WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934
For the quarter ended March 31, 1997
OR
_____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 34-16533
SOVEREIGN BANCORP, INC.
- --------------------------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2453088
- --------------------------------- --------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1130 Berkshire Boulevard, Wyomissing, Pennsylvania 19610
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (610) 320-8400
N/A
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report.)
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 ___.
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at May 13, 1997
- ------------------------------- ----------------------------
Common Stock (no par value) 65,976,000 shares
Preferred Stock (no par value) 2,000,000 shares
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 1997
and December 31, 1996 3
Consolidated Statements of Operations
for the three-month periods ended
March 31, 1997 and 1996 4
Consolidated Statements of Cash Flows
for the three-month periods
ended March 31, 1997 and 1996 5
Notes to Consolidated Financial Statements 6 - 16
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 17 - 30
PART II. OTHER INFORMATION
Item 6. Reports on Form 8-K 31
PART III. FINANCIAL DATA SCHEDULE 32
SIGNATURES 33
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
---- ----
(Unaudited) (Note)
(in thousands, except
per share data)
<S> <C> <C>
ASSETS
Cash and amounts due from
depository institutions $ 106,168 $ 111,296
Interest-earning deposits 37,340 6,273
Loans held for resale (approximate fair
value of $19,810 and $33,162 at
March 31, 1997 and December 31, 1996,
respectively) 19,777 32,955
Investment and mortgage-backed securities
available-for-sale 559,599 494,997
Investment and mortgage-backed securities
held-to-maturity (approximate fair value
of $2,703,659 and $2,464,844 at March 31,
1997 and December 31, 1996, respectively) 2,756,105 2,487,615
Loans 6,563,717 6,649,537
Allowance for possible loan losses (50,537) (46,093)
Premises and equipment 60,176 63,763
Real estate owned 9,206 10,634
Accrued interest receivable 57,947 56,848
Goodwill and other intangible assets 110,795 113,606
Other assets 54,101 59,928
----------- -----------
TOTAL ASSETS $10,284,394 $10,041,359
=========== ===========
LIABILITIES
Deposits $ 5,736,579 $ 5,606,333
Borrowings:
Short-term 2,786,851 2,765,118
Long-term 946,867 1,097,076
Advance payments by borrowers
for taxes and insurance 35,273 25,949
Other liabilities 170,964 38,044
----------- -----------
TOTAL LIABILITIES 9,676,534 9,532,520
----------- -----------
Corporation-obligated mandatorily redeemable
capital securities of subsidiary
trust holding solely subordinated
debentures of Sovereign
Bancorp, Inc. 97,574 --
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock; no par value; $50 liquidation
preference; 7,500,000 shares
authorized; 2,000,000 shares issued at
March 31, 1997 and December 31, 1996, respectively 96,446 96,446
Common stock; no par value;
100,000,000 shares authorized;
69,843,681 shares issued at March 31,
1997 and 69,475,922 shares issued at
December 31, 1996 299,161 297,145
Unallocated common stock held by the Employee
Stock Ownership Plan at cost;
4,067,046 shares at March 31, 1997
and 4,067,046 at December 31, 1996 (33,091) (33,015)
Treasury stock at cost; 11,924 shares at March 31,
1997 and 7,934 shares at December 31, 1996 (149) (88)
Unrecognized gain on investment
and mortgage-backed securities
available-for-sale, net of tax 1,926 2,362
Retained earnings 145,993 145,989
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 510,286 508,839
----------- -----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $10,284,394 $10,041,359
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
Note: The balance sheet at December 31, 1996 is taken from the audited financial
statements at that date but does not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
- 3 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three-Month Period
Ended March 31,
---------------------
1997 1996
---- ----
(in thousands, except
per share data)
Interest income:
Interest on interest-earning deposits $ 649 $ 1,031
Interest and dividends on investment
and mortgage-backed securities
available-for-sale 8,477 9,103
Interest and dividends on investment
and mortgage-backed securities
held-to-maturity 43,974 40,175
Interest and fees on loans 121,960 101,460
--------- ---------
Total interest income 175,060 151,769
--------- ---------
Interest expense:
Interest on deposits 55,893 57,528
Interest on borrowings 57,480 37,404
--------- ---------
Total interest expense 113,373 94,932
--------- ---------
Net interest income 61,687 56,837
Provision for possible loan losses (1) 8,700 800
--------- ---------
Net interest income after provision for
possible loan losses 52,987 56,037
--------- ---------
Other income:
Other loan fees and service charges 1,549 2,888
Deposit fees 3,327 2,921
(Loss)/gain on sale of loans held for
resale and investment and mortgage-
backed securities available-for-sale (17) 1,135
Gain on sale of loans held for resale 1,065 547
Miscellaneous income 1,443 837
--------- ---------
Total other income 7,367 8,328
--------- ---------
General and administrative expenses:
Salaries and employee benefits 14,648 13,537
Occupancy and equipment expenses 6,574 6,043
Outside services 4,388 5,721
Deposit insurance premiums 828 2,781
Advertising 1,529 1,302
Other administrative expenses 5,378 3,847
--------- ---------
Total general and administrative expenses 33,345 33,231
--------- ---------
Other operating expenses:
One-time, merger-related charge 7,955 --
Amortization of goodwill and other intangibles 2,710 2,991
Real estate owned losses, net 92 570
--------- ---------
Total other operating expenses 10,757 3,561
--------- ---------
Income before income taxes 16,252 27,573
Income tax provision 7,045 10,387
--------- ---------
Net Income (2) $ 9,207 $ 17,186
========= =========
Net Income Applicable to Common Stock $ 7,645 $ 15,623
========= =========
Earnings per share (2) (3) $ .12 $ .22
========= =========
Dividends per share (3) $ .023 $ .019
========= =========
(1) Includes $7.9 million of a one-time charge related to the acquisition of
First State Financial Services, Inc. ("First State").
(2) Excluding the one-time, after-tax charge of $10.7 million related to the
acquisition of First State, net income and earnings per share were $19.9
million and $.25 per share, respectively, for the three-month period ended
March 31, 1997.
(3) Per share amounts have been adjusted to reflect all stock dividends and
stock splits.
See accompanying notes to consolidated financial statements.
- 4 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three-Month Period
Ended March 31,
-------------------
1997 1996
---- ----
(in thousands)
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 9,207 $ 17,186
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for possible loan losses and deferred taxes 15,154 7,908
Depreciation 1,963 1,613
Amortization 1,238 2,903
Gain on sale of loans, investment and
mortgage-backed securities and real estate owned 108 (176)
Net change in:
Loans held for resale 13,178 61,236
Accrued interest receivable (1,099) (2,290)
Prepaid expenses and other assets (8,102) (10,038)
Other liabilities 132,920 9,102
--------- ---------
Net cash provided by operating activities 164,567 87,444
--------- ---------
Cash Flows from Investing Activities:
Proceeds from sales of investment
and mortgage-backed securities:
Available-for-sale 49,068 532,927
Proceeds from repayments and maturities of investment
and mortgage-backed securities:
Available-for-sale 17,744 28,762
Held-to-maturity 204,417 132,704
Purchases of investment and mortgage-backed securities:
Available-for-sale (108,955) (48,186)
Held-to-maturity (499,180) (567,700)
Proceeds from sales of loans 920 955
Purchase of loans (59,533) (276,952)
Net change in loans other than purchases and sales 150,050 (9,680)
Proceeds from sales of premises and equipment 3,444 438
Purchases of premises and equipment (1,875) (1,360)
Proceeds from sale of real estate owned 2,095 3,048
Other, net (5,208) --
--------- ---------
Net cash used by investing activities (247,013) (205,044)
--------- ---------
Cash Flows from Financing Activities:
Net increase/(decrease) in deposits 130,531 (103,146)
Net (decrease)increase in short-term borrowings (221,600) 215,704
Proceeds from long-term borrowings 192,246 --
Net increase in advance payments by
borrowers for taxes and insurance 9,324 805
Cash dividends paid to stockholders (3,062) (2,843)
Net proceeds from issuance of common stock 1,007 680
Purchase of treasury stock (61) --
--------- ---------
Net cash provided by financing activities 108,385 111,200
--------- ---------
Net change in cash and cash equivalents 25,939 (6,400)
Cash and cash equivalents at beginning of period 117,569 159,563
--------- ---------
Cash and cash equivalents at end of period $ 143,508 $ 153,163
========= =========
Reconciliation of Cash and Cash Equivalents to Consolidated
Balance Sheets:
Cash and amounts due from depository institutions $ 106,168 $ 139,566
Interest-earning deposits 37,340 13,597
--------- ---------
Cash and cash equivalents at end of period $ 143,508 $ 153,163
========= =========
</TABLE>
Supplemental Disclosures:
Income tax payments totaled $610,100 for the three-month period ended March 31,
1997 and $3.3 million for the same period in 1996. Interest payments totaled
$111.0 million for the three-month period ended March 31, 1997 and $96.8 million
for the same period in 1996. Noncash activity consisted of mortgage loan
securitization of $70.6 million for the three-month period ended March 31, 1997
and $125.8 million for the same period in 1996; reclassification of long-term
borrowings to short-term borrowings of $245.0 million for the three-month period
ended March 31, 1997 and $75.0 million for the same period in 1996; and
reclassification of mortgage loans to real estate owned of $4.8 million for the
three-month period ended March 31, 1997 and $1.9 million for the same period in
1996.
See accompanying notes to consolidated financial statements.
- 5 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) GENERAL
The accompanying financial statements of Sovereign Bancorp, Inc. and
Subsidiaries ("Sovereign") include the accounts of the parent company, Sovereign
Bancorp, Inc. and its wholly-owned subsidiary: Sovereign Bank ("Sovereign
Bank"). All material intercompany balances and transactions have been eliminated
in consolidation. These financial statements have been prepared in accordance
with the instructions for Form 10-Q and therefore do not include certain
information or footnotes necessary for the presentation of financial condition,
results of operations, and cash flows in conformity with generally accepted
accounting principles. However, in the opinion of management, the consolidated
financial statements reflect all adjustments (which consist of normal recurring
accruals) necessary for a fair presentation of the results for the unaudited
periods. The preparation of these financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
The results of operations for the three-month period ended March 31, 1997
are not necessarily indicative of the results which may be expected for the
entire year. The consolidated financial statements should be read in conjunction
with Form 10-K for the year ended December 31, 1996.
- 6 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(2) EARNINGS PER SHARE
Earnings per share have been computed on a fully diluted basis based on the
weighted average number of common shares (including assumed conversion of
convertible preferred shares) and common equivalent shares (dilutive stock
options) outstanding during the periods. Fully diluted shares for the
three-month periods ended March 31, 1997 and 1996 were 79.0 million and 76.6
million, respectively. Earnings per share have been adjusted to reflect all
stock dividends and stock splits. The following table presents the computation
of fully diluted earnings per share at the dates indicated:
Three-Month Period
Ended March 31,
-------------------
1997 1996
---- ----
(in thousands, except
per share data)
Net Income (1) $ 9,207 $17,186
------- -------
Average common and common equivalent
shares outstanding at end of period 77,547 75,007
Average stock options considered to be
common stock equivalents, net of shares
assumed to be repurchased under the
treasury stock method 1,441 1,615
------- -------
Total average fully diluted shares 78,987 76,622
======= =======
Fully diluted earnings per share $ .12 $ .22
======= ======
(1) The results for the three-month period ended March 31, 1997 include a one-
time, after-tax charge of $10.7 million related to the acquisition of First
State. Excluding the one-time charge, fully diluted earnings per share for
the three-month period ended March 31, 1997 would have been $.25.
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 128, Earnings per Share,
which is required to be adopted on December 31, 1997. At that time, Sovereign
will be required to change the method currently used to compute earnings per
share and to restate all prior periods. Under the new requirements for
calculating earnings per share, the dilutive effect of stock options will be
excluded. The impact of SFAS No. 128 on the calculation of primary and fully
diluted earnings per share for these quarters is not expected to be material.
For additional information with respect to SFAS No. 128, see Note 10 in the
Notes to Consolidated Financial Statements.
- 7 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(3) INVESTMENT AND MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE
The following table presents the composition and fair value of investments
available-for-sale at the dates indicated: (dollars in thousands)
<TABLE>
<CAPTION>
March 31, 1997
--------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---- ------------ ------------ -----
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 4,981 $ 21 $ -- $ 5,002
Equity securities 277,396 4,645 -- 282,041
Other securities -- -- -- --
Mortgage-backed Securities:
FHLMC 25,196 -- 477 24,719
GNMA 62,674 -- 945 61,729
Collateralized mortgage
obligations 186,406 318 616 186,108
Other securities -- -- -- --
-------- -------- -------- --------
Total investment and
mortgage-backed securities
available-for-sale $556,653 $ 4,984 $ 2,038 $559,599
======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1996
-----------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---- ------------ ------------ -----
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 5,728 $ 43 $ 7 $ 5,764
Equity securities 286,773 3,525 -- 290,298
Other securities 7,720 -- 248 7,472
Mortgage-backed Securities:
FHLMC 25,288 -- 287 25,001
GNMA -- -- -- --
Collateralized mortgage
obligations 164,459 895 129 165,225
Other securities 1,259 -- 22 1,237
-------- -------- -------- --------
Total investment and
mortgage-backed securities
available-for-sale $491,227 $ 4,463 $ 693 $494,997
======== ======== ======== ========
</TABLE>
- 8 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(4) INVESTMENT AND MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY
The following table presents the composition and fair value of investment
and mortgage-backed securities held-to-maturity at the dates indicated: (dollars
in thousands)
<TABLE>
<CAPTION>
March 31,1997
-------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---- ------------ ------------ -----
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 9,375 $ 28 $ 190 $ 9,213
Corporate securities 1,005 19 -- 1,024
Other securities 31,880 -- 178 31,702
Mortgage-backed Securities:
FHLMC 188,049 692 5,583 183,158
FNMA 235,631 252 8,265 227,618
GNMA 270,715 1,737 2,077 270,375
Private issues 261,012 13 8,538 252,487
Collateralized mortgage
obligations 1,758,438 1,617 31,973 1,728,082
Other securities -- -- -- --
---------- ---------- ---------- ----------
Total investment and
mortgage-backed securities
held-to-maturity $2,756,105 $ 4,358 $ 56,804 $2,703,659
========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1996
-----------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---- ------------ ------------ -----
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 13,426 $ 60 $ 171 $ 13,315
Corporate securities 1,006 32 -- 1,038
Other securities 65,086 86 242 64,930
Mortgage-backed Securities:
FHLMC 145,075 900 3,425 142,550
FNMA 193,607 374 5,102 188,879
GNMA 194,782 3,590 370 198,002
Private issues 272,778 87 9,529 263,336
Collateralized mortgage
obligations 1,599,769 4,589 13,614 1,590,744
Other securities 2,086 -- 36 2,050
---------- ---------- ---------- ----------
Total investment and
mortgage-backed securities
held-to-maturity $2,487,615 $ 9,718 $ 32,489 $2,464,844
========== ========== ========== ==========
</TABLE>
- 9 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(5) COMPOSITION OF LOAN PORTFOLIO
The following table presents the composition of the loan portfolio by type
of loan and by fixed and adjustable rates at the dates indicated: (dollars in
thousands)
<TABLE>
<CAPTION>
March 31, 1997 December 31, 1996
-------------- -----------------
Amount Percent Amount Percent
------ ------- ------ -------
<S> <C> <C> <C> <C>
Residential real estate loans $5,205,746 79.31% $5,286,017 79.50%
Residential construction loans
(net of loans in process of
$30,983 and $45,088, respectively) 68,523 1.04 82,579 1.24
---------- ------ ---------- ------
Total Residential Loans 5,274,269 80.35 5,368,596 80.74
---------- ------ ---------- ------
Multi-family loans 67,788 1.03 71,815 1.08
Commercial real estate loans 139,512 2.13 140,973 2.12
Commercial loans 132,647 2.02 125,706 1.89
---------- ------ ---------- ------
Total Commercial Loans 339,947 5.18 338,494 5.09
---------- ------ ---------- ------
Consumer loans (1) 949,501 14.47 942,447 14.17
---------- ------ ---------- ------
Total Loans $6,563,717 100.00% $6,649,537 100.00%
========== ====== ========== ======
Total Loans with: (2)
Fixed rates $1,571,834 23.95% $1,503,497 22.61%
Variable rates 4,991,883 76.05 5,146,040 77.39
---------- ------ ---------- ------
Total Loans $6,563,717 100.00% $6,649,537 100.00%
========== ====== ========== ======
</TABLE>
(1) Consumer loan balances include home equity loans of $594.4 million at March
31, 1997 and $583.2 million at December 31, 1996.
(2) Loan totals do not reflect the impact of off-balance sheet interest rate
swaps used for interest rate risk management as discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Loan Portfolio."
- 10 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(6) DEPOSIT PORTFOLIO COMPOSITION
The following table presents the composition of deposits at the dates
indicated: (dollars in thousands)
<TABLE>
<CAPTION>
March 31, 1997 December 31, 1996
-------------- -----------------
Weighted Weighted
Average Average
Account Type Amount Percent Rate Amount Percent Rate
------------ ------ ------- -------- ------ ------- -----
<S> <C> <C> <C> <C> <C> <C>
Demand deposit accounts $ 263,511 4.59% -- % $ 272,445 4.86% -- %
NOW accounts 473,458 8.25 1.27 469,810 8.38 1.40
Savings accounts 1,132,991 19.75 2.41 1,091,556 19.47 2.38
Money market accounts 644,871 11.24 3.94 661,987 11.81 3.96
Retail certificates 3,073,834 53.59 5.36 2,951,917 52.65 5.31
Jumbo certificates 147,914 2.58 5.52 158,618 2.83 5.56
---------- ------ ---- ---------- ------ ----
Total Deposits $5,736,579 100.00% 4.04% $5,606,333 100.00% 4.00%
========== ====== ==== ========== ====== ====
</TABLE>
(7) BORROWINGS
The following table presents information regarding borrowings at the dates
indicated: (dollars in thousands)
March 31, 1997 December 31, 1996
-------------- -----------------
Weighted Weighted
Average Average
Balance Rate Balance Rate
------- ---- ------- ----
FHLB advances $3,565,851 5.86% $3,694,446 5.85%
Other borrowings (1) 265,441 8.07 167,748 7.46
---------- ---- ---------- ----
Total Borrowings $3,831,292 6.01% $3,862,194 5.92%
========== ==== ========== ====
(1) At March 31, 1997, other borrowings included the issuance of $97.6 million
of 9% Trust Preferred securities as discussed in Note 11 in the Notes to
Consolidated Financial Statements.
- 11 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(8) INTEREST RATE EXCHANGE AGREEMENTS
Amortizing and non-amortizing interest rate swaps are generally used to
convert fixed rate assets and liabilities to variable rate assets and
liabilities and vice versa. Interest rate caps are generally used to limit the
exposure from the repricing and maturity of liabilities. Interest rate floors
are generally used to limit the exposure from repricing and maturity of assets.
Interest rate caps and floors are also used to limit the exposure created by
other interest rate swaps. In certain cases, interest rate caps or floors are
simultaneously bought and sold to create a range of protection against changing
interest rates while limiting the cost of that protection. The following table
presents information regarding interest rate exchange agreements at the dates
indicated: (dollars in thousands)
<TABLE>
<CAPTION>
March 31, 1997
--------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
------ ----- ---------- --------
<S> <C> <C> <C> <C>
Amortizing interest rate swaps:
Pay variable-receive fixed (1) $ 712,541 $ -- $(16,893) 3.4
Pay fixed-receive variable (2) 391,455 -- 2,695 2.1
Non-amortizing interest rate swaps:
Pay variable-receive fixed (3) 125,000 -- (2,773) 2.4
Pay fixed-receive variable (4) 1,580,000 -- 5,641 2.9
Interest rate caps (5) 500,000 8,770 9,692 4.2
Interest rate floors (6) 100,000 (1,003) (445) 4.9
Interest rate corridors (7) 100,000 4,268 4,695 4.9
---------- ------- --------
$3,508,996 $12,035 $ 2,612
========== ======= ========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1996
-----------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
------ ----- ---------- --------
<S> <C> <C> <C> <C>
Amortizing interest rate swaps:
Pay variable-receive fixed (1) $ 713,448 $ -- $(10,459) 3.6
Pay fixed-receive variable (2) 398,565 -- (464) 2.3
Non-amortizing interest rate swaps:
Pay variable-receive fixed (3) 50,000 -- (1,738) 3.7
Pay fixed-receive variable (4) 1,355,000 -- 9,152 2.2
Interest rate caps (5) 500,000 9,283 7,264 4.5
---------- ------- --------
$3,017,013 $ 9,283 $ 3,755
========== ======= ========
</TABLE>
- 12 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(1) The weighted average pay rate was 5.53% and 5.50% and the weighted average
receive rate was 5.93% and 5.93% at March 31, 1997 and December 31, 1996,
respectively.
(2) The weighted average pay rate was 6.76% and 6.76% and the weighted average
receive rate was 6.17% and 6.18% at March 31, 1997 and December 31, 1996,
respectively.
(3) The weighted average pay rate was 6.08% and 6.91% and the weighted average
receive rate was 6.54% and 6.75% at March 31, 1997 and December 31, 1996,
respectively.
(4) The weighted average pay rate was 5.44% and 5.28% and the weighted average
receive rate was 5.55% and 5.53% at March 31, 1997 and December 31, 1996,
respectively. Of the March 31, 1997 notional amount, $250.0 million has an
effective date of March 18, 1998.
(5) The weighted average contract rate was 6.00% and 6.00% at March 31, 1997
and December 31, 1996, respectively.
(6) The weighted average contract rate was 5.25% at March 31, 1997.
(7) The weighted average contract rate range was 5.25% - 7.25% at March 31,
1997.
The following table summarizes by notional amounts the activity of
Sovereign's interest rate exchange agreements: (dollars in thousands)
<TABLE>
<CAPTION>
Amortizing Non-Amortizing Interest Interest Interest
Interest Interest Rate Rate Rate
Rate Swaps Rate Swaps Caps Floors Corridors
---------- ---------- ---- ------ ---------
<S> <C> <C> <C> <C> <C>
Balance,
December 31, 1996 $1,112,013 $1,405,000 $ 500,000 $ -- $ --
---------- ---------- ---------- ---------- ----------
Additions -- 850,000 -- 100,000 100,000
Maturities/Amortization 8,017 -- -- -- --
Terminations -- 550,000 -- -- --
---------- ---------- ---------- ---------- ----------
Balance, March 31, 1997 $1,103,996 $1,705,000 $ 500,000 $ 100,000 $ 100,000
========== ========== ========== ========== ==========
</TABLE>
At March 31, 1997, Sovereign's balance sheet included a net deferred loss
of $3.8 million related to interest rate exchange agreements terminated in
December 1995 and June 1996 which were originally accounted for as hedges. Of
this net deferred loss, $3.3 million will amortize into interest expense in 1997
and $465,000 will amortize into interest expense in 1998.
Net interest income resulting from interest rate exchange agreements
includes $1.5 million of income and $2.2 million of expense for the three-month
period ended March 31, 1997.
- 13 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(9) ACQUISITIONS
On February 18, 1997, Sovereign acquired First State Financial Services,
Inc. ("First State"), a $603 million savings institution headquartered in West
Caldwell, New Jersey with 14 branch offices located throughout central and
northern New Jersey. In accordance with the merger agreement, First State
shareholders received 1.225 (1.47 shares as adjusted for all subsequent stock
dividend and stock splits) shares of Sovereign common stock in exchange for each
share of First State common stock. Sovereign issued approximately 4.9 million
new shares (5.9 million new shares as adjusted for all subsequent stock
dividends and stock splits) of Sovereign common stock in connection with the
transaction, which was tax-free to First State and First State shareholders.
This transaction was accounted for as a pooling-of-interests and accordingly,
the consolidated financial statements have been restated to include the accounts
of First State for all periods presented.
The results of operations previously reported by the separate enterprises
and the combined amounts presented in the accompanying consolidated financial
statements are summarized below:
Years Ended December 31,
1996 1995
-----------------------------------
Net interest income
Sovereign $216,710 $174,226
First State 25,185 22,584
-------- --------
Combined $241,895 $196,810
======== ========
Net income (loss):
Sovereign $ 51,463 $ 56,408
First State (5,649) 3,998
---------- -------
Combined $ 45,814 $ 60,406
========== ========
Prior to the combination, First State's fiscal year end was September 30,
and accordingly, Sovereign's consolidated results of operations for the
three-month period ended March 31, 1997 include First State's results of
operations for the and Sovereign's consolidated results of operations for the
three-month period ended March 31, 1996 include First State's results of
operations for the three-month period ended December 31, 1995. A net decrease to
Sovereign's stockholders' equity of $5.2 million has been made to reflect First
State's activity for the three-month period ended December 31, 1996. That
activity consisted of proceeds from the exercise of stock options of $1.0
million, net loss of $6.4 million and net change in unrecognized loss on
available-for-sale securities of $228,000.
- 14 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
On February 5, 1997, Sovereign executed a Definitive Agreement to acquire
Bankers Corp., Inc. ("Banker's"), a $2.5 billion financial services holding
company headquartered in Perth Amboy, New Jersey. Bankers' sole banking
subsidiary, Bankers Savings, operates 15 branch offices located in Middlesex,
Monmouth, and Ocean counties, New Jersey. The transaction will add loans,
deposits, and shareholders' equity to Sovereign of $1.7 billion, $1.6 billion,
and $193.0 million, respectively. The terms of the Agreement call for Sovereign
to exchange $25.50 in Sovereign common stock (subject to adjustment under
certain conditions) for each outstanding common share of Bankers. The
transaction will be tax-free to Bankers and Bankers' shareholders, and will be
accounted for as a pooling-of-interests. Sovereign anticipates that the
transaction will close during the third quarter of 1997.
(10) ACCOUNTING CHANGES
In February 1997, the FASB issued SFAS No. 128, Earnings Per Share. This
statement supersedes APB Opinion No. 15, "Earnings per Share" and FASB Statement
No. 85, "Yield Test for Determining whether a Convertible Security Is a Common
Stock Equivalent". The overall objective of SFAS No. 128 is to simplify the
calculation of earnings per share and achieve comparability with the recently
issued International Accounting Standard No. 33, "Earnings Per Share". SFAS No.
128 is effective for all periods ending after December 15, 1997. Subsequent to
the effective date, all prior-period earnings per share amounts are required to
be restated to conform to the provisions of SFAS No. 128.
Under SFAS No. 128, primary earnings per share will be replaced with basic
earnings per share. Basic earnings per share will be calculated by dividing
income available to common stockholders by the weighted average common shares
outstanding, excluding options, warrants, and convertible securities from the
calculation.
Fully diluted earnings per share has been renamed diluted earnings per
share. Income available to common stockholders will be adjusted for the assumed
conversion of all potentially dilutive securities. In calculating diluted
earnings per share, the dilutive effect of options and warrants will continue to
be calculated using the treasury stock method. However, unlike the existing
calculation of fully diluted earnings per share, the treasury stock method will
be applied using the average market price for the period rather that the higher
of the average market price or the ending market price. The dilutive effect of
convertible debt or preferred stock will continue to be calculated using the
if-converted method.
(11) RECENT DEVELOPMENTS
During March 1997, Sovereign issued $100 million of preferred capital
securities ("Trust Preferred") through Sovereign Capital Trust I ("Trust"), a
special-purpose statutory trust created expressly for the issuance of these
securities. Distributions on the Trust Preferred will be payable at an annual
- 15 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
rate of 9% of the stated liquidation amount of $1,000 per capital security,
payable semi-annually. After issuance costs, proceeds of $97.6 million were
invested in Junior Subordinated Debentures of Sovereign, at terms identical to
the Trust Preferred offering. Cash distributions on the Trust Preferred are made
to the extent interest on the debentures is received by the Trust. In the event
of certain changes or amendments to regulatory requirements or federal tax
rules, the Trust Preferred securities are redeemable in whole. Otherwise, the
Trust Preferred securities are generally redeemable in whole or in part on or
after April 1, 2007, at a declining redemption price ranging from 103.875% to
100% of the liquidation amount. On or after April 1, 2017, the Trust Preferred
securities may be redeemed at 100% of the liquidation amount.
The Trust Preferred offering is classified as and is similar to minority
interests and is presented as "Corporation-obligated mandatorily redeemable
capital securities of subsidiary trust holding solely subordinated debentures of
Sovereign Bancorp, Inc." The Trust Preferred offering qualifies for Tier 1
capital treatment for Sovereign, and the loan payments from Sovereign to the
Trust are fully tax deductible. Sovereign intends to use the proceeds of the
transaction for general corporate purposes.
- 16 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
RESULTS OF OPERATIONS
General
Net income for the three-month period ended March 31, 1997, excluding a
one-time, after-tax charge of $10.7 million related to the acquisition of First
State, was $19.9 million, an increase of 16% when compared to net income of
$17.2 million for the three-month period ended March 31, 1996. Earnings per
share, excluding the one-time, merger-related charge, for the three-month period
ended March 31, 1997 was $.25 per share, an increase of 14% when compared to
$.22 per share for the same period in 1996.
Net income for the three-month period ended March 31, 1997, which includes
the impact of the one-time, merger-related charge, was $9.2 million and earnings
per share was $.12. Earnings per share have been adjusted to reflect all stock
dividends and stock splits.
Return on average equity, return on average total assets, and average
equity to average total assets, excluding the one-time, merger related charge,
were 15.34%, .78%, and 5.09%, respectively, for the three-month period ended
March 31, 1997 compared to 14.23%, .79% and 5.52%, respectively, for the same
period in 1996.
Net Interest Income
Net interest income for the three-month period ended March 31, 1997 was
$61.7 million compared to $56.8 million for the same period in 1996. The
increase is attributable to an increase in average balances resulting from
internal growth, partially offset by a decline in Sovereign's net interest
margin. Sovereign's net interest margin (net interest income divided by
interest-earning assets) was 2.60% for the three-month period ended March 31,
1997 compared to 2.79% for the same period in 1996.
Interest on interest-earning deposits for the three-month period ended
March 31, 1997 was $649,000 compared to $1.0 million for the same period in
1996. The average balance of interest-earning deposits was 14.5 million with an
average yield of 18.13% for the three-month period ending March 31, 1997
compared to an average balance of $29.5 million with an average yield of 13.82%
for the same period in 1996. The high yields on Sovereign's interest-earning
deposits are the result of a contractual arrangement whereby a third-party
vendor performed check processing and reconcilement functions for Sovereign's
disbursement accounts. Under the agreement, the vendor is required to pay
Sovereign interest on disbursed funds during the two to three day float period,
effectively producing interest income with no corresponding asset balance. This
agreement will continue to favorably impact the yield on Sovereign's
interest-earning deposits in 1997 and future years.
- 17 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Interest on investment and mortgage-backed securities available-for-sale
was $8.5 million for the three-month period ended March 31, 1997 compared to
$9.1 million for the same period in 1996. The average balance of investment and
mortgage-backed securities available-for-sale was $544.9 million with an average
yield of 6.25% for the three-month period ended March 31, 1997 compared to an
average balance of $552.1 million with an average yield of 6.76% for the same
period in 1996.
Interest on investment and mortgage-backed securities held-to-maturity was
$44.0 million for the three-month period ended March 31, 1997 compared to $40.2
million for the same period in 1996. The average balance of investment and
mortgage-backed securities held-to-maturity was $2.49 billion with an average
yield of 7.06% for the three-month period ended March 31, 1997 compared to an
average balance of $2.24 billion with an average yield of 7.14% for the same
period in 1996.
Interest and fees on loans were $122.0 million for the three-month period
ended March 31, 1997 compared to $101.5 million for the same period in 1996. The
average balance of loans was $6.62 billion with an average yield of 7.41% for
the three-month period ended March 31, 1997 compared to an average balance of
$5.38 billion with an average yield of 7.56% for the same period in 1996. The
increases in the average balance of loans and in the interest and fees on loans
are primarily due to the full year-to-date effect of Sovereign's record level of
loan originations in 1996.
Interest on deposits was $55.9 million for the three-month period ended
March 31, 1997 compared to $57.5 million for the same period in 1996. The
average balance of deposits was $5.61 billion with an average cost of 4.04% for
the three-month period ended March 31, 1997 compared to an average balance of
$5.54 billion with an average cost of 4.17% for the same period in 1996. Despite
a general rise in interest rates, the cost of deposits has decreased due to
increased balances of lower interest rate deposit products.
Interest on borrowings was $57.5 million for the three-month period ended
March 31, 1997 compared to $37.4 million for the same period in 1996. The
average balance of borrowings was $3.89 billion with an average cost of 5.92%
for the three-month period ended March 31, 1997 compared to an average balance
of $2.51 billion with an average cost of 5.98% for the same period in 1996. The
increase in the average balance of borrowings is the result of balance sheet
growth being funded principally by borrowings.
Provision for Possible Loan Losses
The provision for possible loan losses was $8.7 million for the
three-month period ended March 31, 1997, which includes $7.9 million of reserves
attributable to a change in strategic direction related to the workout of
certain non-performing assets acquired from First State.
- 18 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
In 1996, Sovereign diversified its lending efforts and began to offer small
business loans and an expanded line of consumer products, such as automobile
loans and credit cards. As a result of the increased risk inherent in these
products and as Sovereign continues to place emphasis on small business and
consumer lending in 1997 and future years, management will continually evaluate
its loan portfolio and record additional loan loss reserves as is necessary. For
additional information with respect to Sovereign's asset quality, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Loan Portfolio."
During the three-month period ended March 31, 1997, Sovereign charged-off
(net of recoveries) $1.6 million of loans compared to $1.7 million for the same
period in 1996.
The following table presents the activity in the allowance for possible
loan losses for the periods indicated: (dollars in thousands)
Three-Month Period Ended March 31,
1997 1996
---------------------------------
Allowance, beginning of period $46,093 $40,938
Charge-offs:
Residential 1,903 1,005
Consumer 498 218
Commercial - -
Commercial Real Estate 363 594
------- -------
Total Charge-offs 2,764 1,817
------- -------
Recoveries:
Residential 288 47
Consumer 12 29
Commercial Real Estate 882 -
------- ------
Total Recoveries 1,182 76
------- -------
Charge-offs, net of recoveries 1,582 1,741
Provision for possible loan losses 8,700 800
Other additions (1) (2,674) -
------- ------
Allowance, end of period $50,537 $39,997
======= =======
(1) Represents net charge-offs of First State for the three-month period ended
December 31, 1996 resulting from the differing fiscal year end of First
State as previously discussed in Note 9 in the Notes to Consolidated
Financial Statements.
Other Income
Other income was $7.4 million for the three-month period ended March 31,
1997 compared to $8.3 million for the same period in 1996.
- 19 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Other loan fees and service charges were $1.5 million for the three-month
period ended March 31, 1997 compared to $2.9 million for the same period in
1996. The decrease in other loan fees and service charges is primarily the
result of fees earned in 1996 by First State's credit card portfolio which was
sold prior to Sovereign's acquisition of First State in February 1997. Excluding
First State's credit card portfolio in 1996, other loan fees and service charges
result primarily from Sovereign's loan servicing portfolio. Sovereign serviced
$5.25 billion of its own loans and $1.35 billion of loans for others at March
31, 1997 compared to $4.52 billion of its own loans and $1.22 billion of loans
for others at March 31, 1996.
Deposit fees were $3.3 million for the three-month period ended March 31,
1997 compared to $2.9 million for the same period in 1996. This increase is
primarily the result of growth in the number of Sovereign's transaction accounts
over the last year.
(Losses)/gains on sales of loans and investment and mortgage-backed
securities available-for-sale were $(17,000) for the three-month period ended
March 31, 1997 compared to $1.1 million for the same period in 1996. This
decrease is primarily attributable to losses of $912,000 relating to the
liquidation of $29.1 million of investments.
Gains on sales of loans held for resale were $1.1 million for the
three-month period ended March 31, 1997 compared to $547,000 for the same period
in 1996. Gains on sales of loans held for resale have increased as rates have
declined and loan volumes have accelerated in 1997 compared to 1996.
Miscellaneous income was $1.4 million for the three-month period ended
March 31, 1997 compared to $837,000 for the same period in 1996. This increase
is primarily due to increased inter-change income resulting from growth in the
number of Sovereign's check cards and credit cards over the last year.
General and Administrative Expenses
Total general and administrative expenses were $33.3 million for the
three-month period ended March 31, 1997 compared to $33.2 million for the same
period in 1996. The ratio of general and administrative expenses to average
assets, excluding the one-time, merger-related charge, for the three-month
period ended March 31, 1997 was 1.33%, a significant improvement compared to
1.55% for the same period in 1996. In addition, Sovereign's efficiency ratio
(all general and administrative expenses as a percentage of net interest income
and recurring non-interest income), excluding the one-time, merger-related
charge, for the three-month period ended March 31, 1997 was 48.29% compared to
51.90% for the same period in 1996. The decrease in these expense ratios is the
result of efficiencies realized from recent acquisitions and an increase in
average balances and net interest income without a corresponding increase in
operating expenses.
- 20 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Other operating expenses were $10.8 million for the three-month period ended
March 31, 1997 compared to $3.6 million for the same period in 1996. This
increase is primarily the result of a one-time charge of $8.0 million related to
the acquisition of First State. These expenses include human resources related
costs, loss on sale of certain assets, and other expenses, including investment
banker fees and legal expenses.
Income Tax Provision
The income tax provision was $7.0 million for the three-month period ended
March 31, 1997 compared to $10.4 million for the same period in 1996. The
effective tax rate for the three-month period ended March 31, 1997 was 43.3%
compared to 37.7% for the same period in 1996. The decrease in the income tax
provision for the three-month period ended March 31, 1997 is attributable to
pre-tax income for the first quarter of 1997 of $16.3 million resulting from the
one-time, after-tax charge of $10.7 million related to the acquisition of First
State. The increase in Sovereign's effective tax rate for the three-month period
ended March 31, 1997 is due to the tax effect of certain non-deductible
merger-related costs.
FINANCIAL CONDITION
Loan Portfolio
Sovereign's loan portfolio at March 31, 1997 was $6.56 billion compared to
$6.65 billion at December 31, 1996. This decrease was the result of planned
payoffs of certain commercial loans and normal residential loan amortization
exceeding new loan origination volumes. During the three-month period ended
March 31, 1997, Sovereign closed approximately $161.9 million of first mortgage
loans including approximately $91.5 million of variable rate mortgage loans.
This compares to first mortgage loan closings of $602.5 million including
approximately $450.4 million of variable rate mortgage loans for the same period
in 1996.
Sovereign is currently placing an increased emphasis on commercial loan and
consumer loan originations. As a result, during the three-month period ended
March 31, 1997, Sovereign closed $20.0 million of commercial loans and $134.4
million of consumer loans. These results compare to $25.8 million of commercial
loans and $57.2 million of consumer loans closed during the same period in 1996.
Sovereign's primary residential loan products are variable rate mortgage
loans on owner-occupied residential real estate. As a result, at March 31, 1997,
90% of Sovereign's total loan portfolio was secured by residential real estate
and 80% of the total loan portfolio was comprised of variable rate loans.
However, as a result of Sovereign's use of interest rate swaps for interest rate
risk management, at March 31, 1997, $560.7 million of variable rate mortgage
loans have been effectively converted to fixed rate mortgage loans. Also,
- 21 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
$241.5 million of intermediate variable rate mortgage loans (loans with a
five-year fixed rate period) and $150.0 million of short-term variable rate
mortgage loans (loans with less than a five-year fixed rate period) have
effectively been converted to a variable rate over the fixed rate period.
At March 31, 1997, Sovereign's total loan portfolio included $5.21 billion
of first mortgage loans secured primarily by liens on owner-occupied one-to-four
family residential properties. With its increased focus on non-residential
lending, at March 31, 1997, Sovereign's total loan portfolio also included
$340.0 million of commercial loans and $949.5 million of consumer loans,
including $594.4 million of outstanding home equity loans ($341.8 million of
additional unused commitments for home equity lines of credit) secured primarily
by second mortgages on owner-occupied one-to-four family residential properties.
At March 31, 1997, Sovereign's non-performing assets were $55.5 million
compared to $74.1 million at December 31, 1996. Non-performing assets as a
percentage of total assets were .54% at March 31, 1997 compared to .74% at
December 31, 1996. This decrease is primarily attributable to the liquidation of
$21.0 million of certain problem commercial loans and non-performing assets
during the first quarter which were acquired in the First State transaction. At
March 31, 1997, 87% of non-performing assets consisted of loans or REO related
to real estate compared to 76% at December 31, 1996. The remainder of
Sovereign's non-performing assets consist principally of commercial and
multi-family REO; most of which have been acquired through acquisitions.
Non-performing assets at March 31, 1997, included $9.2 million of REO which is
carried at lower of cost or estimated fair value less estimated costs to sell.
Sovereign places all 90 days or more delinquent (except loans guaranteed by the
government or secured by deposit accounts) on non-performing status.
- 22 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table presents the composition of non-performing assets at
the dates indicated: (dollars in thousands)
March 31, December 31,
1997 1996
---- ----
Non-Accrual Loans:
Past due 90 days or more
as to interest or principal:
Real estate related $38,882 $49,018
Other 6,304 12,076
Past due less than 90 days as to
interest and principal:
Real estate related 638 639
Other -- 160
------- -------
Total Non-Accrual Loans 45,824 61,893
Restructured Loans 431 1,561
------- -------
Total Non-Performing Loans 46,255 63,454
------- -------
Real Estate Owned:
Real estate related 8,660 6,974
Other 546 3,660
------- -------
Total Real Estate Owned 9,206 10,634
------- -------
TOTAL NON-PERFORMING ASSETS $55,461 $74,088
======= =======
Past due 90 days or more as to
interest or principal and
accruing interest (1) $ 6,364 $12,869
Non-Performing Assets as a
percentage of Total Assets .54% .74%
Non-Performing Loans as a
percentage of Total Loans .70% .95%
Non-Performing Assets as a
percentage of Total Loans
and Real Estate Owned .94% 1.30%
Allowance for Possible Loan
Losses as a percentage of
Total Non-Performing Assets 88.96% 57.41%
Allowance for Possible Loan
Losses as a percentage of
Total Non-Performing Loans 106.67% 67.03%
- 23 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
(1) At March 31, 1997 and December 31, 1996, non-performing assets past due 90
days or more as to interest or principal and accruing interest included
$6.4 million and $10.5 million, respectively, of government-guaranteed
student loans which are 100% guaranteed and Sovereign retains minimal risk
of credit losses related to these loans.
Management constantly evaluates the adequacy of its allowance for possible
loan losses. 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 could have loss
potential, geographic and industry concentrations, delinquency trends, economic
conditions and other relevant factors. At March 31, 1997, the allowance for
possible loan losses was $50.5 million or .77% of total loans compared to $46.1
million or .69% of total loans at December 31, 1996.
The following table presents the allocation of the allowance for possible
loan losses and the percentage of such allocation to each loan type for the
dates indicated: (dollars in thousands)
March 31, December 31,
1997 1996
Balance at End of -------------------------------------------
Period Attributable to Amount Percent Amount Percent
- ---------------------- ------ ------- ------ -------
Residential real estate $13,360 26.44% $17,390 37.73%
Commercial real estate 7,981 15.79 5,581 12.11
Commercial 3,630 7.18 3,100 6.72
Consumer 8,239 16.30 8,037 17.44
Unallocated 17,327 34.29 11,985 26.00
------- ------ ------- ------
Total $50,537 100.00% $46,093 100.00%
======= ====== ======= ======
Potential problem loans (consisting of loans as to which management has
serious concerns as to the ability of such borrowers to comply with present
repayment terms, although not currently classified as non-performing loans)
amounted to approximately $15.3 million at March 31, 1997. These loans consist
of $2.1 million of multi-family loans and $13.2 million of commercial real
estate loans.
- 24 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Investment and Mortgage-backed Securities
Investment securities consist primarily of U.S. Treasury and government
agency securities, corporate debt securities and stock in the Federal Home Loan
Bank of Pittsburgh ("FHLB"). Mortgage-backed securities consist of collateral
mortgage obligations issued by FHLMC, FNMA, GNMA, RTC or private label issues.
Sovereign's mortgage-backed securities are generally either guaranteed as to
principal and interest by the issuer or have ratings of "AAA" by Standard and
Poor's and Fitch at the date of issuance. The classes are backed by single
family residential loans which are primary residences geographically dispersed
throughout the United States. Sovereign purchases classes which are senior
positions backed by subordinate classes. The subordinate classes absorb the
losses and must be completely eliminated before any losses flow through the
senior positions. Sovereign's strategy is to purchase classes which have an
average life of three years or less. At March 31, 1997, Sovereign's total
investment portfolio had no securities classified as high risk as defined by the
FFIEC Policy Statement on securities activities. The effective duration of the
total investment portfolio at March 31, 1997 was 2.8 years.
At March 31, 1997, total investment and mortgage-backed securities
available-for-sale were $559.6 million compared to $495.0 million at December
31, 1996 and investment and mortgage-backed securities held-to-maturity were
$2.76 billion compared to $2.49 billion at December 31, 1996. For additional
information with respect to Sovereign's investment and mortgage-backed
securities, see Notes 3 and 4 in the Notes to Consolidated Financial Statements.
Long-Lived Assets
In March 1995, the Financial Accounting Standards Board (AFASB@) issued
SFAS No. 121, AAccounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed of@, which requires impairment losses to be
recorded on long-lived assets used in operations when indicators of impairment
are present and the undiscounted cash flows estimated to be generated by those
assets are less than the assets carrying amount. SFAS No. 121 also addresses the
accounting for long-lived assets that are expected to be disposed of. Sovereign
adopted SFAS No. 121 in the first quarter of 1996 and the effect of adoption was
not material.
At March 31, 1997, Sovereign had a $1.6 million reserve for assets that are
expected to be disposed of in connection with the acquisition of First State.
Goodwill and Other Intangible Assets
Total goodwill and other intangible assets at March 31, 1997 were $110.8
million compared to $113.6 million at December 31, 1996.
- 25 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Deposits
Deposits are attracted from within Sovereign's primary market area through
the offering of various deposit instruments including NOW accounts, money market
accounts, savings accounts, certificates of deposit and retirement savings
plans.
Total deposits at March 31, 1997 were $5.74 billion compared to $5.61
billion at December 31, 1996. For additional information with respect to
Sovereign's deposit portfolio composition, see Note 6 in the Notes to
Consolidated Financial Statements.
Borrowings
Sovereign utilizes borrowings as a source of funds for its asset growth and
its asset/liability management. Collateralized advances are available from the
FHLB provided certain standards related to creditworthiness have been met.
Another source of funds for Sovereign is reverse repurchase agreements. Reverse
repurchase agreements are short-term obligations collateralized by securities
fully guaranteed as to principal and interest by the U.S. Government or an
agency thereof.
Total borrowings at March 31, 1997, including $97.6 million of Trust
Preferred securities, were $3.83 billion of which $2.79 billion were short-term
compared to $3.86 billion of which $2.77 billion were short-term at December 31,
1996. This increase in short-term borrowings is the result of balance sheet
growth being funded principally by borrowings. For additional information with
respect to Sovereign's borrowings, see Note 7 in the Notes to Consolidated
Financial Statements.
Through the use of interest rate swaps, $900.0 million of FHLB advances and
$430.0 million of borrowings have been effectively converted from variable rate
obligations to fixed rate obligations and $75.0 million of FHLB advances have
been effectively converted from a fixed rate obligation to a variable rate
obligation.
At March 31, 1997, other borrowings included $50.0 million of subordinated
debentures which have, through the use of an interest rate swap, been converted
from a fixed rate obligation to a variable rate obligation.
In addition, $500.0 million, $100.0 million, and $100.0 million of
borrowings have been protected from upward repricing through the use of interest
rate caps, floors, and corridors, respectively, and effective March 18, 1998,
$250.0 million of short-term borrowings will, through the use of a forward swap,
be converted to longer-term, fixed rate borrowings.
- 26 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Stockholders' Equity
Total stockholders' equity at March 31, 1997 was $510.3 million compared to
$508.8 million at December 31, 1996. This increase is primarily attributable to
the retention of earnings less dividends paid to shareholders, net of
unallocated common stock held by ESOP and an adjustment to stockholders' equity
to reflect First State's activity for the three-month period ended December 31,
1996 resulting from the differing fiscal year end of First State as previously
discussed in Note 9 in the Notes to Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Sovereign's banking subsidiaries are required under applicable federal
regulations to maintain specified levels of "liquid" investments in cash and
U.S. Treasury and other qualifying investments. Regulations currently in effect
require Sovereign's banking subsidiaries to maintain liquid assets of not less
than 5% of its net withdrawable accounts plus short-term borrowings, of which
short-term liquid assets must consist of not less than 1%. These levels are
changed from time to time by the OTS to reflect economic conditions. The
liquidity ratio of Sovereign Bank for March 31, 1997 was 5.50%.
Sovereign's primary financing sources are deposits obtained in its own
market area and borrowings in the form of securities sold under repurchase
agreements and advances from the FHLB. While the majority of Sovereign's
certificate of deposit accounts are expected to mature within a one year period,
historically, the retention rate has been approximately 70%. If a significant
portion of maturing certificates would not renew at maturity, the impact on
Sovereign's operations and liquidity would be minimal due to cash flows produced
by Sovereign's investment portfolio which approximate $55 million per month. At
March 31, 1997, Sovereign had $3.04 billion in unpledged investments and
mortgage-backed securities which could be used to collateralize additional
borrowings. Sovereign Bank can also borrow from the FHLB, subject to required
collateralization. Other sources of funds include operating activities,
repayments of principal on investment and mortgage-backed securities, repayment
of principal on loans and other investing activities.
For the three-month period ended March 31, 1997, cash and cash equivalents
increased $25.9 million. Net cash provided by operating activities was $155.3
million for the three-month period ended March 31, 1997. Net cash used by
investing activities for the three-month period ended March 31, 1997 was $237.9
million consisting primarily of purchases of mortgage-backed securities which
are classified as held-to-maturity, partially offset by proceeds from sales of
investment and mortgage-backed securities held-to-maturity acquired in the First
State transaction. Net cash provided by financing activities for the three-month
period ended March 31, 1997 was $108.6 million which includes an increase in
deposits of $130.5 million and an increase in proceeds from long-term borrowings
of $192.2 million, partially offset by a decrease in short-term borrowings.
- 27 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA"),
requires the OTS to prescribe uniformly applicable capital standards for all
savings associations. These standards require savings associations to maintain a
minimum tangible capital ratio of not less than 1.5%, a minimum leverage capital
ratio of not less than 3% of tangible assets and not less than 4% of risk
adjusted assets and a minimum risk-based capital ratio (based upon credit risk)
of not less than 8%. In all cases, these standards are to be no less stringent
than the capital standards that are applicable to national banks. The OTS has
issued a regulation that requires a minimum leverage capital requirement of 3%
for associations rated composite 1 under the OTS MACRO rating system. For all
other savings associations, the minimum leverage capital requirement will be 3%
plus at least an additional 100 to 200 basis points.
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA"),
established five capital tiers: well capitalized, adequately capitalized, under
capitalized, significantly under capitalized and critically under capitalized. 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 are subject to various restrictions
regarding capital distributions, payment of management fees, acceptance of
brokered deposits and other operating activities.
At March 31, 1997, Sovereign Bank was classified as well capitalized and in
compliance with all capital requirements. Management anticipates that Sovereign
Bank will continue to be classified as well capitalized and will be in
compliance with all regulatory capital requirements.
The following table sets forth the capital ratios of Sovereign Bancorp and
Sovereign Bank and the current regulatory requirements at March 31, 1997:
<TABLE>
<CAPTION>
Well
Sovereign Sovereign Minimum Capitalized
Bancorp (1) Bank Requirement Requirement
-------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Stockholders' equity to
total assets 4.98% 6.29% None None
Tangible capital to tangible
assets 4.87 5.23 1.50% None
Leverage (core) capital to
tangible assets 4.87 5.23 3.00 5.00%
Leverage (core) capital to
risk adjusted assets 10.28 11.27 4.00 6.00
Risk-based capital to risk
adjusted assets 14.88 12.31 8.00 10.00
</TABLE>
(1) OTS capital regulations do not apply to savings and loan holding companies.
These ratios are computed as if those regulations did apply to Sovereign
Bancorp.
- 28 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
ASSET AND LIABILITY MANAGEMENT
The objective of Sovereign's asset and liability management is to identify,
manage and control its interest rate risk in order to produce consistent
earnings that are not largely contingent upon favorable trends in interest
rates. Sovereign manages its assets and liabilities to attain a stable net
interest margin across a wide spectrum of interest rate environments. This is
accomplished by monitoring the levels of interest rates, the relationships
between the rates earned on assets and the rates paid on liabilities, the
absolute amount of assets and liabilities which reprice or mature over similar
periods, off-balance sheet positions and the effect of all of these factors on
the estimated level of net interest income.
There are a number of industry standards used to measure an institution's
interest rate risk position. Most common among these is the one year gap which
is the ratio representing the difference between assets, liabilities and
off-balance sheet positions which will mature or reprice within one year
expressed as a percentage of total assets. Using management's estimates of asset
prepayments, core deposit decay and core deposit repricing in its computation,
Sovereign estimates that its cumulative one year gap position was a negative
12.74% at March 31, 1997. A negative gap position implies that the Bank is
liability sensitive which could cause net interest income to decrease if
interest rates rise.
Sovereign also utilizes income simulation modeling in measuring its
interest rate risk and managing its interest rate sensitivity. Income simulation
considers not only the impact of changing market interest rates on forecasted
net interest income, but also other factors such as yield curve relationships,
the volume and mix of assets and liabilities, customer preferences and general
market conditions. Sovereign manages the impact to net interest income in a +200
basis point instantaneous rate shock environment to be within a 5% loss. At
March 31, 1997, Sovereign estimates that if interest rates rise by 200 basis
points, net interest income would decrease by .27%.
Pursuant to its interest rate risk management strategy, Sovereign enters
into off-balance sheet transactions which involve interest rate exchange
agreements (swaps, caps and floors) for interest rate risk management purposes.
Sovereign's objective in managing its interest rate risk is to provide
sustainable levels of net interest income while limiting the impact changes in
interest rates have on net interest income. For additional information on
interest rate exchange agreements, see Note 8 in the Notes to Consolidated
Financial Statement.
- 29 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Amortizing and non-amortizing interest rate swaps are generally used to
convert fixed rate assets and liabilities to variable rate assets and
liabilities and vice versa. Sovereign utilizes amortizing interest rate swaps to
convert discounted adjustable rate loans to fixed rate for a period of time. The
amortization of the notional amount of the interest rate swaps are tied to the
level of an index such as the One Year Treasury Constant Maturity, LIBOR, or a
prepayment rate of a pool of mortgage-backed securities. In order for interest
rate swaps to achieve the desired objective, Sovereign selects interest rate
swaps that will have a high degree of correlation to the related financial
instrument. Sovereign generally utilizes non-amortizing swaps to convert fixed
rate liabilities to floating rate, to reduce Sovereign's overall cost of funds.
Interest rate caps are generally used to limit the exposure from the
repricing and maturity of liabilities and interest rate floors are generally
used to limit the exposure from repricing and maturity of assets. Interest rate
caps and floors are also used to limit the exposure created by other interest
rate swaps. In certain cases, interest rate caps or floors are simultaneously
bought and sold to create a range of protection against changing interest rates
while limiting the cost of that protection.
Due to competitive conditions, Sovereign originates fixed rate residential
mortgages. It exchanges the majority of these loans with FHLMC, FNMA and private
investors. The loans are exchanged for marketable fixed rate mortgage-backed
securities which are generally sold, or cash. This helps insulate Sovereign from
the interest rate and prepayment risk associated with these fixed rate assets.
Sovereign uses forward sales, cash sales and options on mortgage-backed
securities as means of hedging loans in the mortgage pipeline which are
originated for resale.
Sovereign's primary funding source is deposits obtained in its own
marketplace. Deposit programs at Sovereign are priced to meet management's
asset/liability objectives, while taking into account the rates available on
investment opportunities and also considering the cost of alternative funding
sources. Borrowings are a significant funding source for Sovereign and have
primarily been in the form of securities sold under repurchase agreements and
advances from the FHLB. Since borrowings are not subject to the market
constraints to which deposits are, Sovereign uses borrowings to add flexibility
to its interest rate risk position.
- 30 -
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Items 1 through 5 are not applicable or the responses are negative.
Item 6 - Reports on Form 8-K.
Report on Form 8-K, dated March 17, 1997 (date of earliest event -
March 17, 1997), contained pro forma financial information showing
the effects of the merger of First State Financial Services, Inc.
with and into Sovereign Bancorp, Inc., which was effective as of
February 18, 1997, and the pending acquisition of Bankers Corp.
Report on Form 8-K, dated February 13, 1997 (date of earliest event
- February 5, 1997), described the Agreement and Plan of Merger
dated February 5, 1997 pursuant to which Sovereign will acquire
Bankers Corp.
Report on Form 8-K, dated February 6, 1997 (date of earliest event -
February 6, 1997), contained a press release announcing the
execution of an Agreement and Plan of Merger for Sovereign to
acquire Bankers Corp.
Report on Form 8-K, dated February 3, 1997 (date of earliest event -
January 20, 1997), contained a press release announcing Sovereign's
earnings for the year ended December 31, 1996 and a press release
announcing an amendment to the timing of the 6 for 5 stock split on
Sovereign common stock which was declared on January 16, 1997.
- 31 -
<PAGE>
SIGNATURES
Pursuant to the requirements 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)
Date May 13, 1997 /s/ Karl D. Gerhart
------------------------ -------------------------------
Karl D. Gerhart
Chief Financial Officer
Date May 13, 1997 /s/ Mark R. McCollom
------------------------ -------------------------------
Mark R. McCollom
Chief Accounting Officer
- 32 -
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
PART III - FINANCIAL DATA SCHEDULE
ARTICLE 5 OF REGULATION S-X
</LEGEND>
<CIK> 0000811830
<NAME> Sovereign Bancorp, Inc.
<MULTIPLIER> 1,000
<CURRENCY> U.S.
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<EXCHANGE-RATE> 1
<CASH> 143,508
<SECURITIES> 3,315,704
<RECEIVABLES> 6,583,494
<ALLOWANCES> (50,537)
<INVENTORY> 0
<CURRENT-ASSETS> 232,049
<PP&E> 104,494
<DEPRECIATION> (44,318)
<TOTAL-ASSETS> 10,284,394
<CURRENT-LIABILITIES> 9,676,534
<BONDS> 0
0
96,446
<COMMON> 266,070
<OTHER-SE> 147,770
<TOTAL-LIABILITY-AND-EQUITY> 10,284,394
<SALES> 0
<TOTAL-REVENUES> 182,427
<CGS> 0
<TOTAL-COSTS> 33,345
<OTHER-EXPENSES> 10,757
<LOSS-PROVISION> 8,700
<INTEREST-EXPENSE> 113,373
<INCOME-PRETAX> 16,252
<INCOME-TAX> 7,045
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,207
<EPS-PRIMARY> .11
<EPS-DILUTED> .12
</TABLE>
