,607,329 1,355,371 1,178,777
---------- ---------- ----------
Interest Expense:
Interest on deposits................................ 428,055 440,300 378,813
Interest on borrowings.............................. 564,618 421,459 367,882
---------- ---------- ----------
Total interest expense......................... 992,673 861,759 746,695
---------- ---------- ----------
Net Interest Income................................... 614,656 493,612 432,082
Provision for loan losses............................. 30,000 27,961 41,125
---------- ---------- ----------
Net interest income after provision for loan losses... 584,656 465,651 390,957
---------- ---------- ----------
Other Income:
Retail banking fees................................. 49,177 31,078 23,892
Mortgage banking fees............................... 29,926 28,209 23,937
Loan fees and service charges....................... 8,856 7,075 3,536
Gain on sale of loans and investment securities..... 4,275 19,844 (7,192)
Bank owned life insurance........................... 22,813 12,572 --
Miscellaneous income................................ 15,295 6,403 4,515
---------- ---------- ----------
Total other income............................. 130,342 105,181 48,688
---------- ---------- ----------
General and Administrative Expenses:
Compensation and benefits........................... 154,880 124,357 105,487
Occupancy and equipment............................. 67,564 53,837 41,067
Outside services.................................... 93,340 47,523 28,708
Merger-related charges.............................. -- 49,932 19,224
Other administrative................................ 77,145 51,644 49,693
---------- ---------- ----------
Total general and administrative expenses...... 392,929 327,293 244,179
---------- ---------- ----------
Other Operating Expenses:
Amortization of goodwill and other intangibles...... 37,967 20,609 13,160
Trust Preferred Securities expense.................. 15,393 12,528 11,677
Other real estate owned (gains)/losses, net......... 95 (804) 767
---------- ---------- ----------
Total other operating expenses................. 53,455 32,333 25,604
---------- ---------- ----------
Income before income taxes............................ 268,614 211,206 169,862
Income tax provision.................................. 89,315 74,751 67,324
---------- ---------- ----------
NET INCOME............................................ $ 179,299 $ 136,455 $ 102,538
========== ========== ==========
NET INCOME APPLICABLE TO COMMON STOCK................. $ 179,299 $ 134,959 $ 96,294
========== ========== ==========
Basic Earnings Per Share.............................. $ 1.02 $ .88 $ .70
========== ========== ==========
Diluted Earnings Per Share............................ $ 1.01 $ .85 $ .66
========== ========== ==========
Dividends Per Common Share............................ $ .098 $ .084 $ .114
========== ========== ==========
See accompanying notes to consolidated financial statements.
38
SOVEREIGN BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
COMMON PREFERRED
SHARES SHARES COMMON PREFERRED RETAINED
OUTSTANDING OUTSTANDING STOCK WARRANTS STOCK EARNINGS
----------- ----------- ---------- -------- --------- --------
Balance, December 31, 1996............................. 134,000 2,000 $ 524,464 $ -- $96,446 $373,974
Comprehensive income:
Net income........................................... -- -- -- -- -- 102,538
Unrecognized income on investment securities
available-for-sale, net of tax..................... -- -- -- -- -- --
Total comprehensive income
Exercise of stock options.............................. 3,207 -- 12,527 -- -- --
Cash in lieu of fractional shares...................... (3) -- (28) -- -- (2)
Sale of stock under Dividend Reinvestment and Employee
Stock Purchase Plan.................................. 216 -- 2,544 -- -- --
Stock dividends........................................ 200 -- 1,855 -- -- (1,855)
Dividends paid on common stock......................... -- -- -- -- -- (15,550)
Dividends paid on preferred stock...................... -- -- -- -- -- (6,244)
Treasury stock repurchase.............................. (40) -- -- -- -- --
Treasury stock sold.................................... 2,608 -- 17,423 -- -- --
Retirement of treasury shares.......................... -- -- (41,981) -- -- --
Conversion of preferred stock.......................... 25 (4) 170 -- (170) --
Allocation of shares under Employee Stock Ownership
Plan................................................. 796 -- 5,132 -- -- --
Adjustment for First State's different fiscal year
end.................................................. 209 -- 1,010 -- -- (6,217)
Other.................................................. -- -- 211 -- -- --
------- ------ ---------- ------- ------- --------
Balance, December 31, 1997............................. 141,218 1,996 523,327 -- 96,276 446,644
------- ------ ---------- ------- ------- --------
Comprehensive income:
Net income........................................... -- -- -- -- -- 136,455
Change in unrecognized income on investment
securities
available-for-sale, net of tax..................... -- -- -- -- -- --
Total comprehensive income
Exercise of stock options.............................. 2,296 -- 15,910 -- -- --
Cash in lieu of fractional shares...................... -- -- (68) -- -- --
Sale of stock under Dividend Reinvestment and Employee
Stock Purchase Plan.................................. 296 -- 4,609 -- -- --
Dividends paid on common stock......................... -- -- -- -- -- (12,790)
Dividends paid on preferred stock...................... -- -- -- -- -- (1,496)
Treasury stock repurchase.............................. (86) -- -- -- -- --
Treasury stock sold.................................... 18 -- -- -- -- --
Conversion of preferred stock.......................... 14,342 (1,996) 96,270 -- (96,270) --
Redemption of preferred stock.......................... -- -- -- -- (6) --
Allocation of shares under Employee Stock Ownership
Plan................................................. 1,643 -- 9,293 -- -- --
Adjustment for ML Bancorp's different fiscal year
end.................................................. -- -- -- -- -- (4,228)
------- ------ ---------- ------- ------- --------
Balance, December 31, 1998............................. 159,727 -- 649,341 -- -- 564,585
------- ------ ---------- ------- ------- --------
Comprehensive income:
Net income........................................... -- -- -- -- -- 179,299
Change in unrecognized loss on investment securities
available-for-sale, net of tax..................... -- -- -- -- -- --
Total comprehensive loss...............................
Issuance of common stock............................... 43,810 -- 331,478 -- -- --
Issuance of warrants................................... -- -- -- 91,500 -- --
Exercise of stock options.............................. 721 -- 6,919 -- -- --
Cash in lieu of fractional shares...................... -- -- (6) -- -- --
Sale of stock under Dividend Reinvestment and Employee
Stock Purchase Plan.................................. 408 -- 4,412 -- -- --
Dividends paid on common stock......................... -- -- -- -- -- (17,104)
Treasury stock repurchase.............................. (3,351) -- -- -- -- --
Treasury stock sold.................................... 26 -- -- -- -- --
Allocation of shares under Employee Stock Ownership
Plan................................................. 270 -- 1,268 -- -- --
Acquisition of Network Companies....................... 235 -- 3,000 -- -- --
Acquisition of People's Bancorp, Inc................... 23,624 -- 255,171 -- -- --
------- ------ ---------- ------- ------- --------
Balance, December 31, 1999............................. 225,470 -- $1,251,583 $91,500 $ -- $726,780
======= ====== ========== ======= ======= ========
See accompanying notes to consolidated financial statements.
39
SOVEREIGN BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
ACCUMULATED
UNALLOCATED OTHER TOTAL
TREASURY STOCK HELD COMPREHENSIVE STOCKHOLDERS'
STOCK BY ESOP INCOME EQUITY
-------- ----------- ------------- -------------
Balance, December 31, 1996.................................. $(64,798) $(40,652) $ 317 $ 889,751
Comprehensive income:
Net income................................................ -- -- -- 102,538
Unrecognized income on investment securities
available-for-sale,
net of tax.............................................. -- -- 18,399 18,399
----------
Total comprehensive income.................................. 120,937
Exercise of stock options................................... 5,423 -- -- 17,950
Cash in lieu of fractional shares........................... -- -- -- (30)
Sale of stock under Dividend Reinvestment and Employee Stock
Purchase Plan............................................. -- -- -- 2,544
Stock dividends............................................. -- -- -- --
Dividends paid on common stock.............................. -- -- -- (15,550)
Dividends paid on preferred stock........................... -- -- -- (6,244)
Treasury stock repurchase................................... (473) -- -- (473)
Treasury stock sold......................................... 17,682 -- -- 35,105
Retirement of treasury shares............................... 41,981 -- -- --
Conversion of preferred stock............................... -- -- -- --
Allocation of shares under Employee Stock Ownership Plan.... -- 3,441 -- 8,573
Adjustment for First State's different fiscal year end...... -- -- 228 (4,979)
Other....................................................... -- -- -- 211
-------- -------- --------- ----------
Balance, December 31, 1997.................................. (185) (37,211) 18,944 1,047,795
-------- -------- --------- ----------
Comprehensive income:
Net income................................................ -- -- -- 136,455
Change in unrecognized income on investment securities
available-for-sale, net of tax.......................... -- -- (32) (32)
----------
Total comprehensive income 136,423
Exercise of stock options................................... -- -- -- 15,910
Cash in lieu of fractional shares........................... -- -- -- (68)
Sale of stock under Dividend Reinvestment and Employee Stock
Purchase Plan............................................. -- -- -- 4,609
Dividends paid on common stock.............................. -- -- -- (12,790)
Dividends paid on preferred stock........................... -- -- -- (1,496)
Treasury stock repurchase................................... (1,258) -- -- (1,258)
Treasury stock sold......................................... 357 -- -- 357
Conversion of preferred stock............................... -- -- -- --
Redemption of preferred stock............................... -- -- -- (6)
Allocation of shares under Employee Stock Ownership Plan.... -- 10,319 -- 19,612
Adjustment for ML Bancorp's different fiscal year end....... -- -- (792) (5,020)
-------- -------- --------- ----------
Balance, December 31, 1998.................................. (1,086) (26,892) 18,120 1,204,068
-------- -------- --------- ----------
Comprehensive income:
Net income................................................ -- -- -- 179,299
Change in unrecognized loss on investment securities
available-for-sale, net of tax.......................... -- -- (229,052) (229,052)
----------
Total comprehensive loss.................................... (49,753)
Issuance of common stock.................................... -- -- -- 331,478
Issuance of warrants........................................ -- -- -- 91,500
Exercise of stock options................................... -- -- -- 6,919
Cash in lieu of fractional shares........................... -- -- -- (6)
Sale of stock under Dividend Reinvestment and Employee Stock
Purchase Plan............................................. -- -- -- 4,412
Dividends paid on common stock.............................. -- -- -- (17,104)
Treasury stock repurchase................................... (47,152) -- -- (47,152)
Treasury stock sold......................................... 285 -- -- 285
Allocation of shares under Employee Stock Ownership Plan.... -- 1,821 -- 3,089
Acquisition of Network Companies............................ -- -- -- 3,000
Acquisition of People's Bancorp, Inc........................ 44,358 (8,770) -- 290,759
-------- -------- --------- ----------
Balance, December 31, 1999.................................. $ (3,595) $(33,841) $(210,932) $1,821,495
======== ======== ========= ==========
See accompanying notes to consolidated financial statements.
40
SOVEREIGN BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
------------------------------------------
1999 1998 1997
---------- ---------- ----------
Cash Flows From Operating Activities:
Net income................................................ $ 179,299 $ 136,455 $ 102,538
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan losses and deferred taxes............ 27,684 37,508 30,812
Depreciation............................................ 18,802 13,434 12,070
Amortization............................................ 58,830 18,204 34,725
Gain/Loss on sale of loans, investment securities and
real estate owned...................................... (4,484) (20,076) 7,959
Allocation of Employee Stock Ownership Plan............. 3,089 19,612 8,573
Net change in:
Loans held for sale....................................... 235,005 13,748 (172,305)
Accrued interest receivable............................... (9,262) (39,560) (18,108)
Other assets.............................................. (273,033) (467,329) (66,276)
Other liabilities......................................... (259,538) 272,989 6,128
---------- ---------- ----------
Net cash used by operating activities....................... (23,608) (15,015) (53,884)
---------- ---------- ----------
Cash Flows From Investing Activities:
Proceeds from sales of investment securities.............. 5,553,469 2,157,904 847,215
Proceeds from repayments and maturities of investment
securities:
Available-for-sale...................................... 1,644,019 1,109,075 314,998
Held-to-maturity........................................ 793,031 2,062,628 965,549
Purchases of investment securities:
Available-for-sale...................................... (8,024,026) (7,996,541) (1,072,205)
Held-to-maturity........................................ (1,312,372) (471,326) (1,418,741)
Proceeds from sales of loans.............................. 1,188,173 1,422,279 23,570
Purchase of loans......................................... (2,022,695) (1,966,864) (2,794,487)
Net change in loans other than purchases and sales........ (1,561,471) 464,382 1,027,549
Proceeds from sales of premises and equipment............. 5,757 18,437 10,112
Purchases of premises and equipment....................... (39,844) (32,872) (15,790)
Proceeds from sales of real estate owned.................. 17,081 19,069 19,593
Net cash received from/(paid for) business combinations... 112,998 (302,808) (8,552)
Other, net................................................ -- (4,228) (4,996)
---------- ---------- ----------
Net cash used by investing activities....................... (3,645,880) (3,520,865) (2,106,185)
---------- ---------- ----------
Cash Flows From Financing Activities:
Assumption of deposits.................................... -- 2,231,149 --
Net increase/(decrease) in deposits....................... (1,117,500) 576,982 855,750
Net increase/(decrease) in short-term borrowings.......... 2,023,868 (2,135,369) 638,573
Proceeds from long-term borrowings........................ 2,500,894 3,169,839 621,630
Repayments of long-term borrowings........................ (455,959)
Net increase/(decrease) in advance payments by borrowers
for taxes and insurance................................. 568 (14,192) (420)
Proceeds from issuance of Trust Preferred Securities...... 187,231 -- 97,574
Cash dividends paid to stockholders....................... (17,104) (14,286) (23,777)
Redemption of preferred stock............................. -- (6) --
Proceeds from issuance of common stock.................... 342,803 20,451 17,919
Proceeds from issuance of warrants........................ 91,500
Advance to the Employee Stock Ownership Plan.............. (436) -- (325)
(Purchase)/issuance of treasury stock..................... (46,867) (901) 34,632
---------- ---------- ----------
Net cash provided by financing activities................... 3,508,998 3,833,667 2,241,556
---------- ---------- ----------
Net change in cash and cash equivalents..................... (160,490) 297,787 81,487
Cash and cash equivalents at beginning of period............ 553,724 255,937 174,450
---------- ---------- ----------
Cash and cash equivalents at end of period.................. $ 393,234 $ 553,724 $ 255,937
========== ========== ==========
Supplemental Disclosures: Income tax payments totaled $101 million in 1999,
$77.4 million in 1998, and $63.2 million in 1997. Interest payments totaled $963
million in 1999, $848 million in 1998, and $717 million in 1997. Noncash
activity consisted of mortgage loan securitization of $1.0 billion in 1999, $1.2
billion in 1998, and $283 million in 1997; reclassification of long-term
borrowings to short-term borrowings of $536 million in 1999, $613 million in
1998, and $862 million in 1997; and reclassification of mortgage loans to real
estate owned of $11.7 million in 1999, $18.8 million in 1998, and $22.1 million
in 1997.
See accompanying notes to consolidated financial statements.
41
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Sovereign Bancorp, Inc. and subsidiaries ("Sovereign") is a Pennsylvania
business corporation and is the holding company of Sovereign Bank. Sovereign is
headquartered in Philadelphia, Pennsylvania and Sovereign Bank is headquartered
in Wyomissing, Pennsylvania, a suburb of Reading, Pennsylvania. Sovereign's
primary business consists of attracting deposits from its network of community
banking offices, located throughout eastern and northcentral Pennsylvania, New
Jersey and northern Delaware, and originating commercial, consumer and
residential mortgage loans in those communities. Sovereign also serves customers
throughout New York and several New England States.
The following is a description of the significant accounting policies of
Sovereign. Such accounting policies are in accordance with generally accepted
accounting principles and have been followed on a consistent basis.
a. Principles of Consolidation -- The accompanying financial statements
include the accounts of the parent company, Sovereign Bancorp, Inc. and its
wholly-owned subsidiaries: Sovereign Bank, Sovereign Delaware Investment
Corporation, Sovereign Deleware Escrow Company, Sovereign Capital Trust I,
Sovereign Capital Trust II, and ML Capital Trust I. All material intercompany
balances and transactions have been eliminated in consolidation.
b. Use of Estimates -- The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
c. Per Share Information -- All per share data has been restated to reflect
the effect of the 6-for-5 stock split which was authorized on January 22, 1998,
with a record date of March 31, 1998 and the 6-for-5 stock split which was
authorized on January 16, 1997, with a record date of March 3, 1997.
Basic earnings per share is calculated by dividing income available to
common stockholders by the weighted average common shares outstanding, excluding
options, warrants, and convertible securities from the calculation. In
calculating diluted earnings per share, the dilutive effect of options and
warrants is calculated using the treasury stock method using the average market
price of the period. The dilutive effect of convertible debt or preferred stock
is calculated using the converted method. See Note 20 for computation of
earnings per share.
d. Interest-earning Deposits -- Interest-earning deposits consist of
deposit accounts with the Federal Home Loan Bank of Pittsburgh ("FHLB") and
deposits with other financial institutions generally having maturities of three
months or less.
e. Investment Securities -- Investment securities that the Company has the
intent and ability to hold to maturity are classified as held-to-maturity and
reported at amortized cost. Securities expected to be held for an indefinite
period of time are classified as available-for-sale and are carried at fair
value with unrealized gains and losses reported as a separate component of
stockholders' equity, net of estimated income taxes. Gains or losses on the
sales of securities are recognized at trade date utilizing the specific
identification method.
f. Forward Commitments and Options -- Sovereign utilizes forward
commitments and options to hedge interest rate risk associated with loans held
for sale. Gains and losses on these transactions are included in the net gain or
loss when the asset is sold.
g. Mortgage Banking Activity -- Loans held for sale consist of residential
mortgage loans originated or purchased by Sovereign and mortgage-backed
securities originated by Sovereign. They are recorded at the lower of cost or
estimated fair value on an aggregate basis. Gains and losses are included in the
consolidated statements of operations.
42
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
The fair value calculation includes consideration of all open positions,
outstanding commitments and related fees paid. Excess servicing fees are
computed as the present value of the difference between the estimated future net
revenues and normal servicing net revenues as established by the federally
sponsored secondary market makers. Resultant premiums are deferred and amortized
over the estimated life of the related mortgages using the constant yield
method.
Mortgage servicing rights are amortized against loan servicing fee income
on an accelerated basis in proportion to, and over the period of, estimated net
future loan servicing fee income, which periods initially do not exceed eight
years. For purposes of measuring impairment of capitalized mortgage servicing
rights and minimizing the impact of risk, Sovereign conservatively evaluates the
loans underlying these rights by stratifying them into certain homogeneous
categories which include, but are not limited to, residential real estate
30-year and 15-year fixed rate mortgage loans, adjustable rate mortgage loans
and balloon loans. See Note 6 for details of mortgage banking activity.
h. Allowance for Loan Losses -- An allowance for loan losses is maintained
at a level that management considers adequate to provide for losses based upon
an evaluation of known and inherent risks in the loan portfolio. Management's
evaluation takes into consideration the risks inherent in the loan portfolio,
past loan loss experience, specific loans which have losses, geographic and
industry concentrations, delinquency trends, economic conditions, the level of
originations and other relevant factors. While management uses the best
information available to make such evaluations, future adjustments to the
allowance may be necessary if conditions differ substantially from the
assumptions used in making the evaluations.
The allowance for loan losses consists of two elements: (i) an allocated
allowance, which is comprised of allowances established on specific loans, and
class allowances based on historical loan loss experience and current trends,
and (ii) unallocated allowances based on both general economic conditions and
other risk factors in the Company's individual markets and portfolios, and to
account for a level of imprecision in management's estimation process.
The specific allowance element is based on a regular analysis of criticized
loans where internal credit ratings are below a predetermined classification.
This analysis is performed at the relationship manager level, and periodically
reviewed by the loan review department. The specific allowance established for
these criticized loans is based on a careful analysis of related collateral
value, cash flow considerations and, if applicable, guarantor capacity.
The class allowance element is determined by an internal loan grading
process in conjunction with associated allowance factors. These class allowance
factors are updated annually and are based primarily on actual historical loss
experience, consultation with regulatory authorities, and peer groups loss
experience. While this analysis is conducted annually, the Company has the
ability to revise the class allowance factors whenever necessary in order to
address improving or deteriorating credit quality trends or specific risks
associated with a given loan pool classification.
Regardless of the extent of the Company analysis of customer performance,
portfolio evaluations, trends or risk management processes established, certain
inherent, but undetected losses are probable within the loan portfolio. This is
due to several factors including inherent delays in obtaining information
regarding a customer's financial condition or changes in their unique business
conditions; the judgemental nature of individual loan evaluations, collateral
assessments and the interpretation of economic trends; volatility of economic or
customer-specific conditions affecting the identification and estimation of
losses for larger non-homogeneous credits; and the sensitivity of assumptions
utilized to establish allocated allowances for homogeneous groups of loans among
other factors. The Company maintains an unallocated allowance to recognize the
existence of these exposures.
These other risk factors are continuously reviewed and revised by
management where conditions indicate that the estimates initially applied are
different from actual results.
43
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
A comprehensive analysis of the allowance for loan losses is performed by
the Company on a quarterly basis. In addition, a review of allowance levels
based on nationally published statistics is conducted on an annual basis. The
Company also has an asset review committee, which has the responsibility of
affirming allowance methodology and assessing the general and specific allowance
factors in relation to estimated and actual net charge-off trends. This
committee is also responsible for assessing the appropriateness of the allowance
for loan losses for each loan pool classification at Sovereign.
i. Loans -- Interest on loans is credited to income as it is earned.
Interest income is not recognized on loans when the loan payment is 90 days or
more delinquent (except auto loans, government-guaranteed loans or loans secured
by deposit accounts) or sooner if management believes the loan has become
impaired. Sovereign defines impairment as the existence of one or a combination
of any of the following loan weaknesses:
o The primary source of repayment is gone or severely impaired and
Sovereign may have to rely on the secondary source
o Loss does not seem likely, but sufficient problems have arisen to cause
Sovereign to go to abnormal lengths to protect its position in order to
maintain a high probability of repayment
o Obligors are unable to generate enough cash flow to reduce their debts
o Deterioration in collateral value or inadequate inspection or
verification of value (if the collateral is expected to be a source of
repayment)
o Flaws in documentation leave Sovereign in a subordinated or unsecured
position when the collateral is needed for repayment of the loan
When a loan is placed on non-accrual status, all accrued yet uncollected
interest is reversed from income. Payments received on non-accrual loans are
generally applied to the outstanding principal balance. A non-accrual loan is a
loan in which it is probable that scheduled payments of principal and interest
will not be paid when due according to the contractual terms of the loan
agreement. In order for a non-accrual loan to revert to accruing status, all
delinquent interest must be paid and Sovereign must approve a repayment plan.
Loans delinquent 180 days or more (120 days for auto loans) are considered
for charge-off unless it can be clearly demonstrated that repayment will occur
regardless of the delinquency status. Examples of this would include: a loan
which is secured by collateral and is in the process of collection; a loan
supported by a valid guarantee or insurance; or a loan supported by a valid
claim against a solvent estate. A decision to charge-off a loan does not
necessarily mean that the asset has no recovery or salvage value, but rather it
is not practical to defer writing off the balance, even though partial or full
recovery may be realized in the future.
SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," requires
that certain impaired loans be measured based on the present value of expected
future cash flows discounted at the loan's effective interest rate or the fair
value of the collateral if the loan is collateral dependent, as amended by SFAS
No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition
and Disclosures." For purposes of measuring impairment as set forth by the
provisions of SFAS No. 114 and SFAS No. 118, Sovereign defines impaired loans as
non-accrual loans and certain loans which are still accruing, which management
has specifically identified as being impaired. The non-accrual portion is
determined by collectively evaluating large groups of smaller balance,
homogeneous loans such as residential mortgages and consumer loans.
j. Loan Fees, Discounts and Premiums -- Loan origination fees and certain
direct loan origination costs are deferred and recognized as adjustments to
interest income in the consolidated statement of operations over the contractual
life of the loan utilizing the level yield method, except in the case of certain
discounted loans in which a portion of the net deferred fee may be amortized
over the discount period. Discounts and
44
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
premiums on loans purchased are amortized into income utilizing methods which
approximate the level yield method.
k. Premises and Equipment -- Premises and equipment are carried at cost,
less accumulated depreciation. Depreciation is calculated utilizing the
straight-line method. Estimated useful lives are as follows:
Office buildings............................................ 15 to 50 years
Leasehold improvements...................................... 5 to 10 years
Furniture, fixtures and equipment........................... 3 to 10 years
Automobiles................................................. 3 years
Expenditures for maintenance and repairs are charged to expense as
incurred.
l. Other Real Estate Owned -- Other real estate owned ("OREO") consists of
properties acquired by or in lieu of foreclosure. OREO is stated at the lower of
cost or estimated fair value minus estimated costs to sell. Write-downs of OREO
which occur after the initial transfer from the loan portfolio are recorded as
other operating expenses. Costs of holding foreclosed property are charged to
expense in the current period, except for significant property improvements
which are capitalized to the extent that carrying value does not exceed
estimated fair value.
m. Income Taxes -- Deferred income taxes are provided on temporary
differences between amounts reported for financial statement and tax purposes in
accordance with SFAS No. 109, "Accounting for Income Taxes."
n. Interest Rate Exchange Agreements (Including Swaps, Caps, and Floors) --
Sovereign has entered into certain interest rate exchange agreements in
connection with its asset/liability management program which are designated as
hedges. Derivatives used as hedges must be effective at reducing the risk
associated with the exposure being hedged and must be designated as a hedge at
the inception of the derivative contract. To ensure effectiveness, the company
performs an analysis to ensure that changes in fair value or cash flow of the
derivative correlates to the equivalent changes in the asset or liability being
hedged. Related fees are deferred and amortized on a straight line basis over
the life of the interest rate exchange agreement, which corresponds to the
estimated life of the asset or liability item being hedged. Net interest
payments/receipts are accrued as an adjustment of interest expense/income on the
hedged assets or liabilities. Gains or losses resulting from early termination
of interest rate exchange agreements are deferred and amortized over the
remaining term of the original exchange agreements. In the event the related
asset/liability is disposed of, such deferred gains or losses are recognized as
an adjustment to the respective gain or loss on disposition and are reflected in
other income. Changes in the value of interest rate exchange agreements are not
recorded in the financial statements because the interest rate exchange
agreements are designated as hedges.
o. General and Administrative Expenses -- General and administrative
expenses are classified on a functional basis, except for salaries and employee
benefits. Certain direct loan origination costs are deferred and are being
amortized as a yield adjustment through net interest income (see j. above).
p. Consolidated Statement of Cash Flows -- For purposes of reporting cash
flows, cash and cash equivalents include cash and amounts due from depository
institutions, interest-earning deposits and securities purchased under resale
agreements with an original maturity of three months or less.
q. Reclassifications -- Certain amounts in the financial statements of
prior periods have been reclassified to conform with the presentation used in
current period financial statements. These reclassifications have no effect on
net income.
r. Intangibles -- Core deposit intangibles are a measure of the value of
checking and savings deposits acquired in business combinations accounted for as
purchases. Core deposit intangibles are amortized in accordance with SFAS No.
72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions,"
over
45
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
the estimated lives of the existing deposit relationships acquired, but not
exceeding 10 years. Goodwill is the excess of the purchase price over the fair
value of net assets of companies acquired through business combinations
accounted for as purchases. Goodwill and core deposit intangibles are being
amortized using the straight line method over various periods not exceeding 25
years. The carrying amount of the goodwill is reviewed if facts and
circumstances suggest that it may be impaired. If this review indicates that
goodwill will not be recoverable, as determined based on the loss of economic
value, the carrying amount of the goodwill is reduced by the estimated loss of
value. In addition, goodwill associated with impaired long-lived assets is
included in the impairment evaluation which Sovereign assesses under the rules
of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of."
s. Segment Reporting -- SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" requires that public companies report
certain information about operating segments in complete sets of financial
statements of the company and in condensed financial statements of interim
periods issued to shareholders. It also requires that public companies report
certain information about their products and services, the geographic areas in
which they operate, and their major customers. Sovereign is a large regional
bank which offers a wide array of products and services to its customers.
Pursuant to its super-community banking strategy, emphasis is placed on building
relationships with its customers, as opposed to building specific lines of
business. As a result, as Sovereign is not organized around discernable lines of
business and prefers to work as an integrated unit to customize solutions for
its customers, with business line emphasis and product offerings changing over
time as needs and demands change. Thus, all necessary requirements of SFAS No.
131 have been met by Sovereign as of December 31, 1999.
t. Pending Accounting Pronouncements -- In June 1999, The Financial
Accounting Standards Board ("FASB") issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities -- Deferral of the Effective Date
of FASB Statement No. 133", which delays the effective date of SFAS No. 133.
Accordingly, SFAS No. 133, shall be effective for all fiscal years beginning
after June 15, 2000. SFASNo. 133 requires the recognition of all derivatives on
the balance sheet at fair value. Derivatives that are not hedges must be
adjusted to fair value as a component of income. If the derivative is a hedge,
depending on the nature of the hedge, changes in the fair value of derivatives
will either be off-set against the change in fair value of the hedged assets,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings. Sovereign expects to adopt SFAS No. 133 effective
January 1, 2001. Management reduced its off-balance sheet positions during 1999
so that the adoption of SFAS No.133 will not have a material impact on the
financial condition of the company.
NOTE 2 -- BUSINESS COMBINATIONS
On June 30, 1999, Sovereign acquired Peoples Bancorp, Inc. ("Peoples"), a
$1.4 billion bank holding company headquartered in Lawrenceville, New Jersey
whose principal operating subsidiary operated 14 community banking offices in
Mercer, Burlington and Ocean counties, New Jersey. The transaction added
investments, loans and deposits to Sovereign of approximately $922 million, $503
million and $515 million, respectively. In accordance with the merger agreement,
Peoples' shareholders received .80 shares of Sovereign common stock for each
outstanding share of Peoples common stock. Sovereign issued approximately 23.6
million shares of Sovereign common stock in connection with the transaction,
which was accounted for as a purchase. Sovereign recorded total intangibles of
$39.5 million, of which $9.8 million was allocated to a core deposit intangible
and $29.7 million was allocated to goodwill. The goodwill and core deposit
intangible are being amortized over 25 years and 10 years, respectively.
Sovereign's results of operations include the operations of Peoples from June,
30 1999 and thereafter.
On June 15, 1999, Sovereign acquired The Network Companies ("Network"), a
privately held specialty leasing company headquartered in Commack, New York.
Network provides financing for the purchase or lease of equipment and specialty
vehicles plus other specialty products for businesses throughout the United
46
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- BUSINESS COMBINATIONS -- (CONTINUED)
States, with transactions ranging from $15,000 to $250,000. The purchase price
of $6 million consisted of $4 million of stock and $2 million of cash. The
acquisition was accounted for as a purchase. Sovereign paid a premium of $6
million, all of which was allocated to goodwill. Network had total assets of
approximately $50 million. The goodwill is being amortized over 25 years.
Sovereign's results of operations include the operations of Network from June
15, 1999 and thereafter.
On September 4, 1998, Sovereign acquired 93 former CoreStates Financial
Corp. ("CoreStates") branch offices from First Union Corporation ("First
Union"). The former CoreStates offices are located throughout Pennsylvania and
New Jersey and added approximately $2.2 billion of commercial bank deposits and
$725 million of commercial and consumer loans to Sovereign's balance sheet. This
transaction was accounted for as a purchase. Sovereign paid a premium of $325
million for the CoreStates branches which was allocated to core deposit
intangible and goodwill. Additionally, Sovereign established an initial loan
loss reserve of $20.5 million. The goodwill and core deposit intangible are
being amortized over 25 years and 10 years, respectively. Sovereign's results of
operations include the operations of the aforementioned branches from September
4, 1998 and thereafter.
On July 31, 1998, Sovereign acquired Carnegie Bancorp ("Carnegie"), a $414
million commercial bank holding company headquartered in Princeton, New Jersey
which operated seven branch offices throughout central New Jersey and one in
Pennsylvania. Carnegie added loans, deposits and stockholders' equity to
Sovereign of approximately $286 million, $329 million and $37 million,
respectively. In accordance with the merger agreement, Carnegie common stock
shareholders received 2.022 shares of Sovereign common stock in exchange for
each share of Carnegie common stock. This transaction was accounted for as a
pooling-of-interests.
On July 31, 1998, Sovereign acquired First Home Bancorp Inc. ("First
Home"), a $510 million savings bank holding company headquartered in Pennsville,
New Jersey. First Home had one principal operating subsidiary which operated ten
branch offices in Salem, Gloucester and Camden counties, New Jersey and New
Castle County, Delaware. First Home added loans, deposits and stockholders'
equity to Sovereign of approximately $273 million, $320 million and $38 million,
respectively. In accordance with the merger agreement, First Home common stock
shareholders received 1.779 shares of Sovereign common stock in exchange for
each share of First Home common stock. This transaction was accounted for as a
pooling-of-interests.
As a result of the Carnegie and First Home transactions, Sovereign issued
approximately 10.9 million new shares of common stock during the third quarter
of 1998.
On February 28, 1998, Sovereign acquired ML Bancorp, Inc. ("ML Bancorp"), a
$2.4 billion bank holding company headquartered in Villanova, Pennsylvania. ML
Bancorp's principal operating subsidiary, Main Line Bank, operated 29 branch
offices located in the suburbs of Philadelphia, Pennsylvania. The transaction
added loans, deposits and stockholders' equity to Sovereign of $1.1 billion,
$1.0 billion and $201 million, respectively. In accordance with the merger
agreement, ML Bancorp shareholders received 1.62 adjusted shares of Sovereign
common stock in exchange for each share of ML Bancorp common stock.
Approximately 20.5 million adjusted new shares of Sovereign common stock were
issued in connection with the transaction. This transaction was accounted for as
a pooling-of-interests.
Prior to the combination, ML Bancorp's fiscal year end was March 31, and
accordingly, Sovereign's consolidated results of operations for the twelve-month
period ended December 31, 1998 include ML Bancorp's results of operations for
the two-month period ended February 28, 1998, Sovereign's consolidated results
of operations for the twelve-month period ended December 31, 1997 include ML
Bancorp's results of operations for the eleven-month period ended February 28,
1998 and a net decrease to Sovereign's stockholders' equity of $5.0 million has
been made to reflect ML Bancorp's activity for the two-month period ended
February 28, 1998. That activity consisted of net income of $4.2 million and net
unrealized gains on investment securities available-for-sale of $792,000.
47
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- BUSINESS COMBINATIONS -- (CONTINUED)
The pre-merger results of operations for Sovereign, ML Bancorp, Carnegie
and First Home (which were acquired pursuant to transactions accounted for as a
pooling-of-interests) were as follows (in thousands):
SOVEREIGN ML BANCORP(1) CARNEGIE(2) FIRST HOME(2) COMBINED
---------- ------------- ----------- ------------- ----------
Year Ended December 31, 1998
Interest income................ $1,284,933 $27,935 $19,517 $22,986 $1,355,371
Interest expense............... 821,529 16,295 9,848 14,087 861,759
Provision for loan losses...... 27,467 -- 260 234 27,961
Other income................... 100,962 3,441 427 808 105,638
Non-interest expense........... 332,710 8,534 10,180 8,659 360,083
Income tax provision........... 71,539 2,319 390 503 74,751
---------- ------- ------- ------- ----------
Net Income..................... $ 132,650 $ 4,228 $ (734) $ 311 $ 136,455
========== ======= ======= ======= ==========
- ------------------
(1) Reflects ML Bancorp's results of operations for the two-month period ended
February 28, 1998.
(2) Reflects Carnegie and First Home results of operations for the seven-month
period ended July 31,1998.
During 1998, Sovereign recorded pre-tax merger-related charges of $49.9
million, ($33.5 million after-tax) or $.21 per share, primarily related to costs
incurred in connection with its acquisitions of ML Bancorp, Inc., Carnegie
Bancorp and First Home Bancorp, Inc. The components of the merger-related
charges were as follows (in thousands):
REQUIRING CASH
CASH OUTFLOW
PROVISION OUTFLOW TO DATE
--------- --------- -------
Severance and employee-related costs........................ $22,257 $22,257 $22,257
Merger transaction costs.................................... 5,307 5,307 5,307
Writedowns of assets........................................ 13,350 -- --
Office closing costs........................................ 3,085 1,274 1,274
Miscellaneous............................................... 5,933 5,933 5,933
------- ------- -------
Total....................................................... $49,932 $34,771 $34,771
======= ======= =======
Severance and employee-related costs relate primarily to severance costs
and related taxes for employees of the three companies who were displaced as a
result of merger, as well as the termination and distribution of ML Bancorp's
ESOP and restricted stock plans in connection with the merger. Writedowns of
assets include obsolescence of data processing equipment at all three companies
as well as writedowns of servicing-related assets at ML Bancorp. The entire
provision of $49.9 million was used in 1998.
On September 19, 1997, Sovereign purchased Fleet Financial Group Inc.'s
("Fleet") Automobile Finance Division ("Fleet Auto"). Fleet Auto consisted of
approximately $2.0 billion of indirect auto loans, automotive floor plan loans
and loans to automotive lessors. Fleet Auto had business relationships with over
2,000 automotive dealerships and served approximately 225,000 customers
throughout New Jersey, New York and several New England states. Sovereign
purchased Fleet Auto at a discount, which in part, reflected the need to
establish initial reserves for possible loan losses of approximately $22.0
million or 1.50% of the indirect auto loans acquired. The transaction added
$10.7 million of goodwill to Sovereign's balance sheet. Sovereign's consolidated
results of operations include Fleet Auto's results of operations from September
19, 1997 and thereafter.
On August 29, 1997, Sovereign acquired Bankers Corp. ("Bankers"), a $2.6
billion financial services holding company headquartered in Perth Amboy, New
Jersey. Bankers' sole banking subsidiary, Bankers Savings, operated 15 branch
offices located in Middlesex, Monmouth and Ocean counties, New Jersey. The
transaction added loans, deposits, and shareholders' equity to Sovereign of $1.5
billion, $1.7 billion, and $204 million, respectively. In accordance with the
merger agreement, Bankers shareholders received 1.854 adjusted
48
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- BUSINESS COMBINATIONS -- (CONTINUED)
shares of Sovereign common stock in exchange for each share of Bankers common
stock. Sovereign issued approximately 23.0 million adjusted new shares of
Sovereign common stock in connection with the transaction. This transaction was
accounted for as a pooling-of-interests.
On February 18, 1997, Sovereign acquired First State Financial Services,
Inc. ("First State"), a $603 million savings institution headquartered in West
Caldwell, New Jersey with 14 branch offices located throughout central and
northern New Jersey. In accordance with the merger agreement, First State
shareholders received 1.225 adjusted shares of Sovereign common stock in
exchange for each share of First State common stock. Sovereign issued
approximately 4.9 million adjusted new shares of Sovereign common stock in
connection with the transaction. This transaction was accounted for as a
pooling-of-interests.
Prior to the combination, First State's fiscal year end was September 30,
and accordingly, Sovereign's consolidated results of operations for the year
ended December 31, 1997 include First State's results of operations for the
twelve-month period ended December 31, 1997. A net decrease to Sovereign's
stockholders' equity of $5.0 million has been made to reflect First State's
activity for the three-month period ended December 31, 1996. That activity
consisted of proceeds from the exercise of stock options of $1.0 million, net
income of $6.2 million and net unrealized losses on investment securities
available-for-sale of $228,000.
The pre-merger results of operations for Sovereign, First State and Bankers
(which were acquired pursuant to transactions accounted for as a
pooling-of-interests) were as follows (in thousands):
SOVEREIGN(1) BANKERS COMBINED
------------ ------- --------
Year Ended December 31, 1997 (unaudited)
Interest income......................................... $360,816 $89,398 $450,214
Interest expense........................................ 234,302 55,548 289,850
Provision for loan losses............................... 9,700 2,300 12,000
Other income............................................ 16,905 1,222 18,127
Non-interest expense.................................... 82,776 10,278 93,054
Income tax provision.................................... 20,230 8,172 28,402
-------- ------- --------
Net income.............................................. $ 30,713 $14,322 $ 45,035
======== ======= ========
- ------------------
(1) Sovereign's result of operations include First State's results of
operations.
49
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- BUSINESS COMBINATIONS -- (CONTINUED)
During 1997, Sovereign recorded pre-tax merger-related charges of $44.1
million ($29.8 million after-tax) or $.19 per share, primarily related to costs
incurred in connection with its acquisitions of Bankers and First State. The
components of the merger-related charges were as follows (in thousands):
REQUIRING CASH
CASH OUTFLOW
PROVISION OUTFLOW TO DATE
--------- --------- -------
Severance and employee-related costs........................ $ 8,613 $ 8,613 $ 8,613
Merger transaction costs.................................... 5,811 5,811 5,811
Credit-related reserves..................................... 24,900 -- --
Loss on sales of assets..................................... 1,093 -- --
Office closing costs........................................ 2,330 -- --
Miscellaneous............................................... 1,377 1,377 1,377
------- ------- -------
Total....................................................... $44,124 $15,801 $15,801
======= ======= =======
Severance and employee-related costs relate primarily to severance costs
and related taxes for employees of the two companies who were displaced as a
result of the mergers. Credit-related costs relate to additional reserves which
Sovereign determined would be necessary as a result of its conservative approach
with respect to an aggressive workout plan for certain assets acquired from
Bankers and First State. With the exception of the credit-related reserves, the
remaining reserves of $19.2 million were used in 1997.
NOTE 3 -- RESTRICTIONS ON CASH AND AMOUNTS DUE FROM DEPOSITORY INSTITUTIONS
Sovereign Bank is required to maintain certain average reserve balances as
established by the Federal Reserve Board. The amounts of those reserve balances
for the reserve computation periods which included December 31, 1999 and 1998
were $72 million and $237 million, respectively.
NOTE 4 -- INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities are as
follows (in thousands):
AT DECEMBER 31,
---------------------------------------------------------------------------------
1999 1998
----------------------------------------------------- -------------------------
AMORTIZED UNREALIZED UNREALIZED AMORTIZED UNREALIZED
COST APPRECIATION DEPRECIATION FAIR VALUE COST APPRECIATION
---------- ------------ ------------ ---------- ---------- ------------
Investment Securities
Available-for-Sale:
Investment Securities:
U.S. Treasury and
government agency
securities.............. $ 77,229 $ 2 $ 1,210 $ 76,021 $ 35,480 $ 1
Corporate securities/Trust
preferred............... 243,915 650 14,231 230,334 40,784 1,627
Asset-backed securities... 685,274 -- 21,149 664,125 193,154 45
Equities.................. 32,142 31 11,420 20,753 54,383 5,381
FHLB stock................ 524,397 -- -- 524,397 345,324 --
Agency preferred stock.... 425,888 4,135 395 429,628 456,861 9,856
Municipal securities...... 32,813 745 1,379 32,179 34,609 1,066
Mortgage-backed Securities:
Passthroughs:
U.S. government
agencies.............. 478,462 909 21,004 458,367 168,840 1,951
Non-agencies............ 2,688,315 -- 132,333 2,555,982 1,969,322 15,976
Collateralized mortgage
obligations........... 3,166,472 2,564 130,610 3,038,426 3,335,794 11,168
---------- ------- -------- ---------- ---------- -------
Total investment securities
available-for-sale........ $8,354,907 $ 9,036 $333,731 $8,030,212 $6,634,551 $47,071
========== ======= ======== ========== ========== =======
AT DECEMBER 31,
-------------------------
1998
-------------------------
UNREALIZED
DEPRECIATION FAIR VALUE
------------ ----------
Investment Securities
Available-for-Sale:
Investment Securities:
U.S. Treasury and
government agency
securities.............. $ 63 $ 35,418
Corporate securities/Trust
preferred............... 121 42,290
Asset-backed securities... 897 192,302
Equities.................. 9,654 50,110
FHLB stock................ -- 345,324
Agency preferred stock.... 5 466,712
Municipal securities...... 629 35,046
Mortgage-backed Securities:
Passthroughs:
U.S. government
agencies.............. 335 170,456
Non-agencies............ 5,510 1,979,788
Collateralized mortgage
obligations........... 1,981 3,344,981
------- ----------
Total investment securities
available-for-sale........ $19,195 $6,662,427
======= ==========
50
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4 -- INVESTMENT SECURITIES -- (CONTINUED)
AT DECEMBER 31,
-------------------------------------------------------
1999
-----------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED
COST APPRECIATION DEPRECIATION FAIR VALUE
---------- ------------ ------------ ----------
Investment Securities
Held-to-Maturity:
Investment Securities:
U.S. Treasury and
government agency
securities.............. $ 4,807 $ -- $ 109 $ 4,698
Corporate securities...... 1,326,827 9,852 165 1,336,514
Municipal securities...... 3,275 96 22 3,349
Mortgage-backed securities:
Passthroughs:
U.S. government
agencies.............. 499,866 2,516 2,365 500,017
Non-agency.............. 52,319 377 224 52,472
Collateralized mortgage
obligations........... 474,957 2,520 7,502 469,975
---------- ------- -------- ----------
Total investment securities
held-to-maturity.......... $2,362,051 $15,361 $ 10,387 $2,367,025
========== ======= ======== ==========
AT DECEMBER 31,
---------------------------------------------------
1998 1998
------------------------- -------------------------
AMORTIZED UNREALIZED UNREALIZED
COST APPRECIATION DEPRECIATION FAIR VALUE
---------- ------------ ------------ ----------
Investment Securities
Held-to-Maturity:
Investment Securities:
U.S. Treasury and
government agency
securities.............. $ 31,179 $ 151 $ 78 $ 31,252
Corporate securities...... 42,249 3,526 26 45,749
Municipal securities...... 8,064 165 -- 8,229
Mortgage-backed securities:
Passthroughs:
U.S. government
agencies.............. 715,558 14,113 285 729,386
Non-agency.............. 74,523 1,165 136 75,552
Collateralized mortgage
obligations........... 968,082 4,541 2,208 970,415
---------- ------- ------- ----------
Total investment securities
held-to-maturity.......... $1,839,655 $23,661 $ 2,733 $1,860,583
========== ======= ======= ==========
The amortized cost and estimated fair value of investment securities at
December 31, 1999 by contractual maturity are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties (in
thousands):
AMORTIZED
COST FAIR VALUE
---------- ----------
Investment Securities Available-for-Sale:
Due in one year or less................................... $ 880,376 $ 692,508
Due after one year through five years..................... 3,533,633 3,484,706
Due after five years through ten years.................... 1,512,764 1,463,514
Due after ten years....................................... 1,892,805 1,844,334
No stated maturity........................................ 556,539 545,150
---------- ----------
Total investment securities available-for-sale......... $8,376,117 $8,030,212
========== ==========
AMORTIZED
COST FAIR VALUE
---------- ----------
Investment Securities Held-to-Maturity:
Due in one year or less................................... $1,548,263 $1,555,406
Due after one year through five years..................... 577,798 583,267
Due after five years through ten years.................... 166,434 162,251
Due after ten years....................................... 69,556 66,101
No stated maturity........................................ -- --
---------- ----------
Total investment securities held-to-maturity........... $2,362,051 $2,367,025
========== ==========
51
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4 -- INVESTMENT SECURITIES -- (CONTINUED)
Proceeds from sales of investment securities and the realized gross gains
and losses from those sales are as follows (in thousands):
HELD-TO-MATURITY
AVAILABLE-FOR-SALE YEAR ENDED
YEAR ENDED DECEMBER 31, DECEMBER 31,
---------------------------------- -------------------
1999 1998 1997 1998 1997
---------- ---------- -------- ------- ---------
Proceeds from sales..................... $1,681,580 $2,145,929 $295,933 $12,432 $ 561,316
========== ========== ======== ======= =========
Gross realized gains.................... 8,335 27,729 3,751 -- 183
Gross realized losses................... 4,603 11,449 2,893 457 10,217
---------- ---------- -------- ------- ---------
Net realized gains/(losses)............. $ 3,732 $ 16,280 $ 858 $ (457) $ (10,034)
========== ========== ======== ======= =========
Proceeds from sales of investment securities held-to-maturity for the years
ended December 31, 1998 and 1997 was the result of the liquidation of certain
held-to-maturity securities acquired from ML Bancorp in 1998 and Bankers in
1997. These sales were completed in accordance with the provisions of SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities" to
maintain Sovereign's pre-merger interest rate risk position, and the impact of
these sales was included as part of the merger-related charges for ML Bancorp
and Bankers.
Tax-exempt income included in interest and dividends on investment
securities for the years ended December 31, 1999, 1998 and 1997 was $19.3
million, $17.9 million and $10.5 million, respectively. Tax expense/(benefit)
related to net realized gains and losses from sales of investment securities for
the years ended December 31, 1999, 1998 and 1997 were $1.2 million, $5.7 million
and $(3.2) million, respectively.
Investment securities with an estimated fair value of $2.7 billion and $1.8
billion were pledged as collateral for borrowings, interest rate agreements and
public deposits at December 31, 1999 and 1998, respectively.
During the fourth quarter of 1999, Sovereign raised $1.8 billion of debt
and equity in anticipation of its planned acquisition of Sovereign Bank New
England. Under the terms of the financing agreements, Sovereign was required to
escrow certain proceeds, with limited ability to invest such proceeds, subject
to completion of the acquisition. Investment securities held-to-maturity include
$1.3 billion of commercial paper representing the escrowed balances at December
31, 1999.
52
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5 -- LOANS
A summary of loans included in the consolidated balance sheets follows (in
thousands):
AT DECEMBER 31,
-------------------------
1999 1998
----------- -----------
Residential real estate loans.............................. $ 5,623,295 $ 5,113,537
Residential construction loans (net of loans in process of
$31,447 and $89,569, respectively)....................... 59,264 62,536
----------- -----------
Total Residential Loans............................... 5,682,559 5,176,073
----------- -----------
Commercial real estate loans............................... 1,516,953 887,938
Commercial loans........................................... 1,690,744 717,440
Automotive floor plan loans................................ 730,623 578,147
Multi-family loans......................................... 137,019 115,195
----------- -----------
Total Commercial Loans................................ 4,075,339 2,298,720
----------- -----------
Home equity loans.......................................... 1,957,945 1,750,883
Auto loans................................................. 1,936,980 1,510,676
Loans to automotive lessors................................ 288,636 252,856
Student loans.............................................. 249,279 256,744
Other...................................................... 35,802 39,888
----------- -----------
Total Consumer Loans.................................. 4,468,642 3,811,047
----------- -----------
Total Loans(1)........................................ $14,226,540 $11,285,840
=========== ===========
Total Loans with:(2)
Fixed rate............................................... $ 8,707,951 $ 5,798,158
Variable rate............................................ 5,518,589 5,487,682
----------- -----------
Total Loans(1)........................................ $14,226,540 $11,285,840
=========== ===========
- ------------------
(1) Loan totals are net of deferred loan fees and unamortized premiums and
discounts of $24.0 million for 1999 and $16.9 million for 1998.
(2) Loan totals do not reflect the impact of off-balance sheet interest rate
swaps used for interest rate risk management as discussed below.
Loans to related parties include loans made to certain officers, directors
and their affiliated interests. At December 31, 1999 and 1998, loans to related
parties totaled $9.2 million and $2.7 million, respectively.
The activity in the allowance for loan losses is as follows (in thousands):
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Balance, beginning of period.......................... $133,802 $116,823 $ 73,847
Acquired reserves and other additions................. 4,799 22,660 20,652
Provision for loan losses............................. 30,000 27,961 41,125
Charge-offs........................................... 55,023 46,330 24,184
Recoveries............................................ 19,408 12,688 5,383
-------- -------- --------
Balance, end of period................................ $132,986 $133,802 $116,823
======== ======== ========
53
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5 -- LOANS -- (CONTINUED)
Sovereign requires loan officers to follow specific procedures in the early
identification and collection of problem loans. If a loan becomes delinquent or
the loan officer is not successful in the resolution of the problem loan, the
account is transferred to Sovereign's Asset Recovery Team. At this time the
account is analyzed for collateral values and the cash flows available to repay
the loan. If it is determined that there is a collateral shortfall and
insufficient cash flow to repay the debt, a reserve will be established. At any
time during this process and at the loan officer's discretion, the account may
be placed on non-accrual status. By following these procedures, losses are
minimized on impaired loans.
Impaired loans are summarized as follows (in thousands):
AT DECEMBER 31,
------------------
1999 1998
-------- -------
Impaired loans without a related allowance.................. $ -- $ --
Impaired loans with a related allowance..................... 108,215 63,296
-------- -------
Total impaired loans...................................... $108,215 $63,296
======== =======
Allowance for impaired loans................................ $ 23,033 $18,582
======== =======
If Sovereign's non-accruing and restructured loans had been current in
accordance with their original terms and had been outstanding throughout the
period, gross interest income for the years ended December 31, 1999, 1998 and
1997 would have increased by approximately $5.0 million, $9.8 million and $7.5
million, respectively. Interest income recorded on these loans for the years
ended December 31, 1999, 1998 and 1997 was $2.1 million, $3.3 million and $2.4
million, respectively.
The average balance of impaired loans for 1999, 1998 and 1997 was $82.3
million, $58.1 million and $29.2 million, respectively.
NOTE 6 -- MORTGAGE BANKING ACTIVITY
At December 31, 1999, 1998, and 1997, Sovereign serviced loans for the
benefit of others totaled $5.7 billion, $6.7 billion, and $6.4 billion,
respectively. The following table presents the activity of Sovereign's mortgage
servicing rights for the years indicated. This activity does not reflect the
reduction from the activity in Sovereign's valuation allowance for mortgage
servicing rights presented in the table below (in thousands):
1999 1998 1997
-------- -------- --------
Balance, beginning of year............................. $ 75,627 $ 68,063 $ 58,759
Net servicing assets recognized during the year........ 14,605 19,439 19,979
Amortization and other................................. (12,883) (11,875) (10,675)
-------- -------- --------
Balance, end of year................................... $ 77,349 $ 75,627 $ 68,063
======== ======== ========
For valuation purposes, at December 31, 1999, a weighted average discount
rate of 9.89% was assumed and assumed prepayment speeds were consistent with
published secondary market rates for Sovereign's market area. Sovereign also
takes into consideration any inherent risks, as well as other relevant factors
associated with each portfolio. Prices are obtained in the secondary market and
are based upon current market prices of similarly traded loans and/or comparable
secondary market instruments.
54
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6 -- MORTGAGE BANKING ACTIVITY -- (CONTINUED)
Activity in the valuation allowance for mortgage servicing rights for the
years indicated consisted of the following (in thousands):
YEAR ENDED DECEMBER 31,
--------------------------
1999 1998 1997
------- ------- ------
Balance, beginning of year................................ $13,295 $ 3,295 $2,200
Change in valuation allowance for mortgage servicing
rights.................................................. (8,437) 10,000 1,095
------- ------- ------
Balance, end of year...................................... $ 4,858 $13,295 $3,295
======= ======= ======
NOTE 7 -- PREMISES AND EQUIPMENT
A summary of premises and equipment, less accumulated depreciation and
amortization, follows (in thousands):
AT DECEMBER 31,
-------------------
1999 1998
-------- --------
Land........................................................ $ 15,790 $ 14,923
Office buildings............................................ 84,130 69,542
Furniture, fixtures, and equipment.......................... 116,163 94,055
Leasehold improvements...................................... 22,154 21,351
Automobiles................................................. 883 849
-------- --------
239,120 200,720
Less accumulated depreciation............................... (119,919) (102,229)
-------- --------
Total premises and equipment.............................. $119,201 $ 98,491
======== ========
Sovereign is committed under various non-cancelable operating leases
relating to branch facilities having initial or remaining terms in excess of one
year. The minimum annual rental commitments under these leases at December 31,
1999, are summarized as follows (in thousands):
AT DECEMBER 31,
1999
---------------
2000.................................................. $15,155
2001.................................................. 14,049
2002.................................................. 11,957
2003.................................................. 9,587
2004.................................................. 6,451
Thereafter............................................ 27,045
-------
Total............................................... $84,244
=======
Total rental expense for all leases for the years ended December 31, 1999,
1998, and 1997 was $16.5 million, $10.6 million and $7.9 million, respectively.
55
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8 -- ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows (in thousands):
AT DECEMBER 31,
----------------------
1999 1998
-------- --------
Accrued interest receivable on:
Investment securities..................................... $ 58,749 $ 57,809
Loans..................................................... 105,971 89,632
-------- --------
Total interest receivable.............................. $164,720 $147,441
======== ========
NOTE 9 -- DEPOSITS
Deposits are summarized as follows (in thousands):
AT DECEMBER 31,
--------------------------------------------------------------------------
1999 1998
---------------------------------- ----------------------------------
BALANCE PERCENT RATE BALANCE PERCENT RATE
----------- ------- ---- ----------- ------- ----
Demand deposit accounts................ $ 1,089,472 9% --% $ 1,104,170 9% --%
NOW accounts........................... 1,578,259 14 2.24 1,281,516 10 1.24
Savings accounts....................... 2,142,708 18 2.69 2,295,448 19 2.83
Money market accounts.................. 1,345,325 12 4.17 1,545,634 13 3.78
Retail certificates of deposit......... 4,708,057 40 5.00 5,172,196 42 5.24
Jumbo certificates of deposit.......... 855,825 7 5.56 923,752 7 5.40
----------- --- ---- ----------- --- ----
Total deposits....................... $11,719,646 100% 3.64% $12,322,716 100% 3.73%
=========== === ==== =========== === ====
Certificate accounts are frequently renewed at maturity rather than paid
out. The following table sets forth the maturity of Sovereign's certificates of
deposit as scheduled to mature contractually at December 31, 1999 (in
thousands):
WITHIN SIX SIX MOS. ONE/ THREE/ FIVE/ OVER
MOS. ONE YR. THREE YRS. FIVE YRS. TEN YRS. TEN YRS. TOTAL
---------- ---------- ---------- --------- -------- -------- ----------
Certificate accounts by rate:
Less than 4.001%................. $ 19,217 $ 973 $ 8,560 $ 56 $ 421 $ 22,989 $ 52,216
4.001% -- 6.000%................. 3,411,736 1,372,275 308,254 80,134 36,130 100,491 5,309,020
6.001% -- 8.000%................. 109,397 19,439 30,516 25,754 10,533 8 195,647
8.001% -- 10.000%................ 874 298 850 422 1,117 144 3,705
Above 10.000%.................... 549 377 275 128 1,887 78 3,294
---------- ---------- -------- -------- ------- -------- ----------
Total certificate accounts....... $3,541,773 $1,393,362 $348,455 $106,494 $50,088 $123,710 $5,563,882
========== ========== ======== ======== ======= ======== ==========
The following table sets forth the maturity of Sovereign's certificates of
deposit as scheduled to mature contractually at December 31, 1999 (in
thousands):
AT DECEMBER 31,
1999
---------------
2000........................................................ $4,935,135
2001........................................................ 242,720
2002........................................................ 105,735
2003........................................................ 60,322
2004........................................................ 46,172
Thereafter.................................................. 173,798
----------
Total..................................................... $5,563,882
==========
56
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- DEPOSITS -- (CONTINUED)
The following table sets forth the maturity of Sovereign's certificates of
deposit of $100,000 or more as scheduled to mature contractually at December 31,
1999 (in thousands):
AT DECEMBER 31,
1999
---------------
Three months or less........................................ $ 317,341
Over three through six months............................... 591,903
Over six through twelve months.............................. 240,868
Over twelve months.......................................... 60,907
----------
Total..................................................... $1,211,019
==========
Interest expense on deposits is summarized as follows (in thousands):
AT DECEMBER 31,
------------------------------------
1999 1998 1997
-------- -------- --------
Demand deposit and NOW accounts........................... $ 21,851 $ 16,387 $ 7,967
Savings accounts.......................................... 58,333 62,694 58,974
Money market accounts..................................... 50,246 45,055 33,719
Certificates of deposit................................... 297,625 316,164 278,153
-------- -------- --------
Total interest expense on deposits...................... $428,055 $440,300 $378,813
======== ======== ========
Deposits of related parties include deposits made by certain officers, directors
and their affiliated interests. At December 31, 1999 and 1998, deposits of
related parties totaled $2.4 million and $1.7 million, respectively.
NOTE 10 -- SHORT-TERM AND LONG-TERM BORROWINGS
Short-term Borrowings. Short-term borrowings included in the consolidated
balance sheets are as follows (in thousands):
AT DECEMBER 31,
--------------------------
1999 1998
---------- ----------
Securities sold under repurchase agreements................. $ 414,553 $ 315,540
Federal Home Loan Bank advances............................. 6,403,952 3,409,243
Current portion of long-term borrowings..................... 83,909 197,569
---------- ----------
Total short-term borrowings............................... $6,902,414 $3,922,352
========== ==========
Included in short-term borrowings are sales of securities under repurchase
agreements, and retail repurchase agreements. Securities underlying sales of
securities under repurchase agreements consisted of investment securities which
had an amortized cost of $141 million and $180 million and a market value of
$139 million and $182 million at December 31, 1999 and 1998, respectively.
Qualifying repurchase agreements are treated as financings and the
obligations to repurchase securities sold are reflected as a liability in the
balance sheet. The dollar amount of securities underlying the agreements remains
in the asset accounts, although the securities underlying the agreements are
delivered to the brokers who arranged the transactions. In certain instances,
the broker may have sold, loaned, or disposed of the securities to other parties
in the normal course of their operations, and have agreed to resell to Sovereign
substantially similar securities at the maturity of the agreements. The
broker/dealers who participate with Sovereign in these agreements are primarily
broker/dealers reporting to the Federal Reserve Bank of New York.
57
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10 -- SHORT-TERM AND LONG-TERM BORROWINGS -- (CONTINUED)
The following table summarizes information regarding short-term securities
sold under repurchase agreements (in thousands):
DECEMBER 31,
------------------------------------------
1999 1998 1997
---------- ---------- ----------
Balance............................................... $ 414,553 $ 315,540 $ 787,700
Weighted average interest rate........................ 4.22% 5.32% 5.61%
Maximum amount outstanding at any month-end during the
year................................................ $2,747,239 $ 956,394 $1,515,156
Average amount outstanding during the year............ $1,428,756 $ 525,986 $1,222,183
Weighted average interest rate during the year........ 5.50% 5.39% 5.67%
The following table summarizes information regarding short-term FHLB advances
(in thousands):
DECEMBER 31,
------------------------------------------
1999 1998 1997
---------- ---------- ----------
Balance............................................... $6,403,952 $3,409,243 $4,626,401
Weighted average interest rate........................ 5.67% 5.32% 5.91%
Maximum amount outstanding at any month-end during the
year................................................ $6,403,952 $5,361,401 $4,709,176
Average amount outstanding during the year............ $3,867,391 $4,420,827 $3,718,562
Weighted average interest rate during the year........ 5.58% 5.98% 6.03%
Long-term Borrowings. Long-term securities sold under repurchase
agreements had weighted average interest rates of 5.78% and 5.58% at December
31, 1999 and 1998, respectively. Long-term FHLB advances had weighted average
interest rates of 4.89% and 4.96% at December 31, 1999 and 1998, respectively.
Long-term borrowings, excluding portion classified as short-term are as follows
(in thousands):
AT DECEMBER 31,
--------------------------
1999 1998
---------- ----------
Securities sold under repurchase agreements, maturing
January 2001 to November 2002............................. $ 170,000 $ 340,000
FHLB advances, maturing January 2001 to April 2012.......... 4,080,952 3,492,262
Senior Secured Credit Facility, due June 30, 2003........... 500,000 --
6.75% senior notes, due July 1, 2000(1)..................... -- 49,896
6.625% senior notes, due March 15, 2001..................... 239,843 --
10.25% senior notes, due May 15, 2004....................... 200,000 --
10.50% senior notes, due November 15, 2006.................. 500,000 --
6.75% subordinated debentures, due 2000(1).................. -- 27,822
8.50% subordinated debentures, due 2002..................... 19,987 19,982
8.00% subordinated debentures, due 2003..................... 49,942 49,925
---------- ----------
Total long-term borrowings................................ $5,760,724 $3,979,887
========== ==========
- ------------------
(1) Notes/debentures mature during year 2000 and therefore are reflected in
short-term borrowings on page 57.
Included in long-term borrowings are sales of securities under repurchase
agreements. Securities underlying these repurchase agreements consist of
investment securities which had a book value of $195 million and $340 million,
and a market value of $192 million and $344 million at December 31, 1999 and
1998, respectively.
FHLB advances are collateralized by qualifying mortgage-related assets as
defined by the FHLB.
58
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10 -- SHORT-TERM AND LONG-TERM BORROWINGS -- (CONTINUED)
The Senior Secured Credit Facility will mature on the date six months prior
to the maturity date of the 10.25% senior notes, but in no event later than June
30, 2003. The facility amortizes in quarterly installments in the following
annual percentages of principal: 2000 -- 5%, $25 million ; 2001 -- 15%, $75
million; 2002 -- 40%, $200 million; and 2003 -- 40%, $200 million with mandatory
prepayments occurring if Sovereign's cash flow exceeds predetermined levels.
Interest is calculated, at the option of the borrower, at LIBOR plus 3.5%, or
the sum of a) the highest of (i) lender's base rate, (ii) .50% over lender's
three month CD rate, or (iii) .50% over the Federal Funds Effective Rate, plus
b) 2.50%. Interest was calculated under the LIBOR option (9.96%) at December 31,
1999. The Senior Secured Credit Facility is secured primarily by first perfected
security interest in the stock of Sovereign Bank owned by Sovereign Bancorp. The
Senior Secured Credit Facility subjects Sovereign to a number of affirmative and
negative covenants.
The 6.75% senior notes are non-amortizing and are not redeemable prior to
maturity. The senior 6.625%, 10.25% and 10.50% notes are non-amortizing and are
redeemable, at a significant premium, at any time prior to maturity.
The 6.75% and 8.00% subordinated debentures are non-amortizing and are not
redeemable prior to maturity. The 8.50% subordinated debentures are
non-amortizing and are redeemable at the option of Sovereign in whole or in
part.
The 6.75% subordinated debentures and a portion of the FHLB advances have,
through the use of interest rate swaps, been effectively converted from fixed
rate obligations to variable rate obligations.
The Senior Secured Credit Facility and the 10.25% and 10.5% Senior Notes
require Sovereign to escrow funds sufficient to redeem these debts in the event
the Sovereign Bank New England acquisition is not completed. Sovereign's ability
to invest these funds is limited to investment categories specified in the
escrow agreements. At the December 31, 1999, investment securities
held-to-maturity includes $1.3 billion of commercial paper of commercial
obligors as required under the escrow agreements.
The following table sets forth the maturity of Sovereign's short-term and
long-term borrowings as scheduled to mature contractually at December 31, 1999
(in thousands):
AT DECEMBER 31,
1999
---------------
2000........................................................ $ 6,902,414
2001........................................................ 599,843
2002........................................................ 589,987
2003........................................................ 764,942
2004........................................................ 650,700
Thereafter.................................................. 3,155,252
-----------
Total..................................................... $12,663,138
===========
NOTE 11 -- TRUST PREFERRED SECURITIES
On November 15, 1999, Sovereign issued 5,750,000 units of Trust Preferred Income
Equity Redeemable Securities (PIERS) resulting in net proceeds to Sovereign of
$278.3 million with a stated maturity of January 15, 2030, of which $91,500 has
been allocated to the value of the warrants and is treated as original issue
discount. The original issue discount is accreted into Trust Preferred
Securities expense over the life of the unit resulting in an effective yield of
11.74%. Each PIERS unit consists of:
A preferred capital security (Trust Preferred II) issued by Sovereign
Capital Trust II (Trust II), valued at $32.50, having a stated liquidation
amount of $50, representing an undivided beneficial ownership interest in
Trust II, which assets consist solely of debentures issued by Sovereign.
59
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 11 -- TRUST PREFERRED SECURITIES -- (CONTINUED)
Distributions are payable quarterly beginning February 15, 2000 at an
annual rate of 7.5% of the stated liquidation value; and
A warrant to purchase, subject to antidilution adjustments, 5.3355
shares of Sovereign common stock at any time prior to November 20, 2029.
The warrants were valued at $17.50 per unit.
The Trust Preferred II securities were issued by a special-purpose
statutory trust created expressly for the issuance of these securities.
Distributions on Trust II will be payable at an annual rate of 7.5% of the
stated liquidation amount of $50 per capital security, payable quarterly. After
issue discount and issuance costs, proceeds of $186.8 million were invested in
Junior Subordinated Debentures of Sovereign, at terms identical to the Trust
Preferred II offering. Cash distributions on Trust Preferred II will be made to
the extent interest on the debentures is received by Trust II. Sovereign may
defer interest payments on the debentures for a period not exceeding 20
consecutive quarters or beyond the original maturity date. Holders may require
Sovereign to repurchase the Trust Preferred II securities at accreted value
following exercise of the warrants.
In the event of certain changes or amendments to regulatory requirements or
federal tax rules, Sovereign may elect to redeem the Trust Preferred II
securities at 100% of accreted value and to redeem the warrants at their value
(combined value $50). Sovereign may elect to redeem the Trust Preferred II
securities and the warrants at $50, if the value of Sovereign's common stock on
20 trading days out of the preceding 30 consecutive trading days and on the day
the election is made exceeds $14.99 after November 20, 2002; $13.12 after
November 15, 2003; or $11.25 after November 15, 2004.
During March 1997, Sovereign issued $100 million of preferred capital
securities ("Trust Preferred") through Sovereign Capital Trust I ("Trust"), a
special-purpose statutory trust created expressly for the issuance of these
securities. Distributions on the Trust Preferred will be payable at an annual
rate of 9% of the stated liquidation amount of $1,000 per capital security,
payable semi-annually. After issuance costs, proceeds of $97.6 million were
invested in Junior Subordinated Debentures of Sovereign, at terms identical to
the Trust Preferred offering. Cash distributions on the Trust Preferred are made
to the extent interest on the debentures is received by the Trust. In the event
of certain changes or amendments to regulatory requirements or federal tax
rules, the Trust Preferred securities are redeemable in whole. Otherwise, the
Trust Preferred securities are generally redeemable in whole or in part on or
after April 1, 2007, at a declining redemption price ranging from 103.875% to
100% of the liquidation amount. On or after April 1, 2017, the Trust Preferred
securities may be redeemed at 100% of the liquidation amount.
During March 1997, ML Bancorp, a predecessor company of Sovereign, issued
$50.0 million of Trust Preferred securities at an interest rate of 9.875%, with
a scheduled maturity of March 1, 2027. The securities were issued by ML Capital
Trust I and proceeds from the issuance were invested in Junior Subordinated
Debentures issued by ML Bancorp. Sovereign assumed ML Bancorp's obligations
under this offering and has the option, subject to required regulatory approval,
to prepay the securities beginning March 1, 2007.
The Trust Preferred offerings are classified as and are similar to a
minority interest and are presented as "Corporation-obligated mandatorily
redeemable capital securities of subsidiary trust holding solely subordinated
debentures of Sovereign Bancorp, Inc." The Trust Preferred offerings qualify for
Tier I capital treatment for Sovereign and the loan payments from Sovereign to
the Trust are fully tax deductible. The warrants, included in the PIERS units,
are classified as additional capital within stockholders' equity.
NOTE 12 -- STOCKHOLDERS' EQUITY
The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA")
requires institutions regulated by the Office of Thrift Supervision (OTS) to
have a minimum leverage capital ratio equal to 3% of tangible assets, and 4% of
risk-adjusted assets, and a risk-based capital ratio equal to 8%. The Federal
Deposit Insurance Corporation Improvement Act ("FDICIA") requires OTSregulated
institutions to have a
60
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12 -- STOCKHOLDERS' EQUITY -- (CONTINUED)
minimum tangible capital equal to 2% of total tangible assets. Sovereign Bank
was in compliance with all of these capital requirements as of December 31,
1999. The following schedule summarizes the actual capital balances of Sovereign
Bank at December 31, 1999 (in thousands):
TANGIBLE LEVERAGE LEVERAGE RISK-BASED
CAPITAL TO CAPITAL TO CAPITAL TO CAPITAL TO
TANGIBLE TANGIBLE RISK-ADJUSTED RISK-ADJUSTED
ASSETS ASSETS ASSETS ASSETS
---------- ---------- ------------- -------------
Sovereign Bank:
Regulatory capital.......................... $2,062,070 $2,062,070 $2,062,070 $2,190,805
Minimum capital requirement................. 502,666 753,999 602,377 1,204,755
---------- ---------- ---------- ----------
Excess.................................... $1,559,404 $1,308,071 $1,459,693 $ 986,050
========== ========== ========== ==========
Capital ratio............................... 8.20% 8.20% 13.69% 14.55%
OTS capital regulations do not apply to thrift holding companies. The
following schedule summarizes actual capital balances and ratios of Sovereign
Bancorp at December 31, 1999 using average tangible assets which is consistent
with the method used by bank holding companies (in thousands):
TANGIBLE LEVERAGE LEVERAGE RISK-BASED
CAPITAL TO CAPITAL TO CAPITAL TO CAPITAL TO
TANGIBLE TANGIBLE RISK-ADJUSTED RISK-ADJUSTED
ASSETS ASSETS ASSETS ASSETS
---------- ---------- ------------- -------------
Sovereign Bancorp:
Regulatory capital.......................... $1,591,695 $1,908,041 $1,908,041 $2,424,776
Minimum capital requirement................. 527,546 760,786 651,477 1,302,955
---------- ---------- ---------- ----------
Excess.................................... $1,064,149 $1,147,255 $1,256,564 $1,121,821
========== ========== ========== ==========
Capital ratio............................... 6.28% 7.52% 11.72% 14.89%
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA")
established five capital tiers: well-capitalized, adequately-capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. A depository institution's capital tier depends upon its
capital levels in relation to various relevant capital measures, which include
leverage and risk-based capital measures and certain other factors. Depository
institutions that are not classified as well-capitalized or
adequately-capitalized are subject to various restrictions regarding capital
distributions, payment of management fees, acceptance of brokered deposits and
other operating activities. At December 31, 1999, Sovereign Bank was classified
as well-capitalized and in compliance with all capital requirements. Management
anticipates that Sovereign Bank will continue to be classified as
well-capitalized and will be in compliance with all regulatory capital
requirements. Although Sovereign Bancorp is not subject to OTS capital
requirements, depending upon the specific facts regarding a proposed
acquisition, the OTS could determine that the pro forma financial condition of a
savings and loan holding company may be inadequate and therefore condition
approval on making prescribed capital levels.
As a result of provisions of the Small Business Jobs Protection Act of 1996
(the "Jobs Protection Act"), which repealed the tax reserve method for bad debts
for thrift institutions and the circumstances requiring bad debt recapture for
large institutions, Sovereign must determine the tax deduction for bad debt
based on actual charge-offs. The Jobs Protection Act retained the existing base
year bad debt reserve and requires recapture into taxable income in certain
circumstances such as in the case of certain excess distributions or complete
redemptions. None of the limited circumstances requiring recapture are
anticipated by Sovereign. Retained earnings at December 31, 1999 included $79.6
million in bad debt reserves, for which no deferred taxes have been provided due
to the indefinite nature of the recapture provisions.
Sovereign maintains a Dividend Reinvestment and Stock Purchase Plan which
permits holders of record of Sovereign common stock to purchase additional
shares of common stock directly from Sovereign via reinvestment of cash
dividends and optional cash purchases. At December 31, 1999, purchases of common
61
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12 -- STOCKHOLDERS' EQUITY -- (CONTINUED)
stock with reinvested dividends are made at a 5% discount from the current
market price as defined and optional cash purchases are limited to a maximum of
$5,000 per quarter.
Sovereign maintains a Stockholder Rights Plan (the "Rights Plan"). The
Rights Plan is designed to protect stockholders from attempts to acquire control
of Sovereign at an inadequate price. Under the Rights Plan, Sovereign
distributed a dividend of one right to purchase a unit of preferred stock on
each outstanding share of Sovereign's common stock. The rights are not currently
exercisable or transferable and no separate certificates evidencing such rights
will be distributed, unless certain events occur. The rights attach to shares of
common stock outstanding on October 2, 1989 and will expire on September 27,
2004 as stated in the amendment to the Rights Plan dated September 27, 1995. The
rights will entitle the holders to purchase either Sovereign's common stock or
the common stock of the potential acquiree at a substantially reduced price.
On November 15, 1999, Sovereign raised $1.3 billion of debt and equity.
This included issuance of 43.8 million shares of common stock resulting in net
proceeds of $331.5 million. In connection with the PIERS offering as described
in the preceding note, Sovereign issued 5.75 million warrants with a fair value,
net of offering expenses, of $91.5 million, classified as stockholders' equity.
The conversion of all warrants would result in an additional 30.7 million shares
outstanding before the effect of repurchase of shares assumed under the treasury
stock method used for fully diluted EPS calculations.
On May 15, 1998, Sovereign redeemed all outstanding shares of its 6 1/4%
Cumulative Convertible Preferred Stock, Series B and issued 14.3 million shares
of common stock in connection with this redemption.
NOTE 13 -- STOCK OPTION PLANS
Sovereign grants stock options for a fixed number of shares to key
officers, certain employees and directors with an exercise price equal to the
fair market value of the shares at the date of grant. Sovereign's stock options
expire not more than ten years and one month after the date of grant and become
fully vested and exercisable within a one to five year period after the date of
grant. Sovereign accounts for stock option grants in accordance with APB Opinion
No. 25, "Accounting for Stock Issued to Employees," and accordingly, recognizes
no compensation expense for the stock option grants. There are 14.2 million
shares of common stock reserved for issuance under the plans. These shares,
along with the per share data in the following summary of option transactions,
have been adjusted to reflect all stock dividends and stock splits.
The following table provides a summary of the Company's stock option
activity for the years ended December 31, 1999, 1998 and 1997 and stock options
exercisable at the end of each of those years (number of options in thousands).
PRICE PER
SHARES SHARE
---------- ---------------
Options outstanding December 31, 1996 (3,758,345 shares
exercisable).............................................. 8,065,895 $ .96 - $8.94
Granted..................................................... 1,382,278 8.17 - 15.94
Exercised................................................... (3,388,704) .97 - 7.51
Forfeited................................................... (26,016) 3.84 - 10.54
Options outstanding December 31, 1997 (4,351,317 shares
exercisable).............................................. 6,033,453 .96 - 16.77
Granted..................................................... 934,070 13.38 - 20.25
Exercised................................................... (2,295,265) .97 - 10.54
Forfeited................................................... (172,550) 8.22 - 20.25
Options outstanding December 31, 1998 (3,371,038 shares
exercisable).............................................. 4,499,708 .96 - 20.25
Options exchanged in conjunction with Peoples acquisition... 473,531 4.41 - 6.86
Granted..................................................... 2,216,479 8.28 - 12.44
Exercised................................................... (720,811) .96 - 8.83
Forfeited................................................... (110,015) 3.78 - 16.35
Options outstanding December 31, 1999 (4,154,213 shares
exercisable).............................................. 6,358,892 $ 1.30 - $20.25
========== ===============
62
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13 -- STOCK OPTION PLANS -- (CONTINUED)
The following table summarizes Sovereign's stock options outstanding at
December 31, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------- ----------------------
WTD. AVG. WTD. AVG. WTD. AVG.
EXERCISE REMAINING EXERCISE
EXERCISE PRICES SHARES PRICE CONTRACTUAL LIFE SHARES PRICE
--------------- ---------- --------- ---------------- ---------- ---------
$ .96-$ 6.94 2,504,011 $ 4.36 4.70 2,504,011 $ 4.36
$7.27-$12.71 2,504,181 $11.01 9.19 299,502 $ 8.65
$13.28-$20.25 1,350,700 $14.67 8.15 1,350,700 $14.67
---------- ------ ---- ---------- ------
Total 6,358,892 $ 9.17 7.20 4,154,213 $ 8.02
========== ====== ==== ========== ======
Companies have a choice either to expense the fair value of employee stock
options over the vesting period (recognition method) or to continue the previous
practice but disclose the pro forma effects on net income and earnings per share
had the fair value method been used (disclosure only method). Sovereign follows
the disclosure only method.
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123 and has been determined as if Sovereign had accounted
for its employee stock options under the fair value method of that statement.
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following assumptions:
Grant date year.............................. 1999 1998 1997
Expected volatility.......................... .296 .278 .200-.840
Expected life in years....................... 6.00 6.00 4.00-7.50
Stock price on date of grant................. $ 8.28-$12.44 $13.38-$20.25 $ 8.17-$15.94
Exercise price............................... $ 8.28-$12.44 $13.38-$20.25 $ 8.17-$15.94
Weighted average exercise price.............. $ 11.34 $ 15.41 $ 10.60
Weighted average fair value.................. $ 3.98 $ 5.45 $ 4.44
Expected dividend yield...................... 1.40% .67% .21%-3.00%
Risk-free interest rate...................... 5.17%-6.75% 4.65%-5.72% 5.76%-6.88%
Vesting period in years...................... 1-5 1 0-4
The Black-Scholes option valuation model was developed for use in
estimating the fair market value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions, including the expected stock
price volatility. Because Sovereign's employee stock options have
characteristics significantly different from those traded options and because
changes in the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide reliable single measure of fair value of its employee stock options.
The pro forma reduction to net income for 1999, 1998 and 1997 was $3.2
million, $2.9 million and $2.8 million, respectively. The pro forma reduction to
diluted earnings per share was $.02, each year.
63
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 14 -- EMPLOYEE BENEFIT PLANS
Sovereign sponsors a non-contributory defined benefit pension plan
(Sovereign Plan) covering substantially all employees who have attained the age
of 21 and completed one year of service. Effective March 31, 1999, Sovereign
announced its intention to terminate the Sovereign Plan and is in the process of
completing that termination. Benefit accruals were frozen at March 31, 1999, and
a curtailment gain of $1.6 million was recorded. Benefits under the Sovereign
Plan were based upon years of service and the employees' average compensation
computed based on the five consecutive plan years of highest pay during the ten
years preceding retirement or termination.
Sovereign also sponsors a supplemental executive retirement plan, several
defined benefit pension and other plans covering former employees of
institutions acquired by Sovereign. Benefits are frozen under all acquired
defined benefit pension plans and Sovereign is in the process of terminating
these plans.
It is Sovereign's policy to fund the minimum contribution as determined by
actuarial valuation. Net periodic pension costs for these plans are comprised of
the following components (in thousands of dollars):
AT DECEMBER 31,
-------------------------------
1999 1998 1997
------- ------ ------
Service cost benefits earned during the period........... $ 351 $2,248 $1,928
Interest cost on projected benefit obligation............ 2,568 2,498 2,550
Actual return on plan assets............................. (224) (7,028) (7,227)
Amortization of unrecognized net assets and other
deferred amounts, net.................................. (2,308) 3,761 3,037
Curtailment gain......................................... (1,564) -- --
Asset gain............................................... -- -- 331
------- ------ ------
Net periodic pension expense........................... $(1,177) $1,479 $ 619
======= ====== ======
64
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 14 -- EMPLOYEE BENEFIT PLANS -- (CONTINUED)
The following table sets forth the Change in Benefit Obligation. Change in
Plan Assets and funded status for Sovereign's pension plan at December 31, 1999
and 1998 (in thousands).
YEAR ENDED
DECEMBER 31,
--------------------
1999 1998
------- -------
Change in Benefit Obligation:
Benefit obligation at beginning of year................... $38,159 $37,214
Service cost.............................................. 351 2,248
Interest cost............................................. 2,568 2,498
Actuarial gains........................................... 3,849 895
Benefits paid and annuity purchases....................... (5,972) (4,696)
Acquisitions.............................................. 4,941 --
Curtailment............................................... (4,174) --
Assumption changes........................................ 4,360 --
------- -------
Benefit obligation at end of year......................... $44,082 $38,159
======= =======
Change in Plan Assets:
Fair value of plan assets at beginning of year............ $46,901 $44,464
Actual return on plan assets.............................. 203 7,028
Company contributions..................................... 104 105
Benefits paid and annuity purchases....................... (5,972) (4,696)
Acquisitions.............................................. 4,706 --
------- -------
Fair value of plan assets at end of year.................. $45,942 $46,901
======= =======
Funded status of the plan................................. $ 1,860 $ 8,742
Unrecognized net actuarial gain (loss).................... 931 (5,351)
Unrecognized net transition asset......................... -- 1,176
Unrecognized prior service cost........................... 660 773
------- -------
Prepaid benefit cost...................................... $ 3,451 $ 5,340
======= =======
In determining the projected benefit obligation, the assumed discount rates
at December 31, 1999, 1998 and 1997 were 6.31%, 6.75% and 6.77%, respectively.
The weighted average rate of salary increase was 4.50% for 1999, 4.50% for 1998
and 4.46% for 1997. The expected long-term rate of return on assets used in
determining net periodic pension expense was 5.13% for 1999, 9.00% for 1998 and
8.92% for 1997. The pension plans' assets consist primarily of short-term U.S.
Treasury and government agency securities, units of fixed income common trust
funds, and Sovereign common stock. At December 31, 1999 the Sovereign Plan held
approximately 79,000 shares of Sovereign stock with a fair market value of $0.6
million.
Sovereign maintains a 401(k) savings plan. Substantially all employees of
Sovereign are eligible to participate in the 401(k) savings plan following their
completion of one year of service and attaining age 21. Sovereign's
contributions to this plan were $2.1 million, $1.5 million and $753,000 during
1999, 1998 and 1997, respectively. Pursuant to this plan, employees can
contribute up to 10% of their compensation to the plan. Sovereign contributes
50% of the employee contribution up to 6% of compensation in the form of
Sovereign common stock.
Sovereign maintains an Employee Stock Ownership Plan ("Sovereign ESOP"),
and substantially all employees of Sovereign are eligible to participate in the
Sovereign ESOP following their completion of one year of service and attaining
age 21. The Sovereign ESOP is a deferred contribution plan which provides
retirement benefits for participants and beneficiaries by purchasing Sovereign
common stock in the open market. The amount of annual contributions to the
Sovereign ESOP by Sovereign is determined by the Board
65
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 14 -- EMPLOYEE BENEFIT PLANS -- (CONTINUED)
of Directors based upon the financial performance of Sovereign each year.
Sovereign recognized as expense $3.4 million, $4.0 million and $7.7 million to
the ESOP during 1999, 1998 and 1997, respectively.
On November 21, 1994, Sovereign's Board of Directors authorized an
amendment to the Sovereign ESOP to add a leverage feature to purchase up to 6.7
million shares of Sovereign's outstanding common stock in the open market or in
negotiated transactions. The Sovereign ESOP is funded through direct loans from
Sovereign. The proceeds from these loans were used to purchase outstanding
shares of Sovereign's common stock. As the debt on these loans is repaid, shares
of Sovereign common stock are released and become eligible for allocation to
employee accounts. In addition, dividends are paid on all shares of Sovereign
common stock, including unallocated shares held by the Sovereign ESOP. Dividends
on the unallocated shares are allocated on a pro-rata basis when purchased
shares are released. Compensation expense is recognized based on the fair value
of the shares committed to be released to employees and the shares then become
outstanding for earnings per share computations. Sovereign has committed to make
contributions sufficient to provide for the ESOP debt requirements.
Peoples also sponsored a leveraged ESOP that Sovereign intends to terminate
effective March 31, 2000.
At December 31, 1999, the ESOPs held 6.4 million shares of Sovereign stock
of which 1.6 million shares were allocated to participant accounts. The
unallocated ESOP shares are presented as a reduction of stockholders' equity in
the consolidated financial statements. The unallocated ESOP shares had a fair
market value of $36.0 million at December 31, 1999. Sovereign recognized as
expense $3.4 million, $4.0 million and $7.7 million for the ESOPs in 1999, 1998
and 1997, respectively. At December 31, 1999, the ESOPs had $45.4 million of
loans outstanding from Sovereign.
Sovereign maintains several bonus deferral plans for selected management
and executive employees. These plans allow employees to defer 50% or more of
their bonus to purchase Sovereign stock. The deferred amount is placed in a
grantor trust and invested in Sovereign common stock. Matching contributions
ranging from 25% to 100% are made by Sovereign into the trust and are also
invested in Sovereign stock. Earnings on the deferral and matching contributions
are also invested in Sovereign stock. Expense is recognized ratably over the
vesting periods of the plans. Benefits vest ratably over three years under the
management plan and after five years under the executive plan. Benefits also
vest under the plans in the event of termination by reason of death, disability,
retirement, involuntary termination or the occurrence of a change of control as
defined by the plans. Voluntary termination or termination for cause (as
defined) generally result in forfeiture of the unvested balance including
employee deferrals. Sovereign recognized as expense $1.0 million, $285,000 and
$250,000 for these plans in 1999, 1998 and 1997, respectively.
Sovereign maintains an Employee Stock Purchase Plan which permits eligible
employees to purchase Sovereign common stock directly from Sovereign. Purchases
of common stock are limited to 15% of a participant's compensation. During 1999,
1998 and 1997, participants purchased Sovereign common stock at a price equal to
92.5% of the fair value of Sovereign common stock on the offering date.
Compensation expense for this plan for the year ended December 31, 1999, 1998
and 1997 was $136,000, $106,000 and $46,000, respectively.
66
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 15 -- INCOME TAXES
The provision for income taxes in the consolidated statement of operations
is comprised of the following components (in thousands):
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
------- ------- -------
Current:
Federal.............................................. $69,656 $92,311 $73,431
State................................................ 807 1,121 4,282
------- ------- -------
70,463 93,432 77,713
Deferred............................................... 18,852 (18,681) (10,389)
------- ------- -------
Total income tax expense............................. $89,315 $74,751 $67,324
======= ======= =======
The following is a reconciliation of the actual tax provisions with taxes
computed at the federal statutory rate of 35% for each of the years indicated:
YEAR ENDED DECEMBER 31,
--------------------------
1999 1998 1997
---- ---- ----
Federal income tax at statutory rate........................ 35.0% 35.0% 35.0%
Increase/(decrease) in taxes resulting from:
Tax-exempt income......................................... (5.8) (5.2) (2.0)
State income taxes, net of federal tax benefit............ 0.2 0.3 1.6
Amortization of intangible assets and other purchase
accounting adjustments................................. 0.9 0.8 1.0
Non-deductible, merger-related costs...................... -- 3.1 2.1
Other..................................................... 2.9 1.4 1.9
---- ---- ----
33.2% 35.4% 39.6%
==== ==== ====
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are presented
below (in thousands):
YEAR ENDED DECEMBER 31,
----------------------------
1999 1998 1997
-------- ------- -------
Deferred tax assets:
Allowance for possible loan losses.................... $ 43,766 $37,849 $37,390
Purchased mortgage servicing rights................... 3,532 4,356 5,364
Employee benefits..................................... 1,344 888 2,593
Merger-related liabilities............................ 6,339 2,313 1,104
Purchase accounting adjustments....................... 8,765 370 1,071
Unrealized loss on available-for-sale portfolio....... 113,764 -- 89
Net operating loss carry forwards..................... 8,630 1,393 1,810
Other................................................. 5,472 847 5,621
-------- ------- -------
Total gross deferred tax assets.................... $191,612 $48,016 $55,042
-------- ------- -------
Deferred tax liabilities:
Purchase accounting adjustments....................... $ 8,177 $ 5,402 $ 6,473
Deferred loan fees.................................... 10,505 7,144 5,739
Tax bad debt reserve recapture........................ 4,393 2,406 2,888
Originated mortgage servicing rights.................. 8,269 3,843 2,678
Option premiums....................................... 2,716 2,716 9,799
Unrealized gain on available-for-sale portfolio....... -- 9,757 9,625
Other................................................. 11,145 4,163 6,609
-------- ------- -------
Total gross deferred tax liabilities.................. $ 45,205 $35,431 $43,811
-------- ------- -------
Net deferred tax asset.................................. $146,407 $12,585 $11,231
======== ======= =======
67
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 15 -- INCOME TAXES -- (CONTINUED)
The Small Business Job Protection Act of 1996 ("the Act") repealed the tax
bad debt deduction computed under the percentage of taxable income method for
tax years beginning after December 31, 1995 and requires thrifts to recapture
into income, over a six-year period, the amount by which their tax bad debt
reserves exceed their base year reserves. As a result, Sovereign is required to
recapture $15.2 million, of which $5.3 million has been recaptured through
December 31, 1999, related to its tax bad debt reserve in excess of its base
year reserve. Sovereign previously recorded a deferred tax liability for this
excess and therefore, the recapture will not impact the statement of operations.
Sovereign has determined that it is not required to establish any valuation
reserve for deferred tax assets since it is more likely than not that deferred
tax assets will ultimately be realized. Sovereign's conclusion that it is "more
likely than not" that the deferred tax assets will be realized is based on a
history of growth in earnings and the prospects for continued growth including
an analysis of potential uncertainties that may affect future operating results.
Sovereign will continue to review the criteria related to the recognition of
deferred tax assets on a quarterly basis.
NOTE 16 -- COMMITMENTS AND CONTINGENCIES
Financial Instruments
Sovereign is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers
and to manage its own exposure to fluctuations in interest rates. These
financial instruments include commitments to extend credit, standby letters of
credit, loans sold with recourse, forward contracts and interest rate swaps,
caps and floors. These financial instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the consolidated balance sheet. The contract or notional amounts of these
financial instruments reflect the extent of involvement Sovereign has in
particular classes of financial instruments.
Sovereign's exposure to credit loss in the event of non-performance by the
other party to the financial instrument for commitments to extend credit,
standby letters of credit and loans sold with recourse is represented by the
contractual amount of those instruments. Sovereign uses the same credit policies
in making commitments and conditional obligations as it does for on-balance
sheet instruments. For interest rate swaps, caps and floors and forward
contracts, the contract or notional amounts do not represent exposure to credit
loss. Sovereign controls the credit risk of its interest rate swaps, caps and
floors and forward contracts through credit approvals, limits and monitoring
procedures. Unless noted otherwise, Sovereign does not require and is not
required to pledge collateral or other security to support financial instruments
with credit risk.
The following schedule summarizes Sovereign's off-balance sheet financial
instruments (in thousands):
CONTRACT OR NOTIONAL AMOUNT
AT DECEMBER 31,
---------------------------
1999 1998
---------- ----------
Financial instruments whose contract amounts represent
credit risk:
Commitments to extend credit............................ $2,236,688 $1,191,599
Standby letters of credit............................... 76,775 21,153
Loans sold with recourse................................ 25,214 35,375
Financial instruments whose notional or contract amounts
exceed the amount of credit risk:
Forward contracts....................................... 75,335 608,104
Interest rate swaps..................................... 452,300 2,955,164
Interest rate caps...................................... 1,200,000 1,200,000
68
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 16 -- COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. Sovereign evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained upon
extension of credit is based on management's credit evaluation of the counter
party. Collateral held usually consists of real estate but may include
securities, accounts receivable, inventory and property, plant and equipment.
Standby letters of credit are conditional commitments issued by Sovereign
to guarantee the performance of a customer to a third party. The guarantees are
primarily issued to support public and private borrowing arrangements. Most
guarantees expire by June 2003 and one guarantee for $1.4 million expires in
January 2011. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
Sovereign holds various collateral to support the commitments.
Loans sold with recourse primarily represent single-family residential
loans. These are seasoned loans with decreasing balances and historical loss
experience has been minimal.
The forward contracts used by Sovereign in its mortgage banking activities
are contracts for delayed delivery of securities in which Sovereign agrees to
make delivery of a specified instrument, at a specified future date, at a
specified price or yield. Risks arise from the possible inability of counter
parties to meet the terms of their contracts and from movements in securities'
values and interest rates.
Interest rate swaps, caps and floors enable Sovereign to transfer, modify
or reduce its interest rate risk and are used as part of asset and liability
management. Sovereign may become a principal in the exchange of interest
payments with another party and therefore, is exposed to loss should one of the
counter parties default. Sovereign minimizes this risk by performing credit
reviews on counter parties.
Notional principal amounts often are used to express the volume of these
transactions, but the amounts potentially subject to credit risk are
significantly smaller.
Litigation
At December 31, 1999, Sovereign was party to a number of lawsuits, which
arise during the normal course of business. While any litigation has an element
of uncertainty, management, after reviewing these actions with legal counsel, is
of the opinion that the liability, if any, resulting from these actions will not
have a material effect on the financial condition or results of operations of
Sovereign.
69
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 17 -- FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents disclosures about the fair value of financial
instruments as defined by SFAS No. 107, "Fair Value of Financial Instruments."
These fair values are presented based upon subjective estimates of relevant
market conditions at a specific point in time and information about each
financial instrument. In cases where quoted market prices are not available,
fair values are based on estimates using present value or other valuation
techniques. These techniques involve uncertainties resulting in variability in
estimates affected by changes in assumptions and risks of the financial
instruments at a certain point in time. Therefore, the derived fair value
estimates presented below cannot be substantiated by comparison to independent
markets. In addition, the fair values do not reflect any premium or discount
that could result from offering for sale at one time an entity's entire holdings
of a particular financial instrument nor does it reflect potential taxes and the
expenses that would be incurred in an actual sale or settlement. Accordingly,
the aggregate fair value amounts presented do not represent the underlying value
of Sovereign (in thousands):
AT DECEMBER 31,
-----------------------------------------------------
1999 1998
------------------------- -------------------------
CARRYING CARRYING
VALUE FAIR VALUE VALUE FAIR VALUE
----------- ----------- ----------- -----------
Financial Assets:
Cash and amounts due from depository
institutions.......................... $ 373,996 $ 373,996 $ 471,074 $ 471,074
Interest-earning deposits............... 19,238 19,238 82,650 82,650
Loans held for sale..................... 61,925 62,439 296,930 297,414
Investment securities
available-for-sale.................... 8,030,212 8,030,212 6,662,427 6,662,427
Investment securities
held-to-maturity...................... 2,362,051 2,367,025 1,839,655 1,860,583
Loans, net.............................. 14,093,554 13,955,482 11,152,038 11,180,004
Mortgage servicing rights............... 72,491 76,606 62,332 64,840
Financial Liabilities:
Deposits................................ 11,719,646 11,686,094 12,322,716 12,314,608
Borrowings(1)........................... 12,663,138 12,442,697 7,907,805 7,887,676
Unrecognized Financial Instruments:(2)
Commitments to extend credit............ 16,003 16,086 5,875 5,880
Loans sold with recourse................ 126 50 177 71
Interest rate swaps, caps and floors.... 4,463 1,198 7,213 (55,755)
- ------------------
(1) Borrowings are shown without unamortized cap premiums, as cap premiums are
reflected separately below in "Interest rate swaps, caps and floors."
(2) The amounts shown under "carrying value" represent accruals or deferred
income arising from those unrecognized financial instruments.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments:
Cash and amounts due from depository institutions and interest-earning
deposits. For these short-term instruments, the carrying amount is a reasonable
estimate of fair value.
Loans held for sale. Fair values are estimated using quoted rates based
upon secondary market sources for securities backed by similar loans. Fair value
estimates include consideration of all open positions (including forward
contracts), outstanding commitments and related fees paid.
Investment securities available-for-sale. The fair value of investment
securities available-for-sale are based on quoted market prices as of the
balance sheet date. In accordance with SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," changes in fair value are reflected
in the carrying value of the asset and are shown as a separate component of
stockholders' equity.
70
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 17 -- FAIR VALUE OF FINANCIAL INSTRUMENTS -- (CONTINUED)
Investment securities held-to-maturity. The carrying amounts for
short-term investment securities held-to-maturity approximate fair value because
of the short maturity of these instruments and they do not present unanticipated
credit concerns. The fair value of long-term investment securities
held-to-maturity is estimated based upon bid quotations received from securities
dealers and an independent pricing servicing bureau.
Loans. Fair value is estimated by discounting cash flows using estimated
market discount rates at which similar loans would be made to borrowers and
reflect similar credit ratings and interest rate risk for the same remaining
maturities.
Mortgage servicing rights. The fair value of mortgage servicing rights are
estimated using quoted rates based upon secondary market sources. The estimated
fair value approximates the amount for which the servicing could currently be
sold.
Deposits. The fair value of deposits with no stated maturity, such as
non-interest bearing demand deposits, NOW accounts, savings accounts and certain
money market accounts, is equal to the amount payable on demand as of the
balance sheet date. The fair value of fixed-maturity certificates of deposit is
estimated by discounting cash flows using currently offered rates for deposits
of similar remaining maturities.
Borrowings. Fair value is estimated by discounting cash flows using rates
currently available to Sovereign for other borrowings with similar terms and
remaining maturities.
Commitments to extend credit. The fair value of commitments to extend
credit is estimated using the fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
present creditworthiness of the counter parties. For fixed rate loan
commitments, fair value also considers the difference between current levels of
interest rates and the committed rates.
Loans sold with recourse. The fair value of loans sold with recourse is
estimated based upon the cost to terminate Sovereign's obligations under the
recourse provisions.
Interest rate swaps, caps and floors. The fair value of interest rate
swaps, caps and floors which represent the estimated amount Sovereign would
receive or pay to terminate the contracts or agreements, taking into account
current interest rates and when appropriate, the current creditworthiness of the
counter parties are obtained from dealer quotes.
71
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 18 -- INTEREST RATE EXCHANGE AGREEMENTS
Interest rate swaps are generally used to convert fixed rate assets and
liabilities to variable rate assets and liabilities and vice versa. Interest
rate caps are generally used to limit the exposure from repricing of
liabilities. Interest rate floors are generally used to limit the exposure from
repricing of assets. In certain cases, interest rate caps and floors are
simultaneously bought and sold to create a range of protection against changing
interest rates while limiting the cost of that protection. The following table
presents information regarding interest rate exchange agreements at the dates
indicated (in thousands):
AT DECEMBER 31, AT DECEMBER 31,
------------------------------------------ ------------------------------------------
WEIGHTED WEIGHTED
ESTIMATED AVERAGE ESTIMATED AVERAGE
NOTIONAL BOOK FAIR MATURITY NOTIONAL BOOK FAIR MATURITY
AMOUNT VALUE VALUE IN YEARS AMOUNT VALUE VALUE IN YEARS
---------- ------ --------- -------- ---------- ------ --------- --------
Amortizing interest rate swaps:
Pay fixed-receive variable(1)........ $ -- $ -- $ -- -- $ 175,164 $ -- $ (617) .3
Non-amortizing interest rate swaps:
Pay variable-receive fixed(2)........ 252,300 -- (6,846) 7.0 -- -- -- --
Pay fixed-receive variable(3)........ 200,000 -- 8,853 3.1 2,780,000 -- (48,382) 4.8
Interest rate
caps/floors/corridors(4)............. 1,200,000 4,463 (809) 2.6 1,200,000 7,213 (6,756) 3.2
---------- ------ ------ ---------- ------ --------
$1,652,300 $4,463 $1,198 $4,155,164 $7,213 $(55,755)
========== ====== ====== ========== ====== ========
- ------------------
(1) The weighted average pay rate was 6.87% and the weighted average receive
rate was 5.99% at December 31, 1998.
(2) The weighted average pay rate was 7.24% and the weighted average receive
rate was 7.00% at December 31, 1999.
(3) The weighted average pay rate was 5.41% and 5.42% and the weighted average
receive rate was 6.13% and 5.26% at December 31, 1999 and 1998,
respectively.
(4) The weighted average strike price range was 5.25% - 9.00% at December 31,
1999 and 5.25% - 9.00% at December 31, 1998.
The following table summarizes by notional amounts the activity of
Sovereign's interest rate exchange agreements (in thousands):
AMORTIZING NON-AMORTIZING INTEREST RATE
INTEREST INTEREST CAPS, FLOORS,
RATE SWAPS RATE SWAPS CORRIDORS TOTAL
---------- -------------- ------------- ----------
Balance, December 31, 1996.................. $1,112,013 $1,405,000 $ 500,000 $3,017,013
---------- ---------- ---------- ----------
Additions................................. -- 4,145,000 700,000 4,845,000
Maturities/Amortization................... 151,136 151,501 -- 302,637
Terminations.............................. 150,000 2,600,000 -- 2,750,000
---------- ---------- ---------- ----------
Balance, December 31, 1997.................. 810,877 2,798,499 1,200,000 4,809,376
---------- ---------- ---------- ----------
Additions................................. -- 1,650,000 -- 1,650,000
Maturities/Amortization................... 86,497 100,000 -- 186,497
Terminations.............................. 549,216 1,568,499 -- 2,117,715
---------- ---------- ---------- ----------
Balance, December 31, 1998.................. 175,164 2,780,000 1,200,000 4,155,164
---------- ---------- ---------- ----------
Additions................................. -- 352,300 -- 352,300
Maturities/Amortization................... 175,164 370,000 -- 545,164
Terminations.............................. -- 2,310,000 -- 2,310,000
---------- ---------- ---------- ----------
Balance, December 31, 1999.................. $ -- $ 452,300 $1,200,000 $1,652,300
========== ========== ========== ==========
Net interest income resulting from interest rate exchange agreements
included $.5 million of income and $8.9 million of expense for 1999, $6.8
million of income and $4.5 million of expense for 1998 and $4.8 million of
income and $4.8 million of expense for 1997.
72
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 19 -- PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Sovereign Bancorp is as follows (in
thousands):
BALANCE SHEETS
---------------------------
AT DECEMBER 31,
---------------------------
1999 1998
---------- ----------
Assets
Cash and due from banks................................... $ 2 $ 114
Investment securities held-to-maturity.................... 765,736 --
Investment in subsidiaries
Bank subsidiary........................................ 2,299,508 1,487,423
Non-bank subsidiaries.................................. 664,908 211,568
Other assets.............................................. 46,312 11,706
---------- ----------
Total Assets................................................ $3,776,466 $1,710,811
========== ==========
Liabilities & Stockholders' Equity
Borrowings:
Short-term borrowings.................................. $ 77,894 $ 200,148
Long-term borrowings................................... 1,509,773 147,625
Non-bank affiliate borrowings.......................... 347,605 144,870
Other liabilities......................................... 19,699 14,100
---------- ----------
Total liabilities........................................... 1,954,971 506,743
---------- ----------
Stockholders' Equity........................................ 1,821,495 1,204,068
---------- ----------
Total Liabilities and Stockholders' Equity.................. $3,776,466 $1,710,811
========== ==========
STATEMENTS OF OPERATIONS
------------------------------
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Dividends from Bank subsidiary.............................. $ -- $ -- $ 1,771
Interest income............................................. 6,847 12,222 8,907
Other income................................................ 149 5,749 8,681
-------- -------- --------
Total income................................................ 6,996 17,971 19,359
-------- -------- --------
Interest expense............................................ 56,668 29,556 24,468
Other expense............................................... 28,976 8,122 9,676
-------- -------- --------
Total expense............................................... 85,644 37,678 34,144
-------- -------- --------
Loss before income taxes and equity in earnings of
subsidiaries.............................................. (78,648) (19,707) (14,785)
Income taxes................................................ (26,058) (6,461) (8,399)
-------- -------- --------
Loss before equity in earnings of subsidiaries.............. (52,590) (13,246) (6,386)
Equity in earnings of: Bank subsidiary...................... 226,219 149,442 109,287
Non-bank subsidiaries................ 5,670 259 (363)
-------- -------- --------
Net Income.................................................. $179,299 $136,455 $102,538
======== ======== ========
73
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 19 -- PARENT COMPANY FINANCIAL INFORMATION -- (CONTINUED)
STATEMENTS OF CASH FLOWS
--------------------------------
YEAR ENDED DECEMBER 31,
--------------------------------
1999 1998 1997
---------- -------- --------
Cash Flows from Operating Activities:
Net income................................................ $ 179,299 $136,455 $102,538
Adjustments to reconcile net income to net cash provided
by operating activities:
Dividend received from bank subsidiary................. -- -- (1,771)
Earnings from:
Bank subsidiary...................................... (226,219) (149,442) (109,287)
Non-bank subsidiaries................................ (5,670) (259) 363
Other, net............................................. (25,969) 29,123 15,808
---------- -------- --------
Net cash provided (used) by operating activities............ (78,559) 15,877 7,651
---------- -------- --------
Cash Flows from Investing Activities:
Net capital contributed to subsidiaries................... (739,777) (346,648) (15,832)
Investment securities:
Maturity and repayments................................ -- 6,183 2,097
Net purchase and sales................................. (994,788) 97,084 (69,545)
Net cash received from business combinations.............. 51 -- --
Other, net................................................ -- (4,228) (638)
---------- -------- --------
Net cash used by investing activities....................... (1,734,514) (247,609) (83,918)
---------- -------- --------
Cash Flows from Financing Activities:
Net change in borrowings.................................. 275,807 219,215 54,133
Net proceeds received from debt offering.................. 1,166,822 -- --
Sale (acquisition) of treasury stock...................... (46,867) (901) 34,632
Cash dividends paid to stockholders....................... (17,104) (14,286) (23,777)
Net proceeds from issuance of common stock................ 342,803 20,451 17,919
Net proceeds from issuance of warrants.................... 91,500 -- --
Other, net................................................ -- (6) 170
---------- -------- --------
Net cash provided by financing activities................... 1,812,961 224,473 83,077
---------- -------- --------
(Decrease) increase in cash and cash equivalents............ (112) (7,259) 6,810
Cash and cash equivalents at beginning of period............ 114 7,373 563
---------- -------- --------
Cash and cash equivalents at end of period.................. $ 2 $ 114 $ 7,373
========== ======== ========
74
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 20 -- EARNINGS PER SHARE
The following table presents the computation of earnings per share based on
the provisions of SFAS No. 128 for the years indicated (in thousands, except per
share data):
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Net income.................................................. $179,299 $136,455 $102,538
Less preferred dividends.................................... -- (1,496) (6,244)
-------- -------- --------
Net income attributable to common stock..................... $179,299 $134,959 $ 96,294
======== ======== ========
Weighted average basic shares............................... 176,021 152,910 136,997
Weighted average diluted shares............................. 176,021 158,172 151,356
Dilutive effect of average stock options.................... 2,146 3,039 4,550
-------- -------- --------
Total weighted average diluted shares....................... 178,167 161,211 155,906
======== ======== ========
Net income per common share:
Basic..................................................... $ 1.02 $ .88 $ .70
======== ======== ========
Diluted................................................... $ 1.01 $ .85 $ .66
======== ======== ========
NOTE 21 -- COMPREHENSIVE INCOME/(LOSS)
The following table presents the components of comprehensive income, net of
related tax, based on the provisions of SFAS No. 130 for the years indicated (in
thousands):
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Net income.................................................. $179,299 $136,455 $102,538
-------- -------- --------
Unrealized (losses) gains on securities arising during the
year...................................................... (216,644) (16,095) 18,399
Less reclassification adjustment(1)......................... 12,408 (16,063) --
-------- -------- --------
Net unrealized (losses) gains recognized in other
comprehensive income...................................... (229,052) (32) 18,399
-------- -------- --------
Comprehensive income/(loss)................................. $(49,753) $136,423 $120,937
======== ======== ========
- ------------------
(1) Sovereign has not calculated the reclassification adjustment for 1997.
Accumulated other comprehensive income, net of related tax, consisted of
net unrealized losses on securities of $210.9 million at December 31, 1999 and
unrealized gains on securities of $18.1 million and $18.9 million at December
31, 1998 and 1997, respectively.
75
SOVEREIGN BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 22 -- SUBSEQUENT EVENT -- PENDING ACQUISITION OF SOVEREIGN BANK NEW ENGLAND
On September 3, 1999, Sovereign entered into a purchase and assumption
agreement with FleetBoston Financial to acquire branch banking offices located
in Connecticut, Massachusetts, New Hampshire and Rhode Island, and related
deposit liabilities, loans and other assets associated with the business of
those branches. On February 28, 2000, Sovereign and FleetBoston Financial agreed
to restructure certain terms of the agreement. Sovereign will purchase
approximately $12 billion of deposits, $9 billion of loans and 285 community
banking offices. The acquisition, which results in the creation of Sovereign
Bank New England, the third largest bank in New England, includes the following:
the former Fleet Bank community banking franchise in eastern Massachusetts; the
entire former BankBoston community banking franchise in Rhode Island; and select
community banking offices of Fleet Bank in southern New Hampshire and BankBoston
in Connecticut. In addition, Sovereign is acquiring a substantial portion of the
middle market and small business-lending group from Fleet in Massachusetts and
New Hampshire, and from BankBoston in Rhode Island and Connecticut. The
acquisition includes the purchase of fully functioning business units, with the
necessary management, relationship officers, support staffs, and other
infrastructure for the acquired loans and deposits to be fully serviced.
Sovereign has obtained the receipt of all required regulatory approvals for this
acquisition.
ACQUISITION TIMETABLE
DATE DIVESTED UNITS DEPOSITS BRANCHES LOANS
---- -------------- ------------ -------- ------------
March 24, 2000......... Rhode Island, Connecticut (BankBoston) $4.0 billion 90 $3.2 billion
June 16, 2000.......... Eastern Mass (Fleet) $4.0 billion 86 $3.5 billion
July 21, 2000.......... Central Mass, New Hampshire (Fleet) $4.0 billion 109 $2.4 billion
Total consideration for the entire consumer and banking franchise is 12% of
acquired deposits, or approximately $1.4 billion. Sovereign will pay
approximately $1.1 billion as the purchases are completed according to the above
schedule. Sovereign will pay the remaining $340 million in periodic installments
between January 2001 and October 2001 if FleetBoston complies with its
non-compete obligations under the agreement and certain other conditions are
met. Sovereign paid a non-refundable deposit of $200 million to FleetBoston to
be credited against amounts due on the third closing, and is required to comply
at each closing with the acquisition plan included with its application as
approved by the Office of Thrift Supervision.
Sovereign raised approximately $1.8 billion of debt and equity in November
and December, 1999 to finance the acquisition. See Notes 10, 11 and 12 to these
financial statements for a more complete description of these financings.
76
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information relating to executive officers of Sovereign is included
under Item 4A in Part I hereof. The information required by this item relating
to directors of Sovereign is incorporated herein by reference to (i) that
portion of the section captioned "Election of Directors" located in the
definitive Proxy Statement to be used in connection with Sovereign's 1999 Annual
Meeting of Shareholders (the "Proxy Statement"). The information required by
this item relating to compliance with Section 16(a) of the Securities Exchange
Act of 1934 is incorporated herein by reference to the section captioned
"Additional Information Regarding Directors and Officers" in the Proxy
Statement.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated herein by reference
to (i) the sections captioned "Compensation Paid to Directors" through
"Indemnification" in the Proxy Statement and (ii) the section captioned
"Performance Graph" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is incorporated herein by reference
to (i) the section captioned "Principal Shareholders" in the Proxy Statement and
(ii) that portion of the section captioned "Election of Directors" in the Proxy
Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated herein by reference
to the sections captioned "Indebtedness of Management" and "Other" in the Proxy
Statement.
77
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(A) 1. FINANCIAL STATEMENTS.
The following financial statements are filed as part of this report:
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
2. FINANCIAL STATEMENT SCHEDULES.
Financial statement schedules are omitted because the required information
is either not applicable, not required or is shown in the respective financial
statements or in the notes thereto.
3. EXHIBITS.
(3.1) Articles of Incorporation, as amended and restated, of
Sovereign Bancorp, Inc. (Incorporated by reference to
Exhibit 3.1 to Sovereign's Annual Report on Form 10-K for
the fiscal year ended December 31, 1995.)
(3.2) By-Laws of Sovereign Bancorp, Inc.
(4.1) Sovereign Bancorp, Inc. has certain long-term debt
outstanding. None of the instruments evidencing such debt
authorizes an amount of securities in excess of 10% of the
total assets of Sovereign Bancorp, Inc. and its subsidiaries
on a consolidated basis; therefore, copies of such
instruments are not included as exhibits to this Annual
Report on Form 10-K. Sovereign Bancorp, Inc. agrees to
furnish copies of such instruments to the Commission on
request.
(10.1) Sovereign Bancorp, Inc. Stock Option Plan. (Incorporated by
reference to Exhibit 10.1 to Sovereign's Annual Report on
Form 10-K for the fiscal year ended December 31, 1994.)
(10.2) Sovereign Bancorp, Inc. Employee Stock Purchase Plan.
(Incorporated by reference to Exhibit 4.1 to Sovereign's
Registration Statement No. 33-44108 on Form S-8.)
(10.3) Agreement dated as of March 1, 1997, between Sovereign
Bancorp, Inc., Sovereign Bank, and Jay S. Sidhu.
(Incorporated by reference to Exhibit 10.1 to Sovereign's
Quarterly Report on Form 10-Q for the quarter ended December
31, 1997.)
(10.4) Agreement dated as of May 1, 1997, between ML Bancorp, Inc.
(a predecessor company of Sovereign Bancorp, Inc.) and
Dennis S. Marlo.
(10.5) Agreement dated as of September 25, 1997, between Sovereign
Bank and Lawrence M. Thompson, Jr. (incorporated by
reference to exhibit 10.5 to Sovereign's Annual Report on
Form 10-K for the year ended December 31, 1997.)
(10.6) Penn Savings Bank Senior Officer Incentive Plan.
(Incorporated by reference to Exhibit 10.6 to Sovereign's
Annual Report on Form 10-K for the year ended December 31,
1994.)
(10.7) Rights Agreement dated September 19, 1989, between Sovereign
Bancorp, Inc. and Harris Trust Company of New York.
(Incorporated by reference to Exhibit 4.3 to Sovereign's
Registration Statement No. 33-89586 on Form S-8).
78
(10.8) Sovereign Bancorp, Inc. Non-Employee Director Incentive
Compensation Plan. (Incorporated by reference to Exhibit
10.12 to Sovereign's Registration Statement No. 33-43195 on
Form S-1).
(10.9) 1993 Sovereign Bancorp, Inc. Stock Option Plan.
(Incorporated by reference to Exhibit 10.23 to Sovereign's
Annual Report on Form 10-K for the year ended December 31,
1992).
(10.10) Indemnification Agreement dated December 21, 1993, between
Sovereign Bank and Jay S. Sidhu. (Incorporated by reference
to Exhibit 10.25 to Sovereign's Annual Report on Form 10-K
for the fiscal year ended December 31, 1993.)
(10.11) Employment Agreement dated as of August 8, 1988, between
Charter Federal Savings Bank and Patrick J. Petrone.
(Incorporated by reference to Exhibit 10.23 to Sovereign's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1994.)
(10.12) Amendment to Employment Agreement between Patrick J. Petrone
and Charter Federal Savings Bank, dated October 17, 1994.
(Incorporated by reference to Exhibit 10.24 to Sovereign's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1994.)
(10.13) Amendment to Rights Agreement, dated as of September 27,
1995, between Sovereign Bancorp, Inc. and Chemical Bank, as
successor to Harris Trust Company of New York, as Rights
Agent. (Incorporated by reference to Exhibit 2.2 of
Amendment No. 1 of Sovereign's Registration Statement on
Form 8-A.)
(10.14) Sovereign Bancorp, Inc. 1997 Non-Employee Directors' Stock
Option Plan. (Incorporated by reference to Exhibit "A" to
Sovereign's definitive proxy statement dated March 16,
1998.)
(10.15) Sovereign Bancorp, Inc. 1996 Stock Option Plan.
(Incorporated by reference to Exhibit "A" to Sovereign's
definitive proxy statement dated March 15, 1996.)
(10.16) Amended and Restated Purchase and Assumption Agreement by
and among Fleet Boston Corporation, Fleet National Bank,
Fleet Bank-NH, BankBoston, N.A., Sovereign Bank and
Sovereign Bancorp, Inc., dated February 28, 2000.
(Incorporated by reference to Exhibit 2.1 to the Current
Report on Form 8-K, dated March 3, 2000, of Sovereign
Bancorp, Inc.)
(21) Subsidiaries of the Registrant
(23.1) Consent of Ernst & Young LLP, Independent Auditors.
(23.2) Consent of KPMG LLP, Independent Auditors.
(23.3) Consent of PricewaterhouseCoopers LLP, Independent
Accountants.
(23.4) Consent of Arthur Andersen LLP, Independent Public
Accountants.
(27) Financial Data Schedule
(99.1) Report of KPMG LLP, Independent Auditors.
(99.2) Report of PricewaterhouseCoopers LLP, Independent
Accountants.
(99.3) Report of Arthur Andersen LLP, Independent Public
Accountants.
(B) REPORTS ON FORM 8-K
1. Report on Form 8-K, dated November 16, 1999 (date of earliest
event--November 10, 1999) reports, under Items 5 and 7, the completion by
Sovereign Bancorp, Inc. of its public offerings of the Common Stock, the Senior
Notes and the Units in connection with Sovereign Bank's purchase of assets and
assumption of liabilities from Fleet National Bank, Fleet Bank-NH and
BankBoston, N.A.
2. Report on Form 8-K, dated October 26, 1999 (date of earliest
event--October 19, 1999) reports, under Items 5 and 7, the filing by Sovereign
Bancorp, Inc. of its preliminary Prospectus Supplements for the Common Stock,
the Senor Notes and the Units in connection with Sovereign Bank's purchase of
assets and assumption of liabilities from Fleet National Bank, Fleet Bank-NH and
BankBoston, N.A.
79
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SOVEREIGN BANCORP, INC.
(Registrant)
March 23, 2000 By /s/JAY S. SIDHU
Jay S. Sidhu, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities and on
the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/S/BRIAN HARD Director March 27, 2000
Brian Hard
/S/RICHARD E. MOHN Chairman of Board and Director March 23, 2000
Richard E. Mohn
/S/RHODA S. OBERHOLTZER Director March 23, 2000
Rhoda S. Oberholtzer
/S/PATRICK J. PETRONE Director March 23, 2000
Patrick J. Petrone
/S/DANIEL K. ROTHERMEL Director March 23, 2000
Daniel K. Rothermel
/S/JAY S. SIDHU Director, President and Chief March 23, 2000
Jay S. Sidhu Executive Officer (Principal Executive
Officer)
/S/CAMERON C. TROILO Director March 23, 2000
Cameron C. Troilo
/S/G. ARTHUR WEAVER Director March 23, 2000
G. Arthur Weaver
/S/DENNIS S. MARLO Chief Financial Officer March 23, 2000
Dennis S. Marlo
/S/MARK R. MCCOLLOM Chief Accounting Officer March 27, 2000
Mark R. McCollom
80