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 September 30, 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 November 12, 1997
- ------------------------------- --------------------------------
Common Stock (no par value) 89,316,645 shares
Preferred Stock (no par value) 1,998,350 shares
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at September 30, 1997
and December 31, 1996 3
Consolidated Statements of Operations for the three-
month and nine-month periods ended September 30,
1997 and 1996 4 - 5
Consolidated Statement of Stockholders' Equity for
the nine-month period ended September 30, 1997 6
Consolidated Statements of Cash Flows for the nine-
month periods ended September 30, 1997 and 1996 7
Notes to Consolidated Financial Statements 8 - 20
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 1 - 35
PART II. OTHER INFORMATION
Item 6. Reports on Form 8-K 36
PART III. FINANCIAL DATA SCHEDULE 37 - 38
SIGNATURES 39
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------ ------------
(Unaudited) (Note)
(in thousands, except
per share data)
<S> <C> <C>
ASSETS
Cash and amounts due from
depository institutions $ 178,269 $ 127,253
Interest-earning deposits 5,990 6,273
Loans held for resale (approximate fair
value of $20,623 and $33,162 at
September 30, 1997 and December 31, 1996,
respectively) 20,539 32,955
Investment and mortgage-backed securities
available-for-sale 869,894 529,178
Investment and mortgage-backed securities
held-to-maturity (approximate fair value
of $2,961,320 and $3,176,660 at September 30,
1997 and December 31, 1996, respectively) 2,937,692 3,195,094
Loans 10,299,998 8,321,771
Allowance for possible loan losses (94,517) (52,689)
Premises and equipment 67,597 74,609
Real estate owned 12,292 15,296
Accrued interest receivable 86,046 72,029
Goodwill and other intangible assets 118,117 116,935
Other assets 99,334 62,439
------------ ------------
TOTAL ASSETS $ 14,601,251 $ 12,501,143
============ ============
LIABILITIES
Deposits $ 7,750,849 $ 7,235,395
Borrowings:
Short-term 5,070,420 3,379,208
Long-term 854,589 1,097,076
Advance payments by borrowers
for taxes and insurance 35,877 38,152
Other liabilities 49,699 49,596
------------ ------------
TOTAL LIABILITIES 13,761,434 11,799,427
------------ ------------
Corporation-obligated mandatorily redeemable
capital securities of subsidiary
trust holding solely subordinated debentures
of Sovereign Bancorp, Inc
("Trust Preferred Securities") 97,452 --
------------ ------------
STOCKHOLDERS' EQUITY
Preferred stock; no par value; $50 liquidation
preference; 7,500,000 shares authorized; 1,998,350
shares issued at September 30, 1997
and December 31, 1996, respectively 96,367 96,446
Common stock; no par value;
200,000,000 shares authorized;
93,354,845 shares issued at September 30,
1997 and 92,425,076 shares issued at
December 31, 1996 380,032 400,638
Unallocated common stock held by the Employee
Stock Ownership Plan at cost;
4,067,047 shares at September 30, 1997
and 4,230,713 shares at December 31, 1996 (33,015) (33,316)
Treasury stock at cost; 12,319 shares at September 30,
1997 and 266,248 shares at December 31, 1996 (177) (27,360)
Unrecognized gain on investment
and mortgage-backed securities
available-for-sale, net of tax 7,440 1,794
Retained earnings 291,718 263,514
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 742,365 701,716
------------ ------------
TOTAL LIABILITIES, MINORITY INTERESTS AND
STOCKHOLDERS' EQUITY $ 14,601,251 $ 12,501,143
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
Note: The balance sheet at December 31, 1996 is taken from the audited
supplemental financial statements at that date restated to reflect Sovereign's
merger with First State Financial Services, Inc., plus additions necessary to
reflect Sovereign's August 29, 1997 acquisition of Bankers Corp., Inc., which
was accounted for as a pooling-of-interests, 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)
<TABLE>
<CAPTION>
Three-Month Period Nine-Month Period
Ended September 30, Ended September 30,
1997 1996 1997 1996
---- ---- ---- ----
(in thousands, except
per share data)
<S> <C> <C> <C> <C>
Interest income:
Interest on interest-earning deposits $ 877 $ 797 $ 2,242 $ 2,581
Interest and dividends on investment
and mortgage-backed securities
available-for-sale 12,703 8,811 32,185 26,271
Interest and dividends on investment
and mortgage-backed securities
held-to-maturity 65,861 54,568 189,761 158,090
Interest and fees on loans 164,930 149,803 470,397 411,906
-------- -------- -------- --------
Total interest income 244,371 213,979 694,585 598,848
-------- -------- -------- --------
Interest expense:
Interest on deposits 83,179 74,391 235,404 222,560
Interest on borrowings 76,099 61,776 213,724 150,456
-------- -------- -------- --------
Total interest expense 159,278 136,167 449,128 373,016
-------- -------- -------- --------
Net interest income 85,093 77,812 245,457 225,832
Provision for possible loan losses (1) 19,199 5,800 31,199 10,166
-------- -------- -------- --------
Net interest income after provision for
possible loan losses 65,894 72,012 214,258 215,666
-------- -------- -------- --------
Other income:
Other loan fees and service charges 2,481 5,445 5,817 13,003
Deposit fees 4,276 3,714 12,118 10,431
Gain on sale of loans
and investment and mortgage-
backed securities available-for-sale 22 1,369 1,251 2,560
Gain on sale of loans held for resale 989 252 3,734 1,368
Miscellaneous income 1,435 1,594 4,410 3,728
-------- -------- -------- --------
Total other income 9,203 12,374 27,330 31,090
-------- -------- -------- --------
General and administrative expenses:
Salaries and employee benefits 15,981 18,519 51,828 51,133
Occupancy and equipment expenses 10,090 6,668 22,550 20,390
Outside services 5,487 9,744 14,975 23,410
Deposit insurance premiums 869 3,002 2,806 9,227
Advertising 1,546 994 4,766 4,101
Other administrative expenses 6,417 5,725 19,854 16,949
-------- -------- -------- --------
Total general and administrative expenses 40,390 44,652 116,779 125,210
-------- -------- -------- --------
</TABLE>
-4-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(continued)
<TABLE>
<CAPTION>
Three-Month Period Nine-Month Period
Ended September 30, Ended September 30,
1997 1996 1997 1996
---- ---- ---- ----
(in thousands, except
per share data)
<S> <C> <C> <C> <C>
Other operating expenses:
One-time, merger-related charge 21,303 -- 29,258 --
Non-recurring SAIF assessment -- 30,657 -- 30,657
Amortization of goodwill and other intangibles 2,876 3,185 8,615 9,571
Trust Preferred Securities expense 2,271 -- 4,718 --
Real estate owned losses, net 170 1,749 694 2,800
------- ------- ------- -------
Total other operating expenses 26,620 35,591 43,285 43,028
------- ------- ------- -------
Income before income taxes 8,087 4,143 81,524 78,518
Income tax provision 5,547 1,902 33,949 29,643
------- ------- ------- -------
Net Income (2) $ 2,540 $ 2,241 $47,575 $48,875
======= ======= ======= =======
Net Income Applicable to Common Stock $ 979 $ 649 $42,890 $44,188
======= ======= ======= =======
Earnings per share (2) (3) $.02 $.02 $.46 $.48
======= ======= ======= =======
Dividends per share (3) $.036 $.038 $.112 $.107
======= ======= ======= =======
</TABLE>
(1) Results for the three-month and nine-month periods ended September 30, 1997
include $17.0 million and $24.9 million, respectively, of one-time,
pre-tax, merger charges related to the acquisitions of First State
Financial Services, Inc. ("First State") in the first quarter of 1997 and
Bankers Corp, Inc. ("Bankers") in the third quarter of 1997.
(2) Excluding the one-time, after-tax, merger related charges of $25.9 million
and $36.6 million for the three-month and nine-month periods ended
September 30, 1997, respectively, net income and earnings per share for the
same periods were $28.6 million and $.28 per share and $84.3 and $.82 per
share, respectively. Excluding the non-recurring, after-tax, SAIF
assessment of $19.0 million paid in September 1996, net income and earnings
per share for the three-month and nine- month periods ended September 30,
1996 were $21.3 million and $.21 per share and $68.0 million and $.67 per
share respectively.
(3) Per share amounts have been adjusted to reflect all stock dividends and
stock splits.
See accompanying notes to consolidated financial statements.
-5-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Common Preferred
Shares Shares Common Preferred Retained
Outstanding Outstanding Stock Stock Earnings
----------- ----------- ------ --------- ----------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1996 87,928 2,000 $ 400,638 $ 96,446 $ 263,514
Net income -- -- -- -- 47,575
Exercise of stock options 866 -- 2,814 -- (461)
Cash in lieu of fractional shares (2) -- (21) -- --
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan 139 -- 1,809 -- --
Dividends paid on common stock,
$.112 per share -- -- -- -- (8,008)
Dividends paid on preferred stock,
$2.34 per share -- -- -- -- (4,685)
Treasury stock repurchase (27) -- -- -- --
Treasury stock sale 23 -- -- -- --
Retirement of treasury shares -- -- (26,508) -- --
Unrecognized gain on investment
and mortgage-backed securities
available-for-sale, net of tax -- -- -- -- --
Conversion of Preferred stock 10 (2) 79 (79) --
Allocation of shares under Employee
Stock Ownership Plan 164 -- -- -- --
Adjustment for First State's
different fiscal year end 174 -- 1,010 -- (6,217)
Other -- -- 211 -- --
--------- --------- --------- --------- ---------
Balance, September 30, 1997 89,275 1,998 $ 380,032 $ 96,367 $ 291,718
========= ========= ========= ========= =========
<CAPTION>
Total
Unallocated Unrecognized Stock-
Treasury Common Stock Gain on Holders'
Stock Held by ESOP AFS Equity
---------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
Balance, December 31, 1996 $ (27,360) $ (33,316) $ 1,794 $ 701,716
Net income -- -- -- 47,575
Exercise of stock options 1,055 -- -- 3,408
Cash in lieu of fractional shares -- -- -- (21)
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan -- -- -- 1,809
Dividends paid on common stock,
$.112 per share -- -- -- (8,008)
Dividends paid on preferred stock,
$2.34 per share -- -- -- (4,685)
Treasury stock repurchase (656) -- -- (656)
Treasury stock sale 276 -- -- 276
Retirement of treasury shares 26,508 -- -- --
Unrecognized gain on investment
and mortgage-backed securities
available-for-sale, net of tax -- -- 5,418 5,418
Conversion of Preferred stock -- -- -- --
Allocation of shares under Employee
Stock Ownership Plan -- 301 -- 301
Adjustment for First State's
different fiscal year end -- -- 228 (4,979)
Other -- -- -- 211
--------- --------- --------- ---------
Balance, September 30, 1997 $ (177) $ (33,015) $ 7,440 $ 742,365
========= ========= ========= =========
</TABLE>
-6-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine-Month Period
Ended September 30,
---------------------------------
1997 1996
---- ----
(in thousands)
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 47,575 $ 48,875
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for possible loan losses and deferred taxes 47,564 17,643
Depreciation 5,730 6,086
Amortization 15,390 3,686
Gain on sale of loans, investment and
mortgage-backed securities and real estate owned (1,167) (1,023)
Net change in:
Loans held for resale 12,416 112,553
Accrued interest receivable (14,017) (11,408)
Prepaid expenses and other assets (79,020) (2,506)
Other liabilities 99,658 11,947
---------- ----------
Net cash provided by operating activities $ 134,129 $ 185,853
---------- ----------
Cash Flows from Investing Activities:
Proceeds from sales of investment
and mortgage-backed securities:
Available-for-sale 231,570 550,452
Proceeds from repayments and maturities of investment
and mortgage-backed securities:
Available-for-sale 77,625 90,800
Held-to-maturity 1,205,338 501,229
Purchases of investment and mortgage-backed securities:
Available-for-sale (483,386) (313,140)
Held-to-maturity (1,104,872) (984,243)
Proceeds from sales of loans 20,084 7,681
Purchase of loans (2,632,063) (1,090,389)
Net change in loans other than purchases and sales 641,699 (558,961)
Proceeds from sales of premises and equipment 9,039 2,527
Purchases of premises and equipment (7,926) (4,653)
Proceeds from sale of real estate owned 13,915 13,466
Net cash received in business combinations -- 4,983
Other, net (4,996) -
----------- ----------
Net cash used by investing activities (2,033,973) (1,780,248)
----------- -----------
Cash Flows from Financing Activities:
Net increase/(decrease) in deposits 516,309 (102,716)
Net increase in short-term borrowings 1,040,244 932,847
Proceeds from long-term borrowings 406,156 785,001
Repayments of long-term borrowings -- (1)
Net increase in advance payments by
borrowers for taxes and insurance (2,275) 56
Cash dividends paid to stockholders (14,674) (14,158)
Net proceeds from issuance of common stock 4,906 3,669
Advance to the Employee Stock Ownership Plan -- (10,000)
Purchase of treasury stock, net (89) (10,684)
----------- -----------
Net cash provided by financing activities 1,950,577 1,584,014
---------- ----------
Net change in cash and cash equivalents 50,733 (10,381)
Cash and cash equivalents at beginning of period 133,526 182,900
---------- ----------
Cash and cash equivalents at end of period $ 184,259 $ 172,519
========== ==========
Reconciliation of Cash and Cash Equivalents to Consolidated
Balance Sheets:
Cash and amounts due from depository institutions $ 178,269 $ 153,029
Interest-earning deposits 5,990 19,490
---------- ----------
Cash and cash equivalents at end of period $ 184,259 $ 172,519
========== ==========
</TABLE>
Supplemental Disclosures:
Income tax payments totaled $31.1 million for the nine-month period ended
September 30, 1997 and $38.8 million for the same period in 1996. Interest
payments totaled $422.8 million for the nine-month period ended September 30,
1997 and $357.4 million for the same period in 1996. Noncash activity consisted
of mortgage loan securitization of $192.1 million for the nine-month period
ended September 30, 1997 and $313.1 million for the same period in 1996;
reclassification of long-term borrowings to short-term borrowings of $649.0
million for the nine-month period ended September 30, 1997 and $629.7 million
for the same period in 1996; and reclassification of mortgage loans to real
estate owned of $16.9 million for the nine-month period ended September 30, 1997
and $12.7 million for the same period in 1996.
See accompanying notes to consolidated financial statements.
-7-
<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, stockholders' equity, 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 and nine-month periods ended
September 30, 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, and the
audited supplemental consolidated financial statements, restated for the merger
of First State Financial Services, Inc. filed on Form 8-K dated June 17, 1997.
-8-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(2) EARNINGS PER SHARE
Primary and fully diluted earnings per share have been computed based on
the weighted average number of common and common equivalent shares outstanding
during the period. Common equivalent shares include dilutive stock options for
both primary and fully diluted earnings per share. Fully diluted shares also
assume the conversion of convertible preferred shares. Primary shares
outstanding for the nine-month periods ended September 30, 1997 and 1996 were
90.5 million and 89.1 million, respectively and fully diluted shares outstanding
for the same periods were 102.6 million and 101.1 million, respectively.
Earnings per share have been adjusted to reflect all stock dividends and stock
splits. The following table presents the computation of primary and fully
diluted earnings per share at the dates indicated: (dollars in thousands, except
per share data)
<TABLE>
<CAPTION>
Nine-Month Period Ended September 30,
---------------------------------------------
Primary Fully Diluted
------- -------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income (1) $47,575 $48,875 $47,575 $48,875
Preferred dividends $ 4,685 $ 4,687 $ 4,685 $ 4,687
Net income applicable to
common stock $42,890 $44,188 $42,890 $44,188
Average common shares
outstanding at end of
period 88,661 87,168 100,632 99,142
Average stock options
considered to be common
stock equivalents, net of
shares assumed to be
repurchased under the
treasury stock method 1,805 1,939 1,967 2,007
------- ------- ------- -------
Average common and common
equivalent shares
outstanding at end of
period 90,466 89,107 102,599 101,149
======= ======= ======= =======
Earnings per share $ .47 $ .50 $ .46 $ .48
======= ======= ======= =======
</TABLE>
(1) Results for the nine-month period ended September 30, 1997 include
one-time, after-tax, merger related charges of $36.6 million. Excluding the
one-time charges, primary and fully diluted earnings per share for the
nine-month period ended September 30, 1997 were $.88 and $.82,
respectively. Results for the nine-month period ended September 30, 1996
include a non-recurring, after- tax, SAIF assessment of $19.0 million.
Excluding the non-recurring SAIF assessment, primary and fully diluted
earnings per share for the nine-month period ended September 30, 1996 were
$.71 and $.67 respectively.
-9-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
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. Contrary to the current computation of
primary earnings per share, the dilutive effect of stock options will be
excluded from the calculation of basic earnings per share under the requirements
of SFAS No. 128. On a pro forma basis, the impact of SFAS No. 128 on the
calculation of primary and fully diluted earnings per share for these quarters
is not material. For additional information with respect to SFAS No. 128, see
Note 10 in the Notes to Consolidated Financial Statements.
-10-
<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>
September 30, 1997
------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---- ------------ ------------ -----
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ -- $ -- $ -- $ --
Equity securities 433,905 11,387 -- 445,292
Other securities -- -- -- --
Mortgage-backed Securities:
FHLMC 82,262 131 -- 82,393
FNMA 33,532 -- 179 33,353
GNMA 61,880 182 -- 62,062
Collateralized mortgage
obligations 246,119 901 226 246,794
Other securities -- -- -- --
-------- -------- -------- --------
Total investment and
mortgage-backed securities
available-for-sale $857,698 $ 12,601 $ 405 $869,894
======== ======== ======== ========
<CAPTION>
December 31, 1997
-----------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---- ------------ ------------ -----
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 40,810 $ 43 $ 908 $ 39,945
Equity securities 286,773 3,525 -- 290,298
Other securities 7,720 -- 248 7,472
Mortgage-backed Securities:
FHLMC 25,288 -- 287 25,001
FNMA -- -- -- --
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 $526,309 $ 4,463 $ 1,594 $529,178
======== ======== ======== ========
</TABLE>
-11-
<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>
September 30, 1997
------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---- ------------ ------------ -----
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 12,131 $ 52 $ 35 $ 12,148
Corporate securities 4,100 30 -- 4,130
Other securities 58,328 2,119 112 60,335
Mortgage-backed Securities:
FHLMC 236,729 5,640 117 242,252
FNMA 151,447 2,618 86 153,979
GNMA 404,763 8,134 -- 412,897
Private issues 110,429 961 127 111,263
Collateralized mortgage
obligations 1,959,765 7,834 3,283 1,964,316
Other securities -- -- -- --
---------- ---------- ---------- ----------
Total investment and
mortgage-backed securities
held-to-maturity $2,937,692 $ 27,388 $ 3,760 $2,961,320
========== ========== ========== ==========
<CAPTION>
December 31, 1997
-----------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---- ------------ ------------ -----
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 13,926 $ 60 $ 171 $ 13,815
Corporate securities 25,492 136 71 25,557
Other securities 66,061 128 242 65,947
Mortgage-backed Securities:
FHLMC 267,014 3,295 3,425 266,884
FNMA 252,515 2,024 5,102 249,437
GNMA 350,826 5,098 463 355,461
Private issues 273,555 87 9,546 264,096
Collateralized mortgage
obligations 1,943,619 5,708 15,914 1,933,413
Other securities 2,086 -- 36 2,050
---------- ---------- ---------- ----------
Total investment and
mortgage-backed securities
held-to-maturity $3,195,094 $ 16,536 $ 34,970 $3,176,660
========== ========== ========== ==========
</TABLE>
-12-
<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>
September 30, 1997 December 31, 1996
------------------ -----------------
Amount Percent Amount Percent
----------- ------- ---------- -------
<S> <C> <C> <C> <C>
Residential real estate loans $ 6,681,859 64.9% $6,848,639 82.3%
Residential construction loans
(net of loans in process of
$38,248 and $45,088, respectively) 60,352 .6 83,736 1.0
----------- ----- ---------- ------
Total Residential Loans 6,742,211 65.5 6,932,375 83.3
----------- ------ ---------- ------
Multi-family loans 75,941 .7 87,417 1.1
Commercial real estate loans 276,321 2.7 175,896 2.1
Commercial loans 151,521 1.5 126,086 1.5
Automotive Floor Plan loans 230,349 2.2 - -
----------- ----- ---------- -----
Total Commercial Loans 734,132 7.1 389,399 4.7
----------- ------ ---------- ------
Home equity loans 778,059 7.5 634,194 7.6
Credit cards 60,338 .6 82,798 1.0
Student loans 182,158 1.8 204,797 2.4
Auto loans 1,513,144 14.7 64,033 .8
Vehicle funding loans 277,351 2.7 - -
Other 12,605 .1 14,175 .2
----------- ------ ---------- ------
Total Consumer Loans 2,823,655 27.4% 999,997 12.0%
----------- ------ ---------- ------
Total Loans $10,299,998 100.00% $8,321,771 100.0%
=========== ====== ========== ======
Total Loans with: (1)
Fixed rates $ 3,268,664 31.7% $1,547,309 18.6%
Variable rates 7,031,334 68.3 6,774,462 81.4
----------- ------ ---------- ------
Total Loans $10,299,998 100.0% $8,321,771 100.0%
=========== ====== ========== ======
</TABLE>
(1) Loan totals do not reflect the impact of off-balance sheet interest rate
swaps used for interest rate risk management as discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Loan Portfolio."
-13-
<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>
September 30, 1997 December 31, 1996
------------------ -----------------
Weighted Weighted
Average Average
Account Type Amount Percent Rate Amount Percent Rate
------------ ------ ------- ------- ------ ------- -----
<S> <C> <C> <C> <C>
Demand deposit accounts $ 333,604 4.3% -- % $ 322,158 4.5% -- %
NOW accounts 552,345 7.1 1.36 552,221 7.6 1.51
Savings accounts 1,273,090 16.4 2.42 1,258,233 17.4 2.41
Money market accounts 1,106,621 14.3 4.23 1,081,568 14.9 4.06
Retail certificates 3,985,959 51.4 5.52 3,795,733 52.5 5.33
Jumbo certificates 499,230 6.5 5.73 225,482 3.1 5.54
---------- ------ ---- ---------- ------ ----
Total Deposits $7,750,849 100.0% 4.31% $7,235,395 100.0% 4.11%
========== ====== ==== ========== ====== ====
</TABLE>
(7) BORROWINGS
The following table presents information regarding borrowings at the dates
indicated: (dollars in thousands)
<TABLE>
<CAPTION>
September 30, 1997 December 31, 1996
------------------ -----------------
Weighted Weighted
Average Average
Balance Rate Balance Rate
------- -------- ------- --------
<S> <C> <C> <C> <C>
Securities sold under
repurchase agreements $ 875,249 5.75% $ 603,090 5.65%
FHLB advances 4,834,265 5.92 3,694,446 5.85
Other borrowings 215,495 5.82 178,748 7.45
---------- ---- ---------- ----
Total Borrowings $5,925,009 5.89% $4,476,284 5.89%
========== ==== ========== ====
</TABLE>
-14-
<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 (interest rate
corridors) 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>
September 30, 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) $ 623,038 $ -- $(4,377) 3.0
Pay fixed-receive variable (2) 218,089 -- 499 1.6
Non-amortizing interest rate swaps:
Pay variable-receive fixed (3) 625,000 -- 543 4.1
Pay fixed-receive variable (4) 2,900,000 -- (3,831) 2.5
Interest rate caps/floors/
corridors (5) 1,200,000 10,656 2,567 4.2
---------- ------- -------
$5,566,127 $10,656 $(4,599)
========== ======= =======
<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>
-15-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(1) The weighted average pay rate was 5.61% and 5.50% and the weighted average
receive rate was 5.99% and 5.93% at September 30, 1997 and December 31,
1996, respectively.
(2) The weighted average pay rate was 6.87% and 6.76% and the weighted average
receive rate was 7.08% and 6.18% at September 30, 1997 and December 31,
1996, respectively.
(3) The weighted average pay rate was 5.86% and 6.91% and the weighted average
receive rate was 7.36% and 6.75% at September 30, 1997 and December 31,
1996, respectively.
(4) The weighted average pay rate was 5.73% and 5.28% and the weighted average
receive rate was 5.72% and 5.53% at September 30, 1997 and December 31,
1996, respectively. Of the September 30, 1997 notional amount, $450.0
million and $650.0 million will become effective during the fourth quarter
of 1997 and first quarter of 1998, respectively.
(5) The weighted average strike price range was 5.25% - 9.00% at September 30,
1997.
The following table summarizes by notional amounts the activity of
Sovereign's interest rate exchange agreements: (dollars in thousands)
<TABLE>
<CAPTION>
Balance Balance
December 31, Maturities/ Sept. 30,
1996 Additions Amortization Terminations 1997
----------- ----------- ------------ ------------ --------
<S> <C> <C> <C> <C> <C>
Amortizing interest $1,112,013 $ -- $ 120,886 $ 150,000 $ 841,127
rate swaps
Non-amortizing interest
rate swaps 1,405,000 3,900,000 180,000 1,600,000 3,525,000
Interest rate
caps/floors/corridors 500,000 700,000 -- -- 1,200,000
---------- ---------- --------- ---------- ---------
$3,017,013 $4,600,000 $ 300,886 $1,750,000 $5,566,127
========== ========== ========= ========== ==========
</TABLE>
At September 30, 1997, Sovereign's balance sheet included a net deferred
loss of $2.2 million related to interest rate exchange agreements terminated in
June 1996 and September 1997 which were originally accounted for as hedges. Of
this net deferred loss, $1.3 million will amortize into interest expense during
the remainder of 1997 and $956,000 will amortize into interest expense in 1998.
Net interest income resulting from interest rate exchange agreements
includes $3.5 million of income and $3.8 million of expense for the nine-month
period ended September 30, 1997.
-16-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(9) ACQUISITIONS
On September 19, 1997, Sovereign acquired Fleet Financial Group Inc.'s
("Fleet") Automobile Finance Division ("Fleet Auto"). Fleet Auto is the result
of Fleet's acquisition over the last two years of Shawmut and NatWest. Fleet
Auto consists of approximately $2.0 billion of indirect auto loans, dealer floor
plan loans and vehicle funding (loans to automotive lessors) loans. Fleet Auto
has business relationships with over 2,000 automotive dealerships and serves
approximately 225,000 customers throughout New Jersey, New York and several New
England states. Sovereign purchased Fleet Auto at a discount, which in part,
reflected the need to establish initial reserves for possible loan losses of
approximately $22.0 million or 1.50% of the indirect auto loans acquired. As
part of the transaction, Sovereign has offered employment to substantially all
of the employees of Fleet Auto.
On August 29, 1997, Sovereign acquired Bankers Corp., Inc. ("Bankers"), a
$2.6 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 added loans, deposits, and shareholders' equity to Sovereign of
$1.5 billion, $1.7 billion, and $203.5 million, respectively. In accordance with
the merger agreement, Bankers shareholders received 1.854 shares of Sovereign
common stock in exchange for each share of Bankers common stock. Sovereign
issued approximately 23.0 million new shares of Sovereign common stock in
connection with the transaction, which was tax-free to Bankers and Bankers
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 Bankers 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 $241,895 $196,810
Bankers 62,226 55,447
-------- --------
Combined $304,121 $252,257
======== ========
Net income
Sovereign $ 45,814 $ 60,406
Bankers 24,325 20,004
---------- -------
Combined $ 70,139 $ 80,410
========== ========
-17-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
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 1.47 shares of Sovereign common stock in exchange for each
share of First State common stock. Sovereign issued 5.9 million new shares 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 and nine-month periods ended September 30, 1997 include First
State's results of operations for the same periods. Sovereign's consolidated
results of operations for the three-month and nine-month periods ended September
30, 1996 include First State's results of operations for the three-month and
nine-month periods ended June 30, 1996, respectively. A net decrease to
Sovereign's stockholders' equity of $5.0 million has been made to reflect First
State's activity for the three-month period ended December 31, 1996. That
activity consisted of proceeds from the exercise of stock options of $1.0
million, net loss of $6.4 million, dividends paid of $223,000 and net change in
unrecognized loss on available-for-sale securities of $228,000.
-18-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
On September 18, 1997, Sovereign executed a Definitive Agreement to acquire
ML Bancorp, Inc. ("ML Bancorp"), a $2.2 billion bank holding company
headquartered in Villanova, Pennsylvania. ML Bancorp's principal operating
subsidiary, Main Line Bank, operates 29 branch offices located in the suburbs of
Philadelphia, Pennsylvania. The terms of the Agreement call for Sovereign to
exchange 1.67 shares of Sovereign common stock for each outstanding share of ML
Bancorp common stock or a total consideration of approximately $345 million in
Sovereign common stock. If Sovereign's average stock price remains between
$13.80 and $18.67 per share (collectively, the "Collars") during a 20-day
pricing period as set forth in the Agreement, the exchange ratio will remain
fixed at 1.67 shares. However, if during the pricing period, Sovereign's average
stock price is outside the lower or upper Collars, the price is fixed for ML
Bancorp's shareholders at $23.05 and $31.18 per share, respectively, subject to
adjustment under certain conditions. The transaction will be tax-free to ML
Bancorp and ML Bancorp shareholders, and will be accounted for a
pooling-of-interests. Sovereign anticipates that the transaction will close
during the first quarter of 1998.
(10) ACCOUNTING CHANGES
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income.
The overall objective of SFAS No. 130 is to provide prominent disclosure of
comprehensive income items. Comprehensive income is the change in equity of a
business enterprise during a period from transactions and other events and
circumstances from non-owner sources. SFAS No. 130 is effective for all periods
ending after December 15, 1997. Subsequent to the effective date, all
prior-period amounts are required to be restated to conform to the provisions of
SFAS No. 130.
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information. SFAS 131 requires that public business
enterprises report certain information about operating segments in complete sets
of financial statements of the enterprise and in condensed financial statements
of interim periods issued to shareholders. It also requires that public business
enterprises report certain information about their products and services, the
geographic areas in which they operate, and their major customers. SFAS No. 131
is effective for all periods ending after December 15, 1997. Subsequent to the
effective date, all prior-period amounts are required to be restated to conform
to the provisions of SFAS No. 131.
Sovereign is currently evaluating the impact of SFAS No. 130 and SFAS No.
131 on its consolidated financial statements.
-19-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
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.
Under SFAS No. 128, fully diluted earnings per share will be 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 than 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. On a pro forma basis, the impact
of SFAS No. 128 on the calculation of primary and fully diluted earnings per
share for current and prior periods is not material.
-20-
<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 September 30, 1997, excluding a
one-time, after-tax charge of $25.9 million related to the acquisitions of
Bankers Corp., Inc. (Bankers") and the Automobile Finance Division from Fleet
Financial Group, Inc. ("Fleet Auto") was $28.6 million, an increase of 34% when
compared to net income of $21.3 million for the same period in 1996, excluding a
non-recurring, after-tax charge of $19.0 million paid during the third quarter
of 1996 for the recapitalization of the Savings Association Insurance Fund
("SAIF"). Earnings per share for the three-month period ended September 30,
1997, excluding the one-time, merger-related charge was $.28 per share, an
increase of 33% when compared to $.21 per share for the same period in 1996,
excluding the non-recurring SAIF assessment.
Net income for the nine-month period ended September 30, 1997, excluding
one-time, after-tax charges totaling $36.6 million related to the acquisitions
of First State Financial Services, Inc. ("First State") during the first quarter
of 1997 and Bankers and Fleet Auto during the third quarter of 1997 was $84.3
million, an increase of 24% when compared to net income of $68.0 million for the
same period in 1996, excluding the non-recurring SAIF assessment. Earnings per
share for the nine-month period ended September 30, 1997, excluding the
one-time, merger-related charges was $.82 per share, an increase of 22% when
compared to $.67 per share for the same period in 1996, excluding the
non-recurring SAIF assessment.
Actual net income and earnings per share for the three-month and nine-month
periods ended September 30, 1997, including the impact of the one-time,
merger-related charges were $2.5 million and $.02 per share and $47.6 million
and $.46 per share, respectively. Actual net income and earnings per share for
the three-month and nine-month periods ended September 30, 1996, including the
impact of the non-recurring charge for the SAIF assessment were $2.2 million and
$.02 per share and $48.9 million and $.48 per share, respectively. 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 charges
were 15.50%, .86% and 5.54%, respectively, for the nine-month period ended
September 30, 1997 compared to 13.31%, .80% and 6.00%, respectively, for the
same period in 1996, excluding the non-recurring SAIF assessment.
Net Interest Income
Net interest income for the three-month and nine-month periods ended
September 30, 1997 was $85.1 million and $245.5 million compared to $77.8
million and $225.8 million for the same periods 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 average interest-earning
assets) for the three-month and nine-month periods ended September 30, 1997 was
2.58% and 2.61% compared to 2.66% and 2.79% for the same periods in 1996.
-21-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Interest on interest-earning deposits for the three-month and nine-month
periods ended September 30, 1997 was $877,000 and $2.2 million compared to
$797,000 and $2.6 million for the same periods in 1996. The average balance of
interest-earning deposits was 13.4 million with an average yield of 22.26% for
the nine-month period ending September 30, 1997 compared to an average balance
of $14.1 million with an average yield of 23.23% 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.
Interest on investment and mortgage-backed securities available-for-sale
was $12.7 million and $32.2 million for the three-month and nine-month periods
ended September 30, 1997 compared to $8.8 million and $26.3 million for the same
periods in 1996. The average balance of investment and mortgage-backed
securities available-for-sale was $689.9 million with an average yield of 6.65%
for the nine-month period ended September 30, 1997 compared to an average
balance of $530.0 million with an average yield of 7.02% for the same period in
1996.
Interest on investment and mortgage-backed securities held-to-maturity was
$65.9 million and $189.8 million for the three-month and nine-month periods
ended September 30, 1997 compared to $54.6 million and $158.1 million for the
same periods in 1996. The average balance of investment and mortgage-backed
securities held-to-maturity was $3.56 billion with an average yield of 7.11% for
the nine-month period ended September 30, 1997 compared to an average balance of
$2.97 billion with an average yield of 7.07% for the same period in 1996.
Interest and fees on loans were $164.9 million and $470.4 million for the
three-month and nine-month periods ended September 30, 1997 compared to $149.8
million and $411.9 million for the same periods in 1996. The average balance of
loans was $8.38 billion with an average yield of 7.50% for the nine-month period
ended September 30, 1997 compared to an average balance of $7.33 billion with an
average yield of 7.50% 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
Sovereign's acquisition of Fleet Auto and the full year-to-date effect of
Sovereign's record level of loan originations in 1996.
Interest on deposits was $83.2 million and $235.4 million for the
three-month and nine-month periods ended September 30, 1997 compared to $74.4
million and $222.6 million for the same periods in 1996. The average balance of
deposits was $7.46 billion with an average cost of 4.22% for the nine-month
period ended September 30, 1997 compared to an average balance of $7.14 billion
with an average cost of 4.16% for the same period in 1996. The increase in the
average balance of deposits is primarily the result of deposits acquired from
the Fleet transaction and Sovereign's relationship selling campaign during 1997.
-22-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Interest on borrowings was $76.1 million and $213.7 million for the
three-month and nine-month periods ended September 30, 1997 compared to $61.8
million and $150.5 million for the same periods in 1996. The average balance of
borrowings was $4.74 billion with an average cost of 5.99% for the nine-month
period ended September 30, 1997 compared to an average balance of $3.39 billion
with an average cost of 5.92% for the same period in 1996. The increase in the
average balance of borrowings is the result of the Fleet Auto acquisition and
other internal balance sheet growth being funded principally by borrowings.
Provision for Possible Loan Losses
The provision for possible loan losses was $19.2 million and $31.2 million
for the three-month and nine-month periods ended September 30, 1997, which
includes $17.0 million and $24.9 million, respectively of additional reserves,
which Sovereign has determined will be necessary as a result of its conservative
approach with respect to an aggressive workout plan for certain assets acquired
from Bankers and First State. This compares to provision for possible loan
losses of $5.8 million and $10.2 million for the same periods in 1996.
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. Sovereign's 1997 acquisition of Fleet Auto and
Sovereign's planned acquisition of ML Bancorp in 1998 will further diversify its
loan portfolio composition. 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 nine-month period ended September 30, 1997, Sovereign
charged-off $10.8 million of loans compared to $10.6 million for the same period
in 1996. This slight increased level of charge-offs for the nine-month period
ended September 30, 1997 has been partially off-set by recoveries of $2.1
million of loans primarily related to the commercial real estate portfolio,
resulting in net charge-offs for 1997 of $8.7 million. This compares to
recoveries of $906,000 and net charge-offs of $9.7 million for the same period
in 1996. In Sovereign's experience, strategy that involves the accelerated
resolution of problem assets is more appropriate than a long-term workout
approach. In connection with this change in philosophy, additional reserves were
deemed appropriate.
-23-
<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 activity in the allowance for possible
loan losses for the periods indicated: (dollars in thousands)
Nine-Month Period Ended September 30,
1997 1996
-------------------------------------
Allowance, beginning of period $52,689 $49,075
Charge-offs:
Residential 6,796 7,093
Commercial Real Estate 542 1,894
Commercial 1,305 252
Consumer 2,182 1,382
------- -------
Total Charge-offs 10,825 10,621
------- -------
Recoveries:
Residential 607 711
Commercial Real Estate 1,074 65
Commercial 172 -
Consumer 273 130
------- -------
Total Recoveries 2,126 906
------- -------
Charge-offs, net of recoveries 8,699 9,715
Provision for possible loan losses 31,199 10,166
Other additions (1) 19,328 716
------- -------
Allowance, end of period $94,517 $50,242
======= =======
(1) Represents net charge-offs for First State of $2.7 million 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, plus the establishment of $22.0
million of initial reserves in connection with the Fleet Auto acquisition.
Other Income
Other income was $9.2 million and $27.3 million for the three-month and
nine-month periods ended September 30, 1997 compared to $12.4 million and $31.1
million for the same periods in 1996.
Other loan fees and service charges were $2.5 million and $5.8 million for
the three-month and nine-month periods ended September 30, 1997 compared to $5.4
million and $13.0 million for the same periods 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, other loan fees and service charges for the three-month and
nine-month periods ended September 30, 1996 were $1.4 million and $4.0 million.
Other loan fees and service charges result primarily from Sovereign's loan
servicing portfolio. Sovereign serviced $8.34 billion of its own loans and
-24-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
$1.45 billion of loans for others at September 30, 1997 compared to $6.38
billion of its own loans and $1.41 billion of loans for others at September 30,
1996.
Deposit fees were $4.3 million and $12.1 million for the three-month and
nine-month periods ended September 30, 1997 compared to $3.7 million and $10.4
million for the same periods in 1996. This increase is primarily the result of
growth in the number of Sovereign's transaction accounts over the last year.
Gains on sales of loans and investment and mortgage-backed securities
available-for-sale were $22,000 and $1.3 million for the three-month and
nine-month periods ended September 30, 1997 compared to $1.4 million and $2.6
million for the same periods in 1996. This decrease is primarily attributable to
the liquidation of $3.5 million of equity securities in September 1996. In
connection with the Bankers acquisition, during the third quarter of 1997,
Sovereign liquidated $750.5 million of investments including some
held-to-maturity securities. This sale was completed in accordance with the
provisions of Statement of Financial Accounting Standard ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities" to maintain
Sovereign's pre-merger interest rate risk position. The $10.3 million (pre-tax)
loss on the sale of these investments is included as part of the one-time,
merger-related charge taken during the third quarter of 1997.
Gains on sales of loans held for resale were $989,000 and $3.7 million for
the three-month and nine-month periods ended September 30, 1997 compared to
$252,000 and $1.4 million for the same periods in 1996. This year-to-date
increase is primarily due to increased mortgage banking gains resulting from a
gain of $1.3 million from the sale of mortgage servicing rights during the
second quarter of 1997 and profitability enhancements made to Sovereign's
secondary marketing area in 1997.
Miscellaneous income was $1.4 million and $4.4 million for the three-month
and nine-month periods ended September 30, 1997 compared to $1.6 million and
$3.7 million for the same periods in 1996. This year-to-date 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 $40.4 million and $116.8
million for the three-month and nine-month periods ended September 30, 1997
compared to $44.7 million and $125.2 million for the same periods in 1996. The
ratio of general and administrative expenses to average assets for both the
three-month and nine-month periods ended September 30, 1997 was 1.19% compared
to 1.47% and 1.48% for the same periods in 1996. Sovereign's efficiency ratio
(all general and administrative expenses as a percentage of net interest income
and recurring non-interest income) for the three-month and nine-month periods
ended September 30, 1997 was 42.8% and 43.0% compared to 49.9% and 49.1% for the
same periods in 1996. The decrease in total general and administrative expenses
-25-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
and the resulting favorable decrease in Sovereign's 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.
Other operating expenses were $26.6 million and $43.3 million for the
three-month and nine-month periods ended September 30, 1997 compared to $35.6
million and $43.0 million for the same periods in 1996. Results for the
three-month and nine-month periods ended September 30, 1997 include $2.3 million
and $4.7 million, respectively, of Trust Preferred Securities expense which was
not incurred in 1996 and one-time, merger-related charges of $21.3 million and
$29.3 million related to Sovereign's 1997 acquisitions. Expenses included as
part of the one-time charge were human resources related costs, losses on the
sale of certain assets and other expenses, including investment banker fees and
legal expenses. Results for both the three-month and nine-month periods ended
September 30, 1996 include a non-recurring SAIF assessment charge of $30.7
million.
Income Tax Provision
The income tax provision was $5.5 million and $33.9 million for the
three-month and nine-month periods ended September 30, 1997 compared to $1.9
million and $29.6 million for the same periods in 1996. The effective tax rate
for the three-month and nine-month periods ended September 30, 1997 was 68.6%
and 41.6% compared to 45.9% and 37.8% for the same periods in 1996. The increase
in the effective tax rate for the three-month and nine-month periods ended
September 30, 1997 was primarily attributable to certain non-deductible expenses
incurred in conjunction with Sovereign's 1997 acquisitions. The increase in the
effective tax rate for the three-month period ended September 30, 1996 was the
result of a non-recurring SAIF assessment charge of $30.7 million paid in
September 1996.
FINANCIAL CONDITION
Loan Portfolio
Sovereign's loan portfolio at September 30, 1997 was $10.3 billion compared
to $8.3 billion at December 31, 1996. This increase is primarily the result of
Sovereign's recent acquisition of Fleet Auto which added $2.0 billion of
commercial and consumer loans to Sovereign's loan portfolio.
During the nine-month period ended September 30, 1997, Sovereign closed
approximately $1.03 billion of first mortgage loans including approximately
$805.7 million of variable rate mortgage loans. This compares to first mortgage
loan closings of $1.98 billion including approximately $1.63 billion of variable
rate mortgage loans for the same period in 1996.
During the nine-month period ended September 30, 1997, Sovereign closed
$91.2 million of commercial loans compared to $116.2 million of commercial loans
closed during the same period in 1996.
-26-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Sovereign closed $464.2 million of consumer loans during the nine-month
period ended September 30, 1997. This compares to $482.6 million of consumer
loans (including the purchase of $200.0 million of government guaranteed student
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 September 30,
1997, 75% of Sovereign's total loan portfolio was secured by residential real
estate and 68% 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 September 30, 1997, $897.4 million of variable rate mortgage
loans have been effectively converted to fixed rate mortgage loans. In addition,
$218.1 million of intermediate variable rate mortgage loans (loans with a
five-year fixed rate period) have effectively been converted to a variable rate
over the fixed rate period through the use of interest rate swaps.
At September 30, 1997, Sovereign's total loan portfolio included $6.68
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 and the Fleet Auto acquisition, at September 30, 1997,
Sovereign's total loan portfolio also included $734.1 million of commercial
loans and $2.82 billion of consumer loans, including $778.1 million of
outstanding home equity loans secured primarily by second mortgages on
owner-occupied one-to-four family residential properties. Sovereign has recorded
as off-balance sheet liabilities $391.3 million of additional unused commitments
for home equity lines of credit.
At September 30, 1997, Sovereign's non-performing assets were $87.3 million
compared to $100.1 million at December 31, 1996. Non-performing assets as a
percentage of total assets were .60% at September 30, 1997 compared to .80% at
December 31, 1996. This decrease is primarily attributable to the sale 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 September
30, 1997, 77% of non-performing assets consisted of loans or REO related to real
estate compared to 83% at December 31, 1996. This decrease is the result of
Sovereign's increased focus on non-residential lending. 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 September 30, 1997 included $12.3 million of REO which
is carried at lower of cost or estimated fair value less estimated costs to
sell. Sovereign places all loans 90 days or more delinquent (except auto loans
and loans guaranteed by the government or secured by deposit accounts) on
non-performing status. Sovereign's auto loans continue to accrue interest until
they are 120 days delinquent, at which time they are placed on non-accrual
status. At September 30, 1997, the allowance for possible loan losses as a
percentage of non-performing assets was 105.77% compared to 49.08% at December
31, 1996. This increase is primarily due to additional reserves related to the
Bankers and Fleet acquisitions completed during the third quarter of 1997, as
previously discussed in "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Provision for Possible Loan Losses."
-27-
<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)
September 30, December 31,
1997 1996
------------- ------------
Non-Accrual Loans:
Past due 90 days or more
as to interest or principal:
Real estate related $ 54,715 $ 70,359
Other 18,919 12,080
Past due less than 90 days as to
interest and principal:
Real estate related 634 639
Other 340 160
-------- --------
Total Non-Accrual Loans 74,608 83,238
Restructured Loans 424 1,561
-------- --------
Total Non-Performing Loans 75,032 84,799
-------- --------
Real Estate Owned:
Real estate related 12,009 11,636
Other 283 3,660
-------- --------
Total Real Estate Owned 12,292 15,296
-------- --------
TOTAL NON-PERFORMING ASSETS $ 87,324 $100,095
======== ========
Past due 90 days or more as to
interest or principal and
accruing interest (1) $ 7,644 $ 15,883
Non-Performing Assets as a
percentage of Total Assets .60% .80%
Non-Performing Loans as a
percentage of Total Loans .73% 1.01%
Non-Performing Assets as a
percentage of Total Loans
and Real Estate Owned .92% 1.39%
Allowance for Possible Loan
Losses as a percentage of
Total Non-Performing Assets 105.77% 49.08%
Allowance for Possible Loan
Losses as a percentage of
Total Non-Performing Loans 123.10% 57.94%
-28-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
(1) At September 30, 1997 and December 31, 1996, non-performing assets past due
90 days or more as to interest or principal and accruing interest included
$6.8 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 September 30, 1997, the allowance for
possible loan losses was $94.5 million or .92% of total loans compared to $52.7
million or .63% 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)
September 30, December 31,
1997 1996
Balance at End of --------------------------------------------
Period Attributable to Amount Percent Amount Percent
- ---------------------- ------ ------- ------ -------
Residential real estate $32,616 34.5% $22,723 43.1%
Commercial real estate 10,337 10.9 6,449 12.2
Commercial 5,550 5.9 3,100 5.9
Consumer 30,188 31.9 8,432 16.0
Unallocated 15,826 16.8 11,985 22.8
------- ------ ------- -----
Total $94,517 100.0% $52,689 100.0%
======= ====== ======= =====
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 $12.4 million at September 30, 1997. These loans
consist of $2.1 million of multi-family loans and $10.3 million of commercial
real estate loans.
-29-
<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 September 30, 1997, five securities, or
approximately 5% of Sovereign's total investment portfolio were classified as
high risk as defined by the FFIEC Policy Statement on securities activities. The
effective duration of the total investment portfolio at September 30, 1997 was
1.8 years.
At September 30, 1997, total investment and mortgage-backed securities
available-for-sale were $869.9 million compared to $529.2 million at December
31, 1996 and investment and mortgage-backed securities held-to-maturity were
$2.94 billion compared to $3.20 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 ("FASB") issued
SFAS No. 121, ?Accounting 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.
Goodwill and Other Intangible Assets
Total goodwill and other intangible assets at September 30, 1997 were
$118.1 million compared to $116.9 million at December 31, 1996. This increase is
primarily due to intangibles related to the Fleet Auto acquisition less normal
year-to-date amortization.
-30-
<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 September 30, 1997 were $7.75 billion compared to $7.24
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 September 30, 1997 were $5.93 billion of which $5.07
billion were short-term compared to $4.48 billion of which $3.38 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, $1.80 billion of FHLB advances have
been effectively converted from variable rate obligations to fixed rate
obligations and a $75.0 million FHLB advance has been effectively converted from
a fixed rate obligation to a variable rate obligation.
At September 30, 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, $1.0 billion, $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. Effective during the fourth quarter of 1997
and first quarter of 1998, $450.0 million and $650.0 million, respectively, of
short-term borrowings will be converted to longer-term, fixed rate borrowings
through the use of forward swaps.
-31-
<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 September 30, 1997 was $742.1 million
compared to $701.7 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 September 30, 1997 was 5.53%.
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 $80.0 million per month.
At September 30, 1997, Sovereign had $2.66 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 nine-month period ended September 30, 1997, cash and cash
equivalents increased $50.7 million. Net cash provided by operating activities
was $134.4 million for the nine-month period ended September 30, 1997. Net cash
used by investing activities for the nine-month period ended September 30, 1997
was $2.03 billion consisting primarily of purchases of mortgage-backed
securities which are classified as held-to-maturity and loans purchased from the
Fleet Auto acquisition, partially offset by proceeds from sales of investment
and mortgage-backed securities held-to-maturity acquired in the Bankers
transaction. Net cash provided by financing activities for the nine-month period
ended September 30, 1997 was $1.95 billion which includes an increase in
deposits of $516.3 million and an increase in short-term borrowings of $1.04
billion.
-32-
<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 September 30, 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 September 30, 1997:
<TABLE>
<CAPTION>
Well
Sovereign Sovereign Minimum Capitalized
Bancorp (1) Bank Requirement Requirement
-------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Stockholders' equity to
total assets 5.08% 6.08% None None
Tangible capital to tangible
assets 4.29 5.25 1.50% None
Leverage (core) capital to
tangible assets 5.31 5.59 3.00 5.00%
Leverage (core) capital to
risk adjusted assets 8.89 9.50 4.00 6.00
Risk-based capital to risk
adjusted assets 12.14 10.64 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.
-33-
<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
.68% at September 30, 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 also monitors the impact to net interest income of
a +200 basis point instantaneous rate shock environment to be within a 5% loss.
At September 30, 1997, Sovereign estimates that if interest rates would
instantaneously rise by 200 basis points, net interest income would increase by
.84%.
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 Statements.
-34-
<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 also 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.
-35-
<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 September 22, 1997 (date of earliest event -
September 18, 1997), contained a press release announcing the
execution of an Agreement and Plan of Merger for Sovereign to acquire
ML Bancorp.
Report on Form 8-K, dated September 12, 1997 (date of earliest event -
August 29, 1997), summarized the completion of Sovereign's acquisition
of Bankers Corp.
Report on Form 8-K, dated June 17, 1997 (date of earliest event -
June 17, 1997), contained Sovereign's 1996 Form 10-K restated to
include the merger of First State Financial Services, Inc. with and
into Sovereign Bancorp, Inc. First State's 1996 Form 10-K was also
presented.
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.
-36-
<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 November 12, 1997 /s/ Karl D. Gerhart
------------------------- ------------------------------------------
Karl D. Gerhart
Chief Financial Officer
Date November 12, 1997 /s/ Mark R. McCollom
-------------------------- ------------------------------------------
Mark R. McCollom
Chief Accounting Officer
-37-
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