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UNITED STATES 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, 2001, 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 ____________ .
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 (I.R.S. Employer
of Incorporation or Organization) Identification No.)
2000 Market Street, Philadelphia, Pennsylvania 19103
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(Address of Principal Executive Offices) (Zip Code)
(215) 557-4630
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Registrant's Telephone Number
Securities registered pursuant to Section 12(B) of the Act:
Name of
Exchange on
Title Which Registered
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Common stock, no par value NYSE
PIERS Units NYSE
Securities registered pursuant to Section 12(G) of the Act:
None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K 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 $3,138,627,693 at
February 28, 2002. As of February 28, 2002, the Registrant had 247,721,207
shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's definitive Proxy Statement to be used in connection
with its 2002 Annual Meeting of Shareholders is incorporated herein by reference
in response to Part III hereof.
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FORM 10-K CROSS REFERENCE INDEX PAGE
Forward-Looking Statements .......................................................................... 1-2
Part I
Item 1 - Business ............................................................................ 3
Item 2 - Properties .......................................................................... 10
Item 3 - Legal Proceedings ................................................................... 10
Item 4 - Submission of Matters to a Vote of Security Holders ................................. 10
Item 4A - Executive Officers of the Registrant ................................................ 10-11
Part II
Item 5 - Market for the Registrant's Common Equity and Related Stockholder Matters ........... 11
Item 6 - Selected Financial Data ............................................................. 12
Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations 13-42
Item 7A - Quantitative and Qualitative Disclosures About Market Risk .......................... 42
Item 8 - Financial Statements and Supplementary Data ......................................... 42-87
Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 88
Part III
Item 10 - Directors and Executive Officers of the Registrant .................................. 88
Item 11 - Executive Compensation .............................................................. 88
Item 12 - Security Ownership of Certain Beneficial Owners and Management ...................... 88
Item 13 - Certain Relationships and Related Transactions ...................................... 88
Part IV
Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K ..................... 88-89
Signatures .......................................................................................... 90
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FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements made by or on behalf of Sovereign Bancorp, Inc.
("Sovereign"). Sovereign may from time to time make forward-looking statements
in Sovereign's filings with the Securities and Exchange Commission (including
this Annual Report on Form 10-K and the Exhibits hereto), in its reports to
shareholders (including its 2001 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. Some
of the disclosure communications by Sovereign, including any statements preceded
by, followed by or which include the words "may," "could," "should," "pro
forma," "looking forward," "will," "would," "believe," "expect," "anticipate,"
"estimate," "intend," "plan," "strive," "hopefully," "try," "assume" or similar
expressions constitute forward-looking statements.
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 statements
relating to:
o growth in cash earnings, operating earnings, net income, shareholder
value and internal tangible equity generation;
o growth in earnings per share;
o return on equity;
o return on assets;
o efficiency ratio;
o Tier 1 leverage ratio;
o annualized net charge-offs and other asset quality measures;
o fee income as a percentage of total revenue;
o ratio of tangible equity to assets;
o book value and tangible book value per share; and
o loan and deposit portfolio compositions, employee retention, deposit
retention, asset quality and reserve adequacy.
These forward-looking statements, implicitly and explicitly, include the
assumptions underlying the statements. Although Sovereign believes that the
expectations reflected in these forward-looking statements are reasonable, these
statements involve risks and uncertainties which are subject to change based on
various important factors (some of which are beyond Sovereign's control). The
following factors, among others, could cause Sovereign's financial performance
to differ materially from its goals, plans, objectives, intentions,
expectations, forecasts and projections (and the underlying assumptions)
expressed in the forward-looking statements:
o the strength of the United States economy in general and the strength of
the regional and local economies in which Sovereign conducts operations;
o 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;
o inflation, interest rate, market and monetary fluctuations;
o Sovereign's ability to successfully integrate any assets, liabilities,
customers, systems and management personnel Sovereign acquires into its
operations and its ability to realize related revenue synergies and cost
savings within expected time frames;
o Sovereign's timely development of competitive new products and services
in a changing environment and the acceptance of such products and
services by customers;
o the willingness of customers to substitute competitors' products and
services and vice versa;
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o the impact of changes in financial services policies, laws and
regulations, including laws, regulations and policies concerning taxes,
banking, capital, liquidity, proper accounting treatment, securities and
insurance, and the application thereof by regulatory bodies and the
impact of changes in and interpretation of generally accepted accounting
principles;
o technological changes;
o changes in consumer spending and savings habits;
o terrorist attacks in the United States or upon United States interests
abroad, or armed conflicts relating to these attacks;
o regulatory or judicial proceedings;
o changes in asset quality; and
o Sovereign's success in managing the risks involved in the foregoing.
If one or more of the factors affecting Sovereign's forward-looking information
and statements proves incorrect, then its actual results, performance or
achievements could differ materially from those expressed in, or implied by,
forward-looking information and statements. Therefore, Sovereign cautions you
not to place undue reliance on any forward-looking information and statements.
Sovereign does not intend to update any forward-looking information and
statements, whether written or oral, to reflect any change. All forward-looking
statements attributable to Sovereign are expressly qualified by these cautionary
statements.
Operating earnings and cash earnings which are included and defined herein, and
the related ratios using these measures are not a substitute for other financial
measures determined in accordance with generally accepted accounting principles.
Because all companies do not calculate these measures in the same fashion, these
measures as presented may not be comparable to other similarly titled measures
of other companies.
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PART I
Item 1. Business.
General
Sovereign Bancorp, Inc. ("Sovereign" or "the Company"), is the parent company of
Sovereign Bank ("Sovereign Bank" or "the Bank"), a $35 billion financial
institution with approximately 500 community banking offices, approximately 1000
ATMs and about 7,100 team members in Pennsylvania, New Jersey, Connecticut, New
Hampshire, New York, Rhode Island and Massachusetts. Sovereign's primary
business consists of attracting deposits from its network of community banking
offices, and originating small business and middle market commercial and
asset-based loans, consumer and residential mortgage loans and home equity lines
of credit in the communities served by those offices.
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 in 1987. Sovereign has
acquired 23 financial institutions, branch networks and related businesses since
1990. Fourteen of these acquisitions, with assets totaling approximately $22
billion, have been completed since 1995. In July 2001, Sovereign entered into a
definitive agreement with Main Street Bancorp, Inc. ("Main Street") for
Sovereign to acquire Main Street. This acquisition, which is expected to close
in the first quarter of 2002, will result in Sovereign becoming a pro forma $37
billion financial institution with approximately 530 community banking offices
reaching from north of Boston to south of Philadelphia.
Sovereign is a Pennsylvania business corporation and its principal executive
offices are located at 2000 Market Street, Philadelphia, Pennsylvania. Sovereign
Bank is headquartered in Wyomissing, Pennsylvania, a suburb of Reading,
Pennsylvania.
Sovereign Bank is a federally chartered savings bank and operates in a heavily
regulated environment. Changes in laws and regulations affecting Sovereign and
its subsidiaries may have an impact on its operations. See
"Business--Supervision and Regulation."
Business Strategy
Sovereign believes that as a result of continuing consolidation in the financial
industry, there is an increasing need for super-community banks throughout the
northeastern United States. Sovereign considers a super-community bank to be a
bank with the size and range of commercial, business and consumer products to
compete with larger institutions, but with the orientation to relationship
banking and personalized service usually found at smaller community banks.
In response to this need, in 1996 Sovereign initiated a strategy to transform
itself from a traditional mortgage lender into a super-community bank by:
o targeting small and medium size businesses through an offering of a
broader array of commercial and business banking products and services;
o changing the mix of its deposits and, while endeavoring to preserve its
credit quality, changing the mix of its assets to be more characteristic
of a commercial bank;
o increasing its penetration into larger, more densely populated markets
in the northeastern United States;
o preserving its orientation toward relationship banking and personalized
service, as well as its sales-driven culture; and
o increasing its non-interest income as a percentage of net income.
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During 2000, Sovereign substantially completed its transformation by acquiring
$12.3 billion of deposits, $8.0 billion of loans (exclusive of $1 billion of
non-relationship mortgage loans sold immediately after the acquisition), and
over 280 community banking offices located in Massachusetts, Rhode Island,
Connecticut and New Hampshire from FleetBoston Financial Corporation (the "New
England Acquisition"). As a result of the New England Acquisition, Sovereign
doubled its deposit base, changed the mix of loans and deposits to be more
characteristic of a commercial bank, and increased the breadth and depth of
senior and middle management.
Recent Developments
On July 17, 2001, Sovereign announced the signing of a definitive agreement to
acquire Main Street Bancorp, Inc. for approximately $170 million in stock and
cash. Main Street is a $1.5 billion bank holding company headquartered in
Reading, Pennsylvania, with 42 community banking offices serving southeastern
Pennsylvania. The transaction was completed on March 8, 2002 and provided
Sovereign with approximately $1.3 billion of deposits and $800 million of loans
before purchase accounting adjustments, enhancing Sovereign's small business and
middle market lending capabilities in the region.
Subsidiaries
Sovereign has six wholly-owned subsidiaries: Sovereign Bank, Sovereign Delaware
Investment Corporation, Sovereign Capital Trust I, Sovereign Capital Trust II,
Sovereign Capital Trust III, and ML Capital Trust I. Sovereign Delaware
Investment Corporation is a Delaware corporation whose primary purpose is to
purchase and hold certain investment securities. Sovereign Capital Trust I,
Sovereign Capital Trust II, Sovereign Capital Trust III, and ML Capital Trust I
are special-purpose statutory trusts created expressly for the issuance of
preferred capital securities.
Employees
At December 31, 2001, Sovereign had 6,147 full-time and 956 part-time employees.
None of these employees are represented by a collective bargaining agreement,
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, the convenience of office locations, and
the availability of alternate channels of distribution. Direct competition for
deposits comes primarily from commercial banks and other thrift institutions.
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 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 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.
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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 could 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
together 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, 2001, 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%, 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 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 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 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
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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. Associations whose exposure to interest-rate risk
is deemed to be above normal will be required to deduct a portion of such
exposure in calculating their risk-based capital. The OTS may establish, on a
case-by-case basis, individual minimum capital requirements for a savings
association that vary from the minimum requirements that otherwise would apply
under the OTS capital regulations. The OTS has not yet established such
individual minimum capital requirements. 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 account of a savings association. At
December 31, 2001, Sovereign Bank met the criteria to be classified as
"well-capitalized."
The OTS Order (the "OTS Order") issued in connection with the New England
Acquisition requires Sovereign Bank to be "well capitalized" and also to meet
certain other additional capital ratio requirements above the regulatory
minimum, and other conditions. Sovereign's various agreements with its lenders
also require it to cause Sovereign Bank to be "well capitalized" at all times
and in compliance with all regulatory requirements. To be "well capitalized", an
OTS institution must maintain a Tier 1 leverage ratio of at least 5%, a Tier 1
risk-based capital ratio of at least 6% and total risk-based capital of at least
10%. As of December 31, 2001,
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Sovereign Bank was classified as well capitalized and in compliance with the
conditions and capital requirements discussed above. Management expects that
Sovereign Bank will continue to be classified as well capitalized and in
compliance with such capital requirements and conditions. Although OTS capital
regulations do not apply to savings and loan holding companies, the OTS Order
requires Sovereign to maintain certain Tier 1 capital and related liquidity
levels. Sovereign is presently in compliance with these requirements and expects
to remain in compliance.
Standards for Safety and Soundness. The federal banking agencies adopted
certain operational and managerial standards for depository institutions,
including internal audit system components, loan documentation requirements,
asset growth parameters, information technology and data security practices, 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 1 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 1 risk-based capital ratios of less than 4% or a total
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. In addition,
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 annual rate for all insured institutions is 1.84 basis points
for each $100 in domestic deposits. These assessments are revised quarterly and
will continue until the bonds mature in the year 2017.
Federal Restrictions on Transactions with Affiliates. All banks and
savings institutions are subject to affiliate and insider transaction rules
applicable to member banks of the Federal Reserve System set forth in Sections
23A, 23B, 22(g) and 22(h) of the Federal Reserve Act, as well as such additional
limitations as the institutions' primary federal regulator may adopt. These
provisions prohibit or limit a savings institution from extending credit to, or
entering into certain transactions with, affiliates, principal stockholders,
directors and executive officers of the savings institution and its affiliates.
For these purposes, the term "affiliate" generally includes a holding company
such as Sovereign and any company under common control with the savings
institution. In addition, the federal law governing unitary savings and loan
holding companies prohibits Sovereign Bank from making any loan to any affiliate
whose activity is not permitted for a subsidiary of a bank holding company. This
law also prohibits Sovereign Bank from making any equity investment in any
affiliate that is not its subsidiary.
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Restrictions on Subsidiary Savings Institution Capital Distributions.
Sovereign's principal sources of funds are cash dividends paid to it by
Sovereign Bank, investment income and borrowings. OTS regulations limit the
ability of savings associations such as Sovereign Bank to pay dividends and make
other capital distributions. Associations that are subsidiaries of a savings and
loan holding company must file a notice with the OTS at least 30 days before the
proposed declaration of a dividend or approval of the proposed capital
distribution by its board of directors. In addition, a savings association must
obtain prior approval from the OTS if it fails to meet certain regulatory
conditions, or if, after giving effect to the proposed distribution, the
association's capital distributions in a calendar year would exceed its
year-to-date net income plus retained net income for the preceding two years or
the association would not be at least adequately capitalized or if the
distribution would violate a statute, regulation, regulatory agreement or a
regulatory condition to which the association is subject.
Qualified Thrift Lender. All savings institutions are required to meet a
qualified thrift lender test to avoid certain restrictions on their operations.
This test requires a savings institution to have at least 65% of its portfolio
assets, as defined by regulation, in qualified thrift investments. As an
alternative, the savings institution may maintain 60% of its assets in those
assets specified in Section 7701(a)(19) of the Internal Revenue Code. Under
either test, such assets primarily consist of residential housing related loans
and investments. Sovereign Bank is currently in compliance with the qualified
thrift lender regulations.
Any savings institution that fails to meet the qualified thrift lender test must
convert to a national bank charter, unless it requalifies as a qualified thrift
lender and thereafter remains a qualified thrift lender. If an institution does
not requalify and converts to a national bank charter, it must remain SAIF
insured until the FDIC permits it to transfer to the BIF. If such an institution
has not yet requalified or converted to a national bank, its new investments and
activities are limited to those permissible for both a savings institution and a
national bank, and it is limited to national bank branching rights in its home
state. In addition, the institution is immediately ineligible to receive any new
FHLB borrowings and is subject to national bank limits for payment of dividends.
If such an institution has not requalified or converted to a national bank
within three years after the failure, it must divest itself of all investments
and cease all activities not permissible for a national bank. In addition, it
must repay promptly any outstanding FHLB borrowings, which may result in
prepayment penalties. If any institution that fails the qualified thrift lender
test is controlled by a holding company, then within one year after the failure,
the holding company must register as a bank holding company and become subject
to all restrictions on bank holding companies.
Other Loan Limitations. Federal law limits the amount of non-residential
mortgage loans a savings institution, such as Sovereign Bank, may make. Separate
from the qualified thrift lender test, the law limits a savings institution to a
maximum of 10% of its assets in large commercial loans, with another 10% of
assets permissible in "small business loans." Commercial loans secured by real
estate, however, are in addition to the above amounts, and can be made in an
amount up to four times an institution's capital. An institution can also have
commercial leases in addition to the above, up to 10% of its assets. Commercial
paper, corporate bonds, and consumer loans taken together cannot exceed 35% of
an institution's assets. For this purpose, however, residential mortgage loans
and credit card loans are not considered consumer loans, and are both unlimited
in amount. The foregoing limitations are established by statute, and cannot be
waived by the OTS.
Federal Reserve Regulation. Under Federal Reserve Board regulations,
Sovereign Bank is required to maintain a reserve against its transaction
accounts (primarily interest-bearing and non interest-bearing checking
accounts). Because reserves must generally be maintained in cash or in non
interest-bearing accounts, the effect of the reserve requirements is to increase
an institution's cost of funds. These regulations generally require that
Sovereign Bank maintain reserves against net transaction accounts in the amount
of 3% on amounts of $41.3 million or less, plus 10% on amounts in excess of
$41.3 million. Institutions may designate and exempt $5.7 million of certain
reservable liabilities from these reserve requirements. These amounts and
percentages are subject to adjustment by the Federal Reserve Board. A savings
bank, like other depository institutions maintaining reservable accounts, may
borrow from the Federal Reserve Bank discount window, but the Federal Reserve
Board's regulations require the savings bank to exhaust other reasonable
alternative sources before borrowing from the Federal Reserve Bank.
Numerous other regulations promulgated by the Federal Reserve Board affect the
business operations of Sovereign Bank. These include regulations relating to
equal credit opportunity, electronic fund transfers, collection of checks, truth
in lending, truth in savings, availability of funds, home mortgage disclosure,
and margin credit.
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Federal Home Loan Bank System. The FHLB System was created in 1932 and
consists of twelve regional FHLBs. The FHLBs are federally chartered but
privately owned institutions created by Congress. The Federal Housing Finance
board ("Finance Board") is an agency of the federal government and is generally
responsible for regulating the FHLB System. Each FHLB is owned by its member
institutions. The primary purpose of the FHLBs is to provide funding to their
members for making housing loans as well as for affordable housing and community
development lending. FHLBs are generally able to make advances to their member
institutions at interest rates that are lower than could otherwise be obtained
by such institutions.
Under current rules, a FHLB member is generally required to purchase FHLB stock
in an amount equal to at least 5% of the aggregate outstanding advances made by
the FHLB to the member. Generally, an institution is eligible to be a member of
the FHLB for the district where the member's principal place of business is
located. Sovereign Bank is a member of the Pittsburgh FHLB.
Community Reinvestment Act. The Community Reinvestment Act ("CRA")
requires financial institutions regulated by the federal financial supervisory
agencies to ascertain and help meet the credit needs of their delineated
communities, including low- to moderate-income neighborhoods within those
communities, while maintaining safe and sound banking practices. A bank's
performance under the CRA is important in determining whether the bank may
obtain approval for, or utilize streamlined procedures in, certain applications
for acquisitions or to engage in new activities. Sovereign Bank's lending
activities are in compliance with applicable CRA requirements.
Recent 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 significant 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.
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 have adopted 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.
The OTS and other banking regulators adopted amendments to their capital rules
concerning the treatment of residual interests in asset securitizations and
other transfers of financial assets. Generally, the rule varies the capital
requirements for securitization transactions based on their credit ratings,
requires that risk-based capital be held in an amount equal to the amount of
residual interests retained on an institution's balance sheet, and limits the
amount of residual interests that may be included in Tier 1 capital.
In January 2001, the four federal banking agencies jointly issued expanded
examination and supervision guidance relating to subprime lending activities. In
the guidance, "subprime" lending generally refers to programs that target
borrowers with weakened credit histories or lower repayment capacity. The
guidance principally applies to institutions with subprime lending programs with
an aggregate credit exposure equal to or greater than 25 percent of an
institution's Tier 1 capital. Such institutions would be subject to more
stringent risk management standards and, in many cases, additional capital
requirements. As a starting point, the guidance generally expects that such an
institution would hold capital against subprime portfolios in an amount that is
one and one-half to three times greater than the amount appropriate for similar
types of non-subprime assets. The guidance is primarily directed at insured
depository institutions that target subprime borrowers. Sovereign's aggregate
credit exposure to subprime lending is substantially less than the 25 percent of
the Tier I capital threshold, and as such, Sovereign is not currently subject to
the more rigorous risk management and capital requirements.
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9
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In December 2001, the Federal Reserve Board amended the regulations that
implement the Home Ownership and Equity Protection Act ("HOEPA"). The amendments
to Regulation Z (Truth in Lending) broaden the scope of loans subject to the
provisions of HOEPA by adjusting the price triggers that determine coverage
under the act. The regulations lower the interest rate-based trigger and revise
the fee-based trigger to include optional insurance premiums and similar credit
protection products paid at closing. The loans that Sovereign Bank currently
originates are generally below the rate and fee levels that trigger HOEPA.
Sovereign Bank has adopted procedures to screen purchased loan portfolios
against HOEPA covered loans.
In October, 2001 the Uniting and Strengthening America by Providing Appropriate
Tools Required to Intercept and Obstruct Terrorism Act, or the USA Patriot Act,
became effective. Title III of that Act represents a major expansion of the U.S.
anti-money laundering laws granting broad new anti-money laundering powers to
the Secretary of the Treasury and imposing a variety of new compliance
obligations on banks and broker dealers. The Act also requires a bank's
regulator to specifically consider the bank's past record of compliance with the
Bank Secrecy Act (anti-money laundering requirements) when acting on any
applications filed by such bank.
Item 2. Properties.
Sovereign Bank utilizes 570 buildings that occupy a total of 4.7 million square
feet, including 123 owned properties with 900,000 square feet and 447 leased
properties with 3.8 million square feet. Five major buildings contain 1.3
million square feet, which serve as the headquarters or house significant
operational and administrative functions:
Columbia Park Operations Center - Dorchester, Massachusetts
East Providence Call Center - East Providence, Rhode Island
525 Lancaster Avenue Operations Center - Reading, Pennsylvania
1130 Berkshire Boulevard Bank Headquarters and Administrative Offices -
Wyomissing, Pennsylvania
1125 Berkshire Boulevard Operations Center - Wyomissing, Pennsylvania
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 February 28,
2002, is set forth below:
Richard E. Mohn--Age 70. Mr. Mohn was elected the Chairman of the Board of
Sovereign in May 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 50. Mr. Sidhu has served as President and Chief Executive
Officer of Sovereign since November 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 49. Mr. Thompson serves as Chief
Administrative Officer and Secretary of Sovereign. Also, Mr. Thompson was
appointed President and Chief Operating Officer of Sovereign Bank's Consumer
Banking Division in November 2000. 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.
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Dennis S. Marlo--Age 59. Mr. Marlo was appointed Chief Risk Management
Officer of Sovereign in April 2001. Mr. Marlo joined Sovereign in February
1998 as the President of the Pennsylvania Division of Sovereign Bank. He was
appointed Chief Financial Officer and Treasurer of Sovereign in May 1998 and
served in that capacity through April 2001. Prior thereto, Mr. Marlo served
as President and Chief Executive Officer of ML Bancorp, a predecessor
company of Sovereign.
John P. Hamill--Age 61. Mr. Hamill was named Chairman and Chief Executive
Officer of SBNE in January 2000. Prior thereto, Mr. Hamill served as
President of Fleet National Bank--Massachusetts for eight years and
President of Shawmut Corporation.
Joseph P. Campanelli--Age 45. Mr. Campanelli was named President and Chief
Operating Officer of Sovereign Bank's Commercial and Business Banking
Division in November 2000 and was appointed President and Chief Operating
Officer of SBNE in January 2000. Mr. Campanelli joined Sovereign as
Executive Vice President in September 1997 through Sovereign's acquisition
of the Fleet Automotive Finance Division and assumed the role of Managing
Director of Sovereign's Automotive Finance Division and the Asset Based
Lending Group.
James D. Hogan--Age 57. Mr. Hogan joined Sovereign as Chief Financial
Officer in April 2001. Prior to that Mr. Hogan served as Executive Vice
President and Controller at Firstar Corporation, formerly Star Bancorp, from
May 1993 until April 2001, and as Controller of Star Bank from 1987 until
1993.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters.
Sovereign's common stock is traded on the New York Stock Exchange ("NYSE") under
the symbol "SOV". Sovereign's common stock was listed and commenced trading on
the NYSE on July 10, 2001. Previously, Sovereign's common stock was traded in
the over-the-counter market and was quoted on the Nasdaq National Market under
the symbol "SVRN". At February 28, 2002, the total number of holders of
Sovereign's common stock was 15,055.
The following table sets forth for the periods indicated high and low sale
prices reported on the NYSE and the high and low bid prices reported on the
Nasdaq National Market, as applicable, for Sovereign's common stock, adjusted to
reflect all stock dividends and splits.
High Low
---- ---
2000:
First Quarter $ 7.91 $6.69
Second Quarter 8.00 6.44
Third Quarter 9.88 7.03
Fourth Quarter 9.47 6.78
2001:
First Quarter $ 9.16 $7.66
Second Quarter 13.00 7.94
Third Quarter 13.22 8.86
Fourth Quarter 12.43 8.73
During each quarter of 2001 and 2000 Sovereign paid a cash dividend of $.025.
For certain limitations on the ability of Sovereign Bank to pay dividends to
Sovereign, see Part I, Item I. "Business Supervision and Regulation - Regulatory
Capital Requirements" and Note 14 at Item 8. "Financial Statements and
Supplementary Data" hereof.
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Item 6. Selected Financial Data.
SELECTED FINANCIAL DATA(1)
AT OR FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------ ------------ ------------ ------------ ------------
(Dollars in thousands, except per share data)
Balance Sheet Data
Total assets ................................... $ 35,474,838 $ 33,457,797 $ 26,607,112 $ 21,913,873 $ 17,655,455
Loans .......................................... 20,399,584 21,912,245 14,288,465 11,582,770 11,634,800
Allowance for loan losses ...................... (264,667) (256,356) (132,986) (133,802) (116,823)
Investment securities .......................... 10,465,116 7,293,852 10,392,263 8,502,082 5,372,713
Deposits and other customer accounts ........... 23,297,574 24,498,917 12,012,675 12,460,022 9,536,903
Borrowings and long term debt .................. 8,939,770 6,240,308 12,370,109 7,764,933 6,842,034
Stockholders' equity ........................... 2,202,481 1,948,884 1,821,495 1,204,068 1,047,795
Summary Statement of Operations
Total interest income .......................... 2,222,475 2,269,735 1,607,329 1,355,371 1,178,777
Total interest expense ......................... 1,168,193 1,414,924 992,673 861,759 746,695
------------ ------------ ------------ ------------ ------------
Net interest income ............................ 1,054,282 854,811 614,656 493,612 432,082
Provision for loan losses ...................... 97,100 56,500 30,000 27,961 41,125
------------ ------------ ------------ ------------ ------------
Net interest income after provision
for loan losses .............................. 957,182 798,311 584,656 465,651 390,957
Other income ................................... 426,066 108,561 130,342 105,181 48,688
General and administrative expenses ............ 789,118 731,491 392,929 327,293 244,179
Other expenses ................................. 444,185 281,613 53,455 32,333 25,604
------------ ------------ ------------ ------------ ------------
Income/(loss) before income taxes
and extraordinary item ....................... 149,945 (106,232) 268,614 211,206 169,862
Income tax provision ........................... 26,575 (65,215) 89,315 74,751 67,324
------------ ------------ ------------ ------------ ------------
Income/(loss) before extraordinary item(2) ..... 123,370 (41,017) 179,299 136,455 102,538
Extraordinary item (net of tax of $3,526 - 2001,
and of $5,225 - 2000) ........................ (6,549) 10,775 -- -- --
------------ ------------ ------------ ------------ ------------
Net income/(loss)(2) ........................... $ 116,821 $ (30,242) $ 179,299 $ 136,455 $ 102,538
============ ============ ============ ============ ============
Share Data(3)
Common shares outstanding at end of period
(in thousands) ............................... 247,470 226,501 225,470 159,727 141,218
Preferred shares outstanding at end of period
(in thousands) ............................... -- -- -- -- 1,996
Basic earnings/(loss) per share(2) ............. $ .48 $ (.13) $ 1.02 $ .88 $ .70
Diluted earnings/(loss) per share(2) ........... $ .45 $ (.13) $ 1.01 $ .85 $ .66
Book value per share at end of period(4) ....... $ 8.90 $ 8.60 $ 8.08 $ 7.54 $ 7.42
Common share price at end of period ............ $ 12.24 $ 8.13 $ 7.45 $ 14.25 $ 17.31
Dividends declared per common share(5) ......... $ .10 $ .10 $ .10 $ .08 $ .15
Selected Financial Ratios
Dividend payout ratio .......................... 22.22% --(6) 9.9% 9.4% 12.1%
Return on average assets ....................... 34% --(6) .75% .70% .63%
Return on average equity ....................... 5.51% --(6) 13.20% 12.42% 10.92%
Average equity to average assets ............... 6.15% 5.83% 5.67% 5.60% 5.75%
(1) All financial data has been restated to reflect all acquisitions which have
been accounted for under the pooling-of-interests method of accounting.
(2) The results for the years ended 2001, 2000, 1999 and 1998 include
merger-related, integration, and other special charges of $164 million, $270
million, $23 million, and $34 million, after tax, respectively.
(3) All per share data have been adjusted to reflect all stock dividends and
stock splits.
(4) Book value per share is calculated using equity divided by common shares
outstanding at end of period.
(5) The higher dividend rate in prior periods is the result of acquisitions
which were accounted for as a pooling-of-interests.
(6) These ratios are not meaningful due to the net loss recognized for the year
ended December 31, 2000.
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12
- ----------------------MANAGEMENT'S DISCUSSION AND ANAYLSIS---------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Overview. Sovereign reported cash earnings of $378 million, or $1.47 per share,
and operating earnings of $287 million, or $1.12 per share, compared to $309
million and $1.48 per share and $240 million, or $1.15 per share for 2001 and
2000, respectively. See the Reconciliation of Net Income to Operating Earnings
below for more information related to operating and cash earnings. Net income
for 2001 was $117 million or $.45 per share versus net loss for 2000 of $30.2
million or $.13 per share.
A reconciliation of net income to operating earnings is presented below:
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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
--------------------- ----------------
2001 2000 2001 2000
--------- --------- ----- -----
Net income/(loss) as reported ........................................ $ 116,821 $ (30,242) $0.45 $(0.13)
Loss on the early extinguishment of debt(1) .......................... 6,549 -- 0.03 --
Net negative carry on escrowed bond proceeds(2) ...................... -- 18,589 -- 0.08
Merger-related and integration costs related to recent acquisitions(3) -- 97,063 -- 0.43
Expense on convertible trust preferred securities ("PIERS")(2) ....... -- 6,502 -- 0.03
Loss on securities due to restructuring of the balance sheet(4) ...... -- 66,956 -- 0.29
Restructuring(5) ..................................................... 5,525 12,025 0.02 0.05
Non-solicitation expense(6) .......................................... 158,106 78,039 0.62 0.35
Assumed income from reinvestment of net proceeds of
common equity and PIERS(2) ......................................... -- (9,051) -- (0.04)
Impact of additional shares outstanding for 2000 common and
PIERS securities offerings(7) ...................................... -- -- -- 0.09
--------- --------- ----- -----
Operating earnings(7) ................................................ $ 287,001 $ 239,881 $1.12 $1.15
========= ========= ===== =====
Cash earnings(7) ..................................................... $ 378,315 $ 308,564 $1.47 $1.48
========= ========= ===== =====
(1) Because the 2001 extinguishment of debt was not part of a structured
deleveraging transaction where an offsetting gain was recorded within our
statement of operations, we have included the extinguishment loss as a
"special charge" in our reconciliation of net income to operating earnings.
(2) In connection with the New England Acquisition, Sovereign raised $1.8
billion of debt and equity capital in November and December of 1999, of
which $1.3 billion of debt proceeds were in escrow with limited ability to
reinvest the proceeds until the acquisition was completed on July 21, 2000.
Consequently, the excess of negative carry and trust preferred expense over
interest expense reduction realized on the raised capital resulted in a net
reduction in pretax income of $24.7 million ($16.0 million after-tax)
comprised of the following components for the year ended December 31, 2000:
a) a reduction of net interest income of $28.6 million ($18.6 million
after-tax); b) expense of $10.0 million ($6.5 million after-tax) associated
with PIERS issued in November 1999; c) an assumed $13.9 million ($9.1
million after-tax) of interest expense reduction from the assumed paydown of
other borrowings with the proceeds of the Trust Preferred Securities and
common stock offerings.
(3) Merger-related and integration charges related to recent acquisitions
include direct costs associated with the New England Acquisition, including
investment banking and debt commitment fees, indirect costs incurred to
integrate recent acquisitions into Sovereign's back-office systems, costs of
training, relocation and associated travel, and management's estimate of the
carrying costs of certain facilities and personnel acquired in the first and
second closings on March 24 and June 16, 2000 that were not fully
operational until July 21, 2000, the date of the final closing. Also
included in merger-related and integration costs are expenses paid related
to a structured real-estate transaction involving certain real estate
related to SBNE.
(4) In June and September 2000, Sovereign sold $2.1 billion of investment
securities as part of a balance sheet deleveraging strategy and incurred a
$103 million loss ($67.0 million after-tax). Sovereign used the proceeds
from such sales primarily to repay short-term borrowings.
(5) As more fully discussed in "Other Operating Expenses", Sovereign recorded
restructuring charges of $27.0 million ($17.5 million after-tax), $8.5
million of which was recorded in 2001 related to the closure of 14 in-store
offices and a redirection of e-commerce efforts, and $18.5 million of which
was recorded in 2000 primarily related to severance and outplacement related
expenses.
(6) As more fully discussed in Note 2 to the Financial Statements, Sovereign was
required to pay $363 million to FleetBoston, subject to FleetBoston's
compliance with a non-solicitation agreement. Sovereign expensed such
payments ratably from the completion of the acquisition until final payment
in September 2001.
(7) Operating earnings per share and cash earnings per share are calculated
using an adjusted weighted average number of shares outstanding, which
include for the year ended December 31, 2000, a pro rata portion of the
shares issued in November 1999 in proportion to deposits acquired on March
24, 2000, June 16, 2000, and July 21, 2000 over total estimated SBNE
deposits acquired in each phase of the New England Acquisition.
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As shown in the reconciliation above, 2001 operating earnings differ from 2001
net income due primarily to non-solicitation payments made through September
2001 to FleetBoston related to the New England Acquisition. The other
reconciling items are discussed within this Management's Discussion and
Analysis. The total after-tax impact of the items excluded from 2001 net income
to arrive at operating earnings was $170.2 million. Operating earnings for 2000
include certain tax benefits related to the sale of minority interests and
exclude special charges related to restructuring and merger-related costs as
more fully described in the footnotes below. The net impact of the tax benefits
and special charges for the year ended December 31, 2000 were $270.1 million
after-tax. Cash earnings are operating earnings excluding amortization
(after-tax) of intangible assets and ESOP-related expense.
Sovereign analyzes its performance on a net income basis determined in
accordance with generally accepted accounting principles, as well as on an
operating and a cash-operating basis referred to in this analysis as "operating
earnings" and "cash earnings". Operating and cash earnings, and ratios derived
from such amounts, and related discussions are presented as supplementary
information in this analysis to enhance the readers' understanding of, and
highlight trends in, its core financial results excluding the non-recurring
effects of discrete business acquisitions and other transactions. The Company
has included these additional disclosures of operations before special charges
because this information is both relevant and useful in understanding
performance of the Company. Operating and cash earnings should not be viewed as
a substitute for net income and earnings per share as determined in accordance
with generally accepted accounting principles.
Formation of Sovereign Bank New England Division. On February 28, 2000,
Sovereign entered into an amended purchase and assumption agreement with
FleetBoston Financial to acquire a business consisting of 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 (the "New England Acquisition"). In total, the Bank purchased
281 community banking offices (exclusive of 4 locations which were resold to a
third party). The New England Acquisition, which resulted in the creation of the
Sovereign Bank New England division of Sovereign Bank included 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 acquired a substantial portion of the middle
market and small business-lending group of Fleet Bank in Massachusetts and New
Hampshire, and of BankBoston in Rhode Island and Connecticut. The New England
Acquisition included the purchase of fully functioning business units, with the
necessary management, relationship officers, support staff and other
infrastructure for the acquired loans and deposits to be fully serviced.
Sovereign completed the New England Acquisition in three phases during 2000.
Sovereign's results include the operations of these acquired branches, assets
and liabilities from their respective acquisition dates, and thereafter. Total
liabilities assumed through the acquisition were $12.3 billion. Additionally,
tangible assets purchased by Sovereign included loan balances of $9.1 billion,
which included $3.1 billion of commercial loans and leases, $1.7 billion of
consumer loans and $4.3 billion of residential mortgages (inclusive of $1.1
billion of residential mortgage loans which were not relationship assets that
were subsequently sold as part of the Bank's asset-liability management strategy
to reduce interest-rate risk), $85 million of currency, $68 million of premises
and equipment, $180 million of precious metals inventory and $213 million of
prepaid and other miscellaneous assets. Cash received, net of the premium paid,
was $1.9 billion.
Total consideration for the New England Acquisition was 12% of acquired deposits
less agreed upon reductions. The premium included $848 million, which was paid
as of the final closing on July 21, 2000, and $363 million, paid in periodic
installments from January 2001 through September 2001 upon FleetBoston's
performance of non-solicitation obligations specified under the purchase
agreement and satisfaction of certain other conditions. These payments related
to the non-solicitation agreement were recorded as expense ratably from the
completion of the New England Acquisition on July 21, 2000 through the
completion of the payments. The New England Acquisition resulted in total
goodwill of $826 million after taking into consideration fair value adjustments
on acquired assets of $163 million, establishment of an initial allowance for
loan losses of $135 million, direct costs associated with the acquisition of $32
million, and the $352 million of purchase price allocated to core deposit
intangible.
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14
- ----------------------MANAGEMENT'S DISCUSSION AND ANAYLSIS---------------------
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000
Net Interest Income. Net interest income for 2001 was $1.1 billion compared to
$855 million for 2000, or an increase of 23%. The increase in net interest
income in 2001 was due to the full-year effect of the interest-earning assets
from the New England Acquisition, internal asset growth, and by the significant
decline in interest rates throughout 2001. The New England Acquisition added
$8.0 billion to average loans and $6.9 billion to average deposits (replacing
higher cost FHLB borrowings) in 2000. Net interest margin (net interest income
divided by average interest-earning assets) was 3.57% for 2001 compared to 3.06%
for 2000.
Interest on interest-earning deposits was $2.5 million for 2001 compared to
$22.2 million for 2000. The average balance of interest-earning deposits was
$65.0 million with an average yield of 3.88% for 2001 compared to an average
balance of $138 million with an average yield of 16.08% for 2000. The high
yields of 2000 were the result of an outsourced accounts payable process whereby
a third-party vendor performed check processing and reconcilement functions for
Sovereign's disbursement accounts and paid Sovereign interest on disbursed funds
during the two-to-three day float period, effectively producing interest income
with no corresponding asset balance. Sovereign terminated this agreement in
2001.
Interest on investment securities available for sale was $538 million for 2001
compared to $487 million for 2000. The increase in interest income was due to
the increase in average investment securities available for sale from $6.8
billion in 2000 to $8.0 billion in 2001, offset by lower interest income on
investment securities available for sale due to declining interest rates.
Interest on investment securities held to maturity was $68.6 million for 2001
compared to $132 million for 2000. The average balance of investment securities
held to maturity was $1.0 billion with an average yield of 6.76% for 2001
compared to an average balance of $2.0 billion with an average yield of 6.80%
for 2000. In 2000, in order to consummate the New England Acquisition, the
Company was required to hold in escrow until the final closing $1.3 billion in
liquid short-term, low yielding securities, which were classified as held to
maturity. The release of those escrowed funds decreased the average balance for
the remainder of 2000 and all of 2001.
Interest and fees on loans were $1.6 billion for both 2001 and 2000. The average
balance of net loans was $20.9 billion with an average yield of 7.75% for 2001
compared to an average balance of $19.4 billion with an average yield of 8.40%
for 2000. Although the New England Acquisition increased average loans by $8
billion in 2000, this growth in average loans was offset by the conversion of
$1.2 billion mortgage loans into mortgage-backed securities, strategic loan
sales of $1.3 billion, and run-off of certain portfolios due to management's
desire to limit credit or interest rate exposure to certain loan types in the
current economic environment. The decline in average yields year to year is due
to the decrease of market rates during the year of 475 basis points. Over 26% of
our loan portfolio reprices monthly or more frequently.
Interest on total deposits was $706 million for 2001 compared to $735 million
for 2000. The average balance of total deposits was $23.5 billion with an
average cost of 3.00% for 2001 compared to an average balance of $19.2 billion
with an average cost of 3.83% for 2000. The increase in the average balance was
due primarily to the full year effect of the New England Acquisition, which
added over $6.9 billion to average deposits during 2000. The decrease in average
cost in 2001 mainly reflects the decrease in deposit rates due to market
conditions.
Interest on borrowings and long-term debt was $462 million for 2001 compared to
$680 million for 2000. The average balance of total borrowings was $8.0 billion
with an average cost of 5.79% for 2001 compared to an average balance of $10.3
billion with an average cost of 6.58% for 2000.
Average non-interest earning assets were $4.6 billion for 2001, as compared to
$3.6 billion for 2000, an increase of $1.0 billion. The increase was due
primarily to the full year impact in 2001 of additions of non-earning assets
during 2000 including $1.2 billion in goodwill and other intangibles from the
New England Acquisition, an additional investment in bank owned life insurance
("BOLI") of $200 million, and the addition of the precious metals business and
equipment of $171 million, also related to the New England Acquisition.
- --------------------------------------------------------------------------------
15
- --------------------------------------------------------------------------------
Table 1 presents a summary on a tax equivalent basis 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,
-----------------------------------------------------------------------------------
2001 2000
----------------------------------------- --------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ---- ------- -------- ----
Interest-earning assets:
Interest-earning deposits .... $ 65,002 $ 2,522 3.88% $ 137,826 $ 22,158 16.08%
Investment securities(1)
available for sale ......... 7,974,688 548,430 6.88 6,840,799 496,922 7.26
held to maturity ........... 1,016,848 68,705 6.76 1,950,093 132,537 6.80
Net loans(1)(2) .............. 20,865,637 1,618,022 7.75 19,411,854 1,631,240 8.40
------------ ------------ ----- ------------ ------------ -----
Total interest-earning
assets ..................... 29,922,175 2,237,679 7.48 28,340,572 2,282,857 8.06
Non-interest-earning
assets ..................... 4,552,095 -- -- 3,607,109 -- --
------------ ------------ ----- ------------ ------------ -----
Total assets ................. $ 34,474,270 $ 2,237,679 6.49% $ 31,947,681 $ 2,282,857 7.15%
============ ------------ ----- ============ ------------ -----
Interest-bearing liabilities:
Deposits:
Demand deposit and
NOW accounts ............. $ 7,508,165 $ 71,156 0.95% $ 5,468,164 $ 81,842 1.50%
Savings accounts ........... 2,952,215 57,905 1.96 2,741,867 67,880 2.48
Money market accounts ...... 4,864,877 144,156 2.96 3,059,568 132,131 4.32
Certificates of deposit:
Jumbo .................... 507,242 28,044 5.53 862,201 54,073 6.27
Retail ................... 7,687,698 404,625 5.26 7,073,742 399,161 5.64
------------ ------------ ----- ------------ ------------ -----
Total deposits ............. 23,520,197 705,886 3.00 19,205,542 735,087 3.83
Total borrowings and long-term
debt ....................... 7,988,839 462,307 5.79 10,338,648 679,837 6.58
------------ ------------ ----- ------------ ------------ -----
Total interest-bearing
liabilities ................ 31,509,036 1,168,193 3.71 29,544,190 1,414,924 4.79
Non-interest-bearing
liabilities ................ 843,660 -- -- 541,035 -- --
------------ ------------ ----- ------------ ------------ -----
Total liabilities .......... 32,352,696 1,168,193 3.61 30,085,225 1,414,924 4.70
Stockholders' equity ......... 2,121,574 -- -- 1,862,456 -- --
------------ ------------ ----- ------------ ------------ -----
Total liabilities and
stockholders' equity ....... $ 34,474,270 $ 1,168,193 3.39 $ 31,947,681 $ 1,414,924 4.43
============ ------------ ----- ============ ------------ -----
Net interest spread(3) ....... 3.10% 2.72%
===== =====
Taxable equivalent interest
income/net interest
margin ..................... 1,069,486 3.57% 867,933 3.06%
===== =====
Tax equivalent
basis adjustment ........... (15,204) (13,122)
------------ ------------
Net interest income ........ $ 1,054,282 $ 854,811
============ ============
Ratio of interest-earning
assets to interest- bearing
liabilities ................ .95x .96x
==== ====
YEAR ENDED DECEMBER 31,
-------------------------------------
1999
------------------------------------
AVERAGE YIELD/
BALANCE INTEREST RATE
------- -------- ----
Interest-earning assets:
Interest-earning deposits .... $ 15,170 $ 4,721 31.12%
Investment securities(1)
available for sale ......... 8,079,731 553,167 6.85
held to maturity ........... 1,440,894 99,949 6.94
Net loans(1)(2) .............. 12,379,295 961,635 7.77
------------ ------------ -----
Total interest-earning
assets ..................... 21,915,090 1,619,472 7.39
Non-interest-earning
assets ..................... 2,027,003 -- --
------------ ------------ -----
Total assets ................. $ 23,942,093 $ 1,619,472 6.76%
============ ------------ -----
Interest-bearing liabilities:
Deposits:
Demand deposit and
NOW accounts ............. $ 2,835,152 $ 34,622 1.22%
Savings accounts ........... 2,246,127 58,333 2.60
Money market accounts ...... 1,288,581 50,246 3.90
Certificates of deposit:
Jumbo .................... 891,333 47,818 5.36
Retail ................... 4,945,452 249,807 5.05
------------ ------------ -----
Total deposits ............. 12,206,645 440,826 3.61
Total borrowings and long-term
debt ....................... 10,101,973 551,847 5.46
------------ ------------ -----
Total interest-bearing
liabilities ................ 22,308,618 992,673 4.45
Non-interest-bearing
liabilities ................ 274,858 -- --
------------ ------------ -----
Total liabilities .......... 22,583,476 992,673 4.40
Stockholders' equity ......... 1,358,617 -- --
------------ ------------ -----
Total liabilities and
stockholders' equity ....... $ 23,942,093 $ 992,673 4.15
============ ------------ -----
Net interest spread(3) ....... 2.61%
=====
Taxable equivalent interest
income/net interest
margin ..................... 626,799 2.86%
=====
Tax equivalent
basis adjustment ........... (12,143)
-----------
Net interest income ........ $ 614,656
===========
Ratio of interest-earning
assets to interest- bearing
liabilities ................ .98x
====
(1) Tax equivalent adjustments to interest on investment securities available
for sale for the years ended December 31, 2001, 2000 and 1999 were $10.2
million, $9.5 million and $9.5 million, respectively. Tax equivalent
adjustments to interest loans for the years ended December 31, 2001, 2000
and 1999, were $5.0 million, $3.6 million and $2.5 million, respectively.
Tax equivalent interest income is based upon an effective tax rate of 35%.
(2) Amortization of net fees of $29.1 million, $14.4 million and $10.4 million
for the years ended December 31, 2001, 2000 and 1999, respectively, are
included in interest income. Average loan balances include non-accrual loans
and loans held for sale.
(3) Represents the difference between the yield on total assets and the cost of
total liabilities and stockholders' equity.
- --------------------------------------------------------------------------------
16
- ----------------------MANAGEMENT'S DISCUSSION AND ANAYLSIS---------------------
Table 2 presents, on a tax equivalent basis, the relative contribution of
changes in volumes and changes in rates to changes in net interest income for
the periods indicated (in thousands):
- --------------------------------------------------------------------------------
TABLE 2: VOLUME/RATE ANALYSIS
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
2001 VS. 2000 2000 VS. 1999
INCREASE/(DECREASE) INCREASE/(DECREASE)
----------------------------------- -----------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ---- ----- ------ ---- -----
Interest-earning assets:
Interest-earning deposits ........ $ (11,708) $ (7,928) $ (19,636) $ 38,171 $ (20,734) $ 17,437
Investment securities
available for sale ............. 82,367 (30,859) 51,508 (84,822) 28,577 (56,245)
Investment securities
held to maturity ............... (63,427) (405) (63,832) 35,321 (2,733) 32,588
Net loans(1) ..................... 122,166 (135,384) (13,218) 546,296 123,309 669,605
--------- ---------
Total interest-earning assets ...... (45,178) 663,385
--------- ---------
Interest-bearing liabilities:
Deposits ......................... 165,142 (194,342) (29,200) 252,755 41,506 294,261
Borrowings ....................... (154,516) (63,014) (217,530) 12,929 115,061 127,990
--------- ---------
Total interest-bearing liabilities . (246,730) 422,251
--------- ---------
Net change in net interest income .. $ 118,772 $ 82,780 $ 201,552 $ 269,282 $ (28,148) $ 241,134
========= ========= ========= ========= ========= =========
(1) Includes non-accrual loans and loans held for sale.
- --------------------------------------------------------------------------------
Provision for Loan Losses. The provision for loan losses is based upon credit
loss experience and an estimation of losses inherent in the current loan
portfolio. The provision for loan losses for 2001 was $97.1 million compared to
$56.5 million for 2000. The higher provisioning was required because of the
higher balance of average loans, increased levels of non-performing and
potential problem loans, and current economic conditions. The overall allowance
as a percentage of loans outstanding increased from 1.17% in 2000 to 1.30% in
2001. As Sovereign continues to place emphasis on commercial and consumer
lending, management will regularly evaluate the risk inherent in its loan
portfolio and increase its loan loss provision as is necessary.
Sovereign's net charge-offs for 2001 were $88.8 million and consisted of
charge-offs of $121 million and recoveries of $32.2 million. This compares to
2000 net charge-offs of $67.8 million consisting of charge-offs of $92.9 million
and recoveries of $25.1 million. Sovereign's increased level of commercial
charge-offs in 2001 was related primarily to deterioration in a segment of the
portfolio concentrated in cash flow-based enterprise value lending, primarily in
syndicated multi-bank credits that were originated by other banks and
participated in by Sovereign. The increase in consumer charge-offs was due to a
17% increase in consumer loans during 2001 and a general deterioration in the
economic environment resulting in higher personal bankruptcies and larger
incidences of consumer loan losses.
The ratio of net loan charge-offs to average loans, including loans held for
sale, was .42% for 2001, compared to .35% for 2000. Commercial loan net
charge-offs as a percentage of average commercial loans were .54% for 2001,
compared to .50% for 2000. Consumer loan net charge-offs as a percentage of
average consumer loans were .59% for 2001, compared to .49% for 2000.
Residential real estate mortgage loan net charge-offs as a percentage of average
residential mortgage loans, including loans held for sale, were .08% for 2001
and .09% for 2000.
- --------------------------------------------------------------------------------
17
- --------------------------------------------------------------------------------
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,
--------------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------ ------------ ------------ ------------ ------------
Allowance, beginning of year ................... $ 256,356 $ 132,986 $ 133,802 $ 116,823 $ 73,847
Charge-offs:
Residential(1) ................................. 7,506 8,293 14,038 6,223 8,869
Commercial ................................... 46,214 41,071 4,659 3,220 3,687
Consumer ..................................... 67,220 43,528 36,326 36,887 11,628
------------ ------------ ------------ ------------ ------------
Total charge-offs .............................. 120,940 92,892 55,023 46,330 24,184
------------ ------------ ------------ ------------ ------------
Recoveries:
Residential .................................. 2,500 1,433 1,629 1,134 1,040
Commercial ................................... 3,177 8,729 1,429 839 2,264
Consumer ..................................... 26,474 14,894 16,350 10,715 2,079
------------ ------------ ------------ ------------ ------------
Total recoveries ............................... 32,151 25,056 19,408 12,688 5,383
------------ ------------ ------------ ------------ ------------
Charge-offs, net of recoveries ................. 88,789 67,836 35,615 33,642 18,801
Provision for loan losses ...................... 97,100 56,500 30,000 27,961 41,125
Acquired allowance and other additions(2) ...... -- 134,706 4,799 22,660 20,652
------------ ------------ ------------ ------------ ------------
Allowance, end of year ......................... $ 264,667 $ 256,356 $ 132,986 $ 133,802 $ 116,823
============ ============ ============ ============ ============
Charge-offs, net of recoveries, to average
total loans .................................. .42% .35% .28% .30% .18%
============ ============ ============ ============ ============
(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 2000, amount represents initial allowance established in connection with
New England Acquisition. For 1999, amount represents Sovereign's June 1999
acquisition of Peoples Bancorp, Inc. For 1998, amount includes $20.5 million
of loan loss allowance established in connection with the CoreStates branch
acquisition. For 1997, amount includes $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 and residential real estate mortgage loans are generally charged
off when deemed to be uncollectible or 180 days past due, whichever comes first.
Charge-offs of commercial loans are made on the basis of management's ongoing
evaluation of non-performing loans.
Other Income. Total other income was $426 million for 2001 compared to $109
million for 2000. Several factors contributed to the increase in other income as
discussed below.
Consumer fees were $158 million for 2001 compared to $97.1 million in 2000. This
increase was primarily due to a favorable shift from time to core deposit
products along with the full year's impact of the New England Acquisition.
Additionally, in 2001 the Company aggressively promoted demand deposit products,
which, in exchange for favorable minimum balance requirements and convenience
for the customer, generally produce higher fee revenues than time deposit
products.
Commercial fees were $75.8 million for 2001 compared to $36.9 million in 2000.
This increase was due to growth in both commercial loans and core deposits
during the year augmented by a full year's impact of the New England
Acquisition.
Mortgage banking revenues were $69.5 million for 2001 compared to $25.2 million
for 2000. Included in mortgage banking revenues are $38.7 million of gains
related to sales of $4.1 billion of whole mortgage loans during 2001 and gains
of $35.0 million related to
- --------------------------------------------------------------------------------
18
- ----------------------MANAGEMENT'S DISCUSSION AND ANAYLSIS---------------------
sales of mortgage-backed securities (recently converted from mortgage loans) as
compared to gains of $7.0 million and $7.9 million for 2000 loans and mortgage
servicing rights sales, respectively, and no gains on the sale of
mortgage-backed securities. At December 31, 2001, Sovereign serviced $5.1
billion of residential loans for others as compared to $4.2 billion at December
31, 2000.
The Capital Markets Group generated revenue of $11.2 million in 2001 and $11.1
million in 2000. The Capital Markets Group was created during 2000 in three
phases. The first phase provided risk management services for corporate clients
including foreign exchange, investments and derivatives, and securitization
expertise for Sovereign's balance sheet assets. The second phase added merger
and acquisitions expertise to assist clients. The third phase, completed in
November 2001, included the formation of a broker dealer.
Income from bank-owned life insurance ("BOLI") was $42.7 million for 2001
compared to $34.3 million for 2000. This increase was primarily due to an
additional investment in BOLI of $200 million which was made during 2000.
Miscellaneous income increased $38.2 million to $53.9 million in 2001 due
primarily to a $28.1 million gain related to the sale of branches located in
southern New Jersey, Delaware and eastern Pennsylvania. The impact of the sale
is not expected to significantly impact future results.
Net gains on sales of investment securities and related derivatives were $15.5
million for 2001, compared to a net loss of $112 million for 2000. This
improvement was due primarily to second and third quarter 2000 balance sheet
deleveraging transactions in which Sovereign sold $2.1 billion of available for
sale mortgage-backed securities, resulting in losses of $103 million.
Periodically, Sovereign will sell certain investment securities and use the
proceeds to pay off short-term advances. Upon repayment of the short-term
advances, related swaps hedging these instruments may be terminated. In these
instances of balance sheet deleveraging, such hedging gains or losses are netted
against the offsetting security loss or gain. Net gains/(losses) on investments
were $30.2 million and ($121.1) million, for the years ended December 31, 2001
and 2000, respectively and net gains/(losses) on related derivative contracts
were ($14.7) million and $9.4 million for the years ended December 31, 2001 and
2000, respectively. Sales of available for sale investment securities have
little impact on stockholders' equity as unrealized gains and losses on these
securities are recognized as market values change and are recorded as an
increase or decrease in the other comprehensive income component of
stockholders' equity in accordance with SFAS 115.
General and Administrative Expenses. Total operating general and administrative
expenses were $789 million for 2001 compared to $582 million in 2000, which
exclude merger related and other special charges in 2000 as described below, or
an increase of 36%. This increase was due primarily to the full year impact in
2001 of the New England Acquisition which increased compensation and benefits
expense for the approximately 3,700 staff and management personnel which were
added throughout 2000, increased occupancy and equipment expenses for the
additional 281 community banking offices acquired, technology expense increased
due to the expanded network and back office platforms built to support the New
England Acquisition, and increased other administrative expenses resulting from
the acquisition. These expenses were reflected in 2000 results from each of the
respective three closing dates. See Note 2 - Business Combinations in the "Notes
to the Consolidated Financial Statements" for more details on the New England
Acquisition. Sovereign's efficiency ratio (all operating general and
administrative expenses as a percentage of net interest income and recurring
non-interest income) for 2001 was 53.9% compared to 54.3% for 2000. Included in
2000 total general and administrative expenses were $149 million of
merger-related, integration and other charges related to recent acquisitions.
These special charges include charges directly attributable to the acquired SBNE
branches, indirect costs incurred to integrate recent acquisitions into
Sovereign's back office systems, costs that management considered redundant due
to separating the New England Acquisition from a single closing into three
separate closings, and expenses related to the structured real estate
transaction that involved properties utilized by SBNE.
Other Operating Expenses. Total other operating expenses were $444 million for
2001 compared to $282 million for 2000. Other operating expenses included
amortization of goodwill and other intangible assets of $134 million for 2001
compared to $98.9 million for 2000 and trust preferred securities expense of
$59.1 million for 2001 compared to $44.3 million for 2000. The increase in
amortization expense is due to the New England Acquisition, which added $1.1
billion to Sovereign's intangible assets. In November 2000, the Company
announced the results of a restructuring initiative. In addition to realigning
the Office of the Chief Executive Officer and the Company around customer
segments, Sovereign analyzed front and back office operations and computer
- --------------------------------------------------------------------------------
19
- --------------------------------------------------------------------------------
operating platforms and eliminated approximately 500 positions. In total,
Sovereign recorded $27 million in restructuring costs, $8.5 million of which was
recorded in the first quarter 2001 related to the closure of 14 "in-store"
offices and a redirection of e-commerce efforts, and the remainder of which was
recorded in 2000, and was comprised of $14 million of severance and outplacement
costs, and a $4.5 million write-off of a redundant computer-operating platform.
As part of the New England Acquisition, Sovereign was required to pay $363
million over a period from January 1, 2001 through September 2001, $120 million
of which was expensed during 2000 and the remaining $243 million expensed in
2001 subject to FleetBoston's performance of non-solicitation obligations under
the purchase agreement and satisfaction of certain other conditions.
Income Tax Provision. The income tax provision, including taxes related to an
extraordinary item, was $23.0 million for 2001 compared to a benefit of $60.0
million for 2000. The effective tax rate for 2001 was 16.4% compared to (66.5%)
for 2000. In 2001, certain components of Sovereign's income are not subject to
tax, including income of $29.1 million related to tax-exempt investments and
income of $42.7 million related to Bank-owned life insurance. Management expects
that the absolute dollar amount of these tax exempt items will not change
significantly during 2002; however, the percent effect of these non-taxed items
on the effective rate will vary in the future depending on the level of pretax
income. The effective tax rate for 2001 and 2000 is not meaningful due to the
high proportion of permanent tax differences, including certain one-time tax
benefits included in operating earnings, in relation to the recorded pretax
income/(loss). For additional information with respect to Sovereign's income
taxes, see Note 18 in the "Notes to Consolidated Financial Statements" hereof.
Extraordinary Items. In March 2001, Sovereign completed a $400 million term and
revolving credit facility with Bank of Scotland of which $350 million was drawn
to prepay an existing $350 million senior secured credit facility. In connection
with this transaction, Sovereign wrote-off $6.5 million net of tax ($10.1
million pre-tax) of deferred issuance costs remaining from the existing line of
credit. These costs were reflected net of tax as an extraordinary item in
accordance with generally accepted accounting principles.
During the first quarter of 2000, Sovereign sold FHLB advances, which resulted
in a pretax gain of $16.0 million ($10.8 million after-tax) and is treated as an
early extinguishment of debt under current generally accepted accounting
principles.
- --------------------------------------------------------------------------------
20
- ----------------------MANAGEMENT'S DISCUSSION AND ANAYLSIS---------------------
FINANCIAL CONDITION
Loan Portfolio. Sovereign's loan portfolio at December 31, 2001 was $20.4
billion compared to $21.9 billion at December 31, 2000, comprised of $8.2
billion of commercial loans, $7.1 billion of consumer loans and $5.0 billion of
residential loans at December 31, 2001. This compares to $7.8 billion of
commercial loans, $6.1 billion of consumer loans, and $8.0 billion of
residential loans at December 31, 2000.
During 2000, Sovereign securitized and removed from the balance sheet commercial
automotive floor plan loans of $579 million and consumer home equity loans of
$369 million. See Note 22 Asset Securitizations in the Notes to Consolidated
Financial Statements for more details. Sovereign also converted $1.2 billion of
residential mortgages to FHLMC mortgage-backed securities which are included in
Sovereign's investment securities held to maturity portfolio at December 31,
2000.
Residential loans decreased to 25% of the total loan portfolio at December 31,
2001 as compared to 36% at December 31, 2000. This decrease was due to the sale
or conversion into mortgage-backed securities of $4.1 billion of residential
mortgages during 2001.
Federal law limits the amount of non-residential mortgage loans a savings
institution, such as Sovereign Bank, may make. The law limits a savings
institution to a maximum of 10% of its assets in large commercial loans, with
another 10% of assets permissible in "small business loans." Commercial loans
secured by real estate, however, are in addition to the above amounts, and can
be made in an amount up to four times an institution's capital. An institution
can also have commercial leases in addition to the above, up to 10% of its
assets. Commercial loans and small business loans, as defined, totaled $3.1
billion and $1.6 billion, respectively, as compared to the 10% of assets
limitation of $3.5 billion at December 31, 2001.
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,
----------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
--------------------- --------------------- -------------------- --------------------- ---------------------
BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Commercial real
estate loans .... $ 3,082,330 15.1% $ 2,793,616 12.7% $ 1,516,953 10.6% $ 887,938 7.7% $ 664,943 5.6%
Commercial and
industrial loans 4,506,198 22.1 4,397,009 20.1 1,690,744 11.8 717,440 6.2 356,517 3.1
Other ............. 657,527 3.2 640,782 3.0 867,642 6.1 693,342 6.0 395,327 3.4
----------- ----- ----------- ----- ----------- ----- ----------- ----- ----------- -----
Total Commercial
Loans ......... 8,246,055 40.4 7,831,407 35.8 4,075,339 28.5 2,298,720 19.9 1,416,787 12.1
----------- ----- ----------- ----- ----------- ----- ----------- ----- ----------- -----
Home equity loans . 3,756,621 18.4 3,256,598 14.9 1,957,945 13.7 1,750,883 15.1 1,050,304 9.0
Auto loans ........ 2,882,417 14.1 2,309,025 10.5 1,936,980 13.6 1,510,676 13.0 1,553,318 13.4
Other ............. 509,272 2.5 536,358 2.4 573,717 4.0 549,488 4.8 532,075 4.6
----------- ----- ----------- ----- ----------- ----- ----------- ----- ----------- -----
Total Consumer
Loans ......... 7,148,310 35.0 6,101,981 27.8 4,468,642 31.3 3,811,047 32.9 3,135,697 27.0
----------- ----- ----------- ----- ----------- ----- ----------- ----- ----------- -----
Residential real
estate loans .... 5,005,219 24.6 7,978,857 36.4 5,744,484 40.2 5,473,003 47.2 7,082,316 60.9%
----------- ----- ----------- ----- ----------- ----- ----------- ----- ----------- -----
Total Loans ..... $20,399,584 100.0% $21,912,245 100.0% $14,288,465 100.0% $11,582,770 100.0% $11,634,800 100.0%
=========== ===== =========== ===== =========== ===== =========== ===== =========== =====
Total Loans with:
Fixed rates ..... $12,875,742 63.1% $14,165,535 64.6% $ 8,769,876 61.4% $ 6,095,088 52.6% $ 4,859,629 41.8%
Variable rates .. 7,523,842 36.9 7,746,710 35.4 5,518,589 38.6 5,487,682 47.4 6,775,171 58.2
----------- ----- ----------- ----- ----------- ----- ----------- ----- ----------- -----
Total Loans ..... $20,399,584 100.0% $21,912,245 100.0% $14,288,465 100.0% $11,582,770 100.0% $11,634,800 100.0%
=========== ===== =========== ===== =========== ===== =========== ===== =========== =====
- --------------------------------------------------------------------------------
21
- --------------------------------------------------------------------------------
Table 5 presents the contractual maturity of Sovereign's commercial loans at
December 31, 2001 (in thousands):
- --------------------------------------------------------------------------------
TABLE 5: LOAN MATURITY SCHEDULE
AT DECEMBER 31, 2001, MATURING
-----------------------------------------------------
IN ONE YEAR ONE TO AFTER
OR LESS FIVE YEARS FIVE YEARS TOTAL
---------- ---------- ---------- ----------
Commercial real estate loans ......................................... $ 484,265 $1,072,062 $1,526,003 $3,082,330
Commercial and industrial loans ...................................... 590,282 1,939,313 1,976,603 4,506,198
Other commercial ..................................................... 96,073 261,870 299,584 657,527
---------- ---------- ---------- ----------
Total .............................................................. $1,170,620 $3,273,245 $3,802,190 $8,246,055
========== ========== ========== ==========
Loans with:
Fixed rates .......................................................... $ 267,909 $1,580,613 $1,299,003 $3,147,525
Variable rates ....................................................... 902,711 1,692,632 2,503,187 5,098,530
---------- ---------- ---------- ----------
Total .............................................................. $1,170,620 $3,273,245 $3,802,190 $8,246,055
========== ========== ========== ==========
- --------------------------------------------------------------------------------
Investment Securities. Sovereign's investment portfolio is concentrated in
mortgage-backed securities and collateralized mortgage obligations issued by
federal agencies or private label issues. All of the CMO private label issues
have ratings of "AAA" by Standard and Poor's and Fitch at December 31, 2001. 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, 2001 was
3.6 years. Sovereign also holds $325 million of corporate trust preferred
securities all with maturities in excess of 10 years.
In determining if and when a decline in market value below amortized cost is
other-than-temporary, Sovereign evaluates the market conditions, offering
prices, trends of earnings, price multiples, and other key measures for
investments in marketable equity securities and debt instruments. When such a
decline in value is deemed to be other-than-temporary, impairment loss is
recognized in the current period operating results to the extent of the decline.
During 2001 and 2000, the Company converted $1.6 billion and $1.2 billion,
respectively, of residential mortgage loans into mortgage-backed securities, and
retained 100% of the securities of the trusts to which the loans were sold. The
book value of these loans was reclassified from loans to investment securities
upon securitization. Classification as available for sale or held to maturity
was determined as discussed below.
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. All of our securities
have readily determinable market prices that are derived from third party
pricing services. 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 prepay obligations without prepayment penalties.
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. On
January 1, 2001, Sovereign reclassified $800 million of held to maturity
investments to available for sale investments as allowed upon adoption of SFAS
133. 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.
- --------------------------------------------------------------------------------
22
- ----------------------MANAGEMENT'S DISCUSSION AND ANAYLSIS---------------------
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 6 presents the book value of investment securities by obligation and Table
7 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, 2001 (dollars in thousands):
- --------------------------------------------------------------------------------
TABLE 6: INVESTMENT SECURITIES BY OBLIGOR
AT DECEMBER 31,
------------------------------------
2001 2000 1999
---------- ---------- ----------
Investment securities available for sale:
U.S. Treasury and government
agency securities ..................... $6,649,220 $ 765,880 $ 964,016
State and municipal securities ........ 24,392 38,769 32,179
Other securities ...................... 2,908,067 4,510,935 7,034,017
---------- ---------- ----------
Total investment securities
available for sale .................... $9,581,679 $5,315,584 $8,030,212
========== ========== ==========
Investment securities held to maturity:
U.S. Treasury and government
agency securities ..................... $ 874,059 $1,568,907 $ 504,673
State and municipal securities ........ 4,128 739 3,275
Other securities ...................... 5,250 408,622 1,854,103
---------- ---------- ----------
Total investment securities
held to maturity ...................... $ 883,437 $1,978,268 $2,362,051
========== ========== ==========
- --------------------------------------------------------------------------------
TABLE 7: INVESTMENT SECURITIES OF SINGLE ISSUERS
AT DECEMBER 31, 2001
--------------------------------
AMORTIZED FAIR
COST VALUE
-------------- --------------
Cendant Mortgage ........................... $ 227,354,649 $ 232,856,483
PNC Mortgage Securities .................... 237,784,952 239,047,306
Structured Asset Securities Corporation .... 300,873,057 302,470,270
First Nationwide Trust ..................... 236,104,581 239,363,211
-------------- --------------
Total .................................... $1,002,117,239 $1,013,737,270
============== ==============
- --------------------------------------------------------------------------------
Goodwill and Intangible Assets. Goodwill and other intangible assets decreased
to $1.3 billion from $1.5 billion which represented 4% of total assets and 61%
of stockholders' equity at December 31, 2001, and is comprised of goodwill of
$955 million and core deposit intangible assets of $389 million. The decrease in
goodwill and other intangible assets was due to amortization offset by an
increase of $23.5 million related to some final purchase price adjustments
recorded in 2001 for the New England Acquisition. Through December 31, 2001,
Sovereign was amortizing goodwill over 25 years. Upon adoption of SFAS 142,
"Goodwill and Other Intangible Assets" on January 1, 2002, Sovereign will cease
to amortize its goodwill, and will measure it for impairment annually or as
indicators of impairment arise.
Sovereign established core deposit intangibles (CDI) in instances where low-cost
deposits were acquired in purchase business combinations. Sovereign determined
the value of its CDI based on the present value of the difference in expected
future cash flows between the cost to replace such deposits (based on applicable
equivalent time deposit rates) versus the then-current yield on core deposits
acquired. The aggregate future cash flows were based on the average expected
life of the deposits acquired for each product less cost to service the
deposits. This intangible is amortized using an accelerated method over the
expected life of the underlying deposit, which is generally 10 years.
- --------------------------------------------------------------------------------
23
- --------------------------------------------------------------------------------
Other Assets. Premises and equipment decreased from 2000 primarily due to
depreciation of $43.1 million and the disposition of $4.4 million of assets
through the sale of branches in southern New Jersey, Delaware and Eastern
Pennsylvania offset by new purchases. Accrued interest receivable decreased
$46.6 million due to the contraction in the loan portfolio and the decreased
yield on loans. Other assets at December 31, 2001 were $1.5 billion compared to
$951.7 million at December 31, 2000. The increase primarily relates to an
increase in loans in process of $357 million from a rise in residential and
consumer loan volume due to the prevailing low rates, deferred taxes of $61.6
million, the market value of derivatives of $46.9 million due principally to
derivatives related to the indirect auto securitization, and other increases.
Deposits. Sovereign attracts deposits within its primary market area by offering
a variety of deposit instruments including demand and NOW accounts, money market
accounts, savings accounts, certificates of deposit and retirement savings
plans. Total deposits at December 31, 2001 were $23.3 billion compared to $24.5
billion at December 31, 2000. The decrease in deposits is attributable to
decreases in jumbo and retail time deposits, which decreased $2.0 billion
year-to-year. Additionally, Sovereign sold 18 branch offices with deposits of
$315 million to another institution in June 2001. Excluding these two items,
deposits increased approximately $1.1 billion or 5% during 2001.
Comparative detail of average balances and rates by deposit type is included in
Table 1 Net Interest Margin earlier in this discussion.
Borrowings. Sovereign utilizes short-term 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. Other sources of
funds available to Sovereign include federal funds, and reverse repurchase
agreements. Reverse repurchase agreements are short-term obligations
collateralized by investment securities. Total borrowings at December 31, 2001
were $2.7 billion, compared to total borrowings of $1.3 billion at December 31,
2000. The increase in short-term borrowings was due to more attractive funding
costs in these funding sources versus retail and jumbo time deposits.
Table 8 presents information regarding Sovereign's borrowings and the related
weighted average rate at the dates indicated (in thousands):
- --------------------------------------------------------------------------------
TABLE 8: BORROWINGS AT DECEMBER 31,
--------------------------------------------
2001 2000
--------------------- --------------------
BALANCE RATE BALANCE RATE
---------- ---- ---------- ----
Federal funds purchased ................... $ 452,002 1.75% $ 130,000 5.23%
Securities sold under repurchase agreements 297,741 1.45% 230,900 6.58%
Federal Home Loan Bank advances ........... 1,929,021 3.08% 970,000 6.62%
---------- ---- ---------- ----
Total borrowings .......................... $2,678,764 2.67% $1,330,900 6.48%
========== ==== ========== ====
- --------------------------------------------------------------------------------
Table 9 summarizes information regarding short-term securities sold under
repurchase agreements and short-term FHLB advances (in thousands):
- --------------------------------------------------------------------------------
TABLE 9: DETAILS OF BORROWINGS DECEMBER 31,
-------------------------
2001 2000
----------- -----------
Securities sold under repurchase agreements:
Balance ................................................... $ 297,741 $ 230,900
Weighted average interest rate ............................ 1.45% 6.58%
Maximum amount outstanding at any month-end during the year $ 398,850 $1,426,828
Average amount outstanding during the year ................ $ 83,046 $ 811,601
Weighted average interest rate during the year ............ 1.45% 6.57%
FHLB advances:
Balance ................................................... $1,929,021 $ 970,000
Weighted average interest rate ............................ 3.07% 6.62%
Maximum amount outstanding at any month-end during the year $3,555,000 $8,753,000
Average amount outstanding during the year ................ $2,119,833 $4,267,647
Weighted average interest rate during the year ............ 4.18% 6.59%
- --------------------------------------------------------------------------------
24
- ----------------------MANAGEMENT'S DISCUSSION AND ANALYSIS----------------------
Refer to Note 10 in the "Notes to Consolidated Financial Statements" hereof for
more information related to Sovereign's borrowings.
Long-Term Debt. Total long-term debt at December 31, 2001 was $6.3 billion
compared to $4.9 billion at December 31, 2000. The increase in long-term debt
was due to the issuance of $821 million of asset-backed floating rate notes,
along with increases in reverse repurchase agreements and FHLB advances to
achieve a lower overall cost of funds. See Note 11 in the "Notes to the
Consolidated Financial Statements" hereof for more information related to
Sovereign's long-term debt.
On November 20, 2001, a consolidated special purpose entity issued $821 million
of asset-backed floating rate notes. On March 1, 2001, Sovereign refinanced the
$500 million senior secured credit facility with a $400 million variable rate
senior secured credit facility consisting of a $350 million revolving line and a
$50 million term note. On February 20, 2001, Sovereign issued $175 million of
senior unsecured notes at 8.625% which will mature on March 15, 2004. The
proceeds of this issuance, along with the proceeds of $150 million from the 20
million shares of common stock issued on February 9, 2001, were used to repay
$240 million of 6.625% senior notes which matured on March 15, 2001 and
strengthened Sovereign's liquidity.
Trust Preferred Securities. Sovereign has outstanding $404 million ($504 million
par value) of mandatorily redeemable trust preferred obligations that have
stated maturities ranging from 2027 through 2030 and have stated dividends of
7.50% to 9.875% of par value. On December 10, 2001, Sovereign issued $100
million of Trust Preferred Securities with an annual dividend rate of 8.75%. On
December 27, 2001, Sovereign completed an open market repurchase of $15.4
million (par value) of its Trust Preferred Securities with an annual
distribution rate of 9%. The difference between book value and par value of the
Trust Preferred Securities is being accreted into expense over the life of the
securities using the level yield method. See Note 12 in the "Notes to the
Consolidated Financial Statements" for a more detailed discussion on Sovereign's
Trust Preferred Securities.
Securitization Transactions. Securitization transactions contribute to
Sovereign's overall funding and regulatory capital management. The total face
amount of the outstanding debt and equity securities assumed by third parties at
December 31, 2001 approximates $2.6 billion. These transactions involve periodic
transfers of loans or other financial assets to special purpose entities (SPEs)
and are either recorded on Sovereign's Consolidated Balance Sheet or off-balance
sheet depending on whether the transaction qualifies as a sale of assets in
accordance with SFAS 140, "Transfers of Financial Assets and Liabilities" ("SFAS
140").
Off-Balance Sheet Securitizations. In certain transactions, Sovereign has
transferred assets to an SPE qualifying for non-consolidation (QSPE), however
retained an interest in the QSPE. At December 31, 2001, off-balance sheet QSPE's
had $1.8 billion of debt related to assets that Sovereign sold to the QSPE which
are not included in Sovereign's consolidated Balance Sheet. Sovereign's interest
retained in such QSPE's was $123 million. See Note 22 in the "Notes to the
Consolidated Financial Statements" for a discussion of Sovereign's policies
concerning valuation and impairment assessment for such interests as well as a
discussion of the assumptions used and sensitivity to changes in those
assumptions.
Sovereign does not provide contractual legal recourse to third party investors
that purchase debt or equity securities issued by the QSPEs beyond the credit
enhancement inherent in Sovereign's subordinated interests in the QSPEs.
However, should the performance of the underlying loans held by those QSPEs
deteriorate to a level that our retained subordinated interests are insufficient
to collateralize the QSPE securities held by third party investors, Sovereign
may decide to provide the QSPEs with additional credit enhancements to reduce
the third party investors' risk of loss, although it is not contractually
required to do so. If management decides not to provide additional credit
enhancements in such a situation, it could adversely impact the availability and
pricing of future transactions. The performance of the underlying collateral in
all of Sovereign's transactions at December 31, 2001 is sufficient such that
management believes it is unlikely Sovereign will need to provide additional
credit enhancements to these transactions in the future.
Securitizations Consolidated in Sovereign's Consolidated Balance Sheet. In a
transaction consummated in November 2001, Sovereign accessed the liquidity of
international markets and transferred $957 million of indirect automobile loans
to SPEs in a financing transaction that does not qualify as a sale of assets
under SFAS 140, and therefore has consolidated both the assets transferred to
the SPEs and the debt and minority interests issued by the SPEs in its
Consolidated Balance Sheet. At December 31, 2001, Sovereign had $821 million of
debt and $64 million of minority interest reflected on its Consolidated Balance
Sheet related to consolidated SPEs.
- --------------------------------------------------------------------------------
25
- --------------------------------------------------------------------------------
Additionally, Sovereign will periodically sell qualifying mortgage loans to
FHLMC, GNMA, and FNMA in return for mortgage-backed securities issued by those
agencies. Sovereign reclassifies the net book balance of the loans sold to such
agencies from loans to investment securities held to maturity and available for
sale. For those loans sold to the agencies in which Sovereign retains servicing
rights, Sovereign allocates the net book balance transferred between servicing
rights and investment securities based on their relative fair values.
Minority Interests. In the financing transaction consummated in November 2001,
Sovereign received $64 million from the sale of ownership interests in
consolidated SPEs to outside investors. The SPEs were formed to issue debt and
equity interests as parts of a securitization transaction which raised a total
of $885 million for Sovereign. The controlling interests in the SPEs are
reflected as minority interests in Sovereign's Consolidated Balance Sheet, along
with the indirect automobile loans and asset-backed notes as the entire
transaction is considered a financing in accordance with SFAS 140.
On August 21, 2000, Sovereign received approximately $140 million of net
proceeds from the issuance of $161.8 million of 12% Series A Noncumulative
Preferred Interests in Sovereign Real Estate Investment Trust ("SREIT"), a
subsidiary of Sovereign Bank which holds primarily residential real estate
loans. The preferred stock was issued at a discount, which is being amortized
over the life of the preferred shares using the effective yield method. The
preferred shares may be redeemed at any time on or after May 16, 2020, at the
option of Sovereign subject to the approval of the OTS. Under certain
circumstances, the preferred shares are automatically exchangeable into
preferred stock of Sovereign Bank. The offering was made exclusively to
institutional investors; however, Sovereign expects to register the SREIT
preferred shares so that they can be offered to other investors. The proceeds of
this offering were principally used to repay corporate debt.
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 other key credit attributes, have also been established. Loan
approval authority ranges from the individual loan officer to the Board of
Directors' Loan Committee. In addition to being subjected to the judgment and
dual approval of experienced loan officers and their managers, loans over a
certain dollar size also require the co-approval of credit officers independent
of the loan officer to ensure consistency and quality in accordance with
Sovereign's credit standards.
The Retail Loan Review Group and the Commercial Asset Review Group conduct
ongoing, independent reviews of the lending process to ensure adherence to
established policies and procedures, monitor compliance with applicable laws and
regulations, provide objective measurement of the risk inherent in the loan
portfolio, and ensure 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. 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. Commercial loan credit quality is strong but is under a high level of
scrutiny by line management, credit officers and the independent Commercial
Asset Review Group, due to current economic conditions.
At December 31, 2001, Sovereign's loan portfolio was 25% residential, 35%
consumer and 40% commercial. At December 31, 2000, Sovereign's loan portfolio
was 36% residential, 28% consumer and 36% commercial. This shift in portfolio
composition reflects increased emphasis in commercial and consumer lending.
Management believes this shift in loan composition brings higher yields and
higher inherent credit risk.
The following discussion summarizes the underwriting policies and procedures for
the major categories within the loan portfolio and addresses Sovereign's
strategies for managing the related credit risk.
- --------------------------------------------------------------------------------
26
- ----------------------MANAGEMENT'S DISCUSSION AND ANALYSIS----------------------
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
capacity and willingness 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 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 and indirect 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 auto loan portfolio is
characterized by high credit scoring borrowers and strong payment performance.
The portion of the consumer portfolio at December 31, 2001, which is secured by
real estate, vehicles, deposit accounts or government guarantees comprises 97.4%
of the entire consumer portfolio.
Residential Loans. Sovereign originates fixed rate and adjustable rate
residential mortgage loans which are secured by the underlying 1-4 family
residential property. 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 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 Asset Review Committee meetings.
Minutes from these meetings are submitted to the Board of Directors of Sovereign
Bank.
Non-performing Assets. At December 31, 2001, Sovereign's non-performing assets
were $228 million compared to $187 million at December 31, 2000. Non-performing
assets as a percentage of total assets was .64% at December 31, 2001 compared to
.56% at December 31, 2000. This increase was caused by the residential and
commercial portfolios. Commercial non-performing loans are higher due to
deterioration in a segment of the portfolio concentrated in cash flow-based
enterprise value lending, primarily in syndicated multi-bank credits that were
originated by other banks and participated in by Sovereign. Residential loan
delinquencies and non-accruals increased due to the weakening economy.
Sovereign places all commercial loans 90 days or more delinquent (except those
in the process of collection) on non-performing status. Residential loans 120
days delinquent (except those well-secured and in the process of collection) are
placed on non-accrual status and a 10% allowance allocation is assigned.
Consumer loans 120 days delinquent are placed on non-accrual status and a 20%
allowance allocation is assigned. In addition, Sovereign calculates a specific
reserve on all loans where it has been determined that a potential for loss
exists. Consumer non-accrual loans decreased from $38.2 million at December 31,
2000 to $27.5 million at December 31, 2001, as a result of a change in practice
in recognizing consumer non-performing loans from 90 to 120 days.
Residential real estate owned increased from $4.4 million at December 31, 2000
to $9.3 million at December 31, 2001 reflecting an accelerated foreclosure
process that occurred in certain parts of the acquired New England portfolio.
Other repossessed assets increased from $3.8 million at December 31, 2000 to
$9.7 million at December 31, 2001, primarily as a result of a methodology change
in one of the serviced- by-others portfolios.
- --------------------------------------------------------------------------------
27
- --------------------------------------------------------------------------------
Table 10 presents the composition of non-performing assets at the dates
indicated (in thousands):
- --------------------------------------------------------------------------------
TABLE 10: NON-PERFORMING ASSETS
AT DECEMBER 31,
--------------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
Non-accrual loans:
Residential ............................ $ 74,500 $ 60,322 $ 32,374 $ 60,582 $ 65,930
Commercial real estate ................. 16,957 12,403 4,110 6,108 2,785
Commercial ............................. 88,810 64,485 12,668 7,305 942
Consumer ............................... 27,530 38,239 26,259 25,964 25,720
-------- -------- -------- -------- --------
Total non-accrual loans .................. 207,797 175,449 75,411 99,959 95,377
Restructured loans ....................... 1,280 3,755 3,755 141 327
-------- -------- -------- -------- --------
Total non-performing loans ............... 209,077 179,204 79,166 100,100 95,704
Other real estate owned and other
repossessed assets
Residential real estate owned .......... 9,261 4,425 2,344 12,147 11,299
Commercial real estate owned ........... -- -- 1,223 665 710
Other repossessed assets ............... 9,667 3,758 1,762 2,772 --
-------- -------- -------- -------- --------
Total other real estate owned and
other repossessed assets ............... 18,928 8,183 5,329 15,584 12,009
-------- -------- -------- -------- --------
Total non-performing assets .............. $228,005 $187,387 $ 84,495 $115,684 $107,713
======== ======== ======== ======== ========
Past due 90 days or more as to interest or
principal and accruing interest ........ $ 54,599 $ 16,733 $ 10,238 $ 9,975 $ 7,053
Non-performing assets as a percentage of
total assets ........................... .64% .56% .32% .53% .61%
Non-performing loans as a percentage of
total loans ............................ 1.02 .82 .55 .86 .82
Non-performing assets as a percentage of
total loans and other real estate owned 1.12 .85 .59 1.00 .92
Allowance for loan losses as a percentage
of total non-performing assets ......... 116.1 136.8 157.4 115.7 108.5
Allowance for loan losses as a percentage
of total non-performing loans .......... 126.6 143.1 168.0 133.7 122.1
- --------------------------------------------------------------------------------
Loans that are past due 90 days or more and still accruing interest increased
from $16.7 million at December 31, 2000 to $54.6 million at December 31, 2001.
This increase was due principally to the phase-in of a methodology change in the
treatment of delinquent loans during the first half of 2001 and a change in
nonaccrual of certain consumer loans from 90 to 120 days past due to ensure
consistency with all other consumer loans. During 2001, Sovereign began to keep
residential and consumer loans secured by real estate that are well-secured
(loan to value of 50% or less) and in the process of collection on accrual
status, in accordance with regulatory guidelines. There were $12.8 million of
such loans at December 31, 2001.
Gross interest income for the years ended December 31, 2001, 2000 and 1999 would
have increased by approximately $9.1 million, $7.0 million and $5.0 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, 2001, 2000, and 1999 was $6.6 million, $3.8 million and $2.1 million,
respectively.
Potential Problem Loans. 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 $102 million and $97 million at December 31, 2001 and
2000, respectively.
Delinquencies. Sovereign's loan delinquencies (all performing loans 30 or more
days delinquent) at December 31, 2001 were $449 million, a decrease from $501
million at December 31, 2000. As a percentage of total loans, performing
delinquencies were 2.20%
- --------------------------------------------------------------------------------
28
- ----------------------MANAGEMENT'S DISCUSSION AND ANALYSIS----------------------
at December 31, 2001, a decrease from 2.29% at December 31, 2000. Residential
performing loan delinquencies decreased from $243 million to $188 million during
the same time periods, but increased as a percentage of total residential loans
from 3.05% to 3.75% as a result of the decrease in the size of the overall
residential portfolio. Consumer performing loan delinquencies increased from
$147 million to $155 million, but decreased as a percentage of total consumer
loans as a result of the increase in the size of the overall consumer portfolio.
Commercial performing loan delinquencies decreased from $110 million to $106
million, and also decreased as a percentage of total commercial loans from 1.40%
to 1.28%.
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, amount of non-performing loans, delinquency trends, economic
conditions and industry trends.
Overall, management believes that delinquency, potential problem loan,
non-performing, and charge-off statistics have evidenced deterioration related
to economic conditions. The allowance has been increased from 1.17% to 1.30% of
total loans reflecting these trends and the shift in portfolio composition
throughout the year, and credit risk management processes continue to identify
deterioration as soon as possible.
Sovereign maintains an allowance for loan losses which management believes is
sufficient to absorb inherent losses in the loan portfolio. Sovereign believes
the current allowance to be at a level adequate to cover such inherent losses.
At December 31, 2001, Sovereign's total allowance was $265 million. Sovereign's
total allowance at year-end equated to approximately 4.1 times the average net
charge-offs for the prior three-year period. Because historical charge-offs are
not necessarily indicative of future charge-off levels, Sovereign also gives
consideration to other risk indicators when determining the appropriate
allowance level.
Sovereign applies similar methods of determining the loan loss allowance for
purchased loan portfolios as it does in establishing allowances for originated
loans. Sovereign established a $135 million allowance for loan losses for the
loans acquired in the New England Acquisition. In establishing this allowance,
Sovereign utilized its methodology, adjusted for increased uncertainty regarding
the quality of the acquired loans. Sovereign performed specific reviews of large
non-homogeneous loans, and established specific allowances accordingly. For
homogenous loans, Sovereign established the loan loss allowance based on limited
available performance history, industry statistics and similar experiences with
other acquired portfolios.
The allowance for loan losses consists of two elements: (i) an allocated
allowance, which for non-homogeneous loans is comprised of allowances
established on specific classified loans, and class allowances for both
homogeneous and non-homogeneous loans based on historical loss experience and
current trends, and (ii) unallocated allowances based on both general economic
conditions and other risk factors in Sovereign's individual markets and
portfolios, and to account for a level of imprecision in management's estimation
process.
The allowance recorded for consumer and residential portfolios is based on an
analysis of product mix, credit scoring and risk composition of the portfolio,
fraud loss and bankruptcy experiences, economic conditions and historical and
expected delinquency and charge-off statistics for each homogeneous category or
group of loans. Based on this information and analysis, an allowance is
established in an amount sufficient to cover estimated net-charge-offs for a
twelve-month period.
The allowance recorded for commercial loans is based on an analysis of the
individual credits and relationships and is separated into two parts, the
specific allowance and the class allowance.
The specific allowance element of the commercial loan allowance is based on a
regular analysis of criticized commercial loans where internal credit ratings
are below a predetermined classification. This analysis is performed by the
Managed Asset Division, where loans with recognized deficiencies are
administered, and periodically reviewed by Credit Risk Management and the
Commercial Asset Review Group. 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.
- --------------------------------------------------------------------------------
29
- --------------------------------------------------------------------------------
The class allowance element of the commercial loan 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,
management 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 management 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 conditions and the sensitivity of assumptions utilized to establish
allocated allowances for homogeneous groups of loans among other factors.
Sovereign 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
management on a quarterly basis. In addition, a review of allowance levels based
on nationally published statistics is conducted on an annual basis. The Chief
Credit Officer, the Chief Risk Management Officer and the Chairman of the Asset
Review Committee have the responsibility to affirm allowance methodology and to
assess the general and specific allowance factors in relation to estimated and
actual net charge-off trends. In addition, the group is also responsible for
assessing the appropriateness of the allowance for loan losses for each loan
pool classification at Sovereign.
Although management determines the amount of each element of the allowance
separately and this process is an important credit management tool, the entire
allowance for credit losses is available for the entire loan portfolio. The
actual amount of losses incurred can vary significantly from the estimated
amounts. Management's methodology includes several factors intended to minimize
the differences between estimated and actual losses. These factors allow
management to adjust its estimate of losses based on the most recent information
available.
- --------------------------------------------------------------------------------
30
- ----------------------MANAGEMENT'S DISCUSSION AND ANALYSIS----------------------
Table 11 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 11: ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
AT DECEMBER 31,
----------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------------- ------------------ ------------------ ------------------ -------------------
% OF % OF % OF % OF % OF
LOANS TO LOANS TO LOANS TO LOANS TO LOANS TO
TOTAL TOTAL TOTAL TOTAL TOTAL
AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
-------- -------- -------- -------- -------- -------- -------- -------- -------- ---------
Allocated allowances:
Commmercial loans ..... $161,075 40% $149,828 36% $ 58,784 29% $ 38,354 20% $ 30,793 12%
Residential real estate
mortgage loans ...... 20,724 25 34,629 36 19,535 40 22,427 47 36,351 61
Consumer loans ........ 61,200 35 48,053 28 43,455 31 48,083 33 24,300 27
Unallocated allowances .. 21,668 n/a 23,846 n/a 11,212 n/a 24,938 n/a 25,379 n/a
-------- --- -------- --- -------- --- -------- --- -------- ---
Total allowance
for loan losses ....... $264,667 100% $256,356 100% $132,986 100% $133,802 100% $116,823 100%
======== === ======== === ======== === ======== === ======== ===
- --------------------------------------------------------------------------------
Residential Portfolio. The allowance for the residential mortgage portfolio
decreased from $34.6 million at December 31, 2000 to $20.7 million at December
31, 2001. The decrease was due primarily to the overall reduction in the
residential portfolio by $3.0 billion from $8.0 billion at December 31, 2000 to
$5.0 billion at December 31, 2001. As a percentage of the total residential
portfolio, the allowance decreased from .43% to .41%. Despite increases in
delinquencies as a percent of loans outstanding and non-performing loans in this
portfolio, residential net charge-offs have not experienced commensurate
increases, and in fact decreased from $6.9 million in 2000 to $5.0 million in
2001. As a percentage of average loans, residential net charge-offs decreased
from .09% in 2000 to .08% in 2001.
Consumer Portfolio. The allowance for the consumer loan portfolio increased from
$48.1 million at December 31, 2000 to $61.2 million at December 31, 2001. This
increase was due to the overall growth in the portfolio which brought higher
levels of substandard assets that carry higher reserve allowance percentages. As
a percentage of the entire consumer portfolio, the reserve increased from .79%
to .86%. During 2001, net charge-offs in this portfolio totaled $40.7 million,
as compared to $28.6 million in the previous year, an increase of 42%; however,
the increase in charge-offs as a percentage of outstandings increased only 20%
from .49% to .59%.
Commercial Portfolio. The allowance for loan losses for the commercial portfolio
increased from $149.8 million at December 31, 2000 to $161.1 million at December
31, 2001. As a percentage of the total commercial portfolio, the allowance
increased from 1.91% to 1.95%. This increase was due primarily to higher levels
of special mention and substandard assets that carry higher reserve allowance
percentages, especially in the cash flow portfolio. During 2001, net charge-offs
in this portfolio totaled $43.0 million, as compared to $32.3 million in 2000;
however, charge-offs only increased from .50% to .54% of the respective average
portfolio, due to the overall increase in the total commercial portfolio during
2001.
Unallocated Allowance. The unallocated allowance decreased from $23.8 million at
December 31, 2000 to $21.7 million at December 31, 2001. As a percentage of the
total reserve, the unallocated portion decreased from 9.3% to 8.2%. This
decrease reflects the bank's increased precision in its methodology of
calculating the allocated portion of the allowance, combined with the increased
familiarity and seasoning of the acquired loan portfolios.
- --------------------------------------------------------------------------------
31
- --------------------------------------------------------------------------------
BANK REGULATORY CAPITAL
Federal law requires institutions regulated by the Office of Thrift Supervision
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%. Federal law
also requires OTS regulated institutions to have a minimum tangible capital
equal to 2% of total tangible assets.
The OTS Order, requires Sovereign Bank to be "well capitalized" and also to meet
certain other additional capital ratio requirements above the regulatory
minimum, and other conditions. Sovereign's various agreements with its lenders
also require it to cause Sovereign Bank to be "well capitalized" at all times
and in compliance with all regulatory requirements. To be "well capitalized", an
OTS institution must maintain a Tier 1 leverage ratio of at least 5%, a Tier 1
risk-based capital ratio of at least 6% and total risk-based capital of at least
10%. As of December 31, 2001, Sovereign Bank was classified as well capitalized
and in compliance with the conditions and capital requirements discussed above.
Management expects that Sovereign Bank will continue to be classified as well
capitalized and in compliance with such capital requirements and conditions.
Although OTS capital regulations do not apply to savings and loan holding
companies, the OTS Order requires Sovereign to maintain certain Tier 1 capital
and related liquidity levels. Sovereign is presently in compliance with these
requirements and expects to remain in compliance. For a detailed discussion on
regulatory capital requirements, see Note 15 in the "Notes to Consolidated
Financial Statements" hereof.
Table 12 presents the capital ratios of Sovereign Bank and the current
regulatory requirements at December 31, 2001.
- --------------------------------------------------------------------------------
TABLE 12: REGULATORY CAPITAL RATIOS
OTS - REGULATIONS(1)
SOVEREIGN -------------------------
BANK WELL
DECEMBER 31, MINIMUM CAPITALIZED
2001 REQUIREMENT REQUIREMENT
------------ ----------- -----------
Tangible capital to tangible assets ............... 7.19% 2.00% None
Tier 1 leverage capital to tangible assets ........ 7.21 3.00 5.00%
Tier 1 risk-based capital to risk adjusted assets.. 9.67 4.00 6.00
Total risk-based capital to risk adjusted assets... 10.68 8.00 10.00
(1) The OTS Order imposes certain additional capital requirements in excess of
the OTS regulated well capitalized requirements.
- --------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
Liquidity represents the ability of Sovereign to obtain cost effective funding
to meet the needs of customers, as well as Sovereign's financial obligations.
Sovereign's primary sources of liquidity include retail deposit gathering,
Federal Home Loan Bank (FHLB) borrowings, federal funds purchases, reverse
repurchase agreements and wholesale deposit purchases. Other sources of
liquidity include asset securitizations, liquid investment portfolio securities
and debt and equity issuances.
Factors which impact the liquidity position of Sovereign include loan
origination volumes, loan prepayment rates, maturity structure of existing
loans, core deposit growth levels, CD maturity structure and retention,
Sovereign's credit ratings, investment portfolio cash flows, maturity structure
of wholesale funding, etc. These risks are monitored and centrally managed. This
process includes reviewing all available wholesale liquidity sources. As of
December 31, 2001, Sovereign had $6.7 billion in available overnight liquidity
in the form of unused federal funds purchased lines, unused FHLB borrowing
capacity and unencumbered investment portfolio securities. Sovereign also
forecasts future liquidity needs and develops strategies to ensure that adequate
liquidity is available at all times.
Sovereign Bank has several sources of funding to meet its liquidity
requirements, including the securities portfolio, the core deposit base, the
ability to acquire large deposits and issue public securities in the local and
national markets, FHLB borrowings, federal funds
- --------------------------------------------------------------------------------
32
- ----------------------MANAGEMENT'S DISCUSSION AND ANALYSIS----------------------
purchased, reverse repurchase agreements, wholesale deposit purchases and the
capability to securitize or package loans for sale.
Sovereign's holding company has the following major sources of funding to meet
its liquidity requirements: dividends and returns of investment from its
subsidiaries, a revolving credit agreement and access to the capital markets.
Sovereign Bank may pay dividends to its parent subject to approval of the OTS.
Sovereign Bank declared and paid dividends to the parent company of $130 million
in 2001, $100 million in 2000 and $25 million in 1999. Sovereign also has
approximately $900 million of availability under a shelf registration statement
on file with the Securities and Exchange Commission permitting ready access to
the public debt and equity markets.
As discussed in other sections of this document including Item 1. Business and
Item 8. Financial Statements and Supplemental Data and in Note 15 to the
Consolidated Financial Statements, subsidiary banks are subject to regulation
and, among other things, may be limited in their ability to pay dividends or
transfer funds to the parent company. Accordingly, consolidated cash flows as
presented in the Consolidated Statements of Cash Flows of Item 8. may not
represent cash immediately available for the payment of cash dividends to
stockholders.
The following material transactions occurred during 2001 that provided
significant sources of liquidity to Sovereign:
Common Stock: On February 9, 2001, Sovereign issued $150 million of common
equity consisting of 20 million shares sold at $7.50 per common stock share. The
proceeds of the issuance were used to repay the 6.625% senior notes at maturity
on March 15, 2001.
Senior Notes: On February 20, 2001, Sovereign issued $175 million of senior
unsecured notes at 8.625% which will mature on March 15, 2004. The proceeds of
this issuance were used to repay the 6.625% senior notes at maturity on March
15, 2001 and for additional liquidity.
Senior Secured Credit Facility: On March 1, 2001, Sovereign refinanced its $500
million senior secured credit facility (outstanding balance at December 31, 2000
of $350 million) with a variable principal rate $400 million senior secured
credit facility consisting of a $350 million revolving line of credit and a $50
million term note. For the first two years, the interest rates on both the line
of credit and term loan is calculated using one of five methods at the option of
Sovereign as: (1) one-month Eurodollar rate plus 250 basis points, (2)
three-month Eurodollar rate plus 250 basis points, (3) six-month Eurodollar rate
plus 250 basis points, (4) twelve-month Eurodollar rate plus 250 basis points,
(5) the greater of the prime rate, plus 75 basis points, or Fed Funds rate plus
125 basis points. The interest rates for years three through six are structured
based upon a rate table beginning with the Eurodollar rate plus 275 basis points
or the greater of the prime rate plus 100 basis points or the federal funds rate
plus 150 basis points, and are decreased based upon each level of Sovereign's
senior unsecured long-term debt credit rating exceeding certain levels. The
revolving line matures $100 million in 2005, $200 million in 2006, and $50
million in 2007, and the term note matures in 2005. At December 31, 2001,
Sovereign had $175 million outstanding under the facility at an average rate of
5.72%.
Trust Preferred Securities: On December 13, 2001, Sovereign issued $100 million
of preferred capital securities through Sovereign Capital Trust III, a
special-purpose statutory trust created expressly for the issuance of these
securities. Distributions on the securities will be payable at an annual rate of
8.75% on a quarterly basis beginning March 31, 2002. Net proceeds were $96.2
million after issuance costs and discounts. Gross proceeds were invested in
Junior Subordinated Debentures of Sovereign, at terms identical to the preferred
capital securities. Cash distributions on the securities are made to the extent
interest on the debentures is received by Sovereign Capital Trust III. In the
event of certain changes or amendments to regulatory requirements or federal tax
rules, the securities are redeemable in whole. Otherwise, the securities are
generally redeemable in whole or in part on or after January 1, 2007, at a price
equal to 100% of the principal amount plus accrued interest to the date of
redemption. The securities must be redeemed on December 31, 2031.
Indirect Automobile Loan Securitization. In a financing transaction consummated
in November, 2001, Sovereign transferred $957 million of indirect automobile
loans to SPEs which provided Sovereign $885 million of lower cost financing
raised in SPEs through the issuance of $821 million of floating rate
asset-backed floating rate notes and $64 million from the sale of ownership
interests in the SPEs to outside investors. The securitization represents a
financing transaction in accordance with SFAS 140 and the indirect automobile
loans, minority interests and asset-backed floating rate notes are included in
Sovereign's Consolidated Balance Sheet at December 31, 2001.
- --------------------------------------------------------------------------------
33
- --------------------------------------------------------------------------------
Cash and cash equivalents decreased $52.4 million for 2001. Net cash used by
operating activities was $277 million for 2001. Net cash used by investing
activities for 2001 was $1.5 billion and consisted primarily of the purchase of
$10.6 billion in available for sale investment securities offset by the proceeds
from the sale of investments and loans of $6.1 billion and $3.7 billion,
respectively. Net cash provided by financing activities for 2001 was $1.8
billion which was primarily due to a net increase in long-term debt and
borrowings of $2.7 billion offset by a decrease in deposits and other customer
accounts of $1.2 billion.
Sovereign's debt agreements impose customary limitations on dividends, other
payments and transactions. These limits are not expected to affect dividend
payments at current levels, and reasonably anticipated increases.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
Sovereign enters into contractual obligations in the normal course of business
as a source of funds for its asset growth and its asset/liability management, to
fund acquisitions, and to meet required capital needs. These obligations require
Sovereign to make cash payments over time as detailed in the table below (For
further information regarding Sovereign's contractual obligations refer to
Footnotes 9 through 13 of our Consolidated Financial Statements, herein.):
- --------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS
PAYMENTS DUE BY PERIOD
-------------------------------------------------------------------
LESS THAN AFTER
TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS
----------- ----------- ----------- ----------- -----------
Borrowings ................ $ 2,678,764 $ 2,678,764 $ -- $ -- $ --
Long-term debt:
Securities sold under
repurchase agreements.. 155,000 -- -- 155,000 --
FHLB advances ........... 4,105,929 400,000 700 312,750 3,392,479
Other long-term debt .... 2,000,077 21,391 432,551 725,135 821,000
Trust Preferred securities. 503,635 -- -- -- 503,635
Certificates of deposit ... 7,247,607 5,655,282 1,291,853 170,409 130,063
Operating leases .......... 610,555 103,842 191,044 215,336 100,333
----------- ----------- ----------- ----------- -----------
Total contractual cash
obligations ............. $17,301,567 $ 8,859,279 $ 1,916,148 $ 1,578,630 $ 4,947,510
=========== =========== =========== =========== ===========
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
34
- ----------------------MANAGEMENT'S DISCUSSION AND ANALYSIS----------------------
Certain of Sovereign's contractual obligations require Sovereign to maintain
certain financial ratios and to maintain a "well capitalized" regulatory status.
Sovereign has complied with these covenants as of December 31, 2001 and expects
to be in compliance with these covenants for the foreseeable future. However, if
in the future Sovereign is not in compliance with these ratios or is deemed to
be other than well capitalized by the OTS, and is unable to obtain a waiver from
its lenders, the debt would be in default and callable by Sovereign's lenders.
Due to cross default provisions in certain of Sovereign's debt agreements, if
more than $25 million of Sovereign's debt is in default, $875 million of senior
notes and the full amount of the senior secured credit facility then outstanding
will become due in full.
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.
- --------------------------------------------------------------------------------
AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
---------------------------------------------------------------
TOTAL
OTHER COMMERCIAL COMMITMENTS AMOUNTS LESS THAN
COMMITTED 1 YEAR 1-3 YEARS 4-5 YEARS OVER 5 YEARS
---------- ---------- ---------- ---------- ----------
Commitments to extend credit $6,765,595 $4,365,528 $ 787,469 $ 371,058 $1,241,540
Standby letters of credit .. 674,397 282,397 128,658 107,297 156,045
Loans sold with recourse ... 54,610 -- -- -- 54,610
Forward contracts .......... 443,162 443,162 -- -- --
---------- ---------- ---------- ---------- ----------
Total commercial commitments $7,937,764 $5,091,087 $ 916,127 $ 478,355 $1,452,195
========== ========== ========== ========== ==========
For further information regarding Sovereign's commitments, refer to Note 19 to
the "Notes to the Consolidated Financial Statements", herein.
- --------------------------------------------------------------------------------
ASSET AND LIABILITY MANAGEMENT
Interest rate risk arises primarily through Sovereign's traditional business
activities of extending loans and accepting deposits. Many factors, including
economic and financial conditions, movements in market interest rates and
consumer preferences, affect the spread between interest earned on assets and
interest paid on liabilities. In managing its interest rate risk, Sovereign
seeks to minimize the variability of net interest income across various likely
scenarios while at the same time maximizing its net interest income and net
interest margin. To achieve these objectives, Sovereign works closely with each
business line in the company and guides new business flows. Sovereign also uses
various other tools to manage interest rate risk including wholesale funding
maturity targeting, investment portfolio purchase strategies, asset
securitization/sale, and financial derivatives.
- --------------------------------------------------------------------------------
35
- --------------------------------------------------------------------------------
Interest rate risk is managed centrally by the Treasury Group with oversight by
the Asset and Liability Committee. Management reviews various forms of analysis
to monitor interest rate risk including net interest income sensitivity, market
value sensitivity, repricing frequency of assets versus liabilities and scenario
analysis. Numerous assumptions are made to produce these analyses including, but
not limited to, assumptions on new business volumes, loan and investment
prepayment rates, deposit flows, interest rate curves, economic conditions, and
competitor pricing.
Sovereign simulates the impact of changing interest rates on its expected future
interest income and interest expense (net interest income sensitivity). This
simulation is run monthly and it includes nine different stress scenarios. These
scenarios shift interest rates up and down. Certain other scenarios shift
short-term rates up while holding longer-term rates constant and vice versa.
This scenario analysis helps management to better understand its risk and is
used to develop proactive strategies to ensure that Sovereign is not overly
sensitive to the future direction of interest rates. At December 31, 2001, the
general level of interest rates represented a unique economic environment in
which several of Sovereign's declining interest rate simulation scenarios would
not apply. At December 31, 2001, if interest rates dropped in parallel 100 basis
points or rose in parallel 200 basis points, Sovereign estimates the loss to net
interest income to remain under 3%. This compares to an estimated loss to net
interest income of 2.2% if rates dropped in parallel 200 basis points and a loss
of .1% if rates rose in parallel 200 basis points at December 31, 2000.
Sovereign also monitors the relative repricing sensitivities of its assets
versus its liabilities. Management attempts to keep assets and liabilities in
balance so that when interest rates do change, the net interest income of
Sovereign will not experience any significant short-term volatility as a result
of assets repricing more quickly than liabilities or vice versa. As of December
31, 2001, the one year cumulative gap was 9%, compared to 1% at December 31,
2000, indicating Sovereign is well balanced and will benefit from rising rates.
Finally, Sovereign will calculate the market value of its balance sheet
including all assets, liabilities and hedges. This market value analysis is very
useful because it measures the present value of all estimated future interest
income and interest expense cash flows of the company. Management will calculate
what it calls Net Portfolio Value (NPV) which is the market value of assets
minus the market value of liabilities. As of December 31, 2001, the NPV as a
percentage of the present value of assets was 11.68%. Management will also
review the sensitivity of NPV to changes in interest rates. Management attempts
to keep the NPV Ratio relatively constant across various interest rate
scenarios. As of December 31, 2001, a 200 basis point rise in interest rates
would increase the NPV ratio by 1.18% and a 100 basis point decline in interest
rates would decrease the NPV by .45%. At December 31, 2000, a 200 basis point
rise or decline in interest rates would decrease the NPV by .42% and 1.54%,
respectively.
Because the assumptions used are inherently uncertain, the model cannot
precisely predict the effect of higher or lower interest rates on net interest
income. Actual results will differ from simulated results due to the timing,
magnitude and frequency of interest rate changes, the difference between actual
experience and the assumed volume and characteristics of new business and
behavior of existing positions, and changes in market conditions and management
strategies, among other factors.
In 2001, the Federal Funds rate declined 475 basis points, which is an unusually
rapid move for a one year time frame. Even though Sovereign's risk position has
been mildly asset sensitive (sensitive to falling rates), management was able to
develop strategies to overcome this move in rates and widen the net interest
margin during the year. This was due to numerous factors. Sovereign aggressively
repriced certain liabilities and improved the loan portfolio mix away from
residential mortgages and into higher spread consumer and commercial loans. The
deposit mix also improved with more core deposits and less CDs. Lastly, the
Company effectively used the wholesale bank (investments funded with wholesale
funding) to hedge interest rate risk created by the relationship business.
Pursuant to its interest rate risk management strategy, Sovereign enters into
hedging transactions that 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, 2001, Sovereign's principal
hedging transactions were to convert liabilities from floating rate to fixed
rate for interest rate risk management purposes.
- --------------------------------------------------------------------------------
36
- ----------------------MANAGEMENT'S DISCUSSION AND ANALYSIS----------------------
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 that are
originated for sale.
To accommodate customer needs, Sovereign enters into customer-related financial
derivative transactions primarily consisting of interest rate swaps, caps, and
floors. Risk exposure from customer positions is managed through transactions
with other dealers.
Table 13 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, 2001 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 13: GAP ANALYSIS AT DECEMBER 31, 2001 REPRICING
-----------------------------------------------------------------------
YEAR ONE YEAR TWO YEAR THREE YEAR FOUR YEAR FIVE
------------ ----------- ------------ ------------ ------------
Interest earning assets:
Investment securities(1)(2) ......................... $ 3,355,972 $ 1,071,038 $ 848,689 $ 722,665 $ 693,089
6.16% 6.36% 6.38% 6.42% 6.39%
Loans(3) ............................................ 11,304,679 3,485,484 2,036,470 1,108,445 947,640
7.00% 7.87% 7.82% 7.39% 6.83%
------------ ----------- ------------ ------------ ------------
Total interest earning assets ......................... $ 14,660,651 $ 4,556,522 $ 2,885,159 $ 1,831,110 $ 1,640,729
6.81% 7.52% 7.39% 7.00% 6.64%
Non-interest earning assets ......................... -- -- -- -- --
------------ ----------- ------------ ------------ ------------
Total assets .......................................... $ 14,660,651 $ 4,556,522 $ 2,885,159 $ 1,831,110 $ 1,640,729
6.81% 7.52% 7.39% 7.00% 6.64%
------------ ----------- ------------ ------------ ------------
Interest bearing liabilities:
Deposits(4) ........................................... $ 10,365,824 $ 3,472,591 $ 2,697,045 $ 2,493,343 $ 1,410,313
2.88% 2.01% 1.50% 1.42% 0.88%
Borrowings ............................................ 3,331,532 872,315 375,064 3,860,859 500,000
3.87% 0.47% 9.50% 5.33% 10.50%
Trust Preferred Securities ............................ -- -- -- -- --
-- -- -- -- --
Minority Interest ..................................... -- -- -- -- --
-- -- -- -- --
------------ ----------- ------------ ------------ ------------
Total interest bearing liabilities .................... 13,697,356 4,344,906 3,072,109 6,354,202 1,910,313
3.12% 1.70% 2.48% 3.80% 3.40%
Non-interest bearing liabilities ...................... -- -- -- -- --
Stockholders' equity .................................. -- -- -- -- --
------------ ----------- ------------ ------------ ------------
Total liabilities and stockholders' equity ............ $ 13,697,356 $ 4,344,906 $ 3,072,109 $ 6,354,202 $ 1,910,313
3.12% 1.70% 2.48% 3.80% 3.40%
Excess assets (liabilities) before effect of
hedging transactions ................................ $ 963,295 $ 211,616 $ (186,950) $ (4,523,092) $ (269,584)
------------ ----------- ------------ ------------ ------------
To total assets ..................................... 2.72% 0.60% (0.53)% (12.75)% (0.76)%
============ =========== ============ ============ ============
Cumulative excess assets (liabilities) before effect of
hedging transactions ................................ $ 963,295 $ 1,174,911 $ 987,961 $ (3,535,131) $ (3,804,715)
============ =========== ============ ============ ============
To total assets ..................................... 2.72% 3.31% 2.78% (9.97)% (10.73)%
Effect of hedging transactions on assets
and liabilities ..................................... $ 2,179,000 $ -- $ 100,000 $ -- $ 20,000
------------ ----------- ------------ ------------ ------------
Excess assets (liabilities) after effect of
hedging transactions ................................ $ 3,142,295 $ 211,616 $ (86,950) $ (4,523,092) $ (249,584)
============ =========== ============ ============ ============
To total assets ..................................... 8.86% 0.60% (0.25)% (12.75)% (0.70)%
Cumulative excess assets (liabilities) after effect of
hedging transactions ................................ $ 3,142,295 $ 3,353,911 $ 3,266,961 $ (1,256,131) $ (1,505,715)
============ =========== ============ ============ ============
To total assets ..................................... 8.86% 9.45% 9.21% (3.54)% (4.24)%
TABLE 13: GAP ANALYSIS AT DECEMBER 31, 2001 REPRICING
------------------------------
THEREAFTER TOTAL
------------ ------------
Interest earning assets:
Investment securities(1)(2) ......................... $ 3,773,663 $ 10,465,116
6.50% 6.35%
Loans(3) ............................................ 1,516,866 20,399,584
6.65% 7.22%
------------ ------------
Total interest earning assets ......................... $ 5,290,529 $ 30,864,700
6.54% 6.92%
Non-interest earning assets ......................... 4,610,138 4,610,138
------------ ------------
Total assets .......................................... $ 9,900,667 $ 35,474,838
3.50% 6.02%
------------ ------------
Interest bearing liabilities:
Deposits(4) ........................................... $ 2,858,458 $ 23,297,574
0.55% 2.03%
Borrowings ............................................ -- 8,939,770
-- 4.78%
Trust Preferred Securities ............................ 404,136 404,136
-- --
Minority Interest ..................................... 203,664 203,664
-- --
------------ ------------
Total interest bearing liabilities .................... 3,466,258 32,845,144
0.45% 2.74%
Non-interest bearing liabilities ...................... 427,213 427,213
Stockholders' equity .................................. 2,202,481 2,202,481
------------ ------------
Total liabilities and stockholders' equity ............ $ 6,095,952 $35,474,838
0.26% 2.53%
Excess assets (liabilities) before effect of
hedging transactions ................................ $ 3,804,715
------------
To total assets ..................................... 10.73%
============
Cumulative excess assets (liabilities) before effect of
hedging transactions ................................ $ --
============
To total assets ..................................... --
Effect of hedging transactions on assets
and liabilities ..................................... $ (2,299,000)
------------
Excess assets (liabilities) after effect of
hedging transactions ................................ $ 1,505,715
============
To total assets ..................................... 4.24%
Cumulative excess assets (liabilities) after effect of
hedging transactions ................................ $ --
============
To total assets ..................................... --
(1) Include interest-earning deposits.
(2) Investment securities include market rate payment and repayment assumptions.
(3) Loan balances include annual prepayment and repayment assumptions between 2%
and 45%. Loan balances are presented net of deferred loan fees and include
loans held for sale.
(4) Saving, NOW, money market and demand deposit accounts have been assumed to
decay at an annual rate of 15.75%.
- --------------------------------------------------------------------------------
37
- --------------------------------------------------------------------------------
Table 14 presents selected quarterly consolidated financial data (in thousands,
except per share data):
- --------------------------------------------------------------------------------
TABLE 14: SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA
THREE MONTHS ENDED
-------------------------------------------------------------------------------------------------
DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
2001 2001 2001 2001 2000 2000 2000 2000
--------- --------- --------- --------- --------- --------- --------- ---------
Total interest income .......... $ 521,681 $ 563,341 $ 557,607 $ 579,846 $ 605,507 $ 634,754 $ 557,593 $ 471,881
Total interest expense ......... 244,022 292,521 299,284 332,366 351,171 380,345 370,779 312,629
--------- --------- --------- --------- --------- --------- --------- ---------
Net interest income ............ 277,659 270,820 258,323 247,480 254,336 254,409 186,814 159,252
Provision for loan losses ...... 32,000 22,000 23,100 20,000 28,500 10,000 10,000 8,000
--------- --------- --------- --------- --------- --------- --------- ---------
Net interest income after
provision .................... 245,659 248,820 235,223 227,480 225,836 244,409 176,814 151,252
--------- --------- --------- --------- --------- --------- --------- ---------
Gain/(loss) on sale of loans and
investment securities ........ (1,997) 4,412 5,752 7,344 5,026 (45,052) (58,216) (22,872)
Other income ................... 93,623 97,739 118,455 100,739 79,438 59,614 46,494 44,130
Other expenses ................. 247,004 340,500 322,248 323,551 327,214 315,745 237,810 132,335
--------- --------- --------- --------- --------- --------- --------- ---------
Income/(loss)before income taxes 90,281 10,471 37,182 12,012 (16,914) (56,774) (72,718) 40,175
Income tax provision ........... 16,820 1,855 7,000 900 (13,590) (40,859) (24,016) 13,250
--------- --------- --------- --------- --------- --------- --------- ---------
Income/(loss) before
extraordinary item ........... 73,461 8,616 30,182 11,112 (3,324) (15,915) (48,702) 26,925
Extraordinary item ............. -- -- -- (6,549) -- -- -- 10,775
--------- --------- --------- --------- --------- --------- --------- ---------
Net income/(loss) .............. $ 73,461 $ 8,616 $ 30,182 $ 4,563 $ (3,324) $ (15,915) $ (48,702) $ 37,700
========= ========= ========= ========= ========= ========= ========= =========
Operating earnings(1) .......... $ 73,461 $ 72,842 $ 77,122 $ 63,577 $ 55,632 $ 74,121 $ 57,298 $ 52,831
========= ========= ========= ========= ========= ========= ========= =========
Net income/(loss) applicable
to common stock .............. $ 73,461 $ 8,616 $ 30,182 $ 4,563 $ (3,324) $ (15,915) $ (48,702) $ 37,700
========= ========= ========= ========= ========= ========= ========= =========
Earnings/(loss) per share:
Basic
Income/(loss) before
extraordinary item ........... $ 0.30 $ 0.03 $ 0.12 $ 0.05 $ (0.01) $ (0.07) $ (0.22) $ 0.12
Extraordinary item ........... -- -- -- (0.03) -- -- -- 0.05
--------- --------- --------- --------- --------- --------- --------- ---------
Net income/(loss) ............ $ 0.30 $ 0.03 $ 0.12 $ 0.02 $ (0.01) $ (0.07) $ (0.22) $ 0.17
========= ========= ========= ========= ========= ========= ========= =========
Diluted
Income/(loss) before
extraordinary item ........... $ 0.28 $ 0.03 $ 0.12 $ 0.05 $ (0.01) $ (0.07) $ (0.22) $ 0.12
Extraordinary item ........... -- -- -- (0.03) -- -- -- 0.05
--------- --------- --------- --------- --------- --------- --------- ---------
Net income/(loss) ............ $ 0.28 $ 0.03 $ 0.12 $ 0.02 $ (0.01) $ (0.07) $ (0.22) $ 0.17
========= ========= ========= ========= ========= ========= ========= =========
Operating earnings (1) ......... $ 0.28 $ 0.28 $ 0.29 $ 0.27 $ 0.25 $ 0.33 $ 0.29 $ 0.34
========= ========= ========= ========= ========= ========= ========= =========
Market prices
High ......................... $ 12 3/7 $13 11/50 $ 13 $ 9 4/25 $ 9 8/17 $ 9 7/8 $ 8 $ 7 29/32
Low .......................... 8 46/63 8 43/50 7 47/50 7 33/50 6 39/50 7 1/32 6 7/16 6 11/16
Dividends declared per common
share ........................ 0.025 0.025 0.025 0.025 0.025 0.025 0.025 0.025
(1) Operating earnings exclude after-tax special charges of $64.2 million, $46.9
million and $59.0 million for the three-month periods ended September 30,
June 30, and March 31, 2001, respectively, and $59.0 million, $90.0 million,
$106.0 million and $15.1 million for the three-month periods ended December
31, September 30, June 30 and March 31, 2000, respectively. See
"Reconciliation of Net Income to Operating Earnings" of Management's
Discussion and Analysis.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
38
- ----------------------MANAGEMENT'S DISCUSSION AND ANALYSIS----------------------
PENDING ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, "Business Combinations", and No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"), effective for fiscal years
beginning after December 15, 2001. Under the new rules, goodwill will no longer
be amortized but will be subject to annual impairment tests in accordance with
the Statements. Other intangible assets will continue to be amortized over their
useful lives.
The Company will apply SFAS 142 beginning in the first quarter of 2002.
Application of the non-amortization provisions of SFAS 142 is expected to result
in an increase in net income of $30 million ($.11 per share) in 2002. The
Company will test goodwill for impairment using the two-step process proscribed
in SFAS 142. The first step is a screen for potential impairment of goodwill and
indefinite lived intangible assets, while the second step measures the amount of
the impairment, if any. The Company has not yet determined what the effect of
these tests will be on its earnings and financial position. The Company
currently evaluates goodwill for impairment if facts and circumstances suggest
that it may be impaired. Management believes that no such circumstances existed
at December 31, 2001. Any impairment that is required to be recognized when
adopting SFAS 142, will be reflected as the cumulative effect of a change in
accounting principle in 2002.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999
Net Interest Income. Net interest income for 2000 was $855 million compared to
$615 million for 1999, or an increase of 39%. The increase in net interest
income in 2000 was due primarily to the increases in interest-earning assets
from the New England Acquisition and internal asset growth, offset slightly by
the deleveraging of the balance sheet in the second and third quarters of 2000.
The New England Acquisition added $8.0 billion to average loans and $6.9 billion
to average deposits (replacing higher cost FHLB borrowings) in 2000. Net
interest margin - operating basis (net interest income adjusted to eliminate the
negative impact from escrowed financing proceeds related to the New England
Acquisition, divided by average interest-earning assets) was 3.19% for 2000
compared to 2.88% for 1999.
Interest on interest-earning deposits was $22.2 million for 2000 compared to
$4.7 million for 1999. The average balance of interest-earning deposits was $138
million with an average yield of 16.08% for 2000 compared to an average balance
of $15.2 million with an average yield of 31.12% for 1999. The increase in
average interest-earning deposits was due to $200 million placed on deposit with
FleetBoston in March 2000 until the acquisition was completed in July 2000. The
high yields of 2000 were the result of an outsourced accounts payable process
whereby a third-party vendor performs check processing and reconcilement
functions for Sovereign's disbursement accounts and pays Sovereign interest on
disbursed funds during the two-to-three day float period, effectively producing
interest income with no corresponding asset balance. The decrease in rates was
due primarily to the lower relative interest rate earned on the $200 million
deposit mentioned above as compared to the implied rate earned on the accounts
payable process.
Interest on investment securities available for sale was $487 million for 2000
compared to $544 million for 1999. The decrease in interest income was due to
the increase in average investment securities available for sale from $8.1
billion in 1999 to $6.8 billion in 2000, which resulted from the sale of
approximately $2.1 billion in investment securities in June and September.
Interest on investment securities held to maturity was $132 million for 2000
compared to $99.8 million for 1999. The average balance of investment securities
held to maturity was $2.0 billion with an average yield of 6.80% for 2000
compared to an average balance of $1.4 billion with an average yield of 6.94%
for 1999. The increase in the average balance was primarily due to the creation
of a $1.3 billion escrow fund in the fourth quarter 1999, which was used to fund
the New England Acquisition. The escrow funds were invested in commercial paper
which matured in conjunction with the escrow break on the final closing of the
acquisition on July 21, 2000.
Interest and fees on loans were $1.6 billion for 2000 compared to $959 million
for 1999. The average balance of net loans was $19.4 billion with an average
yield of 8.40% for 2000 compared to an average balance of $12.4 billion with an
average yield of 7.77% for 1999. The increase in average loan volume was
primarily the result of the New England Acquisition and internal loan growth.
The acquisition added $8.0 billion to average loans. The increase in the rate
was due to a higher mix of higher yielding commercial and consumer loans, and
rate increases reflected in the adjustable rate loans.
- --------------------------------------------------------------------------------
39
- --------------------------------------------------------------------------------
Interest on total deposits was $735 million for 2000 compared to $441 million
for 1999. The average balance of total deposits was $19.2 billion with an
average cost of 3.83% for 2000 compared to an average balance of $12.2 billion
with an average cost of 3.61% for 1999. The increase in the average balance was
due primarily to the acquisition of deposits in the New England Acquisition,
which added over $6.9 billion to average deposits during 2000. The increase in
rates in 2000 mainly reflects the increase in time deposit and money market
account rates due to market conditions.
Interest on borrowings and long-term debt was $680 million for 2000 compared to
$552 million for 1999. The average balance of total borrowings was $10.3 billion
with an average cost of 6.58% for 2000 compared to an average balance of $10.1
billion with an average cost of 5.46% for 1999. Although the average balance was
consistent between 2000 and 1999, borrowings and debt decreased approximately $6
billion on an absolute basis.
Average non-interest earning assets were $3.6 billion for 2000, as compared to
$2.0 billion for 1999, an increase of $1.6 billion. The increase was due
primarily to additions of non-earning assets during 2000 including $1.1 billion
in goodwill from the New England Acquisition, an additional investment in bank
owned life insurance (BOLI) of $200 million, and the addition of the precious
metals business and equipment of $171 million, also related to the New England
Acquisition.
Provision for Loan Losses. The provision for loan loss is based upon credit loss
experience and an estimation of losses arising in the current loan portfolio.
The provision for loan losses for 2000 was $56.5 million compared to $30.0
million for 1999. The higher provisioning was required because of an increase in
net charge-offs during the year, and management's desire to raise the overall
level of the allowance, from 0.93% at 1999 to 1.17% in 2000, given increased
levels of non-performing and potential problem loans, and current economic
conditions.
As Sovereign continues to place emphasis on commercial and consumer lending,
management will regularly evaluate the risk inherent in its loan portfolio and
increase its loan loss provision 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 2000, Sovereign established an initial
allowance of $134.7 million in connection with the New England Acquisition. This
initial allowance for SBNE, together with the provision of $56.5 million
exceeded net charge-offs and thereby increased the loan loss allowance by $123.4
million over 1999 levels.
Sovereign's net charge-offs for 2000 were $67.8 million and consisted of
charge-offs of $92.9 million and recoveries of $25.1 million. This compares to
1999 net charge-offs of $35.6 million consisting of charge-offs of $55.0 million
and recoveries of $19.4 million. Sovereign's increased level of commercial
charge-offs in 2000 was related primarily to deterioration in a segment of the
portfolio concentrated in cash flow, or enterprise lending in syndicated
multi-bank credits that were originated by other banks and participated in by
Sovereign, as well as direct loans made to Sovereign customers.
The ratio of net loan charge-offs to average loans, including loans held for
sale, was .35% for 2000, compared to .29% for 1999 and .30% for 1998. Commercial
loan net charge-offs as a percentage of average commercial loans were .50% for
2000, compared to .11% for 1999 and .14% for 1998. Excluding charge-offs related
to large corporate credits, commercial loan net charge-offs were .26% for 2000.
Consumer loan net charge-offs as a percentage of average consumer loans were
.49% for 2000, compared to .49% for 1999 and .80% for 1998. Residential real
estate mortgage loan net charge-offs as a percentage of average residential
mortgage loans, including loans held for sale, were .09% for 2000, .23% for
1999, and .08% for 1998. The increased level of residential mortgage loan net
charge-offs in 1999 was the result of $7.0 million net charge-offs incurred as a
part of a bulk sale of non-performing residential loans.
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 and residential real estate mortgage loans are generally charged
off when deemed to be uncollectible or 180 days past due, whichever comes first.
Charge-offs of commercial loans are made on the basis of management's ongoing
evaluation of non-performing loans.
- --------------------------------------------------------------------------------
40
- ----------------------MANAGEMENT'S DISCUSSION AND ANALYSIS----------------------
Other Income. Total other income was $109 million for 2000 compared to $130
million for 1999. Several factors contributed to the increase in other income as
discussed below.
Consumer fees were $97.1 million for 2000 compared to $57.1 million in 1999.
This increase was primarily due to favorable shift from time to core deposit
products over the year along with the full year's impact of the New England
Acquisition.
Commercial fees were $36.9 million for 2000 compared to $6.5 million in 1999.
This increase was due to growth in both commercial loans and core deposits
during the year augmented by a full year's impact of the New England
Acquisition.
Mortgage banking revenues were $25.2 million for 2000 compared to $29.9 million
for 1999. At December 31, 2000, Sovereign serviced $4.2 billion of residential
loans for others as compared to $5.7 billion at December 31, 1999. Sovereign
sold mortgage servicing rights related to $2.5 billion of loans during 2000.
During 2000, Sovereign created a Capital Markets Group. The group was built in
three phases. The first phase provided risk management services for corporate
clients including foreign exchange, investments and derivatives. The first phase
also included securitization expertise for Sovereign's balance sheet assets. The
second phase added merger and acquisitions expertise to assist clients. The
third phase, in process at December 31, 2000, included the formation of a broker
dealer. The Capital Markets Group generated revenue of $11.1 million in 2000.
Income from bank-owned life insurance ("BOLI") was $34.3 million for 2000
compared to $24.1 million for 1999. This increase was primarily due to an
additional investment in BOLI of $200 million which was made during the year.
Net gain/(loss) on sale of investment securities and related derivatives was
$(111.7) million for 2000, compared to a net gain of $9.5 million for 1999,
which included net investment security gains/(losses) of $(121.1) million and
$3.7 million, and net gains/(losses) on related derivative contracts of $9.4
million and $0 million in 2000 and 1999, respectively. This decrease was due
primarily to the balance sheet deleveraging transactions. During the second and
third quarters of 2000, Sovereign sold $2.1 billion of available for sale
mortgage-backed securities, resulting in losses of $103 million. The net impact
of the sales on equity was minimal as these losses were previously reflected as
unrealized losses included as a reduction of stockholders' equity in accordance
with SFAS 115.
General and Administrative Expenses. Total general and administrative expenses
were $731 million for 2000 compared to $393 million in 1999. Included in 2000
total general and administrative expenses were $149 million of merger-related,
integration and other charges related to recent acquisitions. These special
charges include charges directly attributable to the acquired New England
branches, indirect costs incurred to integrate recent acquisitions into
Sovereign's back office systems, costs that management considered redundant due
to separating the New England Acquisition from a single closing into three
separate closings, and expenses related to the structured real estate
transaction that involved properties utilized by SBNE. Included in 1999 general
and administrative expenses were $30.8 million of merger and integration
charges. Excluding the special charges, general and administrative expenses were
$582 million and $362 million for 2000 and 1999, respectively, or an increase of
61%. This increase was due primarily to the New England Acquisition which
increased compensation and benefits expense for the approximately 3,700 staff
and management personnel which were added, increased occupancy and equipment
expenses for the additional 281 community banking offices acquired, and
increased other administrative expenses resulting from the acquisition. These
expenses were reflected in 2000 results from each of the respective three
closing dates. See Note2 - Business Combinations for more details on the New
England Acquisition. Sovereign's efficiency ratio (all operating general and
administrative expenses as a percentage of net interest income and recurring
non-interest income) for 2001 was 54.3% compared to 48.6% for 1999.
Other Operating Expenses. Total other operating expenses were $282 million for
2000 compared to $53 million for 1999. Other operating expenses included
amortization of goodwill and other intangible assets of $98.9 million for 2000
compared to $38.0 million for 1999 and trust preferred securities expense of
$44.3 million for 2000 compared to $15.4 million for 1999. The increase in
amortization expense is due to the New England Acquisition which added $1.1
billion to Sovereign's intangible assets. Trust preferred securities expense
increased due to the issuance of additional securities in November 1999.
- --------------------------------------------------------------------------------
41
- --------------------------------------------------------------------------------
Income Tax Provision. The income tax (benefit) was ($65.2) million for 2000
compared to a provision of $89.3 million for 1999. The effective tax rate for
2000 was (66.5%) compared to 33.2% for 1999. The effective tax rate for year
2000 is not meaningful due to the high proportion of permanent tax differences,
including certain one-time tax benefits included in operating earnings, in
relation to the recorded pretax loss. For additional information with respect to
Sovereign's income taxes, see Note 18 in the "Notes to Consolidated Financial
Statements" hereof.
- --------------------------------------------------------------------------------
Item 7a. Quantitative and Qualitative Disclosures about 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.
Item 8. Financial Statements and Supplementary Data.
Index to Financial Statements and Supplementary Data Page
Report of Management ...................................................... 43
Report of Independent Auditors ............................................ 44
Consolidated Balance Sheets ............................................... 45
Consolidated Statements of Operations ..................................... 46
Consolidated Statements of Stockholders' Equity .........................47-48
Consolidated Statements of Cash Flows ...................................49-50
Notes to Consolidated Financial Statements ..............................51-87
- --------------------------------------------------------------------------------
42
- ------------------------------REPORT OF MANAGEMENT------------------------------
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, 2001, and 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 Control over Financial Reporting
Management is responsible for establishing and maintaining effective internal
control over financial reporting. The system contains monitoring mechanisms and
actions are taken to correct deficiencies identified.
There are inherent limitations in the effectiveness of any 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 over financial reporting as of
December 31, 2001. 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 as of December
31, 2001.
/s/Jay S. Sidhu /s/James D. Hogan /s/George S. Rapp
Jay S. Sidhu James D. Hogan George S. Rapp
President and Chief Chief Financial Officer Chief Accounting Officer
Executive Officer
- --------------------------------------------------------------------------------
43
- -------------------------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, 2001 and 2000, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 2001. 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 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 provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Sovereign Bancorp,
Inc. at December 31, 2001 and 2000, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.
As discussed in Note 1 to the financial statements, in 2001 Sovereign changed
its method of accounting for its derivative financial instruments.
/s/Ernst & Young LLP
Philadelphia,
Pennsylvania
January 18, 2002
- --------------------------------------------------------------------------------
44
- --------------------------CONSOLIDATED BALANCE SHEETS---------------------------
(in thousands, except share data) YEAR ENDED DECEMBER 31,
----------------------------
2001 2000
------------ ------------
Assets
Cash and amounts due from depository institutions ....................................... $ 887,964 $ 945,196
Interest-earning deposits ............................................................... 19,315 14,447
Investment securities available for sale ................................................ 9,581,679 5,315,584
Investment securities held to maturity (fair value approximates $883,208 in 2001
and $1,971,896 in 2000) ............................................................... 883,437 1,978,268
Loans (including loans held for sale of $308,950 in 2001 and $59,993 in 2000) ........... 20,399,584 21,912,245
Allowance for loan losses ............................................................... (264,667) (256,356)
Premises and equipment .................................................................. 251,587 290,134
Other real estate owned (including other repossessed assets of $9,667 in 2001
and $3,758 in 2000) ................................................................... 18,928 8,183
Accrued interest receivable ............................................................. 183,913 230,514
Goodwill and other intangible assets .................................................... 1,343,904 1,455,331
Bank owned life insurance ............................................................... 706,175 612,580
Other assets ............................................................................ 1,463,019 951,671
------------ ------------
Total Assets .......................................................................... $ 35,474,838 $ 33,457,797
============ ============
Liabilities
Deposits and other customer accounts .................................................... $ 23,297,574 $ 24,498,917
Borrowings .............................................................................. 2,678,764 1,330,900
Long-term debt:
Repurchase agreements and FHLB advances ............................................... 4,260,929 3,544,984
Senior secured credit facility ........................................................ 225,000 350,792
Senior notes and subordinated debentures .............................................. 1,775,077 1,013,632
Advance payments by borrowers for taxes and insurance ................................... 20,943 24,009
Other liabilities ....................................................................... 406,270 287,464
------------ ------------
Total Liabilities ................................................................... $ 32,664,557 $ 31,050,698
------------ ------------
Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding
junior subordinated debentures of Sovereign ("Trust Preferred Securities") ............ 404,136 319,545
Minority interest-preferred securities of subsidiaries .................................. 203,664 138,670
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 252,386,163 in 2001 and
231,465,030 in 2000 .................................................................. 1,416,267 1,259,374
Warrants ................................................................................ 91,500 91,500
Unallocated common stock held by the Employee Stock Ownership Plan
(4,247,873 in 2001 shares and 4,565,924 in 2000 shares at cost) ....................... (30,945) (33,230)
Treasury stock (108,792 in 2001 shares and 397,756 in 2000 shares at cost) .............. (515) (3,789)
Restricted stock (559,791 shares in 2001, at cost) ...................................... (6,272) --
Accumulated other comprehensive loss .................................................... (33,135) (38,521)
Retained earnings ....................................................................... 765,581 673,550
------------ ------------
Total Stockholders' Equity .............................................................. 2,202,481 1,948,884
------------ ------------
Total Liabilities and Stockholders' Equity .............................................. $ 35,474,838 $ 33,457,797
============ ============
See accompanying notes to consolidated financial statements.
- --------------------------------------------------------------------------------
45
- ---------------------CONSOLIDATED STATEMENTS OF OPERATIONS----------------------
(in thousands except per share data) YEAR ENDED DECEMBER 31,
-----------------------------------------
2001 2000 1999
----------- ----------- -----------
Interest Income:
Interest on interest-earning deposits .............................. $ 2,522 $ 22,158 $ 4,721
Interest and dividends on investment securities:
available for sale ............................................... 538,318 487,448 543,631
held to maturity ................................................. 68,607 132,442 99,813
Interest and fees on loans ......................................... 1,613,028 1,627,687 959,164
----------- ----------- -----------
Total interest income ............................................ 2,222,475 2,269,735 1,607,329
----------- ----------- -----------
Interest Expense:
Interest on deposits ............................................... 705,886 735,087 440,826
Interest on borrowings and long-term debt .......................... 462,307 679,837 551,847
----------- ----------- -----------
Total interest expense ........................................... 1,168,193 1,414,924 992,673
----------- ----------- -----------
Net interest income .................................................. 1,054,282 854,811 614,656
Provision for loan losses ............................................ 97,100 56,500 30,000
----------- ----------- -----------
Net interest income after provision for loan losses .................. 957,182 798,311 584,656
----------- ----------- -----------
Other Income:
Consumer fees ...................................................... 157,502 97,081 57,110
Commercial fees .................................................... 75,825 36,913 6,480
Mortgage banking revenue ........................................... 69,509 25,207 29,926
Capital markets revenue ............................................ 11,185 11,090 --
Bank owned life insurance .......................................... 42,671 34,324 24,126
Miscellaneous income ............................................... 53,863 15,661 3,175
----------- ----------- -----------
Total fees and other income ...................................... 410,555 220,276 120,817
Gain/(loss) on sale of investment securities and related derivatives 15,511 (111,715) 9,525
----------- ----------- -----------
Total other income ............................................... 426,066 108,561 130,342
----------- ----------- -----------
General and Administrative Expenses:
Compensation and benefits .......................................... 318,686 270,799 154,880
Occupancy and equipment ............................................ 220,311 158,629 67,564
Technology expense ................................................. 71,654 46,396 25,882
Outside services ................................................... 53,109 119,792 67,458
Other administrative ............................................... 125,358 135,875 77,145
----------- ----------- -----------
Total general and administrative expenses ........................ 789,118 731,491 392,929
----------- ----------- -----------
Other Operating Expenses:
Amortization of goodwill and other intangibles ....................... 133,551 98,940 37,967
Trust Preferred Securities and other minority interest expense ....... 59,063 44,293 15,393
Other real estate owned (gains)/losses, net .......................... (170) (180) 95
Restructuring ........................................................ 8,500 18,500 --
Non-solicitation expense ............................................. 243,241 120,060 --
----------- ----------- -----------
Total other operating expenses ................................... 444,185 281,613 53,455
----------- ----------- -----------
Income/(loss) before income taxes .................................... 149,945 (106,232) 268,614
Income tax provision/(benefit) ....................................... 26,575 (65,215) 89,315
----------- ----------- -----------
INCOME/(LOSS) BEFORE EXTRAORDINARY ITEM .............................. 123,370 (41,017) 179,299
Extraordinary item (net of tax of $3,526 and $5,225) ................. (6,549) 10,775 --
----------- ----------- -----------
NET INCOME/(LOSS) .................................................... $ 116,821 $ (30,242) $ 179,299
=========== =========== ===========
Earnings/(loss) per share:
Basic
Income/(loss) before extraordinary item ............................ $ 0.51 $ (0.18) $ 1.02
Extraordinary item ................................................. (0.03) 0.05 --
----------- ----------- -----------
Net income/(loss) .................................................. $ 0.48 $ (0.13) $ 1.02
=========== =========== ===========
Diluted
Income/(loss) before extraordinary item ............................ $ 0.48 $ (0.18) $ 1.01
Extraordinary item ................................................. (0.03) 0.05 --
----------- ----------- -----------
Net income/(loss) .................................................. $ 0.45 $ (0.13) $ 1.01
=========== =========== ===========
Dividends Declared Per Common Share .................................. $ .10 $ .10 $ .10
=========== =========== ===========
See accompanying notes to consolidated financial statements.
- --------------------------------------------------------------------------------
46
- ----------------CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY-----------------
(in thousands) COMMON
SHARES COMMON RETAINED
OUTSTANDING STOCK WARRANTS EARNINGS
----------- ----------- ----------- -----------
Balance, December 31, 1998 .................................... 159,665 $ 651,808 $ -- $ 564,585
----------- ----------- ----------- -----------
Comprehensive income:
Net income .................................................. -- -- -- 179,299
Change in unrecognized gain/(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 repurchased .................................... (3,351) -- -- --
Treasury stock sold ........................................... 26 -- -- --
Allocation of shares under Employee Stock Ownership Plan ...... 270 1,255 -- --
Acquisition of Network Companies .............................. 235 3,000 -- --
Acquisition of People's Bancorp, Inc .......................... 23,624 255,171 -- --
----------- ----------- ----------- -----------
Balance, December 31, 1999 .................................... 225,408 1,254,037 91,500 726,780
----------- ----------- ----------- -----------
Comprehensive income:
Net income .................................................. -- -- -- (30,242)
Change in unrecognized gain/(loss) on investment securities
available for sale, net of tax ............................ -- -- -- --
Total comprehensive income
Exercise of stock options ..................................... 196 678 -- --
Cash in lieu of fractional shares ............................. -- (3) -- (79)
Sale of stock under Dividend Reinvestment and
Employee Stock Purchase Plan ................................ 621 4,569 -- --
Dividends paid on common stock ................................ -- -- -- (22,420)
Treasury stock repurchased .................................... (62) -- -- --
Treasury stock sold ........................................... 48 -- -- --
Allocation of shares under Employee
Stock Ownership Plan ........................................ 290 93 -- (489)
----------- ----------- ----------- -----------
Balance, December 31, 2000 .................................... 226,501 1,259,374 91,500 673,550
----------- ----------- ----------- -----------
Comprehensive income:
Net income .................................................. -- -- -- 116,821
Effect of change in accounting principle for derivatives .... -- -- -- --
Change in unrecognized gain/(loss), net of tax:
Investments available for sale ............................ -- -- -- --
Derivative financial instruments .......................... -- -- -- --
Total comprehensive income
Issuance of common stock ...................................... 20,000 149,000 -- --
Exercise of stock options ..................................... 490 3,046 -- --
Cash in lieu of fractional shares ............................. -- (8) -- (137)
Sale of stock under Dividend Reinvestment and
Employee Stock Purchase Plan ................................ 432 3,911 -- --
Dividends paid on common stock ................................ -- -- -- (24,653)
Treasury stock repurchased .................................... (64) -- -- --
Treasury stock sold ........................................... 88 (20) -- --
Treasury stock transferred to restricted stock ................ -- -- -- --
Restricted stock repurchased .................................. (295) -- -- --
Allocation of shares under Employee Stock Ownership Plan ...... 318 964 -- --
----------- ----------- ----------- -----------
Balance, December 31, 2001 .................................... $ 247,470 $ 1,416,267 $ 91,500 $ 765,581
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
- --------------------------------------------------------------------------------
47
- --------------------------------------------------------------------------------
ACCUMULATED
UNVESTED UNALLOCATED OTHER TOTAL
TREASURY RESTRICTED STOCK HELD COMPREHENSIVE STOCKHOLDERS'
STOCK STOCK BY ESOP INCOME EQUITY
----------- ----------- ----------- ----------- -----------
Balance, December 31, 1998 ............................ $ (1,086) $ -- $ (29,359) $ 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 repurchased ............................ (47,152) -- -- -- (47,152)
Treasury stock sold ................................... 285 -- -- -- 285
Allocation of shares under Employee
Stock Ownership Plan ................................ -- -- 1,834 -- 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) -- (36,295) (210,932) 1,821,495
----------- ----------- ----------- ----------- -----------
Comprehensive income:
Net loss ............................................ -- -- -- -- (30,242)
Change in unrecognized loss on investment
securities available for sale, net of tax ......... -- -- -- 172,411 172,411
-----------
Total comprehensive income ............................ 142,169
Exercise of stock options ............................. -- -- -- -- 678
Cash in lieu of fractional shares ..................... -- -- -- -- (82)
Sale of stock under Dividend Reinvestment and
Employee Stock Purchase Plan ........................ -- -- -- -- 4,569
Dividends paid on common stock ........................ -- -- -- -- (22,420)
Treasury stock repurchased ............................ (473) -- -- -- (473)
Treasury stock sold ................................... 279 -- -- -- 279
Allocation of shares under Employee
Stock Ownership Plan ................................ -- -- 3,065 -- 2,669
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2000 ............................ (3,789) -- (33,230) (38,521) 1,948,884
----------- ----------- ----------- ----------- -----------
Comprehensive income:
Net income .......................................... -- -- -- -- 116,821
Effect of change in accounting principle
for derivatives ................................... -- -- -- (9,951) (9,951)
Change in unrecognized gain/(loss), net of tax:
Investments available for sale .................... -- -- -- 46,039 46,039
Derivative financial instruments .................. -- -- -- (30,702) (30,702)
-----------
Total comprehensive income ............................ 122,207
Issuance of common stock .............................. -- -- -- -- 149,000
Exercise of stock options ............................. -- -- -- -- 3,046
Cash in lieu of fractional shares ..................... -- -- -- -- (145)
Sale of stock under Dividend Reinvestment and
Employee Stock Purchase Plan ........................ -- -- -- -- 3,911
Dividends paid on common stock ........................ -- -- -- -- (24,653)
Treasury stock repurchased ............................ (701) -- -- (701)
Treasury stock sold ................................... 786 -- -- -- 766
Treasury stock transferred to restricted stock ........ 3,189 (3,189) -- -- --
Restricted stock repurchased .......................... -- (3,083) -- -- (3,083)
Allocation of shares under Employee
Stock Ownership Plan ................................ -- -- 2,285 -- 3,249
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2001 ............................ $ (515) $ (6,272) $ (30,945) $ (33,135) $ 2,202,481
=========== =========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
- --------------------------------------------------------------------------------
48
- ---------------------CONSOLIDATED STATEMENTS OF CASH FLOWS---------------------
(in thousands) YEAR ENDED DECEMBER 31,
--------------------------------------------
2001 2000 1999
------------ ------------ ------------
Cash Flows From Operating Activities:
Net income/(loss) .................................................... $ 116,821 $ (30,242) $ 179,299
Adjustments to reconcile net income/(loss) to net cash provided
by operating activities:
Provision for loan losses .......................................... 97,100 56,500 30,000
Deferred taxes ..................................................... (15,599) (49,833) 18,852
Depreciation and amortization ...................................... 175,316 128,587 18,802
Amortization/accretion of investment securities and loan discounts . 23,584 (34,747) 58,830
(Gain) loss on sale of investments and related derivatives ......... (15,511) 111,715 (9,525)
(Gain) loss on real estate owned ................................... 170 180 (95)
(Gain) loss on sale of fixed assets ................................ (1,376) (165) --
(Gain) loss on extinguishment of debt .............................. 10,075 (16,000) --
Allocation of Employee Stock Ownership Plan ........................ 2,285 3,065 3,089
Net change in:
Unrealized (gain) loss on derivatives .............................. (40,654) -- --
Loans held for sale ................................................ (248,957) 8,811 235,005
Accrued interest receivable ........................................ 46,601 (11,829) (9,262)
Prepaid expenses and other assets .................................. (545,781) (651,297) (268,087)
Other liabilities .................................................. 118,806 296,326 (280,706)
------------ ------------ ------------
Net cash (used) by operating activities ................................ (277,120) (188,929) (23,608)
------------ ------------ ------------
Cash Flows From Investing Activities:
Proceeds from sales of investment securities ......................... 6,081,704 8,248,463 5,553,469
Proceeds from repayments and maturities of investment securities:
Available for sale ................................................. 1,744,100 836,465 1,644,019
Held to maturity ................................................... 289,463 4,255,897 793,031
Purchases of investment securities:
Available for sale ................................................. (10,586,894) (6,157,701) (8,024,026)
Held to maturity ................................................... (1,224) (2,704,498) (1,312,372)
Proceeds from sales of loans ......................................... 3,724,085 2,385,619 1,188,173
Purchase of loans .................................................... (1,989,269) (2,572,063) (2,022,695)
Net change in loans other than purchases and sales ................... (826,284) 463,389 (1,561,471)
Proceeds from sales of premises and equipment ........................ 32,059 46,490 5,757
Purchases of premises and equipment .................................. (19,673) (178,106) (39,844)
Proceeds from sales of real estate owned ............................. 8,275 3,624 17,081
Net cash received from/(paid for) business combinations .............. -- 1,916,345 112,998
------------ ------------ ------------
Net cash provided (used) by investing activities ....................... (1,543,658) 6,543,924 (3,645,880)
------------ ------------ ------------
Cash Flows From Financing Activities:
Net increase/(decrease) in deposits and other customer accounts ...... (1,201,343) 210,550 (1,117,500)
Net increase/(decrease) in short-term borrowings ..................... 1,346,976 (5,449,523) 2,023,868
Proceeds from long-term notes ........................................ 1,346,000 813,068 2,500,894
Repayments of long-term notes ........................................ (590,000) (569,982) (455,959)
Net increase in other long-term debt ................................. 595,418
Sale of FHLB advances ................................................ -- (911,037) --
Net increase/(decrease) in advance payments by borrowers
for taxes and insurance ............................................ (3,066) (4,213) 568
Proceeds from the issuance of preferred stock by subsidiary .......... -- 140,396 --
Proceeds from minority interest ...................................... 64,187 -- --
Proceeds from issuance of Trust Preferred Securities ................. 96,166 -- 187,231
Repurchase of Trust preferred ........................................ (15,029) -- --
Proceeds from issuance of common stock ............................... 156,893 5,337 342,803
Proceeds from issuance of warrants ................................... -- -- 91,500
Advance to the Employee Stock Ownership Plan ......................... -- -- (436)
(Purchase)/issuance of restricted stock .............................. (3,083)
(Purchase)/issuance of treasury stock ................................ 85 (194) (46,867)
Cash dividends paid to stockholders .................................. (24,790) (22,988) (17,104)
------------ ------------ ------------
Net cash provided (used) by financing activities ....................... 1,768,414 (5,788,586) 3,508,998
------------ ------------ ------------
Net change in cash and cash equivalents ................................ (52,364) 566,409 (160,490)
Cash and cash equivalents at beginning of period ....................... 959,643 393,234 553,724
------------ ------------ ------------
Cash and cash equivalents at end of period ............................. $ 907,279 $ 959,643 $ 393,234
============ ============ ============
- --------------------------------------------------------------------------------
49
- --------------------------------------------------------------------------------
Supplemental Disclosures: Income tax payments totaled $33.6 million in
2001, $6.2 million in 2000, and $101 million in 1999. Interest payments totaled
$1.2 billion in 2001, $1.4 million in 2000, and $963 million in 1999. Noncash
activity consisted of acquisitions which included $9.1 billion of loans and
assumption of $12.3 billion of deposits in 2000, and $551 million of loans and
assumption of $515 million in deposits in 1999. Other noncash activity consisted
of a mortgage loan securitization of $587 million in 2001, $1.2 billion in 2000,
and $1.0 billion in 1999; reclassification of long-term borrowings to short-term
borrowings of $950 million in 2000, and $536 million in 1999; and
reclassification of mortgage loans to real estate owned of $13.3 million in
2001, $6.2 million in 2000, and $11.7 million in 1999.
See accompanying notes to consolidated financial statements.
- --------------------------------------------------------------------------------
50
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Sovereign Bancorp, Inc. and subsidiaries ("Sovereign" or "the Company") is a
Pennsylvania business corporation and is the holding company of Sovereign Bank
("Sovereign Bank" or "the Bank"). Sovereign is headquartered in Philadelphia,
Pennsylvania and Sovereign Bank is headquartered in Wyomissing, Pennsylvania.
Sovereign's primary business consists of attracting deposits from its network of
community banking offices, located throughout eastern Pennsylvania, New Jersey,
New Hampshire, Massachusetts, Connecticut and Rhode Island, and originating
commercial, consumer and residential mortgage loans in those communities.
Sovereign also serves customers throughout New York.
The following is a description of the significant accounting policies of
Sovereign. Such accounting policies are in accordance with accounting principles
generally accepted in the United States 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 Capital Trust I, Sovereign Capital Trust II, Sovereign
Capital Trust III, 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 accounting principles generally accepted in the United States
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 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 preferred stock is
calculated using the if-converted method. See Note 23 for computation of
earnings per share.
d. Interest-earning Deposits - Interest-earning deposits consist of
deposit accounts 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 component of comprehensive
income within 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.
In determining if and when a decline in market value below amortized cost is
other-than-temporary, Sovereign evaluates the market conditions, offering
prices, trends of earnings, price multiples, and other key measures for its
investments in marketable equity securities and debt instruments. When such a
decline in value is deemed to be other-than-temporary, the Company recognizes an
impairment loss in the current period operating results to the extent of the
decline.
f. Loans Held for Sale - Loans held for sale 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.
g. Mortgage Banking Activity - Sovereign recognizes, as separate assets,
the rights to service mortgage loans, whether those rights are acquired through
loan purchase or loan origination activities. The initial recognition of
originated mortgage servicing assets is predicated upon an allocation of the
total cost of the related loans between the loans and the loan servicing rights
based on their relative estimated fair values. Purchased mortgage servicing
assets are recorded at cost. 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.
- --------------------------------------------------------------------------------
51
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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
commercial loans where internal credit ratings are below a predetermined
classification. This analysis is performed at the relationship manager level,
and periodically reviewed by the Commercial Asset 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 at least quarterly and are based primarily on actual historical loss
experience, projected loss experience based on current conditions, consultation
with regulatory authorities, and peer group loss experience. While this analysis
is conducted at least quarterly, 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's 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, 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 Chief
Credit Officer, the Chief Risk Management Officer and the Chairman of the Asset
Review Committee have the responsibility to affirm allowance methodology and to
assess the general and specific allowance factors in relation to estimated and
actual net charge-off trends. In addition, the group is also responsible for
assessing the appropriateness of the allowance for loan losses for each loan
pool classification at Sovereign.
- --------------------------------------------------------------------------------
52
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
i. Loans - Loans are reported net of unearned income. Interest on loans
is credited to income as it is earned. 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. Interest income is not recognized on loans when the
loan payment is 90 days or more delinquent (except auto loans,
government-guaranteed loans, residential and consumer loans with loan to values
less than 50% which are placed on non-accrual after 120 days, or loans secured
by deposit accounts) or sooner if management believes the loan has become
impaired.
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. 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. 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 charged-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.
For purposes of measuring impairment as set forth by the provisions of SFAS No.
114 "Accounting by Creditors for Impairment of a Loan" and SFAS No. 118
"Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosure", Sovereign defines impaired loans as non-accrual, non-homogeneous
loans and certain other loans which are still accruing, which management has
specifically identified as being impaired.
j. 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 ....................................... 10 to 30 years
Leasehold improvements ................................. Remaining lease term*
Furniture, fixtures and equipment ...................... 3 to 10 years
Automobiles ............................................ 5 years
Expenditures for maintenance and repairs are charged to expense as incurred.
*Including option periods, if applicable.
k. 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 and costs of
holding the property are recorded as other operating expenses, except for
significant property improvements which are capitalized to the extent that
carrying value does not exceed estimated fair value.
l. Income Taxes - Deferred income taxes are provided on temporary
differences between amounts reported for financial statement and tax purposes.
m. Derivative Instruments and Hedging Activity - Sovereign enters into
derivative transactions principally to protect against the risk of adverse price
or interest rate movements on the value of certain assets and liabilities and on
expected future cash flows. The Company is also required to recognize certain
commitments as derivatives when the characteristics of those commitments meet
the definition of a derivative.
- --------------------------------------------------------------------------------
53
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Effective January 1, 2001, Sovereign adopted SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities", as amended, which requires all
derivative instruments to be carried at fair value on the balance sheet. SFAS
133 provides special hedge accounting provisions, which permit the change in the
fair value of the hedged item related to the risk being hedged to be recognized
in earnings in the same period and in the same income statement line as the
change in fair value of the derivative.
Derivative instruments designated in a hedge relationship to mitigate exposure
to changes in the fair value of an asset, liability, or firm commitment
attributable to a particular risk, such as interest rate risk, are considered
fair value hedges under SFAS 133. Derivative instruments designated in a hedge
relationship to mitigate exposure to variability in expected future cash flows,
or other types of forecasted transactions, are considered cash flow hedges. The
Company formally documents all relationships between hedging instruments and
hedged items, as well as its risk-management objective and strategy for
undertaking each hedge transaction.
Fair value hedges are accounted for by recording the fair value of the
derivative instrument and the fair value related to the risk being hedged of the
hedged asset or liability on the balance sheet with corresponding offsets
recorded in the income statement. The adjustment to the hedged asset or
liability is included in the basis of the hedged item, while the fair value of
the derivative is recorded as a freestanding asset or liability. Actual cash
receipts or payments and related amounts accrued during the period on
derivatives included in a fair value hedge relationship are recorded as
adjustments to the interest income or expense recorded on the hedged asset or
liability.
Cash flow hedges are accounted for by recording the fair value of the derivative
instrument on the balance sheet as either a freestanding asset or liability,
with a corresponding offset recorded in other comprehensive income within
stockholders' equity, net of tax. Amounts are reclassified from other
comprehensive income to the income statement in the period or periods the hedged
forecasted transaction affects earnings.
Under both the fair value and cash flow hedge scenarios, derivative gains and
losses not considered highly effective in hedging the change in fair value or
expected cash flows of the hedged item are recognized immediately in the income
statement. The Company typically uses interest rate swaps in cash flow and fair
value hedge transactions. The interest rate swaps are designed to be highly
effective in offsetting changes in the fair value or cash flows of the hedged
asset or liability. The hedge transactions typically qualify under SFAS 133 to
receive the "short-cut" method. Under the short-cut method, changes in the fair
value of the derivative are assumed to perfectly offset changes in the hedged
asset or liability and there is no impact on net income. Hedge transactions that
qualify for the short-cut method require no additional analysis after inception
of the hedge. For hedge transactions that do not qualify for the short-cut
method, at the hedge's inception and on a regular basis thereafter, a formal
assessment is performed to determine whether changes in the fair values or cash
flows of the derivative instruments have been highly effective in offsetting
changes in the fair values or cash flows of the hedged items and whether they
are expected to be highly effective in the future. If it is determined a
derivative instrument has not been or will not continue to be highly effective
as a hedge, hedge accounting is discontinued prospectively and the derivative
instrument continues to be carried at fair value but with no corresponding
offset being recorded on the hedged item.
Prior to the adoption of SFAS 133 on January 1, 2001, unrealized gains and
losses on derivatives used for hedging purposes were generally not required to
be recorded in the financial statements. Realized gains and losses on contracts
either settled or terminated were recorded as an adjustment to the basis of the
on-balance sheet asset or liability being hedged and amortized into the income
statement over either the remaining life of the derivative instrument or the
expected life of the asset or liability. If the hedged asset or liability also
was terminated, the gain or loss was recognized immediately. Net amounts
receivable or payable on contracts hedging either interest earning assets or
interest bearing liabilities were accrued as an adjustment to either interest
income or interest expense. On January 1, 2001, after-tax transition amounts
associated with establishing the fair values of the derivative instruments and
hedged items on the balance sheet of $0.7 million and ($6.7) million were
recorded as an increase of net income and a reduction in other comprehensive
income, respectively. Additionally, as allowed by SFAS 133, Sovereign
reclassified $800 million of held to maturity securities to available for sale
on January 1, 2001. These securities had an unrealized loss of ($3.2) million,
net of tax of $1.7 million, at January 1, 2001.
- --------------------------------------------------------------------------------
54
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
n. Foreign Exchange - Sovereign enters into forward exchange contracts
to provide for the needs of its customers. Forward exchange contracts are valued
at current exchange rates. All gains or losses on forward exchange contracts are
included in capital markets revenue.
o. 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.
p. 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.
q. Goodwill and Other 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 generally
amortized using an accelerated method over 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 tangible and
identifiable intangible assets of companies acquired through business
combinations accounted for as purchases. In finalizing a purchase allocation,
the Company considers all the facts that come to its attention during the
allocation period, not to exceed 12 months, and, if necessary, will adjust the
purchase price allocation accordingly based on such facts.
Through December 31, 2001, goodwill is amortized using the straight line method
over various periods not exceeding 25 years. Beginning on January 1, 2002,
goodwill will cease to be amortized - See Pending Accounting Pronouncements in a
later section of this Note. Under generally accepted accounting principles
existing through December 31, 2001, 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". At December 31,
2001, Sovereign had $955 million and $389 million of goodwill and core deposit
intangibles, respectively.
r. Segment Reporting - SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" requires that public companies report
certain information about operating segments. 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 banking strategy, emphasis is placed on building
relationships with its customers, as opposed to building specific lines of
business. As a result, at December 31, 2001 and 2000 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, 2001.
s. Asset Securitizations - When the Company sells home equity loans,
automobile and recreational vehicle loans, and residential mortgage loans, it
may retain interest only strips, one or more subordinated tranches, servicing
rights, and in some cases a cash reserve account, all of which are retained
interests in the securitized receivables. Gain or loss on sale of the
receivables depends in part on the previous carrying amount of the financial
assets involved in the transfer, allocated between the assets sold and the
retained interests based on their relative fair value at the date of the
transfer. The Company generally estimates fair value based on the present value
of expected future cash flows estimated using management's best estimates of the
key assumptions-credit losses, pre-payment speeds, forward yield curves, and
discount rates commensurate with the risks involved.
t. Pending Accounting Pronouncements - In June 2001, the Financial
Accounting Standards Board issued Statements of Financial Accounting Standards
No. 141, "Business Combinations", and No. 142, "Goodwill and Other Intangible
Assets", effective for fiscal years beginning after December 15, 2001. Under the
new rules, goodwill will no longer be amortized but will be subject to annual
impairment tests in accordance with the Statements. Other intangible assets will
continue to be amortized over their useful lives.
- --------------------------------------------------------------------------------
55
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company will apply SFAS 142 beginning in the first quarter of 2002.
Application of the nonamortization provisions of SFAS 142 is expected to result
in an increase in net income of $30 million ($.11 per share) in 2002. The
Company will test goodwill for impairment using the two-step process within the
first half of 2002 as prescribed in SFAS 142. The first step is a screen for
potential impairment of goodwill and indefinite lived intangible assets, while
the second step measures the amount of the impairment, if any. The Company has
not yet determined what the effect of these tests will be on its earnings and
financial position. The Company currently evaluates goodwill for impairment if
facts and circumstances suggest that it may be impaired. Management believes
that no such circumstances existed at December 31, 2001. Any impairment that is
required to be recognized when adopting SFAS 142 will be reflected as the
cumulative effect of a change in accounting principle in 2002.
NOTE 2 - BUSINESS COMBINATIONS
On July 17, 2001, Sovereign announced the signing of a definitive agreement to
acquire Main Street Bancorp, Inc. for approximately $170 million in stock and
cash. Main Street is a $1.5 billion bank holding company headquartered in
Reading, Pennsylvania, with 42 community banking offices serving southeastern
Pennsylvania. The transaction was completed on March 8, 2002 and provided
Sovereign with approximately $1.3 billion of deposits and $800 million of loans
before purchase accounting adjustments, enhancing Sovereign's small business and
middle market lending capabilities in the region.
On February 28, 2000, Sovereign entered into an amended 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 (the "New England Acquisition"). In total, the Bank purchased 281
community banking offices (exclusive of 4 locations which were resold to a third
party). The New England Acquisition, which resulted in the creation of Sovereign
Bank New England division of Sovereign Bank ("SBNE") included 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 acquired a substantial portion of the middle
market and small business-lending group from Fleet Bank in Massachusetts and New
Hampshire, and from BankBoston in Rhode Island and Connecticut. The New England
Acquisition included the purchase of fully functioning business units, with the
necessary management, relationship officers, support staff and other
infrastructure for the acquired loans and deposits to be fully serviced.
In March, June and July 2000, Sovereign completed each of the three phases of
the New England Acquisition. Sovereign's results include the operations of these
acquired SBNE branches, assets and liabilities from their respective acquisition
dates, and thereafter. Total liabilities assumed through the acquisition were
$12.3 billion. Additionally, tangible assets purchased by Sovereign included
loan balances of $9.1 billion, which included $3.1 billion of commercial loans
and leases, $1.7 billion of consumer loans and $4.3 billion of residential
mortgages (inclusive of $1.1 billion of residential mortgage loans which were
not relationship assets that were subsequently sold as part of Sovereign's
asset-liability management strategy to reduce interest-rate risk), $85 million
of currency, $68 million of premises and equipment, $180 million of precious
metals inventory and $213 million of prepaid and other miscellaneous assets.
Cash received, net of the premium paid, was $1.9 billion.
Identifiable intangible assets acquired included $352 million of core deposit
intangible (CDI), which represents the value of the customer relationships
associated with demand, savings, and money market accounts. Sovereign
established the value of the CDI based on the present value of the difference in
expected future cash flows between the cost to replace such deposits (based on
applicable equivalent time deposit rates) versus the then-current yield on core
deposits acquired. The estimated future cash flows were based on the average
expected life of the deposits acquired using average run-off factors for each
product less the cost to service the deposits. Sovereign is amortizing the core
deposit intangible using an accelerated method of amortization over the 10 year
period.
- --------------------------------------------------------------------------------
56
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 2 - BUSINESS COMBINATIONS (CONTINUED)
Total consideration for the New England Acquisition was 12% of acquired deposits
less agreed upon reductions. The premium was comprised of: a) $848 million,
which was paid as of the final closing on July 21, 2000, and b) $363 million,
paid in periodic installments from January 2001 through September 2001 upon
FleetBoston's performance of non-solicitation obligations specified under the
purchase agreement and satisfaction of certain other conditions. These payments
were recorded as expense ratably from the completion of the New England
Acquisition on July 21, 2000 through the completion of the payments. After
taking into consideration fair value adjustments on acquired assets of $163
million, establishment of an initial allowance for loan losses of $135 million,
and direct costs associated with the acquistion of $32 million, total goodwill
of $826 million was recorded in the transaction.
In November 2000, the Company announced the results of a restructuring
initiative. In addition to realigning the Office of the Chief Executive Officer
and the Company around customer segments, Sovereign analyzed front and back
office operations and computer operating platforms and eliminated approximately
500 positions. In total, Sovereign recorded $27 million in restructuring costs,
$8.5 million of which was recorded in 2001 related to the closure of 14
"in-store" offices and a redirection of e-commerce efforts, and $18.5 million
recorded during 2000 which was comprised of $14 million of severance and
outplacement costs, and a $4.5 million write-off of a redundant
computer-operating platform. As of December 31, 2001, $2.0 million of liability
remained.
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. Sovereign issued approximately 23.6 million shares
or .80 shares of Sovereign common stock for each outstanding share of Peoples
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
States, with transactions ranging from $15,000 to $250,000. The initial purchase
price of $6 million consisted of $4 million of stock and $2 million of cash.
Sovereign's results of operations include the operations of Network from June
15, 1999 and thereafter.
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, 2001 and 2000
were $277 million and $243 million, respectively.
- --------------------------------------------------------------------------------
57
- --------------------------------------------------------------------------------
NOTE 4 - INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities are as
follows (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
-----------------------------------------------------------------------------------------------------
2001 2000
------------------------------------------------ -------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
COST APPRECIATION DEPRECIATION VALUE COST APPRECIATION DEPRECIATION VALUE
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Investment Securities
Available for sale:
Investment Securities:
U.S. Treasury and
government agency
securities ......... $ 23,109 $ 93 $ 23 $ 23,179 $ 92,341 $ 55 $ 455 $ 91,941
Corporate debt and
asset-backed
securities ......... 322,813 5,357 14,310 313,860 823,672 11,581 17,845 817,408
Equities ............. 790,391 2,631 160 792,862 676,881 393 5,899 671,375
State and municipal
securities ......... 22,452 1,942 2 24,392 36,549 2,693 473 38,769
Mortgage-backed
Securities:
U.S. government
agencies ........... 6,625,498 34,371 33,828 6,626,041 676,593 3,025 5,679 673,939
Non-agencies ......... 1,783,485 23,062 5,202 1,801,345 3,069,141 1,091 48,080 3,022,152
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total investment
securities available
for sale ............. $9,567,748 $ 67,456 $ 53,525 $9,581,679 $5,375,177 $ 18,838 $ 78,431 $5,315,584
========== ========== ========== ========== ========== ========== ========== ==========
Held to maturity:
Investment Securities:
U.S. Treasury and
government agency
securities ......... $ 1,905 $ 55 $ -- $ 1,960 $ 6,382 $ -- $ 138 $ 6,244
Corporate debt and
asset-backed
securities ......... -- -- -- -- 35,785 2,282 6 38,061
State and municipal
securities ......... 4,128 35 2 4,161 739 135 6 868
Mortgage-backed
Securities:
U.S. government
agencies ........... 872,154 9,851 10,144 871,861 1,562,525 14,780 16,502 1,560,803
Non-agencies ......... 5,250 47 71 5,226 372,837 883 7,800 365,920
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total investment
securities held
to maturity .......... $ 883,437 $ 9,988 $ 10,217 $ 883,208 $1,978,268 $ 18,080 $ 24,452 $1,971,896
========== ========== ========== ========== ========== ========== ========== ==========
- --------------------------------------------------------------------------------
Proceeds from sales of investment securities available for sale and the realized
gross gains and losses from those sales are as follows (in thousands):
- --------------------------------------------------------------------------------
AVAILABLE FOR SALE
YEAR ENDED DECEMBER 31,
----------------------------------------------
2001 2000 1999
------------ ------------ ------------
Proceeds from sales ........................................................ $ 6,081,704 $ 8,248,463 $ 5,553,469
============ ============ ============
Gross realized gains ....................................................... 36,283 3,039 8,335
Gross realized losses ...................................................... (6,048) (123,916) (4,603)
------------ ------------ ------------
Net realized gains/(losses) ................................................ $ 30,235 $ (120,877) $ 3,732
============ ============ ============
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58
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 4 - INVESTMENT SECURITIES - (CONTINUED)
Contractual maturities (except mortgage-backed securities, see (1)) and yields
of Sovereign's investment securities available for sale at December 31, 2001 are
as follows:
- --------------------------------------------------------------------------------
INVESTMENT SECURITIES AVAILABLE FOR SALE AT DECEMBER 31, 2001(1):
------------------------------------------------------------------------------
DUE AFTER WEIGHTED
DUE WITHIN DUE AFTER 1 DUE AFTER 5 10 YEARS/NO AVERAGE
ONE YEAR WITHIN 5 YRS WITHIN 10 YRS MATURITY TOTAL YIELD (2)
---------- ---------- ---------- ---------- ---------- ----------
U.S. Treasury and government agency ...... $ 19,662 $ 3,517 $ -- $ -- $ 23,179 2.67%
Corporate debt and asset backed securities -- 26,722 83,020 204,118 313,860 9.66%
Equities ................................. -- -- -- 792,862 792,862 --%
State and Municipal securities ........... 51 897 459 22,985 24,392 6.09%
Mortgage-backed Securities:
U.S. government agencies ............... 796,337 2,721,644 1,805,062 1,302,998 6,626,041 6.02%
Non-agencies ........................... 593,387 894,203 233,528 80,227 1,801,345 6.07%
---------- ---------- ---------- ---------- ----------
Total Fair Value ......................... $1,409,437 $3,646,983 $2,122,069 $2,403,190 $9,581,679 5.64%
========== ========== ========== ========== ==========
Weighted average yield (2) ............... 6.02% 6.11% 6.15% 4.26% 5.64%
========== ========== ========== ========== ==========
Total Amortized Cost ..................... $1,421,022 $3,639,767 $2,114,440 $2,392,519 $9,567,748
========== ========== ========== ========== ==========
Maturities and yields of Sovereign's investment securities held to maturity at
December 31, 2001 are as follows:
INVESTMENT SECURITIES HELD TO MATURITY AT DECEMBER 31, 2001(1):
------------------------------------------------------------------------------
DUE AFTER WEIGHTED
DUE WITHIN DUE AFTER 1 DUE AFTER 5 10 YEARS/NO AVERAGE
ONE YEAR WITHIN 5 YRS WITHIN 10 YRS MATURITY TOTAL YIELD (2)
---------- ---------- ---------- ---------- ---------- ----------
U.S. Treasury and government agency ...... $ 150 $ 1,755 $ -- $ -- $ 1,905 6.65%
State and Municipal securities ........... 481 2,890 396 361 4,128 6.05%
Mortgage-backed Securities:
U.S. government agencies ............... 192,256 419,730 173,402 86,766 872,154 5.95%
Non-agencies ........................... 1,643 2,861 667 79 5,250 5.01%
---------- ---------- ---------- ---------- ----------
Total Amortized Cost ..................... $ 194,530 $ 427,236 $ 174,465 $ 87,206 $ 883,437 5.94%
========== ========== ========== ========== ==========
Weighted-average yield (2) ............... 5.90% 5.90% 6.03% 6.09% 5.94%
========== ========== ========== ========== ==========
Total Fair Value ......................... $ 196,919 $ 424,682 $ 174,364 $ 87,243 $ 883,208
========== ========== ========== ========== ==========
(1) Mortgage-backed securities are assigned to maturity categories based on
their estimated average lives.
(2) Weighted-average yields are based on amortized cost. Yields on tax exempt
securities are calculated on a tax equivalent basis and are based on an
effective tax rate of 35%.
- --------------------------------------------------------------------------------
Income not subject to tax included in interest and dividends on investment
securities was $29.1 million, $27.1 million and $27.1 million for years ended
December 31, 2001, 2000 and 1999, respectively. Tax expense/(benefit) related to
net realized gains and losses from sales of investment securities for the years
ended December 31, 2001, 2000 and 1999 were $10.6 million, $(42.3) million and
$1.2 million, respectively.
Investment securities with an estimated fair value of $3.8 billion and $2.3
billion were pledged as collateral for borrowings, interest rate agreements and
public deposits at December 31, 2001 and 2000, respectively.
- --------------------------------------------------------------------------------
59
- --------------------------------------------------------------------------------
NOTE 5 - LOANS
A summary of loans included in the Consolidated Balance Sheets (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
-------------------------
2001 2000
----------- -----------
Commercial real estate loans .. $ 3,082,330 $ 2,793,616
Commercial and industrial loans 4,506,198 4,397,009
Other ......................... 657,527 640,782
----------- -----------
Total Commercial Loans ...... 8,246,055 7,831,407
----------- -----------
Home equity loans ............. 3,756,621 3,256,598
Auto loans .................... 2,882,417 2,309,025
Other ......................... 509,272 536,358
----------- -----------
Total Consumer Loans ........ 7,148,310 6,101,981
----------- -----------
Residential real estate loans . 5,005,219 7,978,857
----------- -----------
Total Loans(1)(2) ............. $20,399,584 $21,912,245
=========== ===========
Total Loans with:
Fixed rate .................. $12,875,742 $14,165,535
Variable rate ............... 7,523,842 7,746,710
----------- -----------
Total Loans(1) .............. $20,399,584 $21,912,245
=========== ===========
(1) Loan totals are net of deferred loan fees of $40 million for 2001 and $33
million for 2000.
(2) Loan totals are net of unamortized discount of $18 million and $65 million
for 2001 and 2000, respectively.
- --------------------------------------------------------------------------------
Loans to related parties include loans made to certain officers, directors and
their affiliated interests. At December 31, 2001 and 2000, loans to related
parties totaled $20.1 million and $14.6 million, respectively.
The activity in the allowance for loan losses is as follows (in thousands):
- --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
----------------------------------------------
2001 2000 1999
------------ ------------ ------------
Balance, beginning of period ......................... $ 256,356 $ 132,986 $ 133,802
Allowance established/acquired in acquisitions ....... -- 134,706 4,799
Provision for loan losses ............................ 97,100 56,500 30,000
Charge-offs .......................................... 120,940 92,892 55,023
Recoveries ........................................... 32,151 25,056 19,408
------------ ------------ ------------
Balance, end of period ............................... $ 264,667 $ 256,356 $ 132,986
============ ============ ============
- --------------------------------------------------------------------------------
Impaired loans are summarized as follows (in thousands):
AT DECEMBER 31,
---------------------------
2001 2000
----------- -----------
Impaired loans without a related allowance .. $ -- $ --
Impaired loans with a related allowance ..... 352,562 232,817
----------- -----------
Total impaired loans ...................... $ 352,562 $ 232,817
=========== ===========
Allowance for impaired loans ................ $ 73,741 $ 56,311
=========== ===========
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
60
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 5 - LOANS - (CONTINUED)
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, 2001, 2000 and
1999 would have increased by approximately $9.1 million, $7.0 million and $5.0
million, respectively. Interest income recorded on these loans for the years
ended December 31, 2001, 2000 and 1999 was $6.6 million, $3.8 million and $2.1
million, respectively.
NOTE 6 - MORTGAGE BANKING ACTIVITY
At December 31, 2001, 2000, and 1999, Sovereign serviced loans for the benefit
of others totaling $5.1 billion, $4.2 billion, and $5.7 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):
- --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
----------------------------------------------
2001 2000 1999
------------ ------------ ------------
Balance, beginning of period .......................... $ 41,541 $ 77,349 $ 75,627
Servicing assets sold ................................. -- (34,842) --
Net servicing assets recognized ....................... 29,083 7,971 14,605
Amortization and other ................................ (9,626) (8,937) (12,883)
------------ ------------ ------------
Balance, end of year .................................. $ 60,998 $ 41,541 $ 77,349
============ ============ ============
- --------------------------------------------------------------------------------
For valuation purposes, at December 31, 2001, a weighted average discount rate
of 9.6% 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.
Activity in the valuation allowance for mortgage servicing rights for the years
indicated consisted of the following (in thousands):
- --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
----------------------------------------------
2001 2000 1999
------------ ------------ ------------
Balance, beginning of period ......................... $ 2,183 $ 4,858 $ 13,295
Increase/(decrease) in valuation
allowance for mortgage servicing rights ............ 8,097 (2,675) (8,437)
------------ ------------ ------------
Balance, end of year ................................. $ 10,280 $ 2,183 $ 4,858
============ ============ ============
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
61
- --------------------------------------------------------------------------------
NOTE 7 - PREMISES AND EQUIPMENT
A summary of premises and equipment, less accumulated depreciation and
amortization, follows (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
---------------------------
2001 2000
----------- -----------
Land ........................................ $ 11,581 $ 13,200
Office buildings ............................ 74,865 108,890
Furniture, fixtures, and equipment .......... 215,313 214,106
Leasehold improvements ...................... 65,044 57,723
Automobiles ................................. 441 605
----------- -----------
367,244 394,524
Less accumulated depreciation ............... (115,657) (104,390)
----------- -----------
Total premises and equipment .............. $ 251,587 $ 290,134
=========== ===========
- --------------------------------------------------------------------------------
Included in occupancy and equipment expense for 2001, 2000 and 1999 was
depreciation expense of $43.1 million, $36.6 million, and $15.1 million,
respectively. Sovereign also recorded rental expense of $72.9 million, $52.0
million and $16.5 million, net of $11.2 million $5.2 million, and $1.2 million
of sublease income in 2001, 2000 and 1999, respectively.
On June 30, 2000, Sovereign was party to a structured real estate transaction
pursuant to which 127 commercial properties. were transferred to non-affiliated
third parties. Sovereign simultaneously entered into 127 separate operating
leases each of which had an initial term of approximately 20 years. The
transfers and leases included 104 commercial properties that were transferred by
FleetBoston and 23 commercial properties owned by Sovereign. Sovereign recorded
an $11.9 million gain on the sale of the 23 properties it sold to the third
parties. This was deferred and is being amortized over the lease term of the 23
properties sold and subsequently leased back.
NOTE 8 - ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
---------------------------
2001 2000
----------- -----------
Accrued interest receivable on:
Investment securities ..................... $ 65,357 $ 55,465
Loans ..................................... 118,556 175,049
----------- -----------
Total interest receivable ................. $ 183,913 $ 230,514
=========== ===========
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
62
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 9 - DEPOSITS
Deposits are summarized as follows (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
-------------------------------------------------------------------------
2001 2000
------------------------------------- ---------------------------------
BALANCE PERCENT RATE BALANCE PERCENT RATE
----------- ------- ---- ----------- ------- ----
Demand deposit accounts .................. $ 3,910,171 17% --% $ 3,475,994 14% --%
NOW accounts ............................. 4,162,169 18 0.87 4,247,194 17 2.67
Savings accounts ......................... 2,985,464 13 1.44 2,952,960 12 2.38
Money market accounts .................... 4,992,163 21 1.73 4,553,020 19 4.44
Retail certificates of deposit ........... 6,985,397 30 4.14 8,371,936 34 5.91
Jumbo certificates of deposit ............ 262,210 1 3.04 897,813 4 6.55
----------- --- ---- ----------- --- ----
Total deposits ......................... $23,297,574 100% 1.99% $24,498,917 100% 3.83%
=========== === ==== =========== === ====
Deposits of related parties include deposits made by certain officers, directors
and their affiliated interests. At December 31, 2001 and 2000, deposits of
related parties totaled $1.5 million and $1.2 million, respectively.
- --------------------------------------------------------------------------------
Interest expense on deposits is summarized as follows (in thousands):
- --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
----------------------------------------------
2001 2000 1999
------------ ------------ ------------
Demand deposit and NOW accounts ........................ $ 71,156 $ 81,842 $ 34,622
Savings accounts ....................................... 57,905 67,880 58,333
Money market accounts .................................. 144,156 132,131 50,246
Certificates of deposit ................................ 432,669 453,234 297,625
------------ ------------ ------------
Total interest expense on deposits ................... $ 705,886 $ 735,087 $ 440,826
============ ============ ============
- --------------------------------------------------------------------------------
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,
2001 (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
---------------
2001
----------
Three months or less ................... $ 335,046
Over three through six months .......... 290,041
Over six through twelve months ......... 340,226
Over twelve months ..................... 370,591
----------
Total .................................. $1,335,904
==========
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
63
- --------------------------------------------------------------------------------
NOTE 9 - DEPOSITS - (CONTINUED)
The following table sets forth the maturity of Sovereign's certificates of
deposit as scheduled to mature contractually at December 31, 2001 (in
thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
---------------
2001
----------
2002 ................................... $5,655,282
2003 ................................... 1,031,650
2004 ................................... 260,203
2005 ................................... 94,671
2006 ................................... 75,738
Thereafter ............................. 130,063
----------
Total .................................. $7,247,607
==========
- --------------------------------------------------------------------------------
NOTE 10 - BORROWINGS
Short-term borrowings included in the consolidated balance sheets are as follows
(in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
-----------------------------------------------------
2001 2000
----------------------- -----------------------
Balance W.A. Rate Balance W.A. Rate
----------- --------- ----------- ---------
Federal funds purchased ....................................... $ 452,002 1.75% $ 130,000 5.23%
Securities sold under repurchase agreements ................... 297,741 1.45% 230,900 6.58%
Federal Home Loan Bank advances ............................... 1,929,021 3.08% 970,000 6.62%
----------- ---- ----------- ----
Total borrowings .............................................. $ 2,678,764 2.67% $ 1,330,900 6.48%
=========== ==== =========== ====
- --------------------------------------------------------------------------------
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.
Included in 2001 borrowings are sales of securities under repurchase agreements.
Securities underlying sales of securities under repurchase agreements consisted
of investment securities which had an amortized cost of $395 million and a
market value of $386 million at December 31, 2001.
Short-term FHLB advances are collateralized by qualifying mortgage-related
assets as defined by the FHLB.
- --------------------------------------------------------------------------------
64
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 11 - LONG-TERM DEBT
Long-term debt (borrowings with original maturities of more than one year) at
December 31 consisted of the following (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
---------------------------
2001 2000
------------ -----------
Securities sold under repurchase agreements, maturing 2002 through 2006 ..... $ 155,000 $ --
FHLB advances, maturing January 2002 to April 2012 .......................... 4,105,929 3,544,984
Senior secured credit facility, due November 15, 2003 ....................... -- 350,792
Senior secured credit facility, maturing May 31, 2005 to February 28, 2007 .. 225,000 --
Asset-backed floating rate notes, due June 21, 2012 ......................... 821,000 --
6.625% senior notes, due March 15, 2001 ..................................... -- 239,973
8.625% senior notes, due March 15, 2004 ..................................... 174,856 --
10.25% senior notes, due May 15, 2004 ....................................... 200,000 200,000
10.50% senior notes, due November 15, 2006 .................................. 500,000 500,000
8.50% subordinated debentures, due 2002 ..................................... 19,996 19,992
8.00% subordinated debentures, due 2003 ..................................... 49,978 49,960
Other ....................................................................... 9,247 3,707
----------- -----------
$ 6,261,006 $ 4,909,408
=========== ===========
- --------------------------------------------------------------------------------
Long-term debt includes sales of securities under repurchase agreements with
weighted average interest rates of 4.71% at December 31, 2001. Securities
underlying these repurchase agreements consist of investment securities which
had a book value of $159 million, and a market value of $160 million at December
31, 2001.
Long-term FHLB advances are collateralized by qualifying mortgage-related assets
as defined by the FHLB. Long-term FHLB advances had weighted average interest
rates of 5.28% and 5.47% at December 31, 2001 and 2000, respectively.
In March 2001, Sovereign completed a $400 million senior secured credit facility
with Bank of Scotland. Proceeds from the issue were used to prepay an existing
$350 million senior secured credit facility. In connection with this
transaction, Sovereign wrote off $6.5 million net of tax ($10.1 million pre-tax)
of deferred issuance costs remaining from the existing line of credit. These
costs were reflected net of tax as an extraordinary item in accordance with
generally accepted accounting principles.
The senior secured credit facility with Bank of Scotland consists of a $350
million revolving line and a $50 million term note. The revolving line provides
$350 million of capacity through August of 2005 with the maximum amount
available reduced as follows: $300 million - August 31, 2005; $250 million -
November 30, 2005; $200 million - February 28, 2006; $150 million - May 30,
2006; $100 million - August 30, 2006; $50 million - November 30, 2006. The
revolving facility matures on February 28, 2007 with no mandatory prepayments.
The term loan matures on May 31, 2005. The Senior Secured Credit Facility is
secured by a pledge of the stock of Sovereign Bank and Sovereign Delaware
Investment Company. Interest is impacted by Sovereign's Senior Unsecured Long
Term Debt Credit Rating (S&P/Moody's), and is calculated, at the option of the
borrower, at LIBOR or ABR, defined as the greater of (i) the lender's prime rate
and (ii) the Federal Funds Rate plus .50%, plus applicable margin. The
applicable margin for the first two years of the facility is 0.75% for ABR loans
and 2.50% for Eurodollar loans if Sovereign's credit rating is BB+/Ba3 or higher
and 1.00% for ABR loans and 2.75% for Eurodollar loans if Sovereign's credit
rating is below BB+/Ba3. After the second anniversary, the applicable margin is
1.00% for ABR loans and 2.75% for Eurodollar loans if Sovereign's credit rating
is BB+/Ba1 or lower; 0.50% for ABR loans and 2.25% for Eurodollar loans if
Sovereign's credit rating is BBB-/Baa3; 0.25% for ABR loans and 2.00% for
Eurodollar loans if Sovereign's credit rating is BBB/Baa2+; and 0.00% for ABR
loans and 1.75% for Eurodollar loans if Sovereign's credit rating is BBB+/Baa1
or higher. The Senior Secured Credit Facility subjects Sovereign to a number of
affirmative and negative covenants. At December 31, 2001, the rate Sovereign was
paying equaled 5.72%.
- --------------------------------------------------------------------------------
65
- --------------------------------------------------------------------------------
NOTE 11 - LONG-TERM DEBT - (CONTINUED)
In November, 2001, Sovereign accessed the liquidity of international markets and
transferred $957 million of indirect automobile loans to special purpose
entities (SPEs) in return for $885 million raised by the SPEs from the issuance
to outside investors of $821 million of asset-backed floating rate notes and $64
million of equity interests. The securitization transaction is accounted for as
a financing collateralized by assets in accordance with SFAS 140, "Transfers of
Financial Assets and Liabilities", and as such, the indirect automobile loans,
asset-backed floating rate notes and equity interests (reported as minority
interests) are all reflected in Sovereign's Consolidated Balance Sheet at
December 31, 2001 as loans, long-term debt and minority interests, respectively.
The asset-backed notes consist of two classes: $799.1 million of Class A and
$21.9 million of Class B. Interest on the notes accrues at 1 month LIBOR plus
0.375% and 0.575% for classes A and B, respectively, and is paid monthly.
Interest rates were 2.50% and 2.70% December 31, 2001 for classes A and B,
respectively. Combined monthly principal payments of $10.5 million commence
January 2007 and increase to final payments of $16.9 million in January 2012.
Principal reductions are allocated between the classes in proportion to the
combined principal of the classes. Interest and principal payments are to be
paid from the cash flows of the revolving pool of assets transferred to the
SPEs.
On February 20, 2001, Sovereign issued $175 million of senior unsecured notes at
8.625% which will mature on March 15, 2004. The proceeds of this issuance, along
with the proceeds of $150 million from the 20 million shares of common stock
issued on February 9, 2001, were used to repay the 6.625% senior notes at
maturity on March 15, 2001.
The 8.625%, 10.25%, and 10.50% senior notes are non-amortizing and are
redeemable, at a significant premium, at any time prior to maturity. The 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 following table sets forth the contractual maturities of Sovereign's
long-term debt at December 31, 2001 (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
---------------
2001
----------
2002 ................................... $ 421,390
2003 ................................... 56,454
2004 ................................... 376,798
2005 ................................... 462,885
2006 ................................... 730,000
Thereafter ............................. 4,213,479
----------
Total .................................. $6,261,006
==========
- --------------------------------------------------------------------------------
NOTE 12 - TRUST PREFERRED SECURITIES
Sovereign's Trust Preferred Securities consist of the following at December 31,
2001 and 2000
- --------------------------------------------------------------------------------
AT DECEMBER 31,
--------------------------
2001 2000
----------- -----------
Sovereign Capital Trust I (stated maturity $84,635 in 2001 and $100,000 in 2000) . $ 82,782 $ 97,724
Sovereign Capital Trust II (stated maturity $287,500 in 2001 and 2000) ........... 193,688 190,321
Sovereign Capital Trust III (stated maturity $100,000 in 2001) ................... 96,166 --
ML Capital Trust I (stated maturity $31,500 in 2001 and 2000) .................... 31,500 31,500
----------- -----------
Total Trust Preferred Securities ................................................. $ 404,136 $ 319,545
=========== ===========
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
66
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 12 - TRUST PREFERRED SECURITIES - (CONTINUED)
On December 13, 2001, Sovereign issued $100 million of preferred capital
securities through Sovereign Capital Trust III, a special-purpose statutory
trust created expressly for the issuance of these securities. Distributions on
the securities will be payable at an annual rate of 8.75% on a quarterly basis
beginning March 31, 2002. The proceeds were invested in Junior Subordinated
Debentures of Sovereign, at terms identical to the preferred capital securities.
Cash distributions on the securities are made to the extent interest on the
debentures is received by Sovereign Capital Trust III. In the event of certain
changes or amendments to regulatory requirements or federal tax rules, the
securities are redeemable in whole. Otherwise the securities are generally
redeemable in whole or in part on or after January 1, 2007, at a price equal to
100% of the principal amount plus accrued interest to the date of redemption.
The securities must be redeemed on December 31, 2031.
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 $91.5
million has been allocated to the value of the warrants allocated to equity 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:
o 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. Distributions are payable quarterly
beginning February 15, 2000 at an annual rate of 7.5% of the stated
liquidation value; and
o 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 original 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.
Sovereign has outstanding $84.6 million of preferred capital securities through
Sovereign Capital Trust I, a special-purpose statutory trust created expressly
for the issuance of these securities. Distributions on the securities will be
payable at an annual rate of 9% of the stated liquidation amount of $1,000 per
capital security, payable semi-annually. The trusts sole assets consist of
investments in Junior Subordinated Debentures of Sovereign, at terms identical
to the preferred capital securities. Cash distributions on the securities are
made to the extent interest on the debentures is received by Sovereign Capital
Trust I. In the event of certain changes or amendments to regulatory
requirements or federal tax rules, the securities are redeemable in whole.
Otherwise the 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 securities may be
redeemed at 100% of the liquidation amount. On December 27, 2001, Sovereign
completed an open market repurchase $15.4 million of the trust preferred
securities issued by Sovereign Capital Trust I.
Sovereign has outstanding $31.5 million of preferred capital securities through
ML Capital Trust I, which was established by ML Bancorp, Inc., a predecessor
company of Sovereign. The securities bear an interest rate of 9.875%, with a
scheduled maturity of
- --------------------------------------------------------------------------------
67
- --------------------------------------------------------------------------------
NOTE 12 - TRUST PREFERRED SECURITIES - (CONTINUED)
March 1, 2027. 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 Trusts are wholly owned subsidiaries of Sovereign, whose sole assets consist
of investments in and in trust related to the junior subordinated debentures
issued by Sovereign. Sovereign has fully and unconditionally guaranteed the
Trusts' payments on the trust preferred securities. The Trust Preferred
Securities are classified as and are similar to a minority interest and are
presented as "Company-obligated mandatorily redeemable preferred securities of
subsidiary trust holding junior subordinated debentures of Sovereign." The Trust
Preferred Securities qualify for Tier 1 capital treatment for Sovereign Bank and
the loan payments from Sovereign to the trusts are fully tax deductible. The
warrants, included in the PIERS units, are classified as additional capital
within stockholders' equity.
NOTE 13 - MINORITY INTERESTS
In the financing transaction consummated in November 2001, Sovereign received
$64 million from the sale of ownership interests in consolidated SPEs to outside
investors. The SPEs were formed to issue debt and equity interests as parts of a
securitization transaction which raised a total of $885 million for Sovereign.
The ownership interests in the SPEs are reflected as minority interests in
Sovereign's Consolidated Balance Sheet, along with the indirect automobile loans
and asset-backed notes as the entire transaction is considered a financing in
accordance with SFAS 140.
On August 21, 2000, Sovereign received approximately $140 million of net
proceeds from the issuance of $161.8 million of 12% Series A Noncumulative
Preferred Interests in Sovereign Real Estate Investment Trust ("SREIT"), a
subsidiary of Sovereign Bank which holds primarily residential real estate
loans. The preferred stock was issued at a discount, which is being amortized
over the life of the preferred shares using the effective yield method. The
preferred shares may be redeemed at any time on or after May 16, 2020, at the
option of Sovereign subject to the approval of the OTS. Under certain
circumstances, the preferred shares are automatically exchangeable into
preferred stock of Sovereign Bank. The offering was made exclusively to
institutional investors; however, Sovereign expects to register the SREIT
preferred shares so that they may be offered to other investors. The proceeds of
this offering were principally used to repay corporate debt.
NOTE 14 - STOCKHOLDERS' EQUITY
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, each outstanding share
of Sovereign common stock has attached to it one right to purchase one-hundredth
of a share of junior participating preferred stock at an initial exercise price
of $40. The rights are not currently exercisable or transferable, and no
separate certificates evidencing such rights will be distributed, unless certain
events occur.
A holder can exercise the rights to purchase shares of the junior participating
preferred stock if a person, group or other entity acquires or commences a
tender offer or an exchange offer for 9.9% or more of total voting power. A
holder can also exercise if Sovereign's board declares a person or group who has
become a beneficial owner of at least 4.9% of Sovereign common stock or total
voting power an "adverse person", as defined in the Rights Plan.
After the rights become exercisable the rights (other than rights held by a 9.9%
beneficial owner or an "adverse person") generally will entitle the holders to
purchase either Sovereign common stock or the common stock of the potential
acquirer, in lieu of the junior participating preferred stock, at a
substantially reduced price.
- --------------------------------------------------------------------------------
68
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 14 - STOCKHOLDERS' EQUITY - (CONTINUED)
Sovereign can generally redeem the rights at $.001 per right by a majority vote
of "continuing directors" (defined as any member of the board of directors of
Sovereign on June 21, 2001 and successors approved by such persons) at any time
prior to the earlier of the tenth business day following public announcement
that a 9.9% position has been acquired or June 30, 2007. At any time prior to
the date the rights become nonredeemable, the Sovereign board of directors can
extend the redemption period by a vote of "continuing directors". Rights are
redeemable following an "adverse person" determination.
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, 2001, purchases of common
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 also maintains an Employee Stock Purchase Plan
allowing employees with at least six months of employment and who average over
20 hours per week to purchase shares through a payroll deduction at a discount
from fair market value of 7.5% subject to a maximum of the lessor of 15% of pay
or $25,000. All dividends are reinvested according to Sovereign's Dividend
Reinvestment and Stock Purchase Plan.
During 2001, Sovereign instituted a Restricted Stock Plan ("Restricted Stock
Plan") allowing for the distribution of 2.5 million shares of Sovereign common
stock. The restricted stock vests ratably over a three-year plan. Approximately
560,000 shares were transferred into the Restricted Stock Plan during 2001
including shares held in Treasury, of which 532,000 shares were issued. Unvested
shares are treated as a reduction of capital.
On November 2, 2001, the company registered $1.0 billion of debt and equity
instruments for future issuance under a shelf registration of debt securities;
preferred stock; depository shares; common stock; warrants; stock purchase
contracts; and stock purchase units. The Company may offer and sell these
securities from time to time and the securities will be offered at prices and on
terms to be determined by market conditions at the time of offering. Sovereign
has approximately $900 million of availability under the shelf registration at
December 31, 2001.
On February 9, 2001, Sovereign issued $150 million of common equity consisting
of 20 million shares sold at $7.50 per share.
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 Note 12, 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.
Retained earnings at December 31, 2001 included $82.1 million in bad debt
reserves, for which no deferred taxes have been provided due to the indefinite
nature of the recapture provisions. Sovereign's debt agreements impose certain
limitations on dividends, other payments and transactions. These limits are not
expected to affect dividend payments at current levels and reasonably
anticipated increases.
NOTE 15 - REGULATORY MATTERS
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% as defined. The
Federal Deposit Insurance Corporation Improvement Act ("FDICIA") requires OTS
regulated institutions to have a minimum tangible capital equal to 2% of total
tangible assets. Management believes, as of December 31, 2001 and 2000, that
Sovereign Bank met all capital adequacy requirements to which they are subject
in order to be well-capitalized.
- --------------------------------------------------------------------------------
69
- --------------------------------------------------------------------------------
NOTE 15 - REGULATORY MATTERS - (CONTINUED)
The 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.
The OTS Order, as amended, applicable to the approval of the New England
Acquisition (the "OTS Order") requires Sovereign Bank to be "Well Capitalized",
and also to meet certain additional capital ratio requirements above the
regulatory minimums, and other conditions. Various agreements with Sovereign's
lenders also require Sovereign Bank to be "Well Capitalized" at all times and in
compliance with all regulatory requirements. To be "well capitalized", a thrift
institution must maintain a Tier 1 Leverage ratio of at least 5%, a Tier 1
risk-based capital ratio of 6% and total risk-based capital of 10%. Although OTS
capital regulations do not apply to savings and loan holding companies, the OTS
Order requires Sovereign to maintain certain Tier 1 capital levels.
At December 31, 2001, Sovereign had met all quantitative thresholds necessary to
be classified as well-capitalized under regulatory guidelines and the OTS Order.
Federal banking laws, regulations and policies also limit Sovereign Bank's
ability to pay dividends and make other distributions to Sovereign Bancorp.
Sovereign Bank must obtain prior OTS approval to declare a dividend or make any
other capital distribution if, after such dividend or distribution, Sovereign
Bank's total distributions to us within that calendar year would exceed 100% of
its net income during the year plus retained net income for the prior two years,
Sovereign Bank would not meet capital levels imposed by the OTS in connection
with any order, including the OTS Order applicable to the New England
Acquisition, as amended, or if Sovereign Bank is not adequately capitalized at
the time. In addition, OTS prior approval would be required if Sovereign Bank's
examination or CRA ratings fall below certain levels or Sovereign Bank is
notified by the OTS that it is a problem association or an association in
troubled condition. The following schedule summarizes the actual capital
balances of Sovereign Bank at December 31, 2001 and 2000 (in thousands):
- --------------------------------------------------------------------------------
REGULATORY CAPITAL
TIER 1 TIER 1 TOTAL
TANGIBLE LEVERAGE RISK-BASED RISK-BASED
CAPITAL TO CAPITAL TO CAPITAL TO CAPITAL TO
TANGIBLE TANGIBLE RISK ADJUSTED RISK ADJUSTED
ASSETS ASSETS ASSETS ASSETS
----------- ----------- ----------- -----------
Sovereign Bank at December 31, 2001:
Regulatory capital ............................................ $ 2,464,222 $ 2,470,620 $ 2,368,893 $ 2,616,871
Minimum capital requirement (1) ............................... 685,584 2,399,545 979,792 2,571,955
----------- ----------- ----------- -----------
Excess ...................................................... $ 1,778,638 $ 71,075 $ 1,389,101 $ 44,916
=========== =========== =========== ===========
Capital ratio ................................................. 7.19% 7.21% 9.67% 10.68%
Sovereign Bank at December 31, 2000:
Regulatory capital ............................................ $ 2,227,236 $ 2,240,954 $ 2,121,722 $ 2,373,003
Minimum capital requirement (1) ............................... 639,815 1,701,908 910,435 2,330,713
----------- ----------- ----------- -----------
Excess ...................................................... $ 1,587,421 $ 539,046 $ 1,211,287 $ 42,290
=========== =========== =========== ===========
Capital ratio ................................................. 6.97% 7.01% 9.32% 10.43%
(1) As defined by OTS Regulations, or the OTS Order, as applicable.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
70
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 16 - STOCK OPTION PLANS
Beginning in 1990, Sovereign initiated its stock option plan. This plan 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 24.2 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 Sovereign's stock option activity for
the years ended December 31, 2001, 2000 and 1999 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, 1998 (3,371,038 shares exercisable).. 4,631,609 $ .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 ............................................................ (152,415) 3.78 - 16.35
---------
Options outstanding December 31, 1999 (4,154,213 shares exercisable) . 6,448,393 1.30 - 20.25
---------
Granted .............................................................. 2,207,778 6.69 - 7.81
Exercised ............................................................ (195,873) 1.30 - 6.53
Forfeited ............................................................ (449,744) 4.11 - 16.35
---------
Options outstanding December 31, 2000 (6,031,898 shares exercisable) . 8,010,554 1.94 - 20.25
---------
Granted .............................................................. 2,464,97 8.25 - 12.32
Exercised ............................................................ (489,949) 1.94 - 8.94
Forfeited ............................................................ (268,599) 6.24 - 16.35
---------
Options outstanding December 31, 2001 (7,301,406 shares exercisable) . 9,716,981 $2.25 - 20.25
=========
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
71
- --------------------------------------------------------------------------------
NOTE 16 - STOCK OPTION PLANS (CONTINUED)
The following table summarizes Sovereign's stock options outstanding at December
31, 2001:
- --------------------------------------------------------------------------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------- ----------------------
WEIGHTED
WEIGHTED AVERAGE WEIGHTED
AVERAGE REMAINING AVERAGE
EXERCISE CONTRACTUAL EXERCISE
EXERCISE PRICES SHARES PRICE LIFE SHARES PRICE
- --------------- --------- ------- ---- --------- -------
$2.25 - $6.69 ........... 1,851,943 $ 4.50 2.96 1,851,943 $ 4.50
$6.72 - $10.57 .......... 4,828,806 $ 7.82 8.35 2,593,806 $ 7.45
$11.80 - $20.25 ......... 3,036,232 $13.06 7.01 2,855,657 $13.11
--------- ------ ---- --------- ------
Total ................. 9,716,981 $ 8.82 6.90 7,301,406 $ 8.91
========= ====== ==== ========= ======
- --------------------------------------------------------------------------------
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.
For purposes of providing the pro forma disclosures required under SFAS 123,
"Accounting for Stock-Based Compensation", the fair values of stock options
granted were estimated at the date of grant using a Black-Sholes option pricing
model. The Black-Sholes option-pricing model was originally developed for use in
estimating the fair value of traded options, which have different
characteristics from the Company's employee stock options. The model is also
sensitive to changes in subjective assumptions, which can materially affect the
fair value estimate. As a result, management believes the Black-Sholes model may
not necessarily provide a reliable single measure of the fair value of employee
stock options.
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 2001 2000 1999
-------------- ------------- --------------
Expected volatility ...................... .352 .325 .296
Expected life in years ................... 6.00 6.00 6.00
Stock price on date of grant ............. $8.25 - $12.32 $6.69 - $7.81 $8.28 - $12.44
Exercise price ........................... $8.25 - $12.32 $6.69 - $7.81 $8.28 - $12.44
Weighted average exercise price .......... $ 8.55 $ 6.90 $ 11.34
Weighted average fair value .............. $ 3.39 $ 2.73 $ 3.98
Expected dividend yield .................. .82% 1.21% 1.40%
Risk-free interest rate .................. 4.78%-5.01% 6.67%-6.85% 5.17% - 6.75%
Vesting period in years .................. 1-5 1-5 1-5
- --------------------------------------------------------------------------------
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.
Had compensation cost for the Company's stock option plans been determined
consistent with SFAS 123, net income for 2001, 2000 and 1999, would have been
reduced by $3.5 million, $3.5 million and $3.2 million, respectively, and
diluted earnings per share would have been reduced by $.01, $.02 and $.02,
respectively.
- --------------------------------------------------------------------------------
72
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 17 - EMPLOYEE BENEFIT PLANS
Substantially all employees of Sovereign are eligible to participate in the
401(k) retirement plan following their completion of six months service and
attaining age 21. Sovereign recognized expense for contributions to this plan of
$6.5 million, $5.2 million and $2.1 million during 2001, 2000 and 1999,
respectively. Pursuant to this plan, employees can contribute up to 12% of their
compensation to the plan. Sovereign contributes 100% of the employee
contribution up to 3% of compensation and 50% of the employee contribution from
3% to 5% 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 following
completion of one year of service and attaining age 21. 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.
Peoples also sponsored a leveraged ESOP that Sovereign assumed upon acquisition
in 1999 at which point all of the Peoples' shares were converted into Sovereign
shares, (collectively, "the ESOPs").
The ESOPs are defined contribution plans, which provide retirement benefits for
participants and beneficiaries in the form of Sovereign common stock. The ESOPs
were funded through direct loans from the sponsoring company and proceeds from
these loans were used to purchase outstanding shares of the sponsoring company'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.
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 debt
requirements of the ESOPs. Sovereign recognized as expense $3.3 million, $2.6
million and $3.4 million for the ESOPs in 2001, 2000 and 1999, respectively. At
December 31, 2001, the ESOPs held 6.3 million shares of Sovereign stock of which
2.0 million shares were allocated to participant accounts. The unallocated ESOP
shares are presented as a reduction of stockholders' equity in the consolidated
financial statements. At December 31, 2001, the unallocated ESOP shares had a
fair market value of $52.5 million and the ESOPs had $42.7 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 $1.7 million, $1.9 million,
and $1.0 million for these plans in 2001, 2000 and 1999, respectively.
During 2001, Sovereign instituted a Restricted Stock Plan as described in Note
14. Sovereign recognized expense of $2.9 million, during 2001.
Sovereign sponsored several non-contributory defined benefit pension plans,
which covered substantially all employees, and former employees of certain
institutions acquired by Sovereign. Benefits were frozen effective March 31,
1999. Sovereign recorded a curtailment gain of $1.6 million in 1999 and a
settlement gain of $1.3 million (net of excise tax expense of $1.2 million) in
2000. $2.0 million of plan assets were transferred to Sovereign's 401(k) plan
and $6.2 million was returned to Sovereign in 2000 after settlement of benefit
obligations was completed. Sovereign also sponsors a supplemental executive
retirement plan ("SERP") and several postemployment benefit plans of several
institutions acquired by Sovereign. Increasing or decreasing the assumed health
care cost trend rate would not have a significant impact on the accumulated post
retirement benefit obligation at December 31, 2001, and the aggregate of the
service and interest components of net benefit expense for the year ended
December 31, 2001.
- --------------------------------------------------------------------------------
73
- --------------------------------------------------------------------------------
NOTE 17 - EMPLOYEE BENEFIT PLAN - (CONTINUED)
Sovereign's benefit obligation related to its SERP plan was $3.9 million and
$3.8 million at December 31, 2001 and 2000, respectively. Sovereign's benefit
obligation related to its postemployment plans was $1.1 million at December 31,
2001 and 2000. The SERP and the postemployment plans are unfunded plans.
Sovereign recognized as expense $0.7 million, $0.8 million and $0.8 million
related to these plans in 2001, 2000 and 1999, respectively.
NOTE 18 - 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,
----------------------------------------------
2001 2000 1999
------------ ------------ ------------
Current:
Federal .............................................. $ 38,140 $ (10,157) $ 69,656
State ................................................ 508 -- 807
------------ ------------ ------------
38,648 (10,157) 70,463
Deferred:
Federal .............................................. (15,599) (55,181) 18,852
State ................................................ -- 5,348 --
------------ ------------ ------------
Total income tax expense (benefit) ..................... $ 23,049 $ (59,990) $ 89,315
============ ============ ============
- --------------------------------------------------------------------------------
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,
----------------------------------------------
2001 2000 1999
------------ ------------ ------------
Federal income tax at statutory rate ................... 35.0% (35.0)% 35.0%
Increase/(decrease) in taxes resulting from:
Tax-exempt income .................................... (6.8) (5.4) (2.8)
Bank owned life insurance ............................ (10.5) (12.9) (3.0)
State income taxes, net of federal tax benefit ....... 0.2 0.0 0.2
Recordation of valuation allowance ................... 0.0 6.0 0.0
Amortization of intangible
assets and other purchase
accounting adjustments ............................. 2.3 3.5 0.9
Capital loss utilization ............................. 0.0 (26.0) 0.0
Other ................................................ (3.8) 3.3 2.9
------------ ------------ ------------
Effective federal tax rate ............................. 16.4% (66.5)% 33.2%
============ ============ ============
- --------------------------------------------------------------------------------
74
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 18 - INCOME TAXES - (CONTINUED)
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,
---------------------------
2001 2000
----------- -----------
Deferred tax assets:
Allowance for possible loan losses ............... $ 40,144 $ 42,031
Purchased mortgage servicing rights .............. 4,362 --
Employee benefits ................................ -- --
Depreciation and amortization .................... 18,534 14,384
Purchase accounting adjustments .................. 317 6,982
Unrealized loss on available for sale portfolio .. -- 29,300
Unrealized loss on derivatives ................... 21,890 --
Net operating loss carry forwards ................ 1,983 4,542
Non-solicitation covenant ........................ 108,997 33,383
Capital losses ................................... 3,500 22,472
Deferred OID Expense ............................. -- 1,323
Other ............................................ 19,800 3,542
----------- -----------
Total gross deferred tax assets ................ $ 219,527 $ 157,959
----------- -----------
Deferred tax liabilities:
Purchase accounting adjustments .................. $ 7,651 $ 7,077
Deferred income .................................. 62,997 17,342
Tax bad debt reserve recapture ................... 2,451 3,412
Originated mortgage servicing rights ............. 15,612 6,449
Unrealized gain on available for sale portfolio .. 4,969 --
Purchased mortgage servicing rights .............. -- 1,076
Depreciation and amortization .................... -- 7,337
Employee benefits ................................ 1,857 840
Other ............................................ 12,537 8,249
----------- -----------
Total gross deferred tax liabilities ............. $ 108,074 $ 51,782
----------- -----------
Net deferred tax asset ............................. $ 111,453 $ 106,177
=========== ===========
- --------------------------------------------------------------------------------
During 2000, Sovereign established a $5 million valuation allowance related to
previously recognized state tax net operating losses. The valuation allowance
was necessary due to structural changes at Sovereign resulting from the New
England Acquisition. For the remainder of Sovereign's deferred tax assets, no
valuation allowance is necessary due to Sovereign's conclusion that it is "more
likely than not" that the deferred tax assets will be realized, based on a
history of growth in earnings, the prospects for continued growth, including an
analysis of potential uncertainties that may offset future operating results,
and potential tax planning strategies that could be employed in the future.
Sovereign will continue to review the criteria related to the recognition of
deferred tax assets on a quarterly basis.
The Company has an unrecognized deferred tax liability of $858 thousand related
to earnings that are considered permanently reinvested in a consolidated Foreign
special purpose entity related to the indirect automobile loan securitization.
- --------------------------------------------------------------------------------
75
- --------------------------------------------------------------------------------
NOTE 19 - 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.
The following schedule summarizes Sovereign's off-balance sheet financial
instruments (in thousands):
- --------------------------------------------------------------------------------
CONTRACT OR NOTIONAL AMOUNT
AT DECEMBER 31,
---------------------------
2001 2000
----------- -----------
Financial instruments whose contract amounts
represent credit risk:
Commitments to extend credit ................... $ 6,765,595 $ 5,812,328
Standby letters of credit ...................... 674,397 564,226
Loans sold with recourse ....................... 54,610 20,647
Forward contracts .............................. 443,162 115,914
- --------------------------------------------------------------------------------
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 required is
based on management's credit evaluation of the counterparty. Collateral 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. 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. These contracts are also considered derivative instruments under
SFAS 133 and changes in the fair value of contracts are recorded on the balance
sheet as either derivative assets or liabilities. Further discussion of
derivative financial instruments is included in Notes 1 and 21.
Litigation. At December 31, 2001, 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.
- --------------------------------------------------------------------------------
76
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 19 - COMMITMENTS AND CONTINGENCIES - (CONTINUED)
Leases. Sovereign is committed under various non-cancelable operating leases
relating to branch facilities having initial or remaining terms in excess of one
year. Future minimum annual rentals under non-cancelable leases, net of sublease
income at December 31, 2001, are summarized as follows (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31, 2001
----------------------------------------------
FUTURE MINIMUM
----------------------------------------------
LEASE SUBLEASE NET
PAYMENTS INCOME PAYMENTS
------------ ------------ ------------
2002 ................................................... $ 103,842 $ (12,049) $ 91,793
2003 ................................................... 98,706 (8,415) 90,291
2004 ................................................... 92,338 (6,200) 86,138
2005 ................................................... 185,181 (5,224) 179,957
2006 ................................................... 30,155 (4,662) 25,493
Thereafter ............................................. 100,333 (7,329) 93,004
------------ ------------ ------------
Total ................................................ $ 610,555 $ (43,879) $ 566,676
============ ============ ============
- --------------------------------------------------------------------------------
NOTE 20 - 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):
- --------------------------------------------------------------------------------
77
- --------------------------------------------------------------------------------
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS - (CONTINUED)
AT DECEMBER 31
------------------------------------------------------
2001 2000
-------------------------- -------------------------
CARRYING CARRYING
VALUE FAIR VALUE VALUE FAIR VALUE
----------- ----------- ----------- -----------
Financial Assets:
Cash and amounts due from depository institutions ........... $ 887,964 $ 887,964 $ 945,196 $ 945,196
Interest-earning deposits ................................... 19,315 19,315 14,447 14,447
Loans held for sale ......................................... 308,950 308,950 59,993 60,148
Investment securities:
available for sale ........................................ 9,581,679 9,581,679 5,315,584 5,315,584
held to maturity .......................................... 883,437 883,208 1,978,268 1,971,896
Loans, net .................................................. 19,825,967 20,095,784 21,655,889 21,604,291
Mortgage servicing rights ................................... 50,718 55,848 39,358 44,618
Exchange traded futures ..................................... 18,758 18,758 38,849 38,849
Financial Liabilities:
Deposits .................................................... 23,297,574 21,776,746 24,498,917 24,430,465
Borrowings .................................................. 8,939,770 9,138,438 6,240,308 6,202,987
Interest rate derivative instruments (1) .................... (46,922) (46,922) -- --
Trust preferred securities .................................. 404,136 634,695 319,545 312,336
Unrecognized Financial Instruments:(2)
Commitments to extend credit ................................ 50,531 50,665 44,432 44,306
Interest rate derivative instruments (1) .................... -- -- 957 5,779
(1) In 2001, the Company adopted SFAS 133, "Accounting For Derivative
Instruments and Hedging Activities." Accordingly, all derivative financial
instruments are recorded at fair value on the balance sheet at December 31,
2001.
(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.
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.
- --------------------------------------------------------------------------------
78
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS - (CONTINUED)
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 and Long Term Debt. Fair value is estimated by discounting cash flows
using rates currently available to Sovereign for other borrowings with similar
terms and remaining maturities. Certain long-term debt instruments are valued
using available market quotes.
Trust Preferred Securities. Trust preferred securities are valued using
available market quotes.
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 derivative instruments. 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.
Exchange traded futures. Exchange traded futures are valued using available
market quotes.
NOTE 21 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Sovereign uses derivative instruments as part of its interest rate risk
management process, to manage risk associated with its mortgage banking
activities, and to assist its commercial banking customers with their risk
management strategies.
Sovereign's primary market risk is interest rate risk. Management uses
derivative instruments to protect against the risk of interest rate movements on
the value of certain liabilities and on probable future cash outflows. These
instruments primarily include interest rate swaps and interest rate caps and
floors that have underlying interest rates based on key benchmark indexes. The
nature and volume of the derivative instruments used to manage interest rate
risk depend on the level and type of assets and liabilities on the balance sheet
and the risk management strategies for the current and anticipated rate
environment. As discussed in Note 1, on January 1, 2001, the Corporation adopted
SFAS 133, "Accounting for Derivative Instruments and Hedging Activities", which
requires all derivative instruments to be carried at fair value on the balance
sheet. Prior to 2001, unrealized gains and losses on derivatives used for
hedging purposes were generally not required to be reported in the financial
statements. In order to reduce the earnings volatility that would result from
having to recognize in earnings the fair value of certain derivative instruments
used to hedge risks associated with financial instruments not carried at fair
value, SFAS 133 provides special hedge accounting provisions. These provisions
permit the change in the fair value of the hedged item related to the risk being
hedged to be recognized in earnings in the same period and in the same income
statement line as the change in fair value of the derivative. Note 1 provides
further detail on how derivative instruments are accounted for in the financial
statements. The Company designates derivative instruments used to manage
interest rate risk into SFAS 133 hedge relationships with the specific assets,
liabilities, or cash flows being hedged.
Credit risk is the risk that a counterparty to a derivative contract with which
Sovereign has an unrealized gain fails to perform according to the terms of the
agreement. Credit risk is managed by limiting the aggregate amount of net
unrealized gains in agreements outstanding, monitoring the size and the maturity
structure of the derivative portfolio, applying uniform credit standards
maintained for all activities with credit risk, and collateralizing gains.
- --------------------------------------------------------------------------------
79
- --------------------------------------------------------------------------------
NOTE 21 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - (CONTINUED)
The credit risk associated with derivative instruments executed with Sovereign's
commercial banking customers is essentially the same as that involved in
extending loans and is subject to normal credit policies.
Fair Value Hedges. During 2001, Sovereign used receive-fixed interest rate swaps
to hedge the fair values of certain brokered CDs for changes in interest rates.
All of Sovereign's interest rate swaps accounted for as fair value hedges
outstanding as of December 31, 2001, as well as those that matured during the
year, satisfied the criteria in SFAS 133 to use the "short-cut" method of
accounting for changes in fair value. The short-cut method allows the Company to
assume that there is no ineffectiveness in the hedging relationship and that
changes in the fair value of the derivative perfectly offset changes in the fair
value of the hedged asset or liability, resulting in no volatility in earnings.
Cash Flow Hedges. During 2001, Sovereign hedged cash flow variability related to
variable-rate liabilities, specifically FHLB advances, through the use of
pay-fixed interest rate swaps. Sovereign also held pay-fixed interest rate swaps
to hedge forecasted cash flows associated with periodic floating rate interest
payments payable subsequent to 2001. All of Sovereign's interest rate swaps
accounted for as cash flow hedges outstanding as of December 31, 2001, as well
as those that matured during the year, satisfied the criteria in SFAS 133 to use
the short-cut method of accounting for changes in fair value. Refer to the
discussion above regarding the effects of the short-cut method.
Gains and losses on derivative instruments reclassified from accumulated other
comprehensive income to current-period earnings are included in the line item in
which the hedged cash flows are recorded. At December 31, 2001, accumulated
other comprehensive income included a deferred after-tax net loss of $40.7
million, consisting of a loss on pay-fixed interest rate swaps used to hedge
future cash flows on FHLB advances. The loss will be reclassified from other
comprehensive income into earnings during the same period the forecasted
transactions occur. See Note 24 for further detail of the amounts included in
accumulated other comprehensive income. During 2001, $11.4 million pretax was
reclassified out of comprehensive income into current period interest expense as
the forecasted hedge transactions occurred. Sovereign reclassified $14.7 million
of losses into earnings, classified as gain/loss on sale of investment
securities and related derivatives, in 2001 because it became probable that the
original forecasted transaction would not occur.
Other Derivative Activities. Sovereign's derivative portfolio also includes
derivative instruments not included in SFAS 133 hedge relationships. Those
derivatives include mortgage banking loan commitments and forward sales defined
as derivatives under SFAS 133 used for risk management purposes, and derivatives
executed with customers, primarily interest rate swaps and foreign exchange
futures, to facilitate their risk management strategies. In connection with the
indirect automobile loan securitization transaction discussed in Note 11,
Sovereign was required to purchase, on behalf of its securitization SPE, an
interest rate cap with a $900 million notional value from a third party.
Sovereign also sold an identical interest rate cap with a notional value of $
900 million to the same third party. Sovereign assigned the purchased interest
rate cap to the SPE. At December 31, 2001, the fair value of the sold interest
rate cap was an asset of $50.5 million and the fair value of the purchased
interest rate cap was a liability of $50.5 million.
Net gains generated from other than hedging derivative instruments in 2001
totaled $5.9 million and are included as capital markets revenue on the income
statement.
All derivative contracts are valued using either cash flow projection models or
observable market prices. Pricing models used for valuing derivative instruments
are regularly validated by testing through comparison with third parties.
- --------------------------------------------------------------------------------
80
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 21 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - (CONTINUED)
Summary information regarding derivatives designated as accounting hedges under
SFAS 133 at December 31, 2001 follows (in thousands):
- --------------------------------------------------------------------------------
WEIGHTED AVERAGE
------------------------------
NOTIONAL RECEIVE LIFE
AMOUNT ASSET LIABILITY RATE PAY RATE (YEARS)
---------- ---------- ---------- ------- -------- -------
Fair value hedges:
Receive fixed - pay variable interest rate swaps .. $ 397,449 $ 7,568 $ 1,282 5.98% 1.97% 1.5
Cash flow hedges:
Pay fixed - receive floating interest rate swaps .. 3,050,000 10,125 72,668 1.92% 6.09% 5.1
--------- ------ ------ ---- ---- ---
Total derivatives used in SFAS 133
hedging relationships ............................. $3,447,449 $ 17,693 $ 73,950 2.39% 5.62% 4.7
========== ========== ==========
- --------------------------------------------------------------------------------
Summary information regarding other derivative activities at December 31, 2001
follows (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31, 2001
--------------------------------------------------------
NOTIONAL POSITIVE NEGATIVE NET ASSET
AMOUNT FAIR VALUE FAIR VALUE (LIABILITY)
----------- ----------- ----------- -----------
Mortgage banking risk management:
Forward commitments:
To buy loans .............................................. $ 65,000 $ 10 $ (307) $ (297)
To sell loans ............................................. 508,162 5,871 (2,198) 3,673
----------- ----------- ----------- -----------
Total mortgage banking risk management ........................ 573,162 5,881 (2,505) 3,376
----------- ----------- ----------- -----------
Customer related:
Interest rate swaps:
Pay variable-receive fixed .................................. 956,580 39,730 (16,198) 23,532
Pay fixed-receive variable .................................. 848,960 18,716 (34,650) (15,934)
Basis ....................................................... 20,000 -- (21) (21)
Futures ....................................................... 17,512 1,758 -- 1,758
Interest rate caps/floors/collars ............................. 41,420 5 (5) --
----------- ----------- ----------- -----------
Total interest rate risk management ........................... 1,884,472 60,209 (50,874) 9,335
----------- ----------- ----------- -----------
Foreign exchange:
Forwards purchased .......................................... 36,828 272 (159) 113
Forwards sold ............................................... 35,893 369 (190) 179
----------- ----------- ----------- -----------
Total foreign exchange ........................................ 72,721 641 (349) 292
----------- ----------- ----------- -----------
Total other activity .......................................... $ 2,530,355 $ 66,731 $ (53,728) $ 13,003
=========== =========== =========== ===========
- --------------------------------------------------------------------------------
81
- --------------------------------------------------------------------------------
NOTE 21 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - (CONTINUED)
Summary information regarding derivatives used for risk management purposes at
December 31, 2000 follows (in thousands):
- --------------------------------------------------------------------------------
UNREALIZED WEIGHTED AVERAGE
--------------------------------------- ----------------------------------------
NOTIONAL RECEIVE PAY STRIKE
AMOUNT GAINS LOSSES RATE RATE RATE
---------- ---------- ---------- ------- ---- -------------
Interest rate risk management:
Receive fixed - pay variable interest
rate swaps (1) ....................... $ 858,294 $ 16,395 $ 975 7.31% 6.48% --
Pay fixed - receive floating interest
rate swaps (2) ...................... 400,000 -- 10,087 6.49% 7.12% --
Interest rate caps/floors/collars(2) ... 500,000 -- 166 -- -- 6.00% - 6.55%
Mortgage banking loan
commitments (2) ..................... 34,000 115 27 -- -- --
Mortgage banking forward sales (2) ..... 149,914 77 1,333 -- -- --
---------- ---------- ----------
Total interest rate risk management ...... 1,942,208 16,587 12,588
Customer related:
Receive fixed - pay variable interest
rate swaps ........................... 502,532 496 11,320
Pay fixed - receive floating interest
rate swaps ........................... 512,390 13,008 404
Interest rate caps/floors/collars ...... 105,701 105 105
Exchange traded futures ................ 38,849 -- --
---------- ---------- ----------
Total customer related ................... 1,159,472 13,609 11,829
Total derivatives ........................ $3,101,680 $ 30,196 $ 24,417
========== ========== ==========
(1) Recorded through other comprehensive income
(2) Recorded through the income statement
- --------------------------------------------------------------------------------
Net interest income resulting from interest rate exchange agreements included
$11.6 million of income and $11.4 million of expense for 2001, $6.4 million of
income and $.1 million of expense for 2000 and $.5 million of income and $8.9
million of expense for 1999.
NOTE 22 - ASSET SECURITIZATIONS
During 2000 the Company acquired the servicing responsibilities, and retained
interest only strips, related to home equity, boat and recreational vehicles
which were previously securitized, as part of the New England Acquisition. The
Company receives annual servicing fees approximating 0.50% for home equity loans
and for boat and recreational vehicle loans. The investors and securitization
trusts have no recourse to the Company's other assets for failure of debtors to
pay when due. The Company's retained interests are subordinate to investor
interests. Their value is subject to credit, prepayment and interest rate risks
on the transferred financial assets.
In 2000, the Company recognized a pretax gain of $2.5 million on the
securitization of home equity loans and a pretax loss of $(2.3) million on the
securitization of automotive floor plan loans.
- --------------------------------------------------------------------------------
82
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 22 - ASSET SECURITIZATIONS - (CONTINUED)
The types of assets underlying securitizations for which Sovereign owns a
retained interest and the related balances, delinquencies, and net credit losses
are as follows (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31, 2001 AT DECEMBER 31, 2000
-------------------------------------- -------------------------------------
PRINCIPAL PRINCIPAL
TOTAL 90 DAYS NET CREDIT TOTAL 90 DAYS NET CREDIT
PRINCIPAL PAST DUE LOSSES PRINCIPAL PAST DUE LOSSES
---------- ---------- ---------- ---------- ---------- ------
Loans Securitized:
Home Equity Loans ........................ $ 864,730 $ 55,462 $ 6,712 $1,167,879 $ 40,193 $3,492
Boat Loans ............................... 105,798 721 778 153,708 13 698
Recreational Vehicle Loans ............... 210,785 756 2,153 315,840 835 2,175
Automotive Floor Plan Loans .............. 579,000 -- -- 579,000 -- --
---------- ---------- ---------- ---------- ---------- ------
Total Securitized ........................ $1,760,313 $ 56,939 $ 9,643 $2,216,427 $ 41,041 $6,365
---------- ========== ========== ---------- ========== ======
Loans Held in Portfolios:
Home Equity Loans ........................ $3,756,621 $3,256,598
Boat Loans (1) ........................... 5,536 6,521
Recreational Vehicle Loans ............... -- --
Automotive Floor Plan Loans .............. 315,713 317,281
---------- ----------
Total Held in Portfolio .................. 4,077,870 3,580,400
---------- ----------
Total Loans Managed ...................... $5,838,183 $5,796,827
========== ==========
(1) Boat loans are included in other consumer loans.
- --------------------------------------------------------------------------------
The components of retained interest and key economic assumptions used in
measuring the retained interest at the date of securitization resulting from
securitizations completed during the year were as follows (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31
-------------------------------------------------------
RECREATIONAL AUTOMOTIVE
HOME EQUITY BOAT VEHICLES FLOOR PLAN
----------- ---- -------- ----------
Components of Retained Interest:
Subordinated interest retained ................................ $ -- $ 519 $ 511 $ 21,000
Servicing rights .............................................. 6,805 731 1,425 --
Interest only strips .......................................... 55,172 15,126 13,300 657
Cash reserve .................................................. -- -- -- 5,606
----------- ----------- ----------- -----------
Total Retained Interest ....................................... $ 61,977 $ 16,376 $ 15,236 $ 27,263
=========== =========== =========== ===========
Key Economic Assumptions:
Prepayment speed .............................................. 26% 28% 28% N/A
Weighted average life (in years) .............................. 8 5 5 .17
Expected credit losses ........................................ 0.75% 0.40% 0.45% 0.25%
Residual cashflows discount rate .............................. 12% 11% 11% 10%
- --------------------------------------------------------------------------------
The table below summarizes certain cash flows received from and paid to
off-balance sheet securitization trusts (in thousands):
- --------------------------------------------------------------------------------
FOR THE YEAR ENDED
------------------------------------
DECEMBER 31, 2001 DECEMBER 31, 2000
----------------- -----------------
Proceeds from new securitizations .................. $ -- $ 948,456
Servicing fees received ............................ 13,059 1,577
Other cash flows received on retained interests .... 8,755 22,581
Purchases of delinquent or foreclosed assets ....... 928 262
Servicing advances ................................. -- 1,916
Repayments of servicing advances ................... -- 856
- --------------------------------------------------------------------------------
83
- --------------------------------------------------------------------------------
NOTE 22 - ASSET SECURITIZATIONS - (CONTINUED)
At December 31, 2001 and 2000, key economic assumptions and the sensitivity of
the fair value of the retained interests to immediate 10 percent and 20 percent
adverse changes in those assumptions are as follows (in thousands):
- --------------------------------------------------------------------------------
DECEMBER 31, 2001 DECEMBER 31, 2000
----------------------------------------------- -----------------------------------------------
HOME EQUITY BOAT AUTO FLOOR HOME EQUITY BOAT AUTO FLOOR
LOANS LOANS RV LOANS PLAN LOANS LOANS LOANS RV LOANS PLAN LOANS
----- ----- -------- ---------- ----------- ------- --------- ----------
Fair value of retained interests $61,977 $16,376 $15,236 $27,263 $64,691 $18,684 $20,305 $26,689
Weighted-average life (in yrs) . 8 5 5 0.17 18 15 12 0.17
Prepayment speed
assumption (annual rate) ..... 26% 28% 28% -- 27% 2% 2% --
Impact on fair value of
10% adverse change ......... $(1,890) $ (200) $ (751) $ (26) $(1,900) $ (200) $ (200) $ (26)
Impact on fair value of
20% adverse change ......... $(3,460) $ (228) $ (871) $ (47) $(4,700) $ (300) $ (300) $ (47)
Expected credit losses
(annual rate) ................ 0.75% 0.40% 0.45% 0.25% 0.75% 0.26% 0.45% 0.25%
Impact on fair value of
10% adverse change ......... $(1,743) $ (75) $ (250) $ (18) $(2,100) $ (100) $ (100) $ (18)
Impact on fair value
20% adverse change ......... $(3,230) $ (149) $ (449) $ (36) $(3,500) $ (100) $ (100) $ (36)
Residual cash flows
discount rate (annual) ....... 12% 11% 11% 10% 12% 11% 11% 10%
Impact on fair value of
10% adverse change ......... $(2,888) $ (325) $ (629) $ (220) $(3,000) $ (500) $ (400) $ (220)
Impact on fair value of
20% adverse change ......... $(4,793) $ (643) $(1,221) $ (428) $(5,700) $ (900) $(1,500) $ (428)
- --------------------------------------------------------------------------------
These sensitivities are hypothetical and should be used with caution. As the
figures indicate, changes in fair value based on a 10 percent variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another
(for example, increases in market interest rates may result in lower prepayments
and increased credit losses), which might magnify or counteract the
sensitivities.
Actual and expected static pool credit losses as a percent of the original pool
balance are as follows:
- --------------------------------------------------------------------------------
Actual and Projected Credit Losses as of December 31, 2001: 2001 2002 2003
- ----------------------------------------------------------- ---- ---- ----
Home Equity Loans .......................................... 0.55% 0.75% 0.75%
Boat Loans ................................................. 0.19% 0.40% 0.40%
Recreational Vehicle Loans ................................. 0.25% 0.45% 0.45%
Automotive Floor Plan Loans ................................ --% 0.25% 0.25%
- --------------------------------------------------------------------------------
84
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 23 - 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):
- --------------------------------------------------------------------------------
2001 2000 1999
------------ ------------ ------------
Calculation of income/(loss) for EPS:
Income /(loss) before extraordinary item for basic EPS . $ 123,370 $ (41,017) $ 179,299
Extraordinary item, after tax .......................... (6,549) 10,775 --
------------ ------------ ------------
Net income for basic and diluted EPS ................... $ 116,821 $ (30,242) $ 179,299
============ ============ ============
Calculation of shares:
Weighted average basic shares .......................... 244,643 225,881 176,021
Dilutive effect of average stock options and warrants .. 12,252 -- 2,146
------------ ------------ ------------
Weighted average fully diluted shares .................. 256,895 225,881 178,167
============ ============ ============
Earnings/(loss) per share:
Basic
Income/(loss) before extraordinary item .............. $ 0.51 $ (0.18) $ 1.02
Extraordinary item ................................... (0.03) 0.05 --
------------ ------------ ------------
Net income/(loss) .................................... $ 0.48 $ (0.13) $ 1.02
============ ============ ============
Diluted
Income/(loss) before extraordinary item .............. $ 0.48 $ (0.18) $ 1.01
Extraordinary item ................................... (0.03) 0.05 --
------------ ------------ ------------
Net income/(loss) .................................... $ 0.45 $ (0.13) $ 1.01
============ ============ ============
- --------------------------------------------------------------------------------
NOTE 24 - 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,
-----------------------------------------
2001 2000 1999
----------- ----------- -----------
Net income/(loss) ..................................................................... $ 116,821 $ (30,242) $ 179,299
Cumulative change in accounting principle:
Fair value of derivative instruments and hedged items ............................... (6,736) -- --
Reclassification of held-to-maturity securities to available-for-sale ............... (3,215) -- --
----------- ----------- -----------
Net unrealized gain/(loss) on derivative instruments for the period ................... (47,650) -- --
Net unrealized gain/(loss) on investment securities available-for-sale for the period . 65,650 93,841 (227,550)
Less reclassification adjustment: Derivative instruments .............................. (16,948) -- --
Investments available for sale ...................... 19,611 (78,570) 1,502
----------- ----------- -----------
Net unrealized gain/(loss) recognized in other comprehensive income ................... 15,337 172,411 (229,052)
----------- ----------- -----------
Comprehensive income/(loss) ........................................................... $ 122,207 $ 142,169 $ (49,753)
=========== =========== ===========
- --------------------------------------------------------------------------------
85
- --------------------------------------------------------------------------------
NOTE 25 - PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Sovereign Bancorp is as follows (in
thousands):
BALANCE SHEETS AT DECEMBER 31,
----------------------------
2001 2000
----------- -----------
Assets
Cash and due from banks ............................ $ 51,080 $ --
----------- -----------
Investment securities:
Available for sale ............................... 2,005 1,075
Investment in subsidiaries:
Bank subsidiary .................................. 3,642,987 3,521,070
Non-bank subsidiaries ............................ 159,068 131,199
Other assets ....................................... 90,740 115,215
----------- -----------
Total Assets ....................................... $ 3,945,880 $ 3,768,559
=========== ===========
Liabilities and Stockholders' Equity
Borrowings:
Long-term debt ................................... $ 1,169,831 $ 1,359,925
Borrowings from non-bank subsidiaries ............ 505,105 365,970
Other liabilities .................................. 68,463 93,780
----------- -----------
Total liabilities .................................. 1,743,399 1,819,675
----------- -----------
Stockholders' Equity ............................... 2,202,481 1,948,884
----------- -----------
Total Liabilities and Stockholders' Equity ......... $ 3,945,880 $ 3,768,559
=========== ===========
STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31,
--------------------------------------------
2001 2000 1999
------------ ------------ ------------
Dividends from:
Bank subsidiary ............................................... $ 130,000 $ 100,000 $ 25,000
Non-bank subsidiaries ......................................... -- 16,828 --
Interest income ................................................. 3,053 35,016 6,847
Other income .................................................... -- (2,388) 149
------------ ------------ ------------
Total income .................................................... 133,053 149,456 31,996
------------ ------------ ------------
Interest expense ................................................ 156,540 180,761 56,668
Other expense ................................................... 6,360 8,317 28,976
------------ ------------ ------------
Total expense ................................................... 162,900 189,078 85,644
------------ ------------ ------------
Loss before income taxes and equity in earnings of subsidiaries
and extraordinary item ........................................ (29,847) (39,622) (53,648)
Income taxes .................................................... (59,234) (58,450) (28,403)
------------ ------------ ------------
Income/(loss) before equity in earnings of subsidiaries
and extraordinary item ........................................ 29,387 18,828 (25,245)
Extraordinary item (net of tax of $3,526) ....................... 6,549 -- --
------------ ------------ ------------
Income/(loss) before equity in earnings of subsidiaries ......... 22,838 18,828 (25,245)
Equity in undistributed earnings/(loss) of:
Bank subsidiary ............................................... 96,104 (45,504) 198,874
Non-bank subsidiaries ......................................... (2,121) (3,566) 5,670
------------ ------------ ------------
Net income/(loss) ............................................... $ 116,821 $ (30,242) $ 179,299
============ ============ ============
- --------------------------------------------------------------------------------
86
- -------------------NOTES TO CONSOLIDATED FINANCIAL STATEMENTS------------------
NOTE 25 - PARENT COMPANY FINANCIAL INFORMATION (CONTINUED)
STATEMENT OF CASH FLOWS YEAR ENDED DECEMBER 31,
--------------------------------------------
2001 2000 1999
------------ ------------ ------------
Cash Flows from Operating Activities:
Net income/(loss) ...................................... $ 116,821 $ (30,242) $ 179,299
Adjustments to reconcile net income/(loss) to
net cash provided by operating activities:
Undistributed (earnings)/loss of:
Bank subsidiary ...................................... (96,104) 45,504 (198,874)
Non-bank subsidiaries ................................ 2,121 3,566 (5,670)
Loss on retirement of long-term debt ................... 10,075 -- --
Other, net ............................................. (8,728) 6,610 (24,314)
------------ ------------ ------------
Net cash provided (used) by operating activities ....... 24,185 25,438 (49,559)
------------ ------------ ------------
Cash Flows from Investing Activities:
Net capital contributed to subsidiaries ................ (21,088) (563,275) (768,777)
Investment securities:
Maturity and repayments .............................. (930) 765,458 --
Net purchase and sales ............................... -- (797) (994,788)
Net cash received from business combinations ........... -- -- 51
------------ ------------ ------------
Net cash provided (used) by investing activities ....... (22,018) 201,386 (1,763,514)
------------ ------------ ------------
Cash Flows from Financing Activities:
Net change in borrowings:
Repayment of long-term debt .......................... (715,000) (227,742) --
Net proceeds received from long-term debt ............ 525,000 -- 1,239,894
Net change in borrowings from non-bank subsidiaries .. 109,808 18,365 202,735
Sale (acquisition) of treasury stock ................... 85 (194) (46,867)
Acquisition of Restricted Stock ........................ (3,083) -- --
Cash dividends paid to stockholders .................... (24,790) (22,499) (17,104)
Net proceeds from issuance of common stock ............. 156,893 5,244 342,803
Net proceeds from issuance of warrants ................. -- -- 91,500
------------ ------------ ------------
Net cash provided (used) by financing activities ....... 48,913 (226,826) 1,812,961
------------ ------------ ------------
(Decrease) increase in cash and cash equivalents ....... 51,080 (2) (112)
Cash and cash equivalents at beginning of period ....... -- 2 114
------------ ------------ ------------
Cash and cash equivalents at end of period ............. $ 51,080 $ -- $ 2
============ ============ ============
- --------------------------------------------------------------------------------
87
- --------------------------------------------------------------------------------
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
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 2002 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 "Section 16(a)
Beneficial Ownership Reporting Compliance" 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
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.
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
Registration Statement No. 333-86961-01 on Form S-3.)
- --------------------------------------------------------------------------------
88
- --------------------------------------------------------------------------------
3. EXHIBITS. (continued)
(3.2) By-Laws of Sovereign Bancorp, Inc. (Incorporated by reference to
Exhibit 3.2 to Sovereign's Annual Report on Form 10-K for the fiscal year
ended December 31, 1998.)
(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 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, SEC File No.
0-16533, 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) Employment 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 Amended Quarterly Report on Form 10-Q/A, SEC
File No. 0-16533, for the fiscal quarter ended March 31, 1997.)
(10.4) Employment Agreement, dated as of May 1, 1997, between ML Bancorp,
Inc. (a predecessor company of Sovereign Bancorp, Inc.) and Dennis S. Marlo.
(10.5) Employment Agreement, dated as of September 25, 1997, between
Sovereign Bancorp, Inc. and Lawrence M. Thompson, Jr. (Incorporated by
reference to Exhibit 10.5 to Sovereign's Annual Report on Form 10-K, SEC
File No. 0-16533, for the fiscal year ended December 31, 1997.)
(10.6) Amended and Restated Rights Agreement, (the "Rights Agreement"),
dated as of June 21, 2001, between Sovereign Bancorp, Inc. and Mellon
Investor Services LLC (Incorporated herein by reference to Exhibit 4.1 of
the Registrant's 8-K/A No. 2 filed July 3, 2001).
(10.7) Form of Rights Certificate (Incorporated herein by reference to
Exhibit B to the Rights Agreement). Pursuant to the Rights Agreement, Rights
will not be distributed until after the Distribution Date (as defined in the
Rights Agreement).
(10.8) Sovereign Bancorp, Inc. Non-Employee Directors Services Compensation
Plan.
(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, SEC
File No. 0-16533, for the fiscal 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, SEC File No. 0-16533, for the
fiscal year ended December 31, 1993.)
(10.11) Sovereign Bancorp, Inc. 1997 Non-Employee Director's Stock Option
Plan. (Incorporated by reference to Exhibit "A" to Sovereign's definitive
proxy statement, SEC File No. 0-16533, dated March 15, 1996.)
(10.12) Sovereign Bancorp, Inc. 1996 Stock Option Plan. (Incorporated by
reference to Exhibit 4.3 to Sovereign's Registration Statement No. 33-89586
on Form S-8.)
(10.13) Employment Agreement, dated January 7, 2000, between Sovereign
Bancorp, Inc. and John Hamill.
(10.14) Employment Agreement, dated as of July 1, 1997, between Sovereign
Bancorp, Inc. and Joseph P. Campanelli.
(10.15) Employment Agreement dated as of June 23, 2001, between Sovereign
Bancorp, Inc. and James D. Hogan.
(21) Subsidiaries of the Registrant.
(23.1) Consent of Ernst & Young LLP.
(B) REPORTS ON FORM 8-K
On October 19, 2001, Sovereign filed a Current Report on Form 8-K dated
October 19, 2001, reporting information under Items 5 and 7.
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89
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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 22, 2002
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/ JOHN A. FRY Director March 22, 2002
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John A. Fry
/s/ BRIAN HARD Director March 22, 2002
- --------------------------
Brian Hard
/s/ RICHARD E. MOHN Chairman of Board and Director March 22, 2002
- --------------------------
Richard E. Mohn
/s/ ANDREW C. HOVE, JR. Director March 22, 2002
- --------------------------
Andrew C. Hove, Jr.
/s/ DANIEL K. ROTHERMEL Director March 22, 2002
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Daniel K. Rothermel
/s/ JAY S. SIDHU Director, President and Chief Executive Officer
- -------------------------- (Principal Executive Officer)
Jay S. Sidhu March 22, 2002
/s/ CAMERON C. TROILO, SR. Director March 22, 2002
- --------------------------
Cameron C. Troilo, Sr.
/s/ JAMES D. HOGAN Chief Financial Officer March 22, 2002
- --------------------------
James D. Hogan
/s/ GEORGE S. RAPP Chief Accounting Officer March 22, 2002
- --------------------------
George S. Rapp
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90
EXHIBITS INDEX
(3.1) Articles of Incorporation, as amended and restated, of Sovereign
Bancorp, Inc. (Incorporated by reference to Exhibit 3.1 to Sovereign's
Registration Statement No. 333-86961-01 on Form S-3.)
(3.2) By-Laws of Sovereign Bancorp, Inc. (Incorporated by reference to
Exhibit 3.2 to Sovereign's Annual Report on Form 10-K for the fiscal
year ended December 31, 1998.)
(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 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, SEC File No.
0-16533, 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) Employment 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 Amended Quarterly Report on
Form 10-Q/A, SEC File No. 0-16533, for the fiscal quarter ended March
31, 1997.)
(10.4) Employment Agreement, dated as of May 1, 1997, between ML Bancorp, Inc.
(a predecessor company of Sovereign Bancorp, Inc.) and Dennis S. Marlo.
(10.5) Employment Agreement, dated as of September 25, 1997, between Sovereign
Bancorp, Inc. and Lawrence M. Thompson, Jr. (Incorporated by reference
to Exhibit 10.5 to Sovereign's Annual Report on Form 10-K, SEC File No.
0-16533, for the fiscal year ended December 31, 1997.)
(10.6) Amended and Restated Rights Agreement, (the "Rights Agreement"), dated
as of June 21, 2001, between Sovereign Bancorp, Inc. and Mellon
Investor Services LLC (Incorporated herein by reference to Exhibit 4.1
of the Registrant's 8-K/A No. 2 filed July 3, 2001).
(10.7) Form of Rights Certificate (Incorporated herein by reference to Exhibit
B to the Rights Agreement). Pursuant to the Rights Agreement, Rights
will not be distributed until after the Distribution Date (as defined
in the Rights Agreement).
(10.8) Sovereign Bancorp, Inc. Non-Employee Directors Services Compensation
Plan.
(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,
SEC File No. 0-16533, for the fiscal 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, SEC File No. 0-16533, for the
fiscal year ended December 31, 1993.)
(10.11) Sovereign Bancorp, Inc. 1997 Non-Employee Director's Stock Option Plan.
(Incorporated by reference to Exhibit "A" to Sovereign's definitive
proxy statement, SEC File No. 0-16533, dated March 15, 1996.)
(10.12) Sovereign Bancorp, Inc. 1996 Stock Option Plan. (Incorporated by
reference to Exhibit 4.3 to Sovereign's Registration Statement No.
33-89586 on Form S-8.)
(10.13) Employment Agreement, dated January 7, 2000, between Sovereign Bancorp,
Inc. and John Hamill.
(10.14) Employment Agreement, dated as of July 1, 1997, between Sovereign
Bancorp, Inc. and Joseph P. Campanelli.
(10.15) Employment Agreement dated as of June 23, 2001, between Sovereign
Bancorp, Inc. and James D. Hogan.