================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) June 23, 1998
SOVEREIGN BANCORP, INC.
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 0-16533 2-2453088
- ---------------------------- ------------ -------------
(State or other jurisdiction (Commission (IRS Employer
of incorporation File Number) Ident. No.)
1130 Berkshire Boulevard, Wyomissing, Pennsylvania 19610
- -------------------------------------------------- -------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (610) 320-8400
--------------
N/A
-------------------------------------------------------------
(Former name or former address, if changed since last report.)
================================================================================
<PAGE>
FORWARD LOOKING STATEMENTS
Except for historical information, this report may be deemed to contain
"forward looking" statements. Sovereign Bancorp, Inc. ("Sovereign") desires to
avail itself of the Safe Harbor provisions of the Private Securities Litigation
Reform Act of 1995 (the "Act") and is including this cautionary statement for
the express purpose of availing itself of the protection afforded by the Act.
Examples of forward looking statements include, but are not limited to (a)
projections of or statements regarding future earnings, net interest income,
other income, earnings or loss per share, asset mix and quality, growth
prospects, capital structure and other financial terms, (b) statements of plans
and objectives of Sovereign or its management or Board of Directors, (c)
statements of future economic performance, and (d) statements of assumptions,
such as economic conditions in Sovereign's market areas, underlying other
statements and statements about Sovereign or its businesses. Such forward
looking statements can be identified by the use of forward looking terminology
such as "believes," "expects," "may," "intends," "will," "should,"
"anticipates," or the negative of any of the foregoing or other variations
thereon or comparable terminology, or by discussion of strategy.
No assurance can be given that the future results covered by the
forward-looking statements will be achieved. Such statements are subject to
risks, uncertainties, and other factors which could cause actual results to
differ materially from future results expressed or implied by such
forward-looking statements. Important factors that could impact Sovereign's
operating results include, but are not limited to, (i) the effects of changing
economic conditions in Sovereign's market areas and nationally, (ii) credit
risks of commercial, real estate, consumer and other lending activities, (iii)
significant changes in interest rates, (iv) changes in federal and state banking
laws and regulations which could impact Sovereign's operations, (v) funding
costs, and (vi) other external developments which could materially affect
Sovereign's business and operations.
<PAGE>
Item 5. Other Events
On February 28, 1998, Sovereign Bancorp, Inc. ("Sovereign") completed its
acquisition of all of the outstanding capital stock of ML Bancorp, Inc.("ML
Bancorp"), the holding company for Main Line Bank, a $2.4 billion federal
savings bank (the "ML Bancorp Acquisition"). The ML Bancorp Acquisition was
accounted for as pooling of interests.
On December 12, 1997, Sovereign entered into an Agreement and Plan of
Merger with Carnegie Bancorp ("Carnegie") providing, among other things, for the
merger (the "Carnegie Merger") of Carnegie with and into Sovereign. Carnegie, a
New Jersey corporation, is the holding company for Carnegie Bank, N.A., a
national bank. At March 31, 1998, Carnegie had total unaudited consolidated
assets, deposits and shareholders' equity of approximately $423.5 million,
$317.2 million and $35.7 million, respectively. On December 18, 1997, Sovereign
entered into an Agreement and Plan of Merger with First Home Bancorp Inc.
("First Home") providing, among other things, for the merger (the "First Home
Merger") of First Home with and into Sovereign. First Home, a New Jersey
Corporation, is the holding company for First Home Savings Bank, F.S.B., a
federally chartered savings bank. At March 31, 1998, First Home had total
unaudited consolidated assets, deposits and shareholders' equity of
approximately $545.8 million, $378.7 million and $38.2 million, respectively.
In connection with the Carnegie Merger and the First Home Merger, Sovereign
is filing with the Securities and Exchange Commission Registration Statements on
Form S-4 (the "Registration Statements") to register shares of its common stock
for issuance to shareholders of Carnegie and First Home. Pursuant to Item 11(b)
of Form S-4, Sovereign, among other things, is required to either include in the
Prospectus that constitutes a part of the Registration Statements or incorporate
by reference therein, historical financial statements restated to reflect the ML
Bancorp Acquisition. Accordingly, attached hereto as Exhibit 99.1 and
incorporated herein by reference are (i) the audited Consolidated Balance Sheets
as of December 31, 1997 and 1996 and the Consolidated Statements of Operations,
Consolidated Statements of Stockholders' Equity and Consolidated Statements of
Cash Flows for the years ended December 31, 1997, 1996 and 1995 of Sovereign
restated to reflect the ML Bancorp Acquisition and (ii) the Report of Ernst &
Young LLP thereon.
Item 7. Financial Statements and Exhibits.
(c) Exhibits
Exhibit 27 - Financial Data Schedule
Exhibit 99.1 - The Consolidated Balance Sheets as of December 31, 1997
and 1996 and the Consolidated Statements of Operations,
Consolidated Statements of Stockholders' Equity and
Consolidated Statements of Cash Flows for the years
ended December 31, 1997, 1996 and 1995 of Sovereign
Bancorp, Inc. and the related Notes thereto and the
Report of Ernst & Young LLP thereon.
Exhibit 99.2 - The Consolidated Balance Sheets as of February 27, 1998,
and March 31, 1997 and the Consolidated Statements of
Operations, Consolidated Statements of Changes in
Stockholders' Equity and Consolidated Statements of Cash
Flows for the eleven month period ended February 27,
1998, and years ended March 31, 1997 and 1996 of ML
Bancorp, Inc. and the related Notes thereto and the
Report of KPMG Peat Marwick LLP thereon.
2
<PAGE>
Exhibit 99.3 - Consent of Ernst & Young LLP.
Exhibit 99.4 - Consent of KPMG Peat Marwick LLP.
Exhibit 99.5 - Consent of KPMG Peat Marwick LLP.
Exhibit 99.6 - Consent of KPMG Peat Marwick LLP.
3
<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 hereunto duly authorized.
SOVEREIGN BANCORP. INC.
Dated: June 23, 1998
By /s/ Mark R. McCollom
-----------------------------------------
Mark R. McCollom
Chief Accounting Officer
4
<PAGE>
EXHIBIT INDEX
Exhibit
Number
- -------
27 Financial Data Schedule
99.1 The Consolidated Balance Sheets as of December 31, 1997 and 1996 and
the Consolidated Statements of Operations, Consolidated Statements of
Stockholders' Equity and Consolidated Statements of Cash Flows for the
years ended December 31, 1997, 1996 and 1995 of Sovereign Bancorp, Inc.
and the related Notes thereto and the Report of Ernst & Young LLP
thereon.
99.2 The Consolidated Balance Sheets as of February 27, 1998 and March 31,
1997 and the Consolidated Statements of Operations, Consolidated
Statements of Changes in Stockholders' Equity and Consolidated
Statements of Cash Flows for the eleven months ended February 27, 1998
and the years ended March 31, 1997 and 1996 of ML Bancorp, Inc. and
the related Notes thereto and the Report of KPMG Peat Marwick LLP
thereon.
99.3 Consent of Ernst & Young LLP.
99.4 Consent of KPMG Peat Marwick LLP.
99.5 Consent of KPMG Peat Marwick LLP.
99.6 Consent of KPMG Peat Marwick LLP.
5
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<CURRENCY> U.S.
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 219,143
<INT-BEARING-DEPOSITS> 14,502
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1,795,060
<INVESTMENTS-CARRYING> 3,209,966
<INVESTMENTS-MARKET> 3,238,197
<LOANS> 11,067,153
<ALLOWANCE> (110,251)
<TOTAL-ASSETS> 16,685,771
<DEPOSITS> 8,856,651
<SHORT-TERM> 5,320,498
<LIABILITIES-OTHER> 223,845
<LONG-TERM> 1,309,591
0
96,276
<COMMON> 443,948
<OTHER-SE> 434,962
<TOTAL-LIABILITIES-AND-EQUITY> 16,685,771
<INTEREST-LOAN> 742,954
<INTEREST-INVEST> 364,441
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 1,107,395
<INTEREST-DEPOSIT> 351,261
<INTEREST-EXPENSE> 706,978
<INTEREST-INCOME-NET> 400,417
<LOAN-LOSSES> 40,279
<SECURITIES-GAINS> 20,230
<EXPENSE-OTHER> 54,761
<INCOME-PRETAX> 157,288
<INCOME-PRE-EXTRAORDINARY> 157,288
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 94,188
<EPS-PRIMARY> 0.69
<EPS-DILUTED> 0.65
<YIELD-ACTUAL> 2.71
<LOANS-NON> 81,160
<LOANS-PAST> 6,672
<LOANS-TROUBLED> 327
<LOANS-PROBLEM> 16,358
<ALLOWANCE-OPEN> 67,422
<CHARGE-OFFS> 23,261
<RECOVERIES> 5,159
<ALLOWANCE-CLOSE> 110,251
<ALLOWANCE-DOMESTIC> 85,127
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 25,034
</TABLE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Sovereign Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of Sovereign
Bancorp, Inc. as of December 31, 1997 and 1996, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1997. These financial statements
are the responsibility of the management of Sovereign. Our responsibility is to
express an opinion on these financial statements based on our audits. We did not
audit the 1997, 1996, and 1995 financial statements of ML Bancorp, Inc., or the
1996 and 1995 financial statements of First State Financial Services, Inc. and
Bankers Corp., which combined statements reflect total assets constituting 14.1%
and 34.8% as of December 31, 1997 and 1996, respectively, of the related
consolidated financial statement totals, and combined net interest income
constituting 14.9%, 39.5%, and 41.1% in 1997, 1996, and 1995, respectively, of
the related consolidated financial statement totals for each of the three years
in the period ended December 31, 1997. Those statements were audited by other
auditors whose reports have been furnished to us, and our opinion, insofar as it
relates to data included for ML Bancorp, Inc., First State Financial Services,
Inc. and Bankers Corp. for the respective years noted, is based solely on the
reports of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the reports of other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Sovereign Bancorp,
Inc. at December 31, 1997 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
In 1997, the Company changed its method of accounting for transfers of
financial instruments and extinguishment of liabilities, as discussed in Note 1
to the consolidated financial statements. In 1995, the Company changed its
method of accounting for mortgage servicing rights, as discussed in Note 1 to
the consolidated financial statements.
/s/ Ernst & Young LLP
- ------------------------
March 2, 1998
Harrisburg, Pennsylvania
37
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
AT DECEMBER 31,
-------------------------
1997 1996
----------- -----------
<S> <C> <C>
ASSETS
Cash and amounts due from depository institutions........ $ 219,143 $ 137,915
Interest-earning deposits................................ 14,502 13,355
Loans held for sale (approximate fair value of $310,440
and $137,870 at December 31, 1997 and 1996,
respectively)......................................... 310,368 137,663
Investment and mortgage-backed securities
available-for-sale.................................... 1,795,060 1,144,825
Investment and mortgage-backed securities
held-to-maturity (approximate fair value of $3,238,197
and $3,566,558 at December 31, 1997 and 1996,
respectively)......................................... 3,209,966 3,590,580
Loans.................................................... 10,756,785 9,067,039
Allowance for possible loan losses....................... (110,251) (67,422)
Premises and equipment................................... 85,194 91,597
Real estate owned........................................ 10,631 16,628
Accrued interest receivable.............................. 102,043 84,620
Goodwill and other intangible assets..................... 125,816 119,686
Other assets............................................ 166,514 120,448
----------- -----------
TOTAL ASSETS.......................................
$16,685,771 $14,456,934
=========== ===========
LIABILITIES
Deposits................................................. $ 8,856,651 $ 8,068,203
Borrowings
Short-term............................................ 5,320,498 3,919,867
Long-term............................................. 1,309,591 1,490,669
Advance payments by borrowers for taxes and insurance.... 41,431 41,822
Other liabilities........................................ 53,442 53,009
----------- -----------
Total Liabilities.................................. 15,581,613 13,573,570
----------- -----------
----------- -----------
Corporation-obligated mandatorily redeemable capital
securities of subsidiary trust holding solely
subordinated debentures of Sovereign Bancorp, Inc.
("Trust Preferred Securities")........................ 128,972 50,000
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock; no par value; $50 liquidation
preference; 7,500,000 shares authorized; 1,996,467
shares issued and outstanding at December 31, 1997 and
2,000,000 shares issued and outstanding at December
31, 1996.............................................. 96,276 96,446
Common stock; no par value; 200,000,000 shares
authorized; 136,833,840 shares issued at December 31,
1997 and 142,923,811 shares issued at December 31,
1996.................................................. 481,159 493,125
Unallocated common stock held by the Employee Stock
Ownership Plan at cost; 5,984,934 shares at December
31, 1997 and 6,780,338 shares at December 31, 1996.... (37,211) (40,652)
Treasury stock; at cost; 13,210 shares at December 31,
1997 and 10,885,543 shares at December 31, 1996....... (185) (64,798)
Unrecognized gain on investment and mortgage-backed
securities available-for-sale, net of tax............. 18,680 1,391
Retained earnings........................................ 416,467 347,852
----------- -----------
Total Stockholders' Equity............................ 975,186 833,364
----------- -----------
TOTAL LIABILITIES, MINORITY INTERESTS AND
STOCKHOLDERS' EQUITY............................ $16,685,771 $14,456,934
----------- -----------
----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
38
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
---------- -------- --------
<S> <C> <C> <C>
INTEREST INCOME:
Interest on interest-earning deposits............... $ 4,809 $ 3,967 $ 4,499
Interest and dividends on investment and
mortgage-backed securities....................... 359,632 316,753 260,371
Interest and fees on loans.......................... 742,954 635,192 522,196
---------- -------- --------
Total interest income...................... $1,107,395 955,912 787,066
---------- -------- --------
INTEREST EXPENSE:
Interest on deposits................................ 351,261 329,868 332,539
Interest on borrowings.............................. 355,717 267,744 158,508
---------- -------- --------
Total interest expense..................... 706,978 597,612 491,047
---------- -------- --------
NET INTEREST INCOME................................... 400,417 358,300 296,019
Provision for possible loan losses.................... 40,279 20,676 12,150
---------- -------- --------
Net interest income after provision for possible loan
losses.............................................. 360,138 337,624 283,869
---------- -------- --------
OTHER INCOME:
Other loan fees and service charges................. 9,115 19,054 8,573
Deposit fees........................................ 19,829 17,117 14,302
Gain on sale of loans and investment and
mortgage-backed securities available-for-sale.... 2,530 5,424 (1,088)
Mortgage banking gains.............................. 17,700 13,858 10,587
Miscellaneous income................................ 7,298 5,722 7,732
---------- -------- --------
Total other income......................... 56,472 61,175 40,106
---------- -------- --------
GENERAL AND ADMINISTRATIVE EXPENSES:
Salaries and employee benefits...................... 95,868 90,456 71,256
Occupancy and equipment expenses.................... 37,053 33,528 28,274
Outside services.................................... 27,564 36,459 19,105
Deposit insurance premiums.......................... 4,201 12,707 15,515
Advertising......................................... 7,953 6,755 7,928
Other administrative expenses....................... 31,922 29,690 24,433
---------- -------- --------
Total general and administrative
expenses................................. 204,561 209,595 166,511
---------- -------- --------
OTHER OPERATING EXPENSES:
One-time, merger-related charges.................... 29,258 -- --
Non-recurring SAIF assessment....................... -- 38,584 --
Amortization of goodwill and other intangibles...... 13,111 17,363 14,961
Trust Preferred expense............................. 11,677 274 --
Real estate owned losses/(gains), net............... 715 3,693 2,847
---------- -------- --------
Total other operating expenses............. 54,761 59,914 17,808
---------- -------- --------
Income before income taxes............................ 157,288 129,290 139,656
Income tax provision.................................. 63,100 45,341 47,626
---------- -------- --------
NET INCOME............................................ $ 94,188 $ 83,949 $ 92,030
---------- -------- --------
---------- -------- --------
NET (LOSS) INCOME APPLICABLE TO COMMON STOCK.......... $ 87,944 $ 77,699 $ 87,342
---------- -------- --------
---------- -------- --------
BASIC EARNINGS PER SHARE(1) $ .69 $ .62 $ .68
---------- -------- --------
---------- -------- --------
DILUTED EARNINGS PER SHARE(1) $ .65 $ .59 $ .65
---------- -------- --------
---------- -------- --------
DIVIDENDS PER COMMON SHARE(1)......................... $ .103 $ .134 $ .113
---------- -------- --------
---------- -------- --------
</TABLE>
- ------------------
(1) All per share data have been adjusted to reflect all stock dividends and
stock splits declared through January 1998.
See accompanying notes to consolidated financial statements.
39
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
UNALLOCATED
COMMON
COMMON PREFERRED STOCK
SHARES SHARES COMMON PREFERRED RETAINED TREASURY HELD BY
OUTSTANDING OUTSTANDING STOCK STOCK EARNINGS STOCK ESOP
----------- ----------- -------- --------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1994......... 125,053 -- $442,651 $ -- $251,154 $(20,880) $(11,766)
Net Income......................... -- -- -- -- 92,030 -- --
Exercise of stock options.......... 729 -- 537 -- (6) 735 --
Cash in lieu of fractional
shares............................ -- -- (2) -- -- -- --
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan............... 301 -- 1,963 -- -- -- --
Stock dividends.................... 3,292 -- 20,571 -- (20,571) -- --
Dividends on common stock.......... -- -- -- -- (14,607) -- --
Preferred stock offering........... -- 2,000 -- 96,446 -- -- --
Dividends paid on preferred stock.. -- -- -- -- (4,688) -- --
Treasury stock repurchase.......... (2,765) -- -- -- -- (15,991) --
Repurchase and retirement of
company stock..................... (474) -- (3,765) -- -- -- --
Unrecognized gain on investment and
mortgage-backed securities
available-for-sale, net of tax.... -- -- -- -- -- -- --
Purchase of shares under Employee
Stock Ownership Plan.............. (4,509) -- -- -- -- -- (30,286)
Allocation of shares under Employee
Stock Ownership Plan.............. 742 -- 436 -- -- -- 3,771
Other.............................. 30 -- 630 -- (545) -- --
------- ----- -------- ------- -------- -------- --------
BALANCE, DECEMBER 31, 1995......... 122,399 2,000 463,021 96,446 302,767 (36,136) (38,281)
------- ----- -------- ------- -------- -------- --------
Net Income......................... -- -- -- -- 83,949 -- --
Exercise of stock options.......... 825 -- 900 -- -- 918 --
Cash in lieu of fractional
shares............................ -- -- (2) -- (9) -- --
Sale of stock under Dividend
Reinvestment and Employee Stock
Purchase Plan..................... 241 -- 1,699 -- -- -- --
Stock dividends.................... 3,486 -- 24,509 -- (24,509) -- --
Stock dividends on unallocated
Employee Stock Ownership Plan
shares............................ (215) -- -- -- 1,506 -- (1,506)
Dividends on common stock.......... -- -- -- -- (16,857) -- --
Dividends paid on preferred stock.. -- -- -- -- (6,250) -- --
Treasury stock repurchase.......... (4,046) -- -- -- -- (29,580) --
Unrecognized loss on investment and
mortgage-backed securities
available-for-sale, net of tax.... -- -- -- -- -- -- --
Purchase of shares under Employee
Stock Ownership Plan.............. (653) -- -- -- -- -- (4,559)
Allocation of shares under Employee
Stock Ownership Plan.............. 795 -- 1,903 -- -- -- 3,694
Issuance of stock for West
Jersey............................ 2,396 -- 1,030 -- 7,255 -- --
Other.............................. 30 -- 65 -- -- -- --
------- ----- -------- ------- -------- -------- --------
BALANCE, DECEMBER 31, 1996......... 125,258 2,000 493,125 96,446 347,852 (64,798) (40,652)
------- ----- -------- ------- -------- -------- --------
Net Income......................... -- -- -- -- 94,188 -- --
Exercise of stock options.......... 1,767 -- 3,553 -- -- 5,423 --
Cash in lieu of fractional
shares............................ (3) -- (28) -- -- -- --
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan............... 216 -- 2,544 -- -- -- --
Dividends on common stock.......... -- -- -- -- (13,112) -- --
Dividends paid on preferred stock.. -- -- -- -- (6,244) -- --
Treasury stock repurchase.......... (40) -- -- -- -- (473) --
Treasury stock sale................ 2,608 -- 17,423 -- -- 17,682 --
Retirement of treasury shares...... -- -- (41,981) -- -- 41,981 --
Unrecognized gain on investment and
mortgage-backed securities
available-for-sale, net of tax.... -- -- -- -- -- -- --
Conversion of preferred stock...... 25 (4) 170 (170) -- -- --
Allocation of shares under Employee
Stock Ownership Plan.............. 796 -- 5,132 -- -- -- 3,441
Adjustment for First State's
different fiscal year end......... 209 -- 1,010 -- (6,217) -- --
Other.............................. -- -- 211 -- -- -- --
------- ----- -------- ------- -------- -------- --------
BALANCE, DECEMBER 31, 1997......... 130,836 1,996 $481,159 $96,276 $416,467 $ (185) $(37,211)
------- ----- -------- ------- -------- -------- --------
------- ----- -------- ------- -------- -------- --------
<CAPTION>
UNRECOGNIZED
LOSS/GAIN ON
AVAILABLE- TOTAL
FOR-SALE STOCKHOLDERS'
PORTFOLIO EQUITY
------------ -------------
<S> <C> <C>
BALANCE, DECEMBER 31, 1994......... $(6,272) $654,887
Net Income......................... -- 92,030
Exercise of stock options.......... -- 1,266
Cash in lieu of fractional
shares............................ -- (2)
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan............... -- 1,963
Stock dividends.................... -- --
Dividends on common stock.......... -- (14,607)
Preferred stock offering........... -- 96,446
Dividends paid on preferred stock.. -- (4,688)
Treasury stock repurchase.......... -- (15,991)
Repurchase and retirement of
company stock..................... -- (3,765)
Unrecognized gain on investment and
mortgage-backed securities
available-for-sale, net of tax.... 10,291 10,291
Purchase of shares under Employee
Stock Ownership Plan.............. -- (30,286)
Allocation of shares under Employee
Stock Ownership Plan.............. -- 4,207
Other.............................. -- 85
------- --------
BALANCE, DECEMBER 31, 1995......... 4,019 791,836
------- --------
Net Income......................... -- 83,949
Exercise of stock options.......... -- 1,818
Cash in lieu of fractional
shares............................ -- (11)
Sale of stock under Dividend
Reinvestment and Employee Stock
Purchase Plan..................... -- 1,699
Stock dividends.................... -- --
Stock dividends on unallocated
Employee Stock Ownership Plan
shares............................ -- --
Dividends on common stock.......... -- (16,857)
Dividends paid on preferred stock.. -- (6,250)
Treasury stock repurchase.......... -- (29,580)
Unrecognized loss on investment and
mortgage-backed securities
available-for-sale, net of tax.... (2,628) (2,628)
Purchase of shares under Employee
Stock Ownership Plan.............. -- (4,559)
Allocation of shares under Employee
Stock Ownership Plan.............. -- 5,597
Issuance of stock for West
Jersey............................ -- 8,285
Other.............................. -- 65
------- --------
BALANCE, DECEMBER 31, 1996......... 1,391 833,364
------- --------
Net Income......................... -- 94,188
Exercise of stock options.......... -- 8,976
Cash in lieu of fractional
shares............................ -- (28)
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan............... -- 2,544
Dividends on common stock.......... -- (13,112)
Dividends paid on preferred stock.. -- (6,244)
Treasury stock repurchase.......... -- (473)
Treasury stock sale................ -- 35,105
Retirement of treasury shares...... -- --
Unrecognized gain on investment and
mortgage-backed securities
available-for-sale, net of tax.... 17,061 17,061
Conversion of preferred stock...... -- --
Allocation of shares under Employee
Stock Ownership Plan.............. -- 8,573
Adjustment for First State's
different fiscal year end......... 228 (4,979)
Other.............................. -- 211
------- --------
BALANCE, DECEMBER 31, 1997......... $18,680 $975,186
------- --------
------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
40
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................. $ 94,188 $ 83,949 $ 92,030
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for possible loan losses and deferred taxes..... 29,890 21,791 12,139
Depreciation.............................................. 10,562 11,299 9,437
Amortization.............................................. 34,335 23,336 9,904
Gain on sale of loans, investment and mortgage-backed
securities and real estate owned........................ (8,519) (12,784) (3,329)
Allocation of Employee Stock Ownership Plan............... 8,573 5,603 4,353
Net change in:
Loans held for sale..................................... (166,611) 102,390 (133,837)
Accrued interest receivable............................. (17,423) (12,060) (16,460)
Other assets............................................ (65,374) (30,951) 393
Other liabilities....................................... 5,469 (24,315) 7,941
----------- ----------- -----------
Net cash (used)/provided by operating activities............ (74,910) 168,258 (17,429)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of investment and mortgage-backed
securities:
Available-for-sale and held-to-maturity............... 805,076 852,475 184,306
Proceeds from repayments and maturities of investment and
mortgage-backed securities:
Available-for-sale........................................ 292,767 220,644 87,333
Held-to-maturity.......................................... 942,183 704,389 525,442
Purchases of investment and mortgage-backed securities:
Available-for-sale........................................ (985,392) (803,933) (284,182)
Held-to-maturity.......................................... (1,318,911) (1,248,228) (1,556,263)
Proceeds from sales of loans................................ 23,570 69,324 17,178
Purchase of loans and mortgage servicing rights............. (2,775,050) (1,438,331) (502,571)
Net change in loans other than purchases and sales.......... 1,048,727 (513,983) (163,973)
Proceeds from sales of premises and equipment............... 10,112 2,970 10,729
Purchases of premises and equipment......................... (14,644) (12,204) (22,862)
Proceeds from sales of real estate owned.................... 18,486 21,665 17,427
Net cash (paid)/received from business combinations......... (8,552) 1,112 2,421
Other, net.................................................. (4,996) -- --
----------- ----------- -----------
Net cash used by investing activities....................... (1,966,624) (2,144,100) (1,685,015)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Assumption of deposits...................................... -- -- 847,838
Net (decrease)/increase in deposits......................... 789,588 (86,878) 466,225
Net increase/(decrease) in short-term borrowings............ 631,067 1,008,169 (530,137)
Proceeds from long-term borrowings.......................... 584,156 1,005,001 910,499
Repayments of long-term borrowings.......................... -- (2) (716)
Net increase/(decrease) in advance payments by borrowers for
taxes and insurance....................................... (391) 2,726 (3,225)
Proceeds from issuance of Trust Preferred Securities........ 97,574 50,000 --
Cash dividends paid to stockholders......................... (21,337) (22,936) (19,038)
Proceeds from issuance of common stock...................... 8,945 4,595 3,166
Proceeds from issuance of preferred stock................... -- -- 96,446
Advance to the Employee Stock Ownership Plan................ (325) (10,206) (30,286)
Issuance/(purchase) of Treasury Stock....................... 34,632 (29,580) (15,991)
----------- ----------- -----------
Net cash provided by financing activities................... 2,123,909 1,920,889 1,724,781
----------- ----------- -----------
Net change in cash and cash equivalents..................... 82,375 (54,953) 22,337
Cash and cash equivalents at beginning of period............ 151,270 206,223 183,886
----------- ----------- -----------
Cash and cash equivalents at end of period.................. $ 233,645 $ 151,270 $ 206,223
----------- ----------- -----------
----------- ----------- -----------
RECONCILIATION OF CASH AND CASH EQUIVALENTS TO CONSOLIDATED
BALANCE SHEETS:
Cash and amounts due from depository institutions........... $ 219,143 $ 137,915 $ 177,416
Interest-earning deposits................................... 14,502 13,355 28,807
----------- ----------- -----------
Cash and cash equivalents at end of period.................. $ 233,645 $ 151,270 $ 206,223
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
SUPPLEMENTAL DISCLOSURES:
Income tax payments totaled $59.3 million in 1997, $57.4 million in 1996
and $49.3 million in 1995. Interest payments totaled $677.9 million in 1997,
$647.1 million in 1996 and $474.1 million in 1995. Noncash activity consisted of
mortgage loan securitization of $283.0 million in 1997, $372.1 million in 1996
and $200.9 million in 1995; reclassification of long-term borrowings to
short-term borrowings of $824.0 million in 1997, $931.7 million in 1996 and
$315.8 million in 1995; and reclassification of mortgage loans to real estate
owned of $21.7 million in 1997, $20.6 million in 1996 and $16.4 million in 1995.
See accompanying notes to consolidated financial statements.
41
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Sovereign is a Pennsylvania business corporation and is the holding company
for Sovereign Bank. Both Sovereign and Sovereign Bank are headquartered in
Wyomissing, Pennsylvania, a suburb of Reading, Pennsylvnania. Sovereign's
primary business consists of attracting deposits from its network of community
banking offices, located throughout eastern Pennsylvania, New Jersey and
northern Delaware, and originating commercial, consumer and residential mortgage
loans in those communities. In addition, with its recent acquisition of Fleet
Auto, Sovereign also serves customers throughout New York and several New
England States.
The following is a description of the significant accounting policies of
Sovereign Bancorp, Inc. and subsidiaries ("Sovereign"). Such accounting policies
are in accordance with generally accepted accounting principles and have been
followed on a consistent basis.
a. Principles of Consolidation -- The accompanying financial statements
include the accounts of the parent company, Sovereign Bancorp, Inc. and its
wholly-owned subsidiaries: Sovereign Bank and Sovereign Capital Trust I. All
material intercompany balances and transactions have been eliminated in
consolidation.
b. Use of Estimates -- The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
c. Per Share Information -- All per share data has been restated to reflect
the effect of the 6-for-5 stock split which was authorized on January 22, 1998,
with a record date of March 31, 1998, the 20% stock split which was authorized
on January 16, 1997, with a record date of March 3, 1997, the 5% stock dividends
which were authorized on December 20, 1995 and February 22, 1995, with record
dates of February 1, 1996 and March 31, 1995, respectively and all prior stock
dividends and stock splits.
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("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.
Under SFAS No. 128, primary earnings per share has been replaced with basic
earnings per share. Basic earnings per share is calculated by dividing income
available to common stockholders by the weighted average common shares
outstanding, excluding options, warrants, and convertible securities from the
calculation.
Under SFAS No. 128, fully diluted earnings per share has been renamed
diluted earnings per share. Income available to common stockholders is adjusted
for the assumed conversion of all potentially dilutive securities. In
calculating diluted earnings per share, the dilutive effect of options and
warrants continues to be calculated using the treasury stock method. However,
unlike the calculation of fully diluted earnings per share, the treasury stock
method is 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 continues to be calculated using
the if-converted method. Sovereign adopted SFAS No. 128 in December 1997 and
accordingly, the calculation of primary and fully diluted earnings per share for
current and prior periods has been presented and where appropriate, restated to
conform to the provisions of SFAS No. 128.
42
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
The following table presents the computation of earnings per share based on
the provisions of SFAS No. 128 for the years indicated (in thousands, except per
share data):
<TABLE>
<CAPTION>
BASIC EARNINGS PER SHARE: 1997 1996 1995
- ------------------------- -------- -------- --------
<S> <C> <C> <C>
Net income attributable to common stock(1)............ $ 87,944 $ 77,699 $ 87,342
-------- -------- --------
Average basic shares outstanding at end of
period(3)........................................... 127,455 125,579 128,963
-------- -------- --------
-------- -------- --------
Basic earnings per share(2)(3)........................ $ .69 $ .62 $ .68
-------- -------- --------
-------- -------- --------
<CAPTION>
DILUTED EARNINGS PER SHARE: 1997 1996 1995
- --------------------------- -------- -------- --------
Net income(1)......................................... $ 94,188 $ 83,949 $ 92,030
-------- -------- --------
Average diluted shares outstanding at end of
period(3)........................................... 141,814 139,946 138,086
Dilutive effect of average stock options, net of
shares assumed to be repurchased under the treasury
stock method(3)..................................... 3,695 3,145 3,077
-------- -------- --------
Total average diluted shares outstanding at end of
period(3)........................................... 145,509 143,091 141,163
-------- -------- --------
-------- -------- --------
Diluted earnings per share(2)(3)...................... $ .65 $ .59 $ .65
-------- -------- --------
-------- -------- --------
</TABLE>
- ------------------
(1) The 1997 results include the impact of one-time, merger-related charges of
$36.7 million (after-tax) resulting from Sovereign's acquisitions during
1997. The 1996 results include a non-recurring SAIF assessment of $23.9
million (after-tax) paid to the FDIC for the recapitalization of the SAIF.
(2) Excluding the one-time, merger-related charges described in Note 1 above,
basic earnings per share and diluted earnings per share for 1997 were $.98
and $.90, respectively. Excluding the non-recurring SAIF assessment
described in Note 1 above, basic earnings per share and diluted earnings per
share for 1996 were $.81 and $.75, respectively.
(3) All per share data have been adjusted to reflect all stock dividends and
stock splits declared through January 1998.
d. Interest-earning Deposits -- Interest-earning deposits consist of
deposit accounts with the Federal Home Loan Bank of Pittsburgh ("FHLB") and
deposits with other financial institutions generally having maturities of three
months or less.
e. Investment and Mortgage-backed Securities -- Debt securities that the
company has the intent and ability to hold to maturity are classified as
held-to-maturity and reported at amortized cost. Securities expected to be held
for an indefinite period of time are classified as available-for-sale and are
carried at fair value with unrealized gains and losses reported as a separate
component of stockholders' equity, net of estimated income taxes. Securities
that are bought and held principally for the purpose of selling are classified
as trading and reported at fair value, with unrealized gains and losses included
in earnings. Sovereign has no securities held for trading. Gains or losses on
the sales of securities are recognized at trade date utilizing the specific
identification method.
f. Forward Commitments and Options -- Sovereign utilizes forward
commitments and/or options to hedge interest rate risk associated with loans
held for sale and/or commitments to fund loans. Gains and losses on these
transactions are included in the net gain or loss when the asset is sold.
g. Mortgage Banking Activity -- Loans held for sale consist of residential
mortgage loans originated or purchased by Sovereign and mortgage-backed
securities originated by Sovereign. They are recorded at the lower of cost or
estimated fair value on an aggregate basis. Gains and losses are included in the
consolidated
43
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
statements of operations. The fair value calculation includes consideration of
all open positions, outstanding commitments and related fees paid. Excess
servicing fees are computed as the present value of the difference between the
estimated future net revenues and normal servicing net revenues as established
by the federally sponsored secondary market makers. Resultant premiums are
deferred and amortized over the estimated life of the related mortgages using
the constant yield method.
Effective July 1, 1995, Sovereign prospectively adopted SFAS No. 122,
"Accounting for Mortgage Servicing Rights." SFAS No. 122 requires that
management recognizes rights to service mortgage loans for others as separate
assets, regardless of how these servicing rights are acquired. Under the
provisions of SFAS No. 122, management allocates the total cost of mortgage
loans, either purchased or originated, to the loans and the mortgage servicing
rights based on their relative fair value. SFAS No. 122 also requires that
management assess its capitalized mortgage servicing rights for impairment based
on the fair value of those rights, and that this impairment be recognized
through a valuation allowance. The provisions of SFAS No. 122 were adopted in
their entirety by SFAS No. 125, which supercedes SFAS No. 122.
During 1997, Sovereign adopted the requirements of SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities," for various transfers of receivables and other financial assets
that occurred during the year. In December 1996, the FASB issued SFAS No. 127,
"Deferral of the Effective Date of Certain Provisions of SFAS No. 125," which
defers the effective date for the provisions of SFAS No. 125 relating to
accounting for repurchase agreements, dollar rolls, securities lending and
similar transactions until January 1, 1998. As a result of the adoption of SFAS
No. 125 in 1997, as amended by SFAS No. 127, Sovereign continues to record
servicing assets as well as retained rights to future interest income from the
serviced assets that exceed the contractual servicing fee (interest-only strips)
as assets on the balance sheet at the time the receivables are sold. As a
result, the impact of adoption on net income in 1997 was immaterial.
The following table presents the activity of Sovereign's mortgage servicing
rights for the years indicated (in thousands):
1997 1996
------ ------
Balance, beginning of year.......................... $55,675 $23,759
Net servicing assets recognized during the year..... 18,307 40,098
Amortization........................................ (10,364) (8,182)
------ ------
Balance, end of year................................ $63,618 $55,675
------ ------
------ ------
The mortgage servicing rights are amortized against loan servicing fee
income on an accelerated basis in proportion to, and over the period of,
estimated net future loan servicing fee income, which periods initially do not
exceed eight years. For purposes of measuring impairment of capitalized mortgage
servicing rights and minimizing the impact of risk, Sovereign conservatively
evaluates the loans underlying these rights by stratifying them into certain
homogeneous categories which include, but are not limited to, residential real
estate 30-year and 15-year fixed rate mortgage loans, adjustable rate mortgage
loans and balloon loans. Sovereign also takes into consideration any inherent
risks, which historically have been minimal on these loan types, as well as
other relevant factors associated with each portfolio. Prices are obtained in
the secondary market and are based upon current market prices of similarly
traded loans and/or comparable secondary market instruments.
Activity in the valuation allowance for mortgage servicing rights for the
eleven-month period ended February 28, 1998, and the years ended March 31, 1997
and 1996, consisted of the following (in thousands):
Year ended December 31,
-----------------------------------
1997 1996 1995
------ ------ ------
Balance, beginning of year $2,200 $1,200 $ 330
Provision for mortgage
servicing rights in excess
of fair value 1,095 1,000 870
------ ------ ------
Balance, end of year $3,295 $2,200 $1,200
====== ====== ======
h. Allowance for Possible Loan Losses -- An allowance for possible loan
losses is maintained at a level that management considers adequate to provide
for potential losses based upon an evaluation of known and inherent risks in the
loan portfolio. Management's evaluation takes into consideration the risks
inherent in the loan portfolio, past loan loss experience, specific loans which
have loss potential, geographic and industry concentrations, delinquency trends,
economic conditions, the level of originations and other relevant factors. While
management uses the best information available to make such evaluations, future
adjustments to the allowance may be necessary if conditions differ substantially
from the assumptions used in making the evaluations.
44
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
i. Loans -- Interest on loans is credited to income as it is earned.
Interest income is not recognized on loans when the loan payment is 90 days or
more delinquent (except auto loans, government-guaranteed loans or loans
secured by deposit accounts) or sooner if management believes the loan has
become impaired. Sovereign defines impairment as the existence of one or a
combination of any of the following loan weaknesses:
o the primary source of repayment is gone or severely impaired and
Sovereign may have to rely on the secondary source
o loss does not seem likely, but sufficient problems have arisen to
cause Sovereign to go to abnormal lengths to protect its position in
order to maintain a high probability of repayment
o Obligors are unable to generate enough cash flow to reduce their
debts
o Deterioration in collateral value or inadequate inspection or
verification of value (if the collateral is expected to be a source
of repayment)
o Flaws in documentation leave Sovereign in a subordinated or
unsecured position when the collateral is needed for repayment of
the loan
When a loan is placed on non-accrual status, all accrued yet uncollected
interest is reversed from income. Payments received on non-accrual loans are
generally applied to the outstanding principal balance. A non-accrual loan is a
loan in which it is probable that scheduled payments of principal and interest
will not be paid when due according to the contractual terms of the loan
agreement. In order for a non-accrual loan to revert to accruing status, all
delinquent interest must be paid and Sovereign must approve a repayment plan.
Loans delinquent 180 days or more (120 days for auto loans) are
considered for charge-off unless it can be clearly demonstrated that repayment
will occur regardless of the delinquency status. Examples of this would include:
a loan which is secured by collateral and is in the process of collection; a
loan supported by a valid guarantee or insurance; or a loan supported by a valid
claim against a solvent estate. A decision to charge-off a loan does not
necessarily mean that the asset has no recovery or salvage value, but rather it
is not practical to defer writing off the balance, even though partial or full
recovery may be realized in the future.
SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," requires
that certain impaired loans be measured based on the present value of expected
future cash flows discounted at the loan's effective interest rate or the fair
value of the collateral if the loan is collateral dependent, as amended by SFAS
No. 118, "Accounting by Creditors for Impairment of a Loan -- Income Recognition
and Disclosures." For purposes of measuring impairment as set forth by the
provisions of SFAS No. 114 and SFAS No. 118, Sovereign defines impairment as all
non-accrual loans, except for large groups of smaller-balance, homogeneous loans
such as residential mortgage and consumer loans which are collectively evaluated
for impairment.
j. Loan Fees, Discounts and Premiums -- Loan origination fees and certain
direct loan origination costs are deferred and recognized as interest income in
the consolidated statement of operations over the contractual life of the loan
utilizing the level yield method, except in the case of certain discounted loans
in which a portion of the net deferred fee may be amortized over the discount
period. Discounts and premiums on loans purchased are amortized into income
utilizing methods which approximate the level yield method.
45
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
k. Premises and Equipment -- Premises and equipment are carried at cost,
less accumulated depreciation. Depreciation is calculated utilizing both
accelerated and straight-line methods. Estimated useful lives are as follows:
Office buildings.......................... 15 to 50 years
Leasehold improvements.................... 5 to 10 years
Furniture, fixtures and equipment......... 3 to 10 years
Automobiles............................... 3 years
Expenditures for maintenance and repairs are charged to expense as
incurred.
l. Real Estate Owned -- Real estate owned consists of properties acquired
by or in lieu of foreclosure. Real estate owned is stated at the lower of cost
or estimated fair value minus estimated costs to sell. Write-downs of real
estate owned which occur after the initial transfer from the loan portfolio are
recorded as other operating expenses. Costs of holding foreclosed property are
charged to expense in the current period, except for significant property
improvements which are capitalized to the extent that carrying value does not
exceed estimated fair value.
m. Income Taxes -- Deferred income taxes are provided on temporary
differences between amounts reported for financial statement and tax purposes in
accordance with SFAS No. 109, "Accounting for Income Taxes."
n. Interest Rate Exchange Agreements (Including Swaps, Caps, and Floors) --
Sovereign has entered into certain interest rate exchange agreements in
connection with its asset/liability management program which are designated as
hedges. Related fees are deferred and amortized on a straight line basis over
the life of the interest rate exchange agreement, which corresponds to the
estimated life of the asset or liability item being hedged. Net interest
payments/receipts are accrued as an adjustment of interest expense/income on the
hedged assets or liabilities. Gains or losses resulting from early termination
of interest rate exchange agreements are deferred and amortized over the
remaining term of the original exchange agreements. In the event the related
asset/liability is disposed of, such deferred gains or losses are recognized as
an adjustment to the respective gain or loss on disposition. Changes in the
value of interest rate exchange agreements are not recorded in the financial
statements because the interest rate exchange agreements are designated as
hedges.
o. General and Administrative Expenses -- General and administrative
expenses are classified on a functional basis, except for salaries and employee
benefits. Certain direct loan origination costs are deferred and are being
amortized as a yield adjustment through net interest income (see note 1-j).
p. Consolidated Statement of Cash Flows -- For purposes of reporting cash
flows, cash and cash equivalents include cash and amounts due from depository
institutions, interest-earning deposits and securities purchased under resale
agreements with an original maturity of three months or less.
q. Reclassifications -- Certain amounts in the financial statements of
prior periods have been reclassified to conform with the presentation used in
current period financial statements. These reclassifications have no effect on
net income.
r. Long-Lived Assets -- In March 1995, the 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 1996 and the effect of adoption was not material.
46
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
s. Intangibles -- Core deposit intangibles are a measure of the value of
consumer demand and savings deposits acquired in business combinations accounted
for as purchases. Core deposit intangibles are being amortized on accelerated
bases pursuant to core deposit studies and in accordance with SFAS No. 72,
"Accounting for Certain Acquisitions of Banking or Thrift Institutions," over
the estimated lives of the existing deposit relationships acquired, but not
exceeding 15 years. Goodwill is the excess of the purchase price over the fair
value of net assets of companies acquired through business combinations
accounted for as purchases. Goodwill is being amortized using the straight line
method over various periods not exceeding 20 years. The carrying amount of the
goodwill is reviewed if facts and circumstances suggest that it may be impaired.
If this review indicates that goodwill will not be recoverable, as determined
based on the loss of economic value, the carrying amount of the goodwill is
reduced by the estimated loss of value. In addition, goodwill associated with
impaired long-lived assets is included in the impairment evaluation which
Sovereign assesses under the rules of SFAS No. 121.
t. Comprehensive Income -- 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 company during a given period from transactions and
other events from non-owner sources. SFAS No. 130 is effective for fiscal years
beginning 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. Sovereign will adopt SFAS No. 130 in 1998 and accordingly, the
consolidated financial statements will be restated to conform to the provisions
of this statement.
u. Segment Reporting -- In June 1997, the FASB issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS No.
131 requires that public companies report certain information about operating
segments in complete sets of financial statements of the company and in
condensed financial statements of interim periods issued to shareholders. It
also requires that public companies report certain information about their
products and services, the geographic areas in which they operate, and their
major customers. SFAS No. 131 is effective for fiscal years beginning after
December 15, 1997. Sovereign will adopt SFAS No. 131 in 1998.
(2) BUSINESS COMBINATIONS
On February 28, 1998, Sovereign acquired ML Bancorp, Inc. ("ML Bancorp"), a
$2.4 billion bank holding company headquartered in Villanova, Pennsylvania. ML
Bancorp's principal operating subsidiary, Main Line Bank, operates 29 branch
offices located in the suburbs of Philadelphia, Pennsylvania. The transaction
added loans, deposits and stockholders' equity to Sovereign of $1.04 billion,
$989.5 million and $173.1 million, respectively. In accordance with the merger
agreement, ML Bancorp shareholders received 1.62 (1.944 shares as adjusted for
all subsequent stock dividends and stock splits) shares of common stock in
exchange for each share of ML Bancorp common stock. Approximately 20.5 million
new shares (24.6 million new shares as adjusted for all subsequent stock
dividends and stock splits) of Sovereign common stock were issued in connection
with the transaction. The transaction is tax-free to ML Bancorp and ML Bancorp
shareholders, and will be accounted for as a pooling-of-interests.
The pre-merger results of operations for Sovereign and ML Bancorp (which
was acquired pursuant to transactions accounted for as a pooling-of-interests)
are as follows (in thousands):
<TABLE>
<CAPTION>
SOVEREIGN ML BANCORP(1) COMBINED
--------- ------------- --------
<S> <C> <C> <C>
Year Ended December 31, 1997
Net Interest income............................... $340,849 $59,568 $400,417
Net income........................................ 77,640 16,548 94,188
Basic earnings per share.......................... .67 1.51 .69
Diluted earnings per share........................ .63 1.43 .65
</TABLE>
<TABLE>
<CAPTION>
SOVEREIGN ML BANCORP(2) COMBINED
--------- ------------- --------
<S> <C> <C> <C>
Year Ended December 31, 1996
Net Interest income............................... $304,121 $54,179 $358,300
Net income........................................ 70,139 13,810 83,949
Basic earnings per share.......................... .61 1.24 .62
Diluted earnings per share........................ .58 1.20 .59
</TABLE>
<TABLE>
<CAPTION>
SOVEREIGN ML BANCORP(2) COMBINED
--------- ------------- --------
<S> <C> <C> <C>
Year Ended December 31, 1995
Net Interest income............................... $252,257 $43,762 $296,019
Net income........................................ 80,410 11,620 92,030
Basic earnings per share.......................... .72 .94 .68
Diluted earnings per share........................ .69 .92 .65
</TABLE>
- ------------------
(1) Reflects ML Bancorp's results of operations for the eleven-month period
ended February 28, 1998.
(2) Reflects ML Bancorp's results of operations for the years ended March 31,
1997 and 1996, respectively.
Prior to the combination, ML Bancorp's fiscal year end was March 31, and
accordingly, Sovereign's consolidated results of operations for the three-month
period ended March 31, 1998 include ML Bancorp's results of operations for the
two-month period ended February 28, 1998 and Sovereign's consolidated results of
operations for the twelve-month period ended December 31, 1997 include ML
Bancorp's results of operations for the eleven-month period ended February 28,
1998.
On September 19, 1997, Sovereign purchased Fleet Financial Group Inc.'s
("Fleet") Automobile Finance Division ("Fleet Auto"). Fleet Auto consists of
approximately $2.0 billion of indirect auto loans, automotive floor plan loans
and loans to automotive lessors. 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. The transaction added
$10.7 million of goodwill to Sovereign's balance sheet. Sovereign's consolidated
results of operations include Fleet Auto's results of operations from September
19, 1997 and thereafter.
On September 8, 1997, Sovereign completed its acquisition of Penncore
Financial Services Corporation of Bucks County, Pennsylvania. As a result of the
acquisition, Sovereign added approximately $130.0 million in assets and $90.0
million in deposits. Commonwealth State Bank, a wholly owned subsidiary of
Penncore, merged into Sovereign Bank, a wholly owned subsidiary of Sovereign.
Penncore shareholders received $36.56 in cash or a combination of cash and
common shares of Sovereign stock for each of their shares.
On August 29, 1997, Sovereign acquired Bankers Corp. ("Bankers"), a $2.6
billion financial services holding company headquartered in Perth Amboy, New
Jersey. Bankers' sole banking subsidiary, Bankers Savings, 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 (2.225 shares as adjusted
for all subsequent stock dividends and stock splits) shares of Sovereign common
stock in exchange for each share of Bankers common stock. Sovereign issued
approximately 23.0 million new shares (27.6 million new shares as adjusted for
all subsequent stock dividends and stock splits) of Sovereign common stock in
connection with the
47
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) BUSINESS COMBINATIONS -- (CONTINUED)
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.
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 (1.76 shares as adjusted for all subsequent stock
dividends 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 (7.06 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.
Prior to the combination, First State's fiscal year end was September 30,
and accordingly, Sovereign's consolidated results of operations for the years
ended December 31, 1996 and 1995 include First State's results of operations for
the twelve-month periods ended September 30, 1996 and 1995, respectively.
Sovereign's consolidated results of operations for the year ended December 31,
1997 include First State's results of operations for the twelve month period
ended December 31, 1997. A net decrease to Sovereign's stockholders' equity of
$5.0 million has been made to reflect First State's activity for the three-month
period ended December 31, 1996. That activity consisted of proceeds from the
exercise of stock options of $1.0 million, net loss of $6.2 million and net
change in unrecognized loss on available-for-sale securities of $228,000.
The pre-merger results of operations for Sovereign and First State and
Bankers (which were acquired pursuant to transactions accounted for as a
pooling-of-interests) were as follows (in thousands):
<TABLE>
<CAPTION>
SOVEREIGN(1) BANKERS COMBINED
------------ -------- --------
<S> <C> <C> <C>
Six Months Ended June 30, 1997 (unaudited)
Interest income..................................... $360,816 $ 89,398 $450,214
Interest expense.................................... 234,302 55,548 289,850
Provision for possible loan losses.................. 9,700 2,300 12,000
Other income........................................ 16,905 1,222 18,127
Non-interest expense................................ 82,776 10,278 93,054
Income tax provision................................ 20,230 8,172 28,402
-------- -------- --------
Net income.......................................... $ 30,713 $ 14,322 $ 45,035
-------- -------- --------
-------- -------- --------
</TABLE>
<TABLE>
<CAPTION>
SOVEREIGN FIRST STATE(2) BANKERS COMBINED
--------- -------------- -------- --------
<S> <C> <C> <C> <C>
Year Ended December 31, 1996
Interest income........................... $616,250 $ 49,239 $153,105 $818,594
Interest expense.......................... 399,540 24,054 90,879 514,473
Provision for possible loan losses........ 2,516 8,900 3,950 15,366
Other income.............................. 26,683 17,480 2,141 46,304
Non-interest expense...................... 130,053 37,926 19,752 187,731
Non-recurring SAIF assessment............. 27,818 3,096 2,839 33,753
Income tax provision...................... 31,543 (1,608) 13,501 43,436
-------- -------- -------- --------
Net income................................ $ 51,463 $ (5,649) $ 24,325 $ 70,139
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
48
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) BUSINESS COMBINATIONS -- (CONTINUED)
<TABLE>
<CAPTION>
SOVEREIGN FIRST STATE(2) BANKERS COMBINED
-------- -------- -------- --------
Year Ended December 31, 1995
<S> <C> <C> <C> <C>
Interest income........................... $493,031 $ 44,349 $129,265 $666,645
Interest expense.......................... 318,805 21,765 73,818 414,388
Provision for possible loan losses........ 1,000 1,650 5,500 8,150
Other income.............................. 25,829 6,368 739 32,936
Non-interest expense...................... 113,108 22,172 19,999 155,279
Income tax provision...................... 29,539 1,132 10,683 41,354
-------- -------- -------- --------
Net income................................ $ 56,408 $ 3,998 $ 20,004 $ 80,410
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
- ------------------
(1) Sovereign's results of operations include First State's results of
operations.
(2) Reflects First State's results of operations for the years ended September
30, 1996 and 1995, respectively.
On May 31, 1996, Sovereign acquired West Jersey Bancshares, Inc. ("West
Jersey") in a transaction accounted for as a pooling-of-interests; however, the
consolidated financial statements have not been restated due to immateriality.
Sovereign acquired approximately $100.0 million in assets consisting principally
of investment securities and loans and assumed approximately $73.0 million of
deposit liabilities. West Jersey shareholders received .8335 (1.2 shares as
adjusted for all subsequent stock dividends and stock splits) shares of
Sovereign common stock in exchange for each share of West Jersey common stock,
or $8.91 per share. Sovereign issued 1.7 million new shares (2.4 million 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 West
Jersey and West Jersey shareholders.
On November 17, 1995, Sovereign acquired two branch offices and related
deposits of Berkeley Federal Bank & Trust, FSB ("Berkeley"). Sovereign assumed
approximately $111.7 million of deposits for a premium of $5.5 million. Of this
premium, $604,000 was recorded as a core deposit intangible and $4.9 million was
recorded as goodwill. The balances of this core deposit intangible and goodwill
at December 31, 1997 were $334,000 and $4.4 million, respectively.
On November 15, 1995, Sovereign acquired Colonial State Bank in a
transaction accounted for as a purchase. Sovereign acquired $46.5 million of
assets consisting principally of loans and investment securities. Sovereign also
assumed approximately $42.0 million of deposit liabilities. Sovereign acquired
Colonial State Bank in exchange for $6.3 million in cash. This transaction added
goodwill of $3.3 million to Sovereign's balance sheet. The balance of the
goodwill at December 31, 1997 was $2.9 million. After receipt of regulatory
approvals and pursuant to the terms of the agreement entered into by Sovereign
and Colonial State Bank, upon acquisition, Colonial State Bank became a
wholly-owned, BIF-insured subsidiary of Sovereign and converted to a federal
savings bank under the name Colonial Bank for Savings, a Federal Savings Bank.
On April 1, 1996, Colonial Bank for Savings, FSB was renamed Sovereign Community
Bank. During 1997, Sovereign Community Bank was merged into Sovereign Bank.
On November 10, 1995, Sovereign completed the sale of its Pottsville,
Pennsylvania branch office with related deposits totaling $23.9 million to
Northwest Savings Bank ("Northwest") and the sale of its English Village branch
office in North Wales, Pennsylvania with related deposits of $12.4 million to
Union National Bank & Trust Company ("Union National"). As a result of these
transactions, Sovereign recognized a pre-tax gain of $1.1 million and reduced
goodwill by $568,000, respectively.
On April 21, 1995, Sovereign completed its sale of seven southern New
Jersey offices with related deposits totaling $106.7 million to Collective
Bancorp, Inc. ("Collective"). Six of these offices had previously been purchased
from Berkeley as part of a transaction which occurred on January 1, 1995. In
addition, Sovereign acquired $7.0 million of deposits from Collective's
Wilmington,
49
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) BUSINESS COMBINATIONS -- (CONTINUED)
Delaware branch office. As a result of this transaction, Sovereign recognized a
pre-tax gain of $1.5 million and reduced its existing core deposit intangible by
approximately $6.0 million.
On January 1, 1995, Sovereign acquired 23 branch offices located in New
Jersey and Delaware with $909.3 million of deposit liabilities from Berkeley. In
exchange for assuming the deposits of the Berkeley offices, Sovereign acquired
principally cash and fixed assets, net of a deposit premium of $66.6 million
which was recorded as $7.6 million of core deposit intangible and $59.0 million
of goodwill. The balances of this core deposit intangible and goodwill at
December 31, 1997 were $2.6 million and $46.5 million, respectively.
On December 19, 1997, Sovereign executed a Definitive Agreement to acquire
First Home Bancorp, Inc. ("First Home"), a $525 million bank holding company
headquartered in Pennsville, New Jersey. First Home's principal operating
subsidiary operates ten banking offices located in the Salem, Gloucester and
Camden counties, New Jersey and New Castle county, Delaware. The terms of the
Agreement call for Sovereign to exchange $31.25 in Sovereign common stock for
each outstanding share of First Home common stock or a total consideration of
approximately $86 million in Sovereign common stock. If Sovereign's average
stock price remains between $15.00 and $18.33 per share (collectively, the
"Collars") during a 15-day pricing period as set forth in the Agreement, the
price will remain fixed at $31.25. However, if during the pricing period,
Sovereign's average stock price drops to $15.00 per share or lower, First Home
shareholders would receive a fixed exchange ratio of 2.083 shares of Sovereign
common stock for each share of First Home common stock. Conversely, if
Sovereign's average stock price is $18.33 per share or higher, First Home
shareholders would receive a fixed exchange ratio of 1.705 shares of Sovereign
common stock for each share of First Home common stock. First Home has the right
to terminate the Agreement if Sovereign's average stock price during the 15-day
pricing period falls below $11.25. The transaction will be accounted for as a
pooling-of-interests. Sovereign anticipates recording a one-time, after-tax,
merger-related charge of $4 million to $5 million at the closing of the
transaction which is anticipated to be during the third quarter of 1998. All
per share information concerning this transaction has been restated to reflect
all subsequent stock dividends and stock splits declared through January 1998.
On December 15, 1997, Sovereign executed a Definitive Agreement to acquire
Carnegie Bancorp ("Carnegie"), a $424 million commercial bank holding company
headquartered in Princeton, New Jersey. Carnegie's principal operating
subsidiary operates seven banking offices throughout central New Jersey and one
community banking office in Pennsylvania. The terms of the Agreement call for
Sovereign to exchange $35.50 in Sovereign common stock for each outstanding
share of Carnegie common stock or a total consideration of approximately $106
million in Sovereign common stock. If Sovereign's average stock price remains
between $15.00 and $18.33 per share (collectively, the "Collars") during a
15-day pricing period as set forth in the Agreement, the price will remain fixed
at $35.50. However, if during the pricing period, Sovereign's average stock
price drops to $15.00 per share or lower, Carnegie's shareholders would receive
a fixed exchange ratio of 2.366 shares of Sovereign common stock for each share
of Carnegie common stock. Conversely, if Sovereign's average stock price is
$18.33 per share or higher, Carnegie shareholders would receive a fixed exchange
ratio of 1.937 shares of Sovereign common stock for each share of Carnegie
common stock. Carnegie has the right to terminate the Agreement if Sovereign's
average stock price during the 15-day pricing period falls below $12.06 and
Sovereign's decline in value is 15% greater than the percentage decline of a
group of similar financial institutions, subject to Sovereign's right to
increase the exchange ratio in order to result in a minimum price of $28.53 in
Sovereign common stock. The transaction will be accounted for as a
pooling-of-interests. Sovereign anticipates recording a one-time, after-tax,
merger-related charge of $7 million to $8 million at the closing of the
transaction which is anticipated to be during the third quarter of 1998. All
per share information concerning this transaction has been restated to reflect
all subsequent stock dividends and stock splits declared through January 1998.
50
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(3) RESTRICTIONS ON CASH AND AMOUNTS DUE FROM DEPOSITORY INSTITUTIONS
Sovereign Bank is required to maintain certain average reserve balances as
established by the Federal Reserve Board. The amounts of those reserve balances
for the reserve computation periods which included December 31, 1997 and 1996
were $93.7 million and $61.7 million, respectively.
51
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(4) INVESTMENT AND MORTGAGE-BACKED SECURITIES
The amortized cost and estimated fair value of investment and
mortgage-backed securities are as follows (in thousands):
<TABLE>
<CAPTION>
AT DECEMBER 31,
---------------------------------------------------------------------------------
1997 1996
----------------------------------------------------- -------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED
COST APPRECIATION DEPRECIATION VALUE COST APPRECIATION
---------- ------------ ------------ ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C>
Investment and Mortgage-
backed Securities
Available-for-Sale:
Investment Securities:
U.S. Treasury and
government agency
securities.............. $ 19,988 $ 2 $ -- $ 19,990 $ 64,700 $ 43
Equity securities......... 631,692 18,768 39 650,421 323,412 4,718
Other securities.......... 32,873 4,391 298 36,966 26,724 --
Mortgage-backed Securities:
FHLMC..................... 403,913 3,184 375 406,722 329,926 --
FNMA...................... 198,719 1,597 375 199,941 79,725 729
GNMA...................... 247,149 1,498 554 248,093 131,580 --
Collateralized mortgage
obligations............. 218,113 747 179 218,681 164,459 895
Other securities.......... 14,295 9 58 14,246 22,509 --
---------- ------- ------ ---------- ---------- -------
Total investment and
mortgage-backed securities
available-for-sale........ $1,766,742 $30,196 $1,878 $1,795,060 $1,143,035 $ 6,385
---------- ------- ------ ---------- ---------- -------
---------- ------- ------ ---------- ---------- -------
<CAPTION>
AT DECEMBER 31,
-------------------------
1996
-------------------------
UNREALIZED FAIR
DEPRECIATION VALUE
------------ ----------
<S> <C> <C>
Investment and Mortgage-
backed Securities
Available-for-Sale:
Investment Securities:
U.S. Treasury and
government agency
securities.............. $ 1,268 $ 63,475
Equity securities......... -- 328,130
Other securities.......... 908 25,816
Mortgage-backed Securities:
FHLMC..................... 1,220 328,706
FNMA...................... -- 80,454
GNMA...................... 983 130,597
Collateralized mortgage
obligations............. 129 165,225
Other securities.......... 87 22,422
------- ----------
Total investment and
mortgage-backed securities
available-for-sale........ $ 4,595 $1,144,825
------- ----------
------- ----------
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31,
---------------------------------------------------------------------------------
1997 1996
----------------------------------------------------- -------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED
COST APPRECIATION DEPRECIATION VALUE COST APPRECIATION
---------- ------------ ------------ ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C>
Investment and Mortgage-
backed Securities Held-to-
Maturity:
Investment Securities:
U.S. Treasury and
government agency
securities.............. $ 39,483 $ 136 $ 430 $ 39,189 $ 23,861 $ 60
Corporate securities...... 1,050 24 -- 1,074 25,492 136
Other securities.......... 51,797 3,832 150 55,479 66,319 128
Mortgage-backed Securities:
FHLMC..................... 350,775 7,447 445 357,777 392,219 3,295
FNMA...................... 220,265 3,603 397 223,471 376,948 2,024
GNMA...................... 392,312 8,309 -- 400,621 357,956 5,240
RTC....................... 411 -- 1 410 -- --
Private issues............ 119,350 963 82 120,231 293,295 87
Collateralized mortgage
obligations............. 2,034,523 8,038 2,616 2,039,945 2,052,404 5,708
Other securities.......... -- -- -- -- 2,086 --
---------- ------- ------ ---------- ---------- -------
Total investment and
mortgage-backed securities
held-to-maturity.......... $3,209,966 $32,352 $4,121 $3,238,197 $3,590,580 $16,678
---------- ------- ------ ---------- ---------- -------
---------- ------- ------ ---------- ---------- -------
<CAPTION>
UNREALIZED FAIR
DEPRECIATION VALUE
------------ ----------
Investment and Mortgage-
backed Securities Held-to-
Maturity:
Investment Securities:
U.S. Treasury and
government agency
securities.............. $ 512 $ 23,409
Corporate securities...... 71 25,557
Other securities.......... 242 66,205
Mortgage-backed Securities:
FHLMC..................... 5,440 390,074
FNMA...................... 6,615 372,357
GNMA...................... 463 362,733
RTC....................... -- --
Private issues............ 9,625 283,757
Collateralized mortgage
obligations............. 17,696 2,040,416
Other securities.......... 36 2,050
------- ----------
Total investment and
mortgage-backed securities
held-to-maturity.......... $40,700 $3,566,558
------- ----------
------- ----------
</TABLE>
52
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(4) INVESTMENT AND MORTGAGE-BACKED SECURITIES -- (CONTINUED)
The amortized cost and estimated fair value of investment and
mortgage-backed securities at December 31, 1997 by contractual maturity are
shown below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties (in thousands):
<TABLE>
<CAPTION>
AMORTIZED
COST FAIR VALUE
---------- ----------
<S> <C> <C>
Investment and Mortgage-backed Securities
Available-for-Sale:
Due in one year or less................................... $ -- $ --
Due after one year through five years..................... 32,459 32,394
Due after five years through ten years.................... 31,603 31,641
Due after ten years....................................... 1,049,141 1,055,632
No stated maturity........................................ 653,539 675,393
---------- ----------
Total investment and mortgage-backed securities
available-for-sale................................... $1,766,742 $1,795,060
---------- ----------
---------- ----------
<CAPTION>
AMORTIZED
COST FAIR VALUE
---------- ----------
Investment and Mortgage-backed Securities Held-to-Maturity:
Due in one year or less................................... $ 3,934 $ 3,928
Due after one year through five years..................... 33,516 33,776
Due after five years through ten years.................... 99,922 100,205
Due after ten years....................................... 3,072,594 3,100,288
---------- ----------
Total investment and mortgage-backed securities
held-to-maturity..................................... $3,209,966 $3,238,197
---------- ----------
---------- ----------
</TABLE>
Proceeds from sales of investment and mortgage-backed securities and the
realized gross gains and losses from those sales are as follows (in thousands):
<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE HELD-TO-MATURITY
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
----------------------------- -----------------------------
1997 1996 1995 1997 1996 1995
-------- -------- ------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
Proceeds from sales........ $243,760 $852,475 $184,306 $561,316 $ -- $ --
-------- -------- -------- -------- -------- -------
-------- -------- -------- -------- -------- -------
Gross realized gains....... $ 3,318 $ 9,193 $ 1,531 $ 183 $ -- $ --
Gross realized losses...... 2,738 4,760 2,747 10,217 -- --
-------- -------- -------- -------- -------- -------
Net realized
gains/(losses)........... $ 580 $ 4,433 $ (1,216) $(10,034) $ -- $ --
-------- -------- -------- -------- -------- -------
-------- -------- -------- -------- -------- -------
</TABLE>
Proceeds from sales of investment and mortgage-backed securities
held-to-maturity for the year ended December 31, 1997 is a result of the
liquidation of certain held-to-maturity securities acquired from Bankers during
the third quarter of 1997. This sale was completed in accordance with the
provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" to maintain Sovereign's pre-merger interest rate risk
position, and the impact of this sale is included with the one-time, merger-
related charges for Bankers.
Investment and mortgage-backed securities with an estimated fair value of
$1.44 billion and $1.17 billion were pledged as collateral for borrowings,
interest rate agreements and public deposits at December 31, 1997 and 1996,
respectively.
53
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(5) LOANS
A summary of loans included in the consolidated balance sheets follows (in
thousands):
<TABLE>
<CAPTION>
AT DECEMBER 31,
-----------------------
1997 1996
---------- ----------
<S> <C> <C>
Residential real estate loans............................... $ 6,400,715 $7,156,700
Residential construction loans (net of loans in process of
$46,523 and $60,011, respectively)........................ 134,926 133,834
----------- ----------
Total Residential Loans................................ 6,535,641 7,290,534
----------- ----------
Multi-family loans.......................................... 106,108 99,828
Commercial real estate loans................................ 458,786 324,024
Commercial loans............................................ 302,515 210,024
Automotive floor plan loans................................. 279,757 --
----------- ----------
Total Commercial Loans................................. 1,147,166 633,876
----------- ----------
Auto loans.................................................. 1,548,383 68,462
Home equity loans........................................... 1,003,404 765,836
Loans to automotive lessors................................. 267,033 --
Student loans............................................... 190,440 211,358
Credit cards................................................ 54,887 82,798
Other....................................................... 9,831 14,175
----------- ----------
Total Consumer Loans................................... 3,073,978 1,142,629
----------- ----------
Total Loans............................................ $10,756,785 $9,067,039
----------- ----------
Total Loans with:(1)
Fixed rate................................................ $ 4,181,538 $1,858,035
Variable rate............................................. 6,575,247 7,209,004
----------- ----------
Total Loans............................................ $10,756,785 $9,067,039
----------- ----------
----------- ----------
</TABLE>
- ------------------
(1) Loan totals do not reflect the impact of off-balance sheet interest rate
swaps used for interest rate risk management as discussed below.
As a result of Sovereign's use of interest rate swaps for interest rate
risk management, at December 31, 1997, $389.0 million of variable rate mortgage
loans have been effectively converted to fixed rate mortgage loans. In addition,
$208.8 million of intermediate variable rate mortgage loans (loans with a
five-year fixed rate period) have effectively been converted to variable rate
over the fixed rate period.
The majority of all loans are located in Sovereign's marketplace (eastern
Pennsylvania, New Jersey, northern Delaware, New York and several New England
states). This is Sovereign's only significant geographic concentration.
The total amount of loans being serviced for the benefit of others was
$6.36 billion and $5.78 billion at December 31, 1997 and 1996, respectively. At
December 31, 1997 and 1996, Sovereign had recognized excess servicing assets,
which are accounted for as interest-only strips, of $1.0 million and $815,000
and mortgage servicing rights of $63.6 million and $55.7 million, respectively.
54
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(5) LOANS -- (CONTINUED)
The activity in the allowance for possible loan losses is as follows (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Balance, beginning of period............................. $ 67,422 $62,199 $59,896
Acquired reserves and other additions.................... 20,652 716 1,505
Provision for possible loan losses....................... 40,279 20,676 12,150
Charge-offs.............................................. 23,261 17,874 12,424
Recoveries............................................... 5,159 1,705 1,072
-------- ------- -------
Balance, end of period................................... $110,251 $67,422 $62,199
-------- ------- -------
-------- ------- -------
</TABLE>
Sovereign encourages loan officers to follow specific procedures in the
early identification and collection of problem loans. If a loan becomes
seriously delinquent or the loan officer is not successful in the resolution of
the problem loan, the account is transferred to Sovereign's Asset Recovery Team.
At this time the account is analyzed for collateral values and the cash flows
available to repay the loan. If it is determined that there is a collateral
shortfall and insufficient cash flow to repay the debt, a reserve will be
established immediately based on this analysis. At any time during this process
and at the loan officer's discretion, the account may be placed on non-accrual
status. By following these procedures, losses are minimized on impaired loans.
55
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(5) LOANS -- (CONTINUED)
Impaired loans are summarized as follows (in thousands):
AT DECEMBER 31,
-----------------
1997 1996
------- -------
Impaired loans without a related reserve.................... $ 7,435 $16,339
Impaired loans with a related reserve....................... 12,153 12,537
------- -------
Total impaired loans................................... $19,588 $28,876
======= =======
Reserve for impaired loans.................................. $ 5,325 $ 8,449
======= =======
The average balance of impaired loans for 1997, 1996 and 1995 was $23.4
million, $26.7 million and $26.2 million, respectively.
(6) PREMISES AND EQUIPMENT
A summary of premises and equipment, less accumulated depreciation and
amortization, follows (in thousands):
AT DECEMBER 31,
-------------------
1997 1996
-------- --------
Land...................................................... $ 15,247 $ 15,902
Office buildings.......................................... 61,202 66,534
Furniture, fixtures, and equipment........................ 79,382 82,742
Leasehold improvements.................................... 13,447 13,682
Automobiles............................................... 1,052 1,147
-------- --------
170,330 180,007
Less accumulated depreciation............................. (85,136) (88,410)
-------- --------
Total premises and equipment............................ $ 85,194 $ 91,597
======== ========
Sovereign is committed under various non-cancelable operating leases
relating to branch facilities having initial or remaining terms in excess of one
year. The minimum annual rental commitments under these leases at December 31,
1997, are summarized as follows (in thousands):
1998............................................... $ 6,522
1999............................................... 5,845
2000............................................... 5,167
2001............................................... 4,584
2002............................................... 3,262
Thereafter......................................... 14,497
-------
$39,877
=======
Total rental expense for all leases for the years ended December 31, 1997,
1996 and 1995 was $6.8 million, $5.2 million and $3.6 million, respectively.
56
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(7) ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows (in thousands):
AT DECEMBER 31,
-----------------
1997 1996
------- -------
Accrued interest receivable on:
Investment and mortgage-backed securities................. $ 34,043 $31,089
Loans..................................................... 68,000 53,531
-------- -------
Total interest receivable.............................. $102,043 $84,620
-------- -------
-------- -------
Accrued interest receivable is stated net of an allowance for potentially
uncollected interest (for loans on non-accrual and for loans that have been
restructured). If these non-accruing and restructured loans had been current in
accordance with their original terms and had been outstanding throughout the
period, gross interest income for the years ended December 31, 1997 and 1996
would have increased by approximately $6.9 million and $7.8 million,
respectively. Interest income recorded on these loans for the years ended
December 31, 1997 and 1996 was $2.2 million and $2.3 million, respectively.
(8) DEPOSITS
Deposits are summarized as follows (in thousands):
<TABLE>
<CAPTION>
AT DECEMBER 31,
------------------------------------------------------------------
1997 1996
------------------------------ ------------------------------
TYPE OF ACCOUNT BALANCE PERCENT RATE BALANCE PERCENT RATE
- --------------- ---------- ------- ---- ---------- ------- ----
<S> <C> <C> <C> <C> <C> <C>
Demand deposit accounts........... $ 547,394 6% --% $ 440,994 5% --%
NOW accounts...................... 671,228 8 1.28 614,739 8 1.52
Savings accounts.................. 1,777,603 20 2.90 1,766,388 22 2.83
Money market accounts............. 802,438 9 4.06 755,794 9 3.84
Retail certificates of deposit.... 4,490,948 51 5.53 4,189,762 52 5.33
Jumbo certificates of deposit..... 567,040 6 5.78 300,526 4 5.92
---------- --- ---- ---------- --- ----
Total deposits............... $8,856,651 100% 4.22% $8,068,203 100% 4.08%
========== === ==== ========== === ====
</TABLE>
Certificate accounts are frequently renewed at maturity rather than paid
out. The following table sets forth the maturity of Sovereign's certificates of
deposit as scheduled to mature contractually at December 31, 1997 (in
thousands):
<TABLE>
<CAPTION>
WITHIN SIX SIX MOS. -- ONE -- THREE -- FIVE -- OVER
MOS. ONE YR. THREE YRS. FIVE YRS. TEN YRS. TEN YRS. TOTAL
---------- ----------- ---------- --------- ------------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Certificate accounts by
rate:
2.001% -- 4.000%....... $ 53,883 $ 2,108 $ 222 $ 195 $ 19 $ 21 $ 56,448
4.001% -- 6.000%....... 2,486,168 1,414,606 625,801 29,189 8,425 290 4,564,479
6.001% -- 8.000%....... 104,830 99,858 164,197 18,609 32,233 3,000 422,727
8.001% -- 10.000%...... 2,686 1,431 5,344 488 948 318 11,215
Above 10.000%.......... 16 126 995 269 1,713 -- 3,119
---------- ---------- -------- ------- ------- ------ ----------
Total certificate
accounts............. $2,647,583 $1,518,129 $796,559 $48,750 $43,338 $3,629 $5,057,988
---------- ---------- -------- ------- ------- ------ ----------
---------- ---------- -------- ------- ------- ------ ----------
</TABLE>
57
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(8) DEPOSITS -- (CONTINUED)
The following table sets forth the maturity of Sovereign's certificates of
deposit of $100,000 or more as scheduled to mature contractually at December 31,
1997 (in thousands):
AT DECEMBER 31,
1997
---------------
Three months or less........................... $274,980
Over three through six months.................. 319,923
Over six through twelve months................. 150,557
Over twelve months............................. 89,170
--------
Total..................................... $834,630
--------
--------
Interest expense on deposits is summarized as follows (in thousands):
<TABLE>
<CAPTION>
AT DECEMBER 31,
------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Demand deposit and NOW accounts....................... $ 8,312 $ 8,643 $ 8,644
Savings accounts...................................... 51,490 49,676 47,080
Money market accounts................................. 29,345 30,497 29,228
Certificates of deposit............................... 262,114 241,052 247,587
-------- -------- --------
Total interest expense on deposits............... $351,261 $329,868 $332,539
-------- -------- --------
-------- -------- --------
</TABLE>
(9) SHORT-TERM AND LONG-TERM BORROWINGS
Short-term Borrowings. Short-term borrowings included in the consolidated
balance sheets are as follows (in thousands):
<TABLE>
<CAPTION>
AT DECEMBER 31,
-----------------------
1997 1996
---------- ----------
<S> <C> <C>
Securities sold under repurchase agreements................. $ 731,132 $ 895,831
Federal Home Loan Bank advances............................. 4,547,573 3,013,036
Federal funds purchased..................................... -- 11,000
Other borrowings............................................ 41,793 --
---------- ----------
Total borrowings....................................... $5,320,498 $3,919,867
---------- ----------
---------- ----------
</TABLE>
Included in short-term borrowings are sales of securities under repurchase
agreements. Securities underlying these repurchase agreements consisted of
investment and mortgage-backed securities which had a book value of $684.3
million and $907.4 million and a market value of $690.3 million and $910.6
million at December 31, 1997 and 1996, respectively.
Effective January 1, 1998, Sovereign will adopt the provisions of SFAS No.
127, "Deferral of the Effective Date of Certain Provisions of SFAS No. 125." The
provisions of SFAS No. 127 defer the effective date for the provisions of SFAS
No. 125 relating to accounting for repurchase agreements, dollar rolls,
securities lending and similar transactions. Accordingly, qualifying repurchase
agreements are treated as financings and the obligations to repurchase
securities sold are reflected as a liability in the balance sheet. The dollar
amount of securities underlying the agreements remains in the asset accounts,
although the securities underlying the agreements are delivered to the brokers
who arranged the transactions. In certain instances, the broker may have sold,
loaned, or disposed of the securities to other parties in the normal course of
their operations, and have agreed to resell to Sovereign substantially similar
securities at the maturity of the agreements. The broker/dealers who participate
with Sovereign in these agreements are primary broker/dealers reporting to the
Federal Reserve Bank of New York.
58
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(9) SHORT-TERM AND LONG-TERM BORROWINGS -- (CONTINUED)
The following table summarizes information regarding short-term securities
sold under repurchase agreements (in thousands):
SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------
1997 1996 1995
---------- -------- --------
<S> <C> <C> <C>
Balance............................................ $ 731,132 $895,831 $630,822
Weighted average interest rate..................... 5.58% 5.58% 6.09%
Maximum amount outstanding at any month-end during
the period....................................... $1,427,237 $1,243,405 $1,121,549
Average amount outstanding during the period....... $1,172,090 $ 752,719 $ 763,039
Weighted average interest rate during the period... 5.67% 5.78% 5.97%
</TABLE>
The following table summarizes information regarding short-term FHLB
advances (in thousands):
FEDERAL HOME LOAN BANK ADVANCES
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Balance......................................... $4,547,573 $3,013,036 $1,376,174
Weighted average interest rate.................. 5.91% 5.82% 5.72%
Maximum amount outstanding at any month-end
during the period............................. $4,608,252 $3,750,458 $1,473,732
Average amount outstanding during the period.... $3,639,214 $2,290,269 $1,020,698
Weighted average interest rate during the
period........................................ 6.03% 5.88% 5.65%
</TABLE>
FEDERAL FUNDS PURCHASED
The following table summarizes information regarding short-term federal
funds purchased (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Balance................................................ $ -- $11,000 $18,500
Weighted average interest rate......................... --% 7.25% 6.00%
Maximum amount outstanding at any month-end during the
period............................................... $12,000 $31,000 $21,000
Average amount outstanding during the period........... $ 1,288 $ 8,116 $ 5,555
Weighted average interest rate during the period....... 5.68% 5.45% 5.86%
</TABLE>
59
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(9) SHORT-TERM AND LONG-TERM BORROWINGS -- (CONTINUED)
Long-term Borrowings. Long-term securities sold under repurchase agreements
had weighted average interest rates of 5.86% and 5.63% at December 31, 1997 and
1996, respectively. Long-term FHLB advances had weighted average interest rates
of 6.06% and 6.03% at December 31, 1997 and 1996, respectively. Long-term
borrowings are as follows (in thousands):
<TABLE>
<CAPTION>
AT DECEMBER 31,
---------------------
1997 1996
-------- ----------
<S> <C> <C>
Securities sold under repurchase agreements, maturing March
1999 to December 2002 ................................... $ 290,968 $ 204,093
FHLB advances, maturing January 1999 to April 2012......... 872,265 1,118,828
6.75% senior notes, due July 1, 2000....................... 49,655 49,517
6.75% subordinated debentures, due 2000.................... 27,831 49,585
8.50% subordinated debentures, due 2002.................... 19,629 19,550
8.00% subordinated debentures, due 2003.................... 49,243 49,096
-------- ----------
Total long-term borrowings............................ $1,309,591 $1,490,669
---------- ----------
---------- ----------
</TABLE>
Included in long-term borrowings are sales of securities under repurchase
agreements. Securities underlying these repurchase agreements consisted of
investment and mortgage-backed securities which had a book value of $320.9
million and a market value of $324.2 million at December 31, 1997. The 6.75%
notes are non-amortizing and are not redeemable prior to maturity. The 6.75%
debentures are non-amortizing and are not redeemable prior to maturity. The
6.75% debentures have, through the use of an interest rate swap, been
effectively converted from a fixed rate obligation to a variable rate obligation
tied to the 3-month LIBOR plus 140.5 basis points. The 8.50% debentures are non-
amortizing and are redeemable at the option of Sovereign in whole or in part at
any time on or after September 15, 1999. The 8.00% debentures are non-amortizing
and are not redeemable prior to maturity.
(10) TRUST PREFERRED SECURITIES
During March 1997, Sovereign issued $100 million of preferred capital
securities ("Trust Preferred") through Sovereign Capital Trust I ("Trust"), a
special-purpose statutory trust created expressly for the issuance of these
securities. Distributions on the Trust Preferred will be payable at an annual
rate of 9% of the stated liquidation amount of $1,000 per capital security,
payable semi-annually. After issuance costs, proceeds of $97.6 million were
invested in Junior Subordinated Debentures of Sovereign, at terms identical to
the Trust Preferred offering. Cash distributions on the Trust Preferred are made
to the extent interest on the debentures is received by the Trust. In the event
of certain changes or amendments to regulatory requirements or federal tax
rules, the Trust Preferred securities are redeemable in whole. Otherwise, the
Trust Preferred securities are generally redeemable in whole or in part on or
after April 1, 2007, at a declining redemption price ranging from 103.875% to
100% of the liquidation amount. On or after April 1, 2017, the Trust Preferred
securities may be redeemed at 100% of the liquidation amount.
During March 1997, Sovereign also issued $50.0 million of trust preferred
securities at an interest rate of 9.875%, with a scheduled maturity of March 1,
2027. The securities were issued by the Trust and proceeds from the issuance
were invested in Junior Subordinated Debentures issued by Sovereign. Interest of
$2.47 million is payable semi-annually. Sovereign has the option, subject to
required regulatory approval, to prepay the securities beginning March 1, 2007.
The Trust Preferred offerings are classified as and are similar to a
minority interest and are presented as "Corporation-obligated mandatorily
redeemable capital securities of subsidiary trust holding solely subordinated
debentures of Sovereign Bancorp, Inc." The Trust Preferred offerings qualify for
Tier I capital treatment for Sovereign and the loan payments from Sovereign to
the Trust are fully tax deductible.
60
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(11) STOCKHOLDERS' EQUITY
The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA")
requires institutions regulated by the OTS to have minimum regulatory tangible
capital equal to 1.5% of total tangible assets, a minimum leverage capital ratio
equal to 3% of tangible assets and 4% of risk-adjusted assets and a risk-based
capital ratio equal to 8%. Sovereign Bank was in compliance with all of these
capital requirements as of December 31, 1997. The following schedule summarizes
the actual capital balances of Sovereign Bank at December 31, 1997 (in
thousands):
<TABLE>
<CAPTION>
TANGIBLE LEVERAGE LEVERAGE RISK-BASED
CAPITAL TO CAPITAL TO CAPITAL TO CAPITAL TO
TANGIBLE TANGIBLE RISK-ADJUSTED RISK-ADJUSTED
ASSETS ASSETS ASSETS ASSETS
---------- ---------- ------------- -------------
<S> <C> <C> <C> <C>
SOVEREIGN BANK:
- ---------------
Regulatory capital........................ $921,885 $921,885 $921,885 $1,021,719
Minimum capital requirement............... 247,591 499,256 364,597 729,194
-------- -------- -------- --------
Excess.................................. $674,294 $422,629 $557,288 $292,525
-------- -------- -------- --------
-------- -------- -------- --------
Capital ratio............................. 5.59% 5.54% 10.11% 11.21%
</TABLE>
OTS capital regulations do not apply to holding companies. The following
schedule summarizes actual capital balances of Sovereign Bancorp at December 31,
1997 as if those regulations did apply to Sovereign Bancorp (in thousands):
<TABLE>
<CAPTION>
TANGIBLE LEVERAGE LEVERAGE RISK-BASED
CAPITAL TO CAPITAL TO CAPITAL TO CAPITAL TO
TANGIBLE TANGIBLE RISK-ADJUSTED RISK-ADJUSTED
ASSETS ASSETS ASSETS ASSETS
---------- ---------- ------------- -------------
<S> <C> <C> <C> <C>
SOVEREIGN BANCORP:
- ------------------
Regulatory capital........................ $842,913 $940,385 $940,385 $1,188,219
Minimum capital requirement............... 247,729 499,520 369,342 738,684
-------- -------- -------- ----------
Excess.................................. $595,184 $440,865 $571,043 $ 449,535
-------- -------- -------- ----------
-------- -------- -------- ----------
Capital ratio............................. 5.10% 5.65% 10.18% 12.87%
</TABLE>
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA")
established five capital tiers: well-capitalized, adequately-capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. A depository institution's capital tier depends upon its
capital levels in relation to various relevant capital measures, which include
leverage and risk-based capital measures and certain other factors. Depository
institutions that are not classified as well-capitalized or
adequately-capitalized are subject to various restrictions regarding capital
distributions, payment of management fees, acceptance of brokered deposits and
other operating activities. At December 31, 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.
As a result of provisions of the Small Business Jobs Protection Act of 1996
(the "Jobs Protection Act"), which repealed the tax reserve method for bad debts
for thrift institutions and the circumstances requiring bad debt recapture for
large institutions, Sovereign must determine the tax deduction for bad debt
based on actual charge-offs. The Jobs Protection Act retained the existing base
year bad debt reserve and requires recapture into taxable income in certain
circumstances such as in the case of certain excess distributions or complete
redemptions. None of the limited circumstances requiring recapture are
anticipated by Sovereign. Retained earnings at December 31, 1997 included $60.7
61
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(11) STOCKHOLDERS' EQUITY -- (CONTINUED)
million in bad debt reserves, for which no deferred taxes have been provided due
to the indefinite nature of the recapture provisions.
Sovereign maintains a Dividend Reinvestment and Stock Purchase Plan which
permits holders of record of Sovereign common stock to purchase additional
shares of common stock directly from Sovereign via reinvestment of cash
dividends and optional cash purchases. At December 31, 1997, purchases of common
stock with reinvested dividends are made at a 5% discount from the current
market price as defined and optional cash purchases are limited to a maximum of
$5,000 per quarter.
Sovereign maintains a Stockholder Rights Plan (the "Rights Plan"). The
Rights Plan is designed to protect stockholders from attempts to acquire control
of Sovereign at an inadequate price. Under the Rights Plan, Sovereign
distributed a dividend of one right to purchase a unit of preferred stock on
each outstanding share of Sovereign's common stock. The rights are not currently
exercisable or transferable and no separate certificates evidencing such rights
will be distributed, unless certain events occur. The rights attach to shares of
common stock outstanding on October 2, 1989 and will expire on September 27,
2004 as stated in the amendment to the Rights Plan dated September 27, 1995. The
rights will entitle the holders to purchase either Sovereign's common stock or
the common stock of the potential acquirer at a substantially reduced price.
On May 17, 1995, Sovereign completed the sale of 2.0 million shares of
Convertible Preferred Stock, raising $96.4 million in capital. The 6 1/4%
non-voting, Cumulative Convertible Preferred Stock is convertible at the option
of the holder at any time, unless previously redeemed, at a conversion rate
(adjusted to reflect all stock dividends and stock splits declared through
January 1998) of 7.184 shares of common stock for each share of preferred stock;
equivalent to a conversion price of $6.960 per share of common stock. The
preferred stock may not be redeemed prior to May 15, 1998. Thereafter, the
preferred stock is redeemable at the option of Sovereign, in whole or in part,
at $52.188 per share during the twelve months beginning May 15, 1998, and
thereafter at prices declining ratably to par on and after May 15, 2005.
Subsequent to year-end, Sovereign elected to redeem all outstanding shares of
its 6 1/4% Cumulative Convertible Preferred Stock. For additional information,
see Note 19 "Subsequent Events" hereof.
(12) STOCK OPTION PLANS
Sovereign grants stock options for a fixed number of shares to key officers
and directors with an exercise price equal to the fair value of the shares at
the date of grant. Sovereign accounts for stock option grants in accordance with
APB Opinion No. 25, "Accounting for Stock Issued to Employees," and accordingly,
recognizes no compensation expense for the stock option grants. There are 13.0
million shares of common stock reserved for issuance under the plans. These
shares, along with the per share data in the following summary of option
transactions, have been adjusted to reflect all stock dividends and stock splits
declared through January 1998.
<TABLE>
<CAPTION>
1986 PLAN 1987 PLAN 1989 PLAN 1990 PLAN 1993 PLAN 1994 PLAN 1996 PLAN
OPTION PRICE $.96-$6.94 $3.12 $1.53-$5.38 $1.30 $3.78-$9.78 $3.84-$14.56 $6.94-$16.77 TOTAL
------------ ---------- --------- ----------- --------- ----------- ----------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Options outstanding
December 31, 1995......... 1,221,010 380,936 842,184 327,833 1,122,012 2,302,085 -- 6,196,060
--------- -------- --------- -------- ---------- ---------- -------- ----------
Granted................... 86,184 -- 161,924 -- 161,967 299,376 11,520 720,971
Exercised................. (137,105) (44,541) (323,498) (246,169) (73,144) (1,555) -- (826,012)
Forfeited................. (1,512) -- -- -- (64,851) (93,312) -- (159,675)
Options outstanding
December 31, 1996......... 1,168,577 336,395 680,610 81,664 1,145,984 2,506,594 11,520 5,931,344
--------- -------- --------- -------- ---------- ---------- -------- ----------
Granted................... -- -- -- -- 35,597 329,119 690,360 1,055,076
Exercised................. (149,597) (336,395) (399,229) -- (389,051) (667,700) -- (1,941,972)
Forfeited................. -- -- -- -- (11,132) (3,110) (2,880) (17,122)
Options outstanding
December 31, 1997......... 1,018,980 -- 281,381 81,664 781,398 2,164,903 699,000 5,027,326
--------- -------- --------- -------- ---------- ---------- -------- ----------
--------- -------- --------- -------- ---------- ---------- -------- ----------
Options exercisable
December 31, 1997......... 1,018,980 -- 281,381 81,664 114,990 2,164,903 10,080 3,671,998
--------- -------- --------- -------- ---------- ---------- -------- ----------
--------- -------- --------- -------- ---------- ---------- -------- ----------
</TABLE>
62
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(12) STOCK OPTION PLANS -- (CONTINUED)
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," which provides companies with a choice either to expense the fair
value of employee stock options over the vesting period (recognition method) or
to continue the previous practice but disclose the pro forma effects on net
income and earnings per share had the fair value method been used (disclosure
only method). Companies electing the disclosure only method will be required to
include the pro forma effects of all awards granted in fiscal years beginning
after December 15, 1994. Sovereign adopted the disclosure only method during
1996.
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123 and has been determined as if Sovereign had accounted
for its employee stock options under the fair value method of that statement.
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following assumptions:
<TABLE>
<CAPTION>
1986 PLAN 1993 PLAN 1994 PLAN
--------- --------------------------------------- -----------------------------
<S> <C> <C> <C> <C> <C> <C>
Grant date year................. 1996 1995 1996 1997 1996 1997
Options granted................. 86,184 137,416 24,551 35,597 299,376 329,119
Options forfeited............... 1,512 4,057 -- -- 93,312 3,110
Expected volatility............. .254 .254 .254 .254 .84 .84
Expected life in years.......... 6.00 4.00 5.00 - 6.00 5.00 6.00 6.00
Stock price on date of grant.... $6.53 $7.51 $6.66 - $7.50 $9.78 $6.16 - $8.94 $8.17 - $14.56
Exercise price.................. $6.53 $7.51 $6.66 - $7.50 $9.78 $6.16 - $8.94 $8.17 - $14.56
Expected dividend yield......... .22% .21% .21% .21% 2.42% 2.42%
Risk-free interest rate......... 6.30% 5.70% 5.23% - 6.42% 6.20% 6.74% 6.74%
Vesting period in years......... 1 1 0 - 1 0 5 0
</TABLE>
<TABLE>
<CAPTION>
1996 PLAN
-----------------------------
<S> <C> <C>
Grant date year................. 1996 1997
Options granted................. 11,520 690,360
Options forfeited............... 1,440 1,440
Expected volatility............. .254 .254
Expected life in years.......... 6.00 6.00
Stock price on date of grant.... $6.94 $9.38 - $16.78
Exercise price.................. $6.94 $9.38 - $16.78
Expected dividend yield......... .21% .21%
Risk-free interest rate......... 6.86% 5.76% - 6.66%
Vesting period in years......... 1 1
</TABLE>
The Black-Scholes option valuation model was developed for use in
estimating the fair market value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions, including the expected stock
price volatility. Because Sovereign's employee stock options have
characteristics significantly different from those traded options and because
changes in the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide reliable single measure of fair value of its employee stock options.
The pro forma reduction to after-tax net income for 1997 and 1996 was $2.3
million and $1.2 million, respectively. The pro forma reduction to diluted
earnings per share for 1997 was $.016 and for 1996 was $.009.
(13) EMPLOYEE BENEFIT PLANS
Sovereign sponsors a non-contributory defined benefit pension plan which
covers substantially all employees who have attained the age of 21 and completed
one year of service. Benefits under the plan are based upon years of service and
the employees' average compensation computed based upon the five consecutive
plan years of highest pay during the ten years preceding retirement or
termination.
It is Sovereign's policy to fund the minimum contribution as determined by
an actuarial valuation. The net periodic pension costs for this plan are
comprised of the following components (in thousands):
63
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(13) EMPLOYEE BENEFIT PLANS -- (CONTINUED)
YEAR ENDED DECEMBER 31,
------------------------
1997 1996 1995
------ ------ ------
Service cost benefits earned during the period...... $1,546 $1,736 $1,581
Interest cost on projected benefit obligation....... 1,771 2,311 2,138
Actual return on plan assets........................ (7,206) (4,824) (6,450)
Amortization of unrecognized net assets and other
deferred amounts, net............................. 4,177 1,390 3,564
Curtailment loss.................................... -- 542 --
Asset gain.......................................... 331 62 184
------ ------ ------
Net periodic pension expense...................... $ 619 $1,217 $1,017
------ ------ ------
------ ------ ------
The following table sets forth the pension plan's funded status at December
31, 1997 and 1996 (in thousands):
YEAR ENDED
DECEMBER 31,
-----------------
1997 1996
------- -------
Fair value of plan assets................................. $35,516 $40,317
------- -------
------- -------
Projected benefit obligation:
Vested benefits......................................... $24,586 $30,050
Non-vested benefits..................................... 689 1,026
Effect of projected future salary increases............. 3,061 3,876
------- -------
Projected benefit obligation......................... $28,336 $34,952
------- -------
------- -------
Plan assets in excess of (less than) the projected benefit
obligation.............................................. $ 7,180 $ 5,366
Unrecognized net (asset) existing at transition date...... (1,422) (1,834)
Unrecognized net loss..................................... (2,963) (1,028)
Unrecognized prior service cost........................... (41) (83)
------- -------
Net pension asset included in balance sheet............. $ 2,754 $ 2,421
------- -------
------- -------
In determining the projected benefit obligation, the assumed discount rates
at December 31, 1997, 1996 and 1995 were 6.77%, 7.18% and 7.33%, respectively.
The weighted average rate of salary increase was 4.46% for 1997, 5.17% for 1996
and 5.26% for 1995. The expected long-term rate of return on assets used in
determining net periodic pension expense was 8.92% for 1997, 8.73% for 1996 and
8.74% for 1995.
The pension plan's assets consist primarily of common stock, fixed income
securities such as corporate bonds and U.S. Treasury securities and units of
certain common trust funds.
Sovereign also maintains a 401(k) savings plan. Substantially all employees
of Sovereign are eligible to participate in the 401(k) savings plan following
their completion of one year of service and attaining age 21. Sovereign's
contributions to this plan were $490,000, $211,000 and $191,000 during 1997,
1996 and 1995, respectively. Pursuant to this plan, employees can contribute up
to 10% of their compensation to the plan. Sovereign contributes 50% of the
employee contribution up to 6% of compensation in the form of Sovereign common
stock.
Sovereign Employee Stock Ownership Plan. Sovereign maintains an Employee
Stock Ownership Plan ("Sovereign ESOP"). Substantially all employees of
Sovereign are eligible to participate in the Sovereign ESOP following their
completion of one year of service and attaining age 21. The Sovereign ESOP is a
deferred contribution plan which provides retirement benefits for participants
and beneficiaries by purchasing Sovereign common stock in the open market. The
amount of annual contributions to the Sovereign ESOP by Sovereign is determined
by the
64
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(13) EMPLOYEE BENEFIT PLANS -- (CONTINUED)
Board of Directors based upon the financial performance of Sovereign each year.
Sovereign recognized as expense $6.6 million, $4.1 million and $2.4 million to
the ESOP during 1997, 1996 and 1995, respectively.
On November 21, 1994, Sovereign's Board of Directors authorized an
amendment to the Sovereign ESOP to add a leverage feature to purchase up to 6.7
million shares of Sovereign's outstanding common stock in the open market or in
negotiated transactions. The Sovereign ESOP is funded through direct loans from
Sovereign totaling $40.0 million in 1997. The proceeds from these loans were
used to purchase outstanding shares of Sovereign's common stock. As the debt on
these loans is repaid, shares of Sovereign common stock are released and become
eligible for allocation to employee accounts. In addition, dividends are paid on
all shares of Sovereign common stock, including unallocated shares held by the
Sovereign ESOP. Dividends on the unallocated shares are allocated on a pro-rata
basis when purchased shares are released. Compensation expense is recognized
based on the fair value of the shares committed to be released to employees and
the shares then become outstanding for earnings per share computations.
Sovereign has committed to make contributions sufficient to provide for the ESOP
debt requirements. At December 31, 1997, the Sovereign ESOP held 5.9 million
shares of which 1.3 million shares were allocated to employee accounts. The
unallocated ESOP shares are presented as a reduction of stockholders' equity in
the consolidated financial statements. At December 31, 1997, the fair value of
the unallocated shares held by the ESOP was $79.7 million.
Sovereign's Compensation Committee administers the ESOP. Under the ESOP,
the trustees are directed to vote all allocated shares held in the ESOP in
accordance with the instructions of the participants to whom the shares have
been allocated. In addition, the trustees shall vote in their sole discretion
any shares in the unallocated suspense account.
In 1992, Sovereign implemented the Employee Stock Purchase Plan which
permits eligible employees to purchase Sovereign common stock directly from
Sovereign. Purchases of common stock are limited to 15% of a participant's
compensation. During 1997, 1996 and 1995, participants purchased Sovereign
common stock at a price equal to 92.5% of the fair value of Sovereign common
stock on the offering date. Compensation expense for this plan for the year
ended December 31, 1997, 1996 and 1995 was $46,000, $41,000 and $31,000,
respectively.
ML Bancorp Employee Stock Ownership Plan. ML Bancorp, previous to its
merger with Sovereign, had an Employee Stock Ownership Plan ("ML ESOP") for the
benefit of certain eligible employees of ML Bancorp. ML Bancorp initially
purchased 2.0 million shares of common stock on behalf of the ML ESOP, of which
885,000 shares were committed to be released as of February 28, 1998. During
1997, 1996, and 1995, ML Bancorp recorded compensation expense related to the ML
ESOP of $3.0 million, $1.9 million, and $1.4 million, respectively. The fair
market value of the unallocated ML ESOP shares equaled $17.6 million, and are
presented as a reduction to stockholders' equity in the consolidated financial
statements.
Upon consummation of the Merger, Sovereign terminated the ML ESOP and
satisfied its obligation related to the initial share purchase. The remaining
unallocated shares were distributed to the former participants of the ML ESOP,
and the excess of fair value over the cost of those remaining shares was
recognized in the first quarter of 1998 as a one-time, merger related expense.
ML Bancorp Recognition and Retention Plan and Trust. ML Bancorp, previous
to its merger with Sovereign, had a Recognition and Retention Plan and Trust
("ML RRP") for the benefit of ML Bancorp's Board of Directors and executive
officers. At February 28, 1998, Sovereign reflected $2.4 million of deferred
cost of unearned ML RRP shares as a reduction of stockholders' equity. During
1997, 1996, and 1995, ML Bancorp recorded compensation expense related to the ML
RRP of $459,000, $617,000 and $829,000, respectively.
Upon consummation of the Merger, Sovereign terminated the ML RRP. Pursuant
to the merger, the remaining $2.4 million of deferred compensation was paid to
ML Bancorp's Board of Directors and executive officers and was recognized in the
first quarter of 1998 as a one-time, merger related expense.
65
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(14) INCOME TAXES
The provision for income taxes in the consolidated statement of operations
is comprised of the following components (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Current:
Federal................................................ $69,644 $40,339 $43,574
State.................................................. 3,845 3,887 4,063
------- ------- -------
73,489 44,226 47,637
Deferred................................................. (10,389) 1,115 (11)
------- ------- -------
Total income tax expense............................... $63,100 $45,341 $47,626
------- ------- -------
------- ------- -------
</TABLE>
The following is a reconciliation of the actual tax provisions with taxes
computed at the federal statutory rate of 35% for 1997, 1996 and 1995:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Federal income tax at statutory rate........................ 35.0% 35.0% 35.0%
Increase (decrease) in taxes resulting from:
Tax-exempt interest....................................... (2.2) (1.3) (.5)
State income taxes, net of federal tax benefit............ 1.6 2.0 1.9
Amortization of intangible assets and other purchase
accounting adjustments................................. 1.1 1.4 1.4
Non-deductible, merger-related costs...................... 3.2 .2 .1
Other..................................................... 1.4 (2.2) (3.8)
---- ---- ----
40.1% 35.1% 34.1%
---- ---- ----
---- ---- ----
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are presented
below (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Deferred tax assets:
Allowance for possible loan losses................... $ 35,096 $ 23,156 $ 23,702
Purchased mortgage servicing rights.................. 5,364 2,079 923
Employee benefits.................................... 2,593 706 974
Merger related liabilities........................... 1,104 1,006 785
Purchase accounting adjustments...................... 926 2,329 3,538
Unrealized loss on available-for-sale portfolio...... 89 89 30
Net operating loss carryforwards..................... 1,810 1,939 2,066
Other................................................ 5,140 5,652 3,302
-------- -------- --------
Total gross deferred tax assets...................... $ 52,122 $ 36,956 $ 35,320
-------- -------- --------
Deferred tax liabilities:
Purchase accounting adjustments...................... $ 6,473 $ 7,188 $ 8,559
Deferred loan fees................................... 5,543 5,574 2,994
Tax bad debt reserve recapture....................... 2,888 2,888 6,212
Originated mortgage servicing rights................. 2,678 1,398 262
Option premiums...................................... 9,799 7,927 4,767
Unrealized gain on available-for-sale portfolio...... 9,472 2,021 2,778
Other................................................ 6,097 5,517 5,931
-------- -------- --------
Total gross deferred tax liabilities................. $ 42,950 $ 32,513 $ 31,503
-------- -------- --------
Net deferred tax (liability) asset................... $ 9,172 $ 4,443 $ 3,817
-------- -------- --------
-------- -------- --------
</TABLE>
66
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(14) INCOME TAXES -- (CONTINUED)
The Small Business Job Protection Act of 1996 ("the Act") repealed the tax
bad debt deduction computed under the percentage of taxable income method for
tax years beginning after December 31, 1995 and requires thrifts to recapture
into income, over a six-year period, the amount by which their tax bad debt
reserves exceed their base year reserves. As a result of its acquisition of ML
Bancorp, Sovereign will be required to recapture $8.2 million related to ML
Bancorp's tax bad debt reserve in excess of its base year reserve. ML Bancorp
had previously recorded a deferred tax liability for this excess and therefore,
the recapture will not impact the statement of operations.
Sovereign has determined that it is not required to establish any valuation
reserve for deferred tax assets since it is more likely than not that deferred
tax assets will be principally realized through carry back to taxable income in
prior years. Sovereign's conclusion that it is "more likely than not" that the
deferred tax assets will be realized is based on a history of growth in earnings
and the prospects for continued growth including an analysis of potential
uncertainties that may affect future operating results. Sovereign will continue
to review the criteria related to the recognition of deferred tax assets on a
quarterly basis.
(15) COMMITMENTS AND CONTINGENCIES
Financial Instruments
Sovereign is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers
and to manage its own exposure to fluctuations in interest rates. These
financial instruments include commitments to extend credit, standby letters of
credit, loans sold with recourse, forward contracts and interest rate swaps,
caps and floors. These financial instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the consolidated balance sheet. The contract or notional amounts of these
financial instruments reflect the extent of involvement Sovereign has in
particular classes of financial instruments.
Sovereign's exposure to credit loss in the event of non-performance by the
other party to the financial instrument for commitments to extend credit,
standby letters of credit and loans sold with recourse is represented by the
contractual amount of those instruments. Sovereign uses the same credit policies
in making commitments and conditional obligations as it does for on-balance
sheet instruments. For interest rate swaps, caps and floors and forward
contracts, the contract or notional amounts do not represent exposure to credit
loss. Sovereign controls the credit risk of its interest rate swaps, caps and
floors and forward contracts through credit approvals, limits and monitoring
procedures. Unless noted otherwise, Sovereign does not require and is not
required to pledge collateral or other security to support financial instruments
with credit risk.
The following schedule summarizes Sovereign's off-balance sheet financial
instruments (in thousands):
<TABLE>
<CAPTION>
CONTRACT OR NOTIONAL AMOUNT
AT DECEMBER 31,
----------------------------
1997 1996
----------- -----------
<S> <C> <C>
Financial instruments whose contract amounts represent
credit risk:
Commitments to extend credit.............................. $1,019,121 $ 699,362
Standby letters of credit................................. 10,107 5,656
Loans sold with recourse.................................. 139,899 169,113
Financial instruments whose notional or contract amounts
exceed the amount of credit risk:
Forward contracts......................................... 51,872 32,500
Interest rate swaps....................................... 3,589,376 2,517,013
Interest rate caps........................................ 1,200,000 500,000
Notional or contract amounts of off-balance sheet financial
instruments not constituting credit risk:
Forward commitments to sell in the secondary market....... 161,285 53,922
</TABLE>
67
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(15) COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. Sovereign evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained upon
extension of credit is based on management's credit evaluation of the
counterparty. Collateral held usually consists of real estate but may include
securities, accounts receivable, inventory and property, plant and equipment.
Standby letters of credit are conditional commitments issued by Sovereign
to guarantee the performance of a customer to a third party. The guarantees are
primarily issued to support public and private borrowing arrangements. Most
guarantees expire in 1998, one guarantee expires in April 1999, one guarantee
expires in September 2000 and one guarantee for $1.4 million expires in January
2011. The credit risk involved in issuing letters of credit is essentially the
same as that involved in extending loan facilities to customers. Sovereign holds
various collateral to support the commitments.
Loans sold with recourse primarily represent residential loans.
The forward contracts used by Sovereign in its mortgage banking activities
are contracts for delayed delivery of securities in which Sovereign agrees to
make delivery of a specified instrument, at a specified future date, at a
specified price or yield. Risks arise from the possible inability of
counterparties to meet the terms of their contracts and from movements in
securities' values and interest rates.
Interest rate swaps, caps and floors enable Sovereign to transfer, modify
or reduce its interest rate risk and are used as part of asset and liability
management. Sovereign may become a principal in the exchange of interest
payments with another party and therefore, is exposed to loss should one of the
other parties default. Sovereign minimizes this risk by performing credit
reviews on counterparties.
Notional principal amounts often are used to express the volume of these
transactions, but the amounts potentially subject to credit risk are much
smaller.
Litigation
At December 31, 1997, Sovereign was party to a number of lawsuits. While
any litigation has an element of uncertainty, management, after reviewing these
actions with legal counsel, is of the opinion that the liability, if any,
resulting from these actions will not have a material effect on the financial
condition or results of operations of Sovereign.
68
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents disclosures about the fair value of financial
instruments as defined by SFAS No. 107, "Fair Value of Financial Instruments."
These fair values are presented based upon subjective estimates of relevant
market conditions at a specific point in time and information about each
financial instrument. In cases where quoted market prices are not available,
fair values are based on estimates using present value or other valuation
techniques. These techniques involve uncertainties resulting in variability in
estimates affected by changes in assumptions and risks of the financial
instruments at a certain point in time. Therefore, the derived fair value
estimates presented below cannot be substantiated by comparison to independent
markets. In addition, the fair values do not reflect any premium or discount
that could result from offering for sale at one time an entity's entire holdings
of a particular financial instrument nor does it reflect potential taxes and the
expenses that would be incurred in an actual sale or settlement. Accordingly,
the aggregate fair value amounts presented do not represent the underlying value
of Sovereign (in thousands):
<TABLE>
<CAPTION>
AT DECEMBER 31,
-------------------------------------------------
1997 1996
----------------------- -----------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Financial Assets:
Cash and amounts due from depository
institutions...................... $ 219,143 $ 219,143 $ 137,915 $ 137,915
Interest-earning deposits............ 14,502 14,502 13,355 13,355
Loans held for sale.................. 310,368 310,440 137,663 137,870
Investment and mortgage-backed
securities available-for-sale..... 1,795,060 1,795,060 1,144,825 1,144,825
Investment and mortgage-backed
securities held-to-maturity....... 3,209,966 3,238,197 3,590,580 3,566,558
Loans, net........................... 10,646,534 10,710,394 8,999,617 8,999,873
Interest-only strips................. 1,031 5,287 815 4,187
Mortgage servicing rights............ 63,618 66,677 55,675 61,851
Cash surrender value of life
insurance......................... -- -- 11,978 11,978
Financial Liabilities:
Deposits............................. 8,856,651 8,862,328 8,068,203 8,070,020
Borrowings(1)........................ 6,640,516 6,653,017 5,424,683 5,420,214
Unrecognized Financial Instruments:(2)
Commitments to extend credit......... 2,266 2,272 1,315 1,239
Standby letters of credit............ 1 5 7 12
Loans sold with recourse............. 244 98 301 120
Interest rate swaps, caps and
floors............................ 9,963 (12,858) 9,283 3,755
</TABLE>
- ------------------
(1) Borrowings are shown without unamortized cap premiums, as cap premiums are
reflected separately below in "Interest rate swaps, caps and floors."
(2) The amounts shown under "carrying value" represent accruals or deferred
income (cost) arising from those unrecognized financial instruments.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments:
Cash and amounts due from depository institutions and interest-earning
deposits. For these short-term instruments, the carrying amount is a reasonable
estimate of fair value.
Loans held for sale. Fair values are estimated using quoted rates based
upon secondary market sources for securities backed by similar loans. Fair value
estimates include consideration of all open positions (including forward
contracts), outstanding commitments and related fees paid.
69
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS -- (CONTINUED)
Investment and mortgage-backed securities available-for-sale. The fair
value of investment and mortgage-backed securities available-for-sale are based
on quoted market prices as of the balance sheet date. In accordance with SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities,"
changes in fair value are reflected in the carrying value of the asset and are
shown as a separate component of stockholders' equity.
Investment and mortgage-backed securities held-to-maturity. The carrying
amounts for short-term investment and mortgage-backed securities
held-to-maturity approximate fair value because of the short maturity of these
instruments and they do not present unanticipated credit concerns. The fair
value of long-term investments and mortgage-backed securities held-to-maturity
is estimated based upon bid quotations received from securities dealers and an
independent pricing servicing bureau.
Loans. Fair value is estimated by discounting cash flows using estimated
market discount rates at which similar loans would be made to borrowers and
reflect similar credit ratings and interest rate risk for the same remaining
maturities.
Mortgage servicing rights. The fair value of mortgage servicing rights,
including excess servicing rights which are accounted for as interest-only
strips, is estimated using quoted rates based upon secondary market sources. The
estimated fair value approximates the amount for which the servicing could
currently be sold.
Cash surrender value of life insurance. The carrying value of the cash
surrender value of life insurance, which was acquired in the First State
transaction, is a reasonable estimate of fair value.
Deposits. The fair value of deposits with no stated maturity, such as
non-interest bearing demand deposits, NOW accounts, savings accounts and certain
money market accounts, is equal to the amount payable on demand as of the
balance sheet date. The fair value of fixed-maturity certificates of deposit is
estimated by discounting cash flows using currently offered rates for deposits
of similar remaining maturities.
Borrowings. Fair value is estimated by discounting cash flows using rates
currently available to Sovereign for other borrowings with similar terms and
remaining maturities.
Commitments to extend credit. The fair value of commitments to extend
credit is estimated using the fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
present creditworthiness of the counterparties. For fixed rate loan commitments,
fair value also considers the difference between current levels of interest
rates and the committed rates.
Standby letters of credit. The fair value of letters of credit is based on
fees currently charged for similar agreements or on the estimated cost to
terminate them or otherwise settle the obligations with the counterparties.
Loans sold with recourse. The fair value of loans sold with recourse is
estimated based upon the cost to terminate Sovereign's obligations under the
recourse provisions.
Interest rate swaps, caps and floors. The fair value of interest rate
swaps, caps and floors which represent the estimated amount Sovereign would
receive or pay to terminate the contracts or agreements, taking into account
current interest rates and when appropriate, the current creditworthiness of the
counterparties are obtained from dealer quotes.
70
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(17) 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 and floors are
simultaneously bought and sold to create a range of protection against changing
interest rates while limiting the cost of that protection. The following table
presents information regarding interest rate exchange agreements at the dates
indicated (in thousands):
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997 AT DECEMBER 31, 1996
------------------------------------------- -------------------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
NOTIONAL BOOK ESTIMATED MATURITY NOTIONAL BOOK ESTIMATED MATURITY
AMOUNT VALUE FAIR VALUE IN YEARS AMOUNT VALUE FAIR VALUE IN YEARS
---------- ------ ---------- -------- ---------- ------ ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Amortizing interest rate
swaps:
Pay variable-receive
fixed(1)............ $ 602,116 $ -- $ 1,436 2.8 $ 713,448 $ -- $(10,459) 3.6
Pay fixed-receive
variable(2)......... 208,761 -- (9) 1.3 398,565 -- (464) 2.3
Non-amortizing interest
rate swaps:
Pay variable-receive
fixed(3)............ 28,499 -- (561) 2.7 50,000 -- (1,738) 3.7
Pay fixed-receive
variable(4)......... 2,750,000 -- (9,290) 2.3 1,355,000 -- 9,152 2.2
Interest rate
caps/floors(5)........ 1,200,000 9,963 (4,434) 4.0 500,000 9,283 7,264 4.5
---------- ------ -------- ---------- ------ --------
$4,789,376 $9,963 $(12,858) $3,017,013 $9,283 $ 3,755
---------- ------ -------- ---------- ------ --------
---------- ------ -------- ---------- ------ --------
</TABLE>
- ------------------
(1) The weighted average pay rate was 5.58% and 5.50% and the weighted average
receive rate was 5.97% and 5.93% at December 31, 1997 and 1996,
respectively.
(2) The weighted average pay rate was 6.87% and 6.76% and the weighted average
receive rate was 6.80% and 6.18% at December 31, 1997 and 1996,
respectively.
(3) The weighted average pay rate was 7.28% and 6.91% and the weighted average
receive rate was 6.75% and 6.75% at December 31, 1997 and 1996,
respectively.
(4) The weighted average pay rate was 5.89% and 5.28% and the weighted average
receive rate was 4.47% and 5.53% at December 31, 1997 and 1996,
respectively.
(5) The weighted average strike price range was 5.25%-7.50% at December 31, 1997
and the weighted average contract rate was 6.00% at December 31, 1996.
71
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(17) INTEREST RATE EXCHANGE AGREEMENTS -- (CONTINUED)
The following table summarizes by notional amounts the activity of
Sovereign's interest rate exchange agreements (in thousands):
<TABLE>
<CAPTION>
AMORTIZING NON-AMORTIZING
INTEREST INTEREST INTEREST
RATE SWAPS RATE SWAPS RATE CAPS TOTAL
---------- -------------- ---------- ----------
<S> <C> <C> <C> <C>
Balance, December 31, 1994............ $1,085,645 $ 250,000 $ 450,000 $1,785,645
---------- ---------- ---------- ----------
Additions........................... 300,000 280,000 996,000 1,576,000
Maturities/Amortization............. 326,795 200,000 -- 526,795
Terminations........................ 177,720 -- -- 177,720
---------- ---------- ---------- ----------
Balance, December 31, 1995............ 881,130 330,000 1,446,000 2,657,130
---------- ---------- ---------- ----------
Additions........................... 300,000 1,125,000 500,000 1,925,000
Maturities/Amortization............. 69,117 -- 450,000 519,117
Terminations........................ -- 50,000 996,000 1,046,000
---------- ---------- ---------- ----------
Balance, December 31, 1996............ 1,112,013 1,405,000 500,000 3,017,013
---------- ---------- ---------- ----------
Additions........................... -- 4,125,000 700,000 4,825,000
Maturities/Amortization............. 151,136 151,501 -- 302,637
Terminations........................ 150,000 2,600,000 -- 2,750,000
---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1997............ $ 810,877 $2,778,499 $1,200,000 $4,789,376
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
At December 31, 1997, Sovereign's balance sheet included a net deferred
loss of $956,000 related to interest rate exchange agreements terminated in June
1996 and September 1997 which were originally accounted for as hedges. This net
deferred loss will amortize into interest expense in 1998.
Net interest income resulting from interest rate exchange agreements
included $4.8 million of income and $4.8 million of expense for 1997, $5.1
million of income and $7.4 million of expense for 1996 and $1.7 million of
income and $3.6 million of expense for 1995.
72
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(18) PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Sovereign Bancorp, Inc. is as follows
(in thousands):
BALANCE SHEETS
---------------------
AT DECEMBER 31,
---------------------
1997 1996
---------- ---------
Assets
Interest-earning deposits............................ $ 1,688 $ 123
Investment securities................................ 103,233 15,514
Investment in subsidiaries........................... 1,138,616 1,021,113
Other assets......................................... 13,262 22,934
---------- ----------
Total Assets........................................... $1,256,799 $1,059,684
---------- ----------
---------- ----------
Liabilities and Stockholders' Equity
Long-term borrowings................................. $ 147,905 $ 169,295
Other liabilities.................................... 4,736 7,025
---------- ----------
152,641 176,320
---------- ----------
Trust Preferred Securities............................. 128,972 50,000
---------- ----------
Stockholders' Equity................................... 975,186 833,364
---------- ----------
Total Liabilities, Minority Interests and Stockholders'
Equity............................................... $1,256,799 $1,059,684
---------- ----------
---------- ----------
STATEMENTS OF OPERATIONS
---------------------------
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------- ------- -------
Interest income.................................. $ 8,763 $ 2,790 $ 4,460
Other income..................................... 8,624 46,251 30,443
------- ------- -------
Total income..................................... 17,387 49,041 34,903
------- ------- -------
Interest expense................................. 13,089 13,117 11,758
Other expense.................................... 9,146 6,149 5,531
Trust Preferred Securities expense............... 11,677 274 --
------- ------- -------
Total expense.................................... 33,912 19,540 17,289
------- ------- -------
(Loss)/income before taxes, dividends and
undistributed earnings of subsidiaries......... (16,525) 29,501 17,614
Income taxes..................................... (8,273) (5,606) (4,689)
------- ------- -------
(Loss)/income before earnings of subsidiaries.... (8,252) 35,107 22,303
Distributed earnings from subsidiaries........... -- -- 20,544
Undistributed earnings of subsidiaries........... 102,440 48,842 49,183
------- ------- -------
Net Income....................................... $94,188 $83,949 $92,030
------- ------- -------
------- ------- -------
73
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(18) PARENT COMPANY FINANCIAL INFORMATION -- (CONTINUED)
STATEMENTS OF CASH FLOWS
---------------------------
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------- ------- -------
Cash Flows from Operating Activities:
Net income..................................... $94,188 $83,949 $92,030
Adjustments to reconcile net income to net cash
provided by operating activities:
Dividends received from subsidiaries(1)..... 8,000 29,600 40,145
Earnings from subsidiaries.................. (102,440) (48,842) (69,727)
Allocation of Employee Stock Ownership Plan
shares................................... 8,573 5,597 4,353
Change in other assets...................... 9,672 26,561 (45,565)
Change in other liabilities................. (410) 1,260 842
------- ------- -------
Net cash provided (used) by operating
activities..................................... 17,583 98,125 22,078
------- ------- -------
Cash Flows from Investing Activities:
Investment in subsidiaries..................... (31,189) (94,700) (110,764)
Maturity and repayments of investment
securities.................................. 1,781 1,259 1,221
Net change in investment securities(1)......... (80,038) (6,600) (3,161)
Other, net..................................... (4,996) 3,968 7,100
------- ------- -------
Net cash used by investing activities............ (114,442) (96,073) (105,604)
------- ------- -------
Cash Flows from Financing Activities:
Net change in short-term borrowings............ -- (714) (714)
Net change in long-term borrowings............. (21,390) 477 (376)
Proceeds from issuance of Trust Preferred
Securities.................................. 97,574 50,000 --
Cash dividends paid to stockholders............ (21,337) (22,936) (19,038)
Net cash received from debt offering........... -- -- 49,379
Net proceeds from issuance of common stock..... 8,945 4,595 3,166
Net proceeds from issuance of preferred stock.. -- -- 96,446
Purchase of Employee Stock Ownership Plan
shares...................................... -- (4,559) (30,286)
Purchase of treasury stock..................... 34,632 (29,574) (15,991)
------- ------- -------
Net cash provided (used) by financing
activities..................................... 98,424 (2,711) 82,586
------- ------- -------
Increase (decrease) in cash and cash
equivalents.................................... 1,565 (659) (940)
Cash and cash equivalents at beginning of
period......................................... 123 782 1,722
------- ------- -------
Cash and cash equivalents at end of period....... $ 1,688 $ 123 $ 782
------- ------- -------
------- ------- -------
- ------------------
(1) The 1996 results reflect the dissolution and subsequent merger of Sovereign
Investment Corporation into Sovereign Bancorp during 1996.
74
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(19) SUBSEQUENT EVENTS (UNAUDITED)
Business Combinations. On April 27, 1998, Sovereign announced its planned
acquisition of 95 branch offices, approximately $2.3 billion in commercial bank
deposits and approximately $800 million in commercial and consumer loans
throughout Pennsylvania and New Jersey from CoreStates Financial Corp.
("CoreStates") and First Union Corporation ("First Union"). This transaction,
which will be accounted for as a purchase, is subject to governmental approvals
and is expected to close in August 1998.
Preferred Stock. On April 16, 1998, Sovereign announced that it will redeem
all outstanding shares of its 6 1/4% Cumulative Convertible Preferred Stock,
Series B on May 15, 1998 at a redemption price of $52.188 per share plus the
dividends payable on May 15, 1998. On this date, dividends on shares of Series B
Preferred Stock will cease to accrue.
Holders of Series B Preferred Stock who convert such shares on May 15, 1998
will receive shares of common stock of Sovereign issuable upon conversion of
Series B Preferred Stock and will be entitled to receive the quarterly dividend
payable on the Series B Preferred Stock. Holders of Series B Preferred Stock who
convert such shares prior to the Redemption Date will receive shares of common
stock of Sovereign issuable upon conversion of Series B Preferred Stock, but
will not be entitled to receive the quarterly dividend payable on the Series B
Preferred Stock. Holders of Series B Preferred Stock who do not convert such
shares on or prior to the Redemption Date will receive the Redemption Price of
$52.188 per share, plus all accrued and unpaid dividends through the Redemption
Date of $.78125 per share, but will not receive any shares of common stock of
Sovereign issuable upon conversion of Series B Preferred Stock. Accordingly,
Sovereign anticipates that holders of Series B Preferred Stock will convert
their shares of Series B Preferred Stock on May 15, 1998 in order to receive (i)
accrued and unpaid dividends of $.78125 per share of Series B Preferred Stock
and (ii) 7.184 shares of common stock of Sovereign for each share of Series B
Preferred Stock, based on the current conversion price, with a market value of
$159.40 (based on the closing sale price of $22.1875 per share on April 15,
1998) in lieu of receiving the Redemption Price of $52.188 per share of Series B
Preferred Stock.
Impact of Year 2000. The Year 2000 Issue is the result of computer programs
being written using two digits rather than four to define the applicable year.
Any of Sovereign's computer programs that have time-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices, or engage in similar normal business activities.
Based on a continuing assessment, Sovereign has preliminarily determined
that it, or third party vendors with which Sovereign contracts, will be required
to modify or replace portions of software and hardware so that computer systems
will function properly with respect to dates in the year 2000 and thereafter.
Sovereign presently believes that with modifications or replacements to existing
software and hardware and conversions to new software and hardware, the Year
2000 Issue will not pose significant operational problems for its computer
systems. However, if such modifications and conversions are not made, or are not
completed timely, the Year 2000 Issue could have a material impact on the
operations of Sovereign.
Sovereign is initiating an ongoing program of formal communications with
all of its significant suppliers and large customers to determine the extent to
which Sovereign's interface systems are vulnerable to those third parties'
failure to remediate their own Year 2000 Issues. However, there can be no
guarantee that the systems of other companies on which Sovereign's systems rely
will be timely converted and would not have an adverse effect on Sovereign's
systems or operations.
Sovereign will utilize both internal and external resources to reprogram,
or replace, and test the software and hardware for Year 2000 modifications.
Sovereign anticipates completing the Year 2000 project prior to any anticipated
impact on its operating systems. Sovereign estimates that the expenses
associated with the Year 2000 project for 1998 may cost in the $5 million to $10
million range, although this estimate is subject to change. The total cost of
the Year 2000 project is anticipated to be funded through operating cash flows
and expensed as incurred.
The costs of the project and the time table on which Sovereign believes it
will complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future events,
including the continued availability of certain resources, third party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved and actual results could differ materially from
those anticipated. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct all relevant computer codes, and
similar uncertainties.
Although Sovereign believes that the program outlined above should be
adequate to address the Year 2000 Issue, there can be no assurance to that
effect.
75
INDEPENDENT AUDITORS' REPORT
The Board of Directors
ML Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial condition
of ML Bancorp, Inc. and subsidiaries (the "Company") as of February 27, 1998 and
March 31, 1997, and the related consolidated statements of operations, changes
in stockholders' equity, and cash flows for the eleven-month period ended
February 27, 1998 and for each year in the two-year period ended March 31, 1997.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of ML Bancorp, Inc. and
subsidiaries as of February 27, 1998 and March 31, 1997, and the results of its
operations and its cash flows for the eleven-month period ended February 27,
1998 and for each year in the two-year period ended March 31, 1997 in conformity
with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
- --------------------------
June 15, 1998
<PAGE>
ML BANCORP, INC.
Consolidated Statements of Financial Condition
February 27, 1998 and March 31, 1997
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
February 27, March 31,
Assets 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash (including interest-bearing deposits of $1,891 and $7,082
at February 27, 1998 and March 31, 1997, respectively) $ 31,933 17,744
Assets available for sale:
Securities 736,848 597,825
Loans 287,542 104,708
Investments (market value $59,987 and $31,730
at February 27, 1998 and March 31, 1997, respectively) 60,324 32,071
Mortgage-related securities (market value $330,554 and $380,046
at February 27, 1998 and March 31, 1997, respectively) 328,780 385,293
Loans receivable, net of allowance for loan loss ($19,370 and $14,733
at February 27, 1998 and March 31, 1997, respectively) 813,905 730,535
Accrued income receivable 14,931 12,591
Other real estate owned, net 1,753 1,332
Premises and equipment, at cost less accumulated depreciation ($19,996 and $16,904
at February 27, 1998 and March 31, 1997, respectively) 18,016 16,988
Mortgage servicing rights, net 54,690 49,721
Goodwill and other intangible assets 9,909 2,751
Other assets 13,122 8,288
- ----------------------------------------------------------------------------------------------------------------------------------
Total assets $2,371,753 1,959,847
- ----------------------------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' and Members' Equity
- ----------------------------------------------------------------------------------------------------------------------------------
Customer accounts $1,023,354 873,357
Advances from Federal Home Loan Bank 546,491 437,418
Securities sold under agreements to repurchase 535,419 456,285
Advance payments by borrowers for taxes and insurance 2,485 3,670
Other liabilities 13,300 3,413
- ----------------------------------------------------------------------------------------------------------------------------------
Total liabilities 2,121,049 1,774,143
- ----------------------------------------------------------------------------------------------------------------------------------
Corporation-obligated mandatorily redeemable capital securities of subsidiary
trust holding solely junior subordinated debentures of the Corporation 50,000 50,000
Stockholders' equity:
Preferred stock, no par value, authorized 5,000,000 shares; no shares issued and outstanding -- --
Common stock, $.01 par value, authorized 30,000,000 shares; 14,547,600 shares issued
and outstanding 73 73
Additional paid-in capital 117,793 97,237
Common stock acquired by stock benefit plans (6,017) (7,336)
Treasury stock, at cost; 1,605,072 and 3,271,046 shares
at February 27, 1998 and March 31, 1997, respectively) (15,473) (37,147)
Retained earnings 96,494 83,280
Unrealized (loss) gain on securities available for sale 7,834 (403)
- ----------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 200,704 135,704
----------------------------------------------------------------------------------------------------------------------------------
Total liabilities, minority interest in subsidiaries, and stockholders' equity $2,371,753 1,959,847
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
ML BANCORP, INC.
Consolidated Statements of Operations
Eleven-month period ended February 27, 1998 and years ended
March 31, 1997 and 1996
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
Eleven-month
period ended
February 27, Year ended March 31,
------------- -----------------------------
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest income:
Loans $ 66,118 64,022 53,678
Mortgage-related and investment securities 22,741 27,039 30,539
Investments 4,294 2,073 2,743
Assets available for sale 52,964 43,623 32,957
Interest-bearing deposits 550 561 504
- -------------------------------------------------------------------------------------------------------------
Total interest income 146,667 137,318 120,421
- -------------------------------------------------------------------------------------------------------------
Interest expense:
Customer accounts 32,466 33,623 32,555
FHLB advances 27,204 24,365 22,775
Other borrowings 27,429 25,151 21,329
- -------------------------------------------------------------------------------------------------------------
Total interest expense 87,099 83,139 76,659
- -------------------------------------------------------------------------------------------------------------
Net interest income 59,568 54,179 43,762
Provision for loan losses 3,080 5,310 4,000
- -------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 56,488 48,869 39,762
- -------------------------------------------------------------------------------------------------------------
Noninterest income:
Retail fees and charges 3,284 1,832 1,551
Mortgage banking operations 11,312 12,236 4,420
Net gain (loss) on:
Sales of securities available for sale 1,931 (58) 255
Other real estate activities 99 835 99
Rental income 609 605 583
Other 856 256 361
- -------------------------------------------------------------------------------------------------------------
Total noninterest income $ 18,091 15,706 7,269
- -------------------------------------------------------------------------------------------------------------
Noninterest expense:
Compensation and employee benefits $ 23,497 21,501 13,892
Advertising 1,395 1,889 1,939
Data processing 1,813 1,814 1,538
Federal insurance premiums 513 6,236 1,549
Amortization of goodwill and other intangible assets 1,396 4,619 1,412
Net occupancy costs 6,234 6,178 4,211
Professional fees 1,301 891 693
Minority interest in expense of subsidiaries 4,688 274 --
Other 6,470 5,458 3,905
- -------------------------------------------------------------------------------------------------------------
Total noninterest expense 47,307 48,860 29,139
- -------------------------------------------------------------------------------------------------------------
Income before income taxes 27,272 15,715 17,892
Income taxes 10,724 1,905 6,272
- -------------------------------------------------------------------------------------------------------------
Net income $ 16,548 13,810 11,620
- -------------------------------------------------------------------------------------------------------------
Basic earnings per share $ 1.51 1.24 0.94
- -------------------------------------------------------------------------------------------------------------
Diluted earnings per share $ 1.43 1.20 0.92
- -------------------------------------------------------------------------------------------------------------
Weighted average number of shares -- basic 10,925,662 11,096,383 12,375,689
- -------------------------------------------------------------------------------------------------------------
Weighted average number of shares -- diluted 11,534,608 11,504,405 12,628,686
- -------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to combined financial statements.
3
<PAGE>
ML BANCORP, INC.
Consolidated Statements of Changes in Stockholders' Equity
Eleven-month period ended February 27, 1998 and years ended
March 31, 1997, 1996, and 1995
(In thousands)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
Common stock
Additional acquired by
Common paid-in stock benefit Treasury
stock capital plans stock
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at March 31, 1995 $73 95,541 (10,632) (5,648)
- -----------------------------------------------------------------------------------------------------------------
ESOP stock committed to be released -- -- 915 --
Excess of fair value above cost of stock benefit plans -- 436 -- --
RRP stock amortization -- -- 829 --
Net unrealized gain on securities available for sale -- -- -- --
Exercise of stock options -- -- -- 152
Purchase of treasury stock -- -- -- (15,035)
Dividends paid ($0.26 per share) -- -- -- --
Net income -- -- -- --
- -----------------------------------------------------------------------------------------------------------------
Balance at March 31, 1996 73 95,977 (8,883) (20,531)
- -----------------------------------------------------------------------------------------------------------------
ESOP stock committed to be released -- -- 930 --
Excess of fair value above cost of stock benefit plans -- 1,260 -- --
RRP stock amortization -- -- 622 --
Net unrealized gain on securities available for sale -- -- -- --
Exercise of stock options -- -- -- 6
Purchase of treasury stock -- -- -- (16,622)
Dividends paid ($0.38 per share) -- -- -- --
Net income -- -- -- --
- -----------------------------------------------------------------------------------------------------------------
Balance at March 31, 1997 73 97,237 (7,336) (37,147)
- -----------------------------------------------------------------------------------------------------------------
ESOP stock committed to be released (1) -- -- 844 --
Excess of fair value above cost of stock benefit plans -- 2,296 -- --
RRP stock amortization (1) -- -- 475 --
Net unrealized gain on securities available for sale -- -- -- --
Exercise of stock options -- 837 -- 4,368
Issuance of treasury stock (1) -- 17,423 -- 17,306
Dividends paid ($0.32 per share) -- -- -- --
Net income -- -- -- --
- -----------------------------------------------------------------------------------------------------------------
Balance at February 27, 1998 $73 117,793 (6,017) (15,473)
- -----------------------------------------------------------------------------------------------------------------
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
Unrealized gain
(loss) on securities Total
available for sale Retained stockholders'
net of taxes earnings equity
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at March 31, 1995 (3,200) 65,166 141,300
- ---------------------------------------------------------------------------------------------------------------
ESOP stock committed to be released -- -- 915
Excess of fair value above cost of stock benefit plans -- -- 436
RRP stock amortization -- -- 829
Net unrealized gain on securities available for sale 3,320 -- 3,320
Exercise of stock options -- (6) 146
Purchase of treasury stock -- -- (15,035)
Dividends paid ($0.26 per share) -- (3,194) (3,194)
Net income -- 11,620 11,620
- ---------------------------------------------------------------------------------------------------------------
Balance at March 31, 1996 120 73,586 140,337
- ---------------------------------------------------------------------------------------------------------------
ESOP stock committed to be released -- -- 930
Excess of fair value above cost of stock benefit plans -- -- 1,260
RRP stock amortization -- -- 622
Net unrealized gain on securities available for sale (523) -- (523)
Exercise of stock options -- -- 6
Purchase of treasury stock -- -- (16,622)
Dividends paid ($0.38 per share) -- (4,116) (4,116)
Net income -- 13,810 13,810
- ---------------------------------------------------------------------------------------------------------------
Balance at March 31, 1997 (403) 83,280 135,704
- ---------------------------------------------------------------------------------------------------------------
ESOP stock committed to be released (1) -- -- 844
Excess of fair value above cost of stock benefit plans -- -- 2,296
RRP stock amortization (1) -- -- 475
Net unrealized gain on securities available for sale 8,237 -- 8,237
Exercise of stock options -- -- 5,205
Issuance of treasury stock (1) -- -- 34,729
Dividends paid ($0.32 per share) -- (3,334) (3,334)
Net income -- 16,548 16,548
- ---------------------------------------------------------------------------------------------------------------
Balance at February 27, 1998 7,834 96,494 200,704
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
ML BANCORP, INC.
Consolidated Statements of Cash Flows
Eleven-month period ended February 27, 1998 and years ended
March 31, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
Eleven-month
period ended
February 27, Year ended March 31,
------------ -----------------------
1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net cash flows from operating activities:
Net income $ 16,548 13,810 11,620
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Amortization of:
Goodwill 1,394 4,619 1,412
Deferred loan origination fees (1,799) (2,083) (2,345)
Premiums and discounts 5,735 3,155 1,063
Mortgage servicing rights 9,695 7,985 3,703
Common stock acquired by stock benefit plans 3,615 2,818 2,326
Provision for loan losses 3,080 5,310 4,000
Net (gain) loss on sale of assets available for sale:
Securities (1,931) 58 (255)
Loans (6,094) (7,289) (2,129)
Net (gain) loss on other real estate activities (99) (835) (99)
Depreciation 2,880 2,980 2,156
Increase/decrease in:
Loans available for sale (176,740) (2,386) (67,637)
Accrued income receivable (2,340) (506) (1,401)
Deferred federal income taxes (4,177) (3,328) (1,540)
Other assets (4,834) (4,871) (1,717)
Other liabilities 12,942 (5,211) (6,942)
- ----------------------------------------------------------------------------------------------------------------
Total adjustments (158,673) 416 (69,405)
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (142,125) 14,226 (57,785)
- ----------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Net increase in loans receivable (85,594) (43,190) (144,510)
Proceeds from sale of:
FHLB stock 8,270 14,843 12,907
Securities available for sale 25,631 141,433 100,801
Proceeds from maturities or repayments of:
Mortgage-related securities -- 56,811 56,735
Securities available for sale 151,695 107,250 87,333
Investments 5,000 6,041 30,000
Purchases of:
Mortgage-related securities 54,958 (39,754) (49,834)
Securities available for sale (305,849) (379,895) (183,458)
Investments (42,656) (28,009) (21,681)
Mortgage servicing rights
Purchases (10,405) (32,780) (11,985)
Originations (4,259) (3,061) (760)
Net decrease (increase) in other real estate owned 42 153 972
Proceeds from other real estate activities 579 2,612 330
Excess of liabilities assumed over assets acquired (8,552) (3,871) (3,148)
Purchases of premises and equipment (3,908) (5,625) (2,828)
- ----------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (215,048) (207,042) (129,126)
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
(Continued)
5
<PAGE>
ML BANCORP, INC.
Consolidated Statements of Cash Flows
Eleven-month period ended February 27, 1998 and years ended
March 31, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
Eleven-month
period ended
February 27, Year ended March 31,
------------ -------------------------
1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from financing activities:
Net increase in customer accounts $ 149,997 12,341 137,010
Proceeds from customer accounts purchased -- -- 28,925
Dividends paid (3,334) (4,116) (3,194)
Proceeds from securities sold under agreements to repurchase 258,227 170,575 202,414
Payments of securities sold under agreements to repurchase (179,093) (86,483) (215,524)
Proceeds from FHLB advances 119,823 138,405 166,165
Payments of FHLB advances (10,750) (77,000) (110,080)
Net decrease in advance payments by borrowers for taxes and insurance (1,185) 137 (454)
Net proceeds from issuance of capital securities -- 50,000 --
Net proceeds from issuance of common stock -- -- --
Common stock acquired by stock benefit plans, net -- -- --
Issuance (purchase) of treasury stock 34,729 (16,622) (15,035)
Exercise of stock options 2,948 -- --
- ----------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 371,362 187,237 190,227
- ----------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 14,189 (5,579) 3,316
Cash and cash equivalents:
Beginning of period 17,744 23,323 20,007
- ----------------------------------------------------------------------------------------------------------------------------
End of period $ 31,933 17,744 23,323
- ----------------------------------------------------------------------------------------------------------------------------
Supplemental disclosure:
Cash payments for interest $ 80,494 82,824 75,120
Cash payment (refunds) for income taxes 14,991 5,310 14,498
Transfer of loans receivable into other real estate owned 943 1,219 1,077
Net cash paid for companies acquired 3,418 -- 3,200
Transfer of mortgage-related securities to securities available for sale -- -- 56,828
Net unrealized (loss) gain on securities available for sale 11,616 (1,291) 5,576
Tax effect on unrealized (loss) gain on securities available for sale 3,379 (768) 2,256
Tax effect of exercise of stock options 2,257 -- --
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements
6
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
February 27, 1998 and March 31, 1997 and 1996
- --------------------------------------------------------------------------------
(1) Merger of ML Bancorp, Inc.
On February 28, 1998, Sovereign Bancorp, Inc. acquired ML Bancorp, Inc.
wherein shareholders of ML Bancorp, Inc. received 1.62 shares of Sovereign
common stock for each share of ML Bancorp, Inc. common stock (1.944 shares
after adjustment for stock splits and dividends). The accompanying
financial statements do not reflect this transaction, nor any other
transaction which occurred with the merger.
(2) Summary of Significant Accounting Policies
Conversion to Capital Stock Form of Ownership. On August 11, 1994, Main
Line Bank (the "Bank") converted from a federally chartered mutual savings
bank to a federally chartered stock savings bank with the concurrent
formation of ML Bancorp, Inc. (the "Bancorp"), a unitary savings and loan
holding company (the "Conversion") and issued 7,273,800 shares of its
common stock (currently 14,547,600 shares based upon the two-for-one stock
split in September, 1996) in a public offering which resulted in proceeds
to Bancorp of $95.6 million, net of $2.6 million of costs associated with
the Conversion.
Business. The Bancorp's principal subsidiary, Main Line Bank, conducts
business from its bank branch system located in Bucks, Chester, Delaware
and Montgomery Counties, Pennsylvania, and its loan production offices in
Delaware, Florida, New Jersey and Pennsylvania. The Bank is subject to
competition from other financial institutions and other companies which
provide financial services. The Bank and Bancorp are subject to the
regulations of certain federal agencies and undergo periodic examinations
by those regulatory authorities.
Principles of Consolidation. The consolidated financial statements include
the accounts of the Bancorp, the Bank and the wholly owned subsidiaries
(collectively referred to as the "Company"). All significant inter-company
transactions have been eliminated in consolidation. Additionally, certain
reclassifications have been made in order to conform with the current
year's presentation. The accompanying consolidated financial statements
have been prepared on an accrual basis.
Basis of Financial Statement Presentation. The consolidated financial
statements have been prepared in conformity with generally accepted
accounting principles. In preparing the consolidated financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the statement
of financial condition and revenues and expenses for the period. Actual
results could differ significantly from those estimates.
(Continued)
7
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Material estimates that are particularly susceptible to significant change
in the near-term relate to the determination of the allowance for loan
losses, the valuation of other real estate owned, and the valuation of
deferred tax assets as well as the effect of prepayments on mortgage
servicing rights and premiums and discounts associated with investments and
mortgage-related securities. Management believes that these estimates are
adequate. Various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan
losses, valuation of other real estate owned and other accounting
estimates.
Cash. For purposes of the statement of cash flows, cash and cash
equivalents include cash and interest-bearing deposits in other depository
institutions.
Assets Available for Sale. Included in assets available for sale are any
investments, loans, debt, and/or mortgage-related securities which the
Company believes may be involved in interest rate risk, liquidity, or other
asset/liability management decisions which might reasonably result in such
assets not being held until maturity. Assets available for sale are carried
at fair value with net unrealized gains and losses included, net of income
taxes, in stockholders' equity.
Loans available for sale are accounted for at the lower of cost or market
which is determined on an aggregate basis, with depreciation, if any,
recorded in the statement of operations. Realized gains and losses on
assets available for sale are computed using the specific identification
method.
Investments and Mortgage-Related Securities. Investments and
mortgage-related securities, including equity securities which are not
readily marketable, are stated at cost, adjusted for the amortization of
premiums and the accretion of discounts using a method which approximates
level yield, because management has the ability and the intent to hold such
securities until maturity. The Company is required to maintain stock in the
Federal Home Loan Bank of Pittsburgh ("FHLB") in an amount of 5% of total
borrowings from the FHLB. Such stock is carried by the Company at cost.
Loans Receivable. Loans held to maturity are stated at the amount of the
unpaid principal balance net of loan origination fees and certain direct
origination costs. These fees and costs are deferred and amortized over the
contractual life of the related loans using a level yield method. Interest
on loans is credited to income as it is earned. Generally, interest income
is not accrued for loans delinquent 90 days or greater. Payments received
on nonaccrual and impaired loan are generally applied to the outstanding
principal balance. The Bank considers a loan to be impaired when, based on
current information and events, it is probable that they will be unable to
collect scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. Large groups of
smaller-balance, homogeneous loans such as residential mortgage and
consumer loans are collectively evaluated for impairment and are not
included in the impaired loans category. The Company generally does not
recognize interest on impaired loans.
(Continued)
8
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Allowance for Possible Loan Losses. The allowance for possible loan losses
is maintained at a level that management considers adequate to provide for
potential losses based upon an evaluation of known and inherent risks in
the loan portfolio. Management believes that the allowance for possible
loan losses is adequate. Management's periodic evaluation is based upon
analysis of the portfolio, past loss experience, current economic
conditions, and other relevant factors. While management uses the best
information available to make such evaluations, future adjustments to the
allowance may be necessary if economic conditions differ substantially from
the assumptions used in making the evaluation. In addition, various
regulatory agencies as an integral part of their examination process,
periodically review the allowance for possible loan losses. Such agencies
may require the Company to recognize additions to the allowance for
possible loan losses based on their judgments of information which is
available to them at the time of their examination.
Other Real Estate Owned, Net. Real estate acquired through foreclosure is
classified as other real estate owned and is carried at the lower of cost
or fair value, less estimated selling costs. Fair value is generally
determined through the use of independent appraisals. In certain cases,
internal cash flow analyses are used as the basis for fair value, if such
amounts are lower than the appraised values.
Premises and Equipment. Premises and equipment are carried at cost.
Depreciation and amortization are generally computed on the straight-line
method over their useful lives (30 years for buildings and 3 to 10 years
for furniture and equipment).
Mortgage Servicing Rights. Mortgage servicing rights represent the carrying
value of the rights to service mortgage loans for others. The mortgage
servicing rights are amortized against loan servicing fee income on an
accelerated basis in proportion to, and over the period of, estimated net
future loan servicing fee income, which periods initially do not exceed
eight years.
Servicing fee income is recognized when the related loan payments are
collected. Management evaluates the remaining balances of mortgage
servicing rights to determine if the fair value of the disaggregated
servicing rights indicate that the carrying value is not considered
recoverable. Assumptions utilized in the evaluations are based on current
prepayment and investor rates of return provided by an independent
investment advisor.
Impairment of mortgage servicing rights is assessed quarterly based upon a
fair market valuation of those rights using discounted cash flows based on
current market interest rates. For purposes of measuring impairment, the
rights are stratified based upon the predominant risk characteristics of
the underlying loans relying primarily on interest rate bands or pools. The
impairment recognized is the amount by which the mortgage servicing rights
exceed the fair value for each individual band.
Goodwill. Goodwill, which represents the excess cost over fair value of
assets acquired and liabilities assumed, is being amortized to expense
using the straight-line method over periods not exceeding 15 years.
(Continued)
9
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Income Taxes. Deferred tax assets and liabilities are recognized for the
future consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases, as well as operating loss and tax credit
carryforwards. Deferred tax assets are recognized for future deductible
temporary differences and tax loss and credit carryforwards if their
realization is "more likely than not." Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to be recovered
or settled.
Earnings Per Share. All share and per share data have been adjusted to
reflect the Company two-for-one stock split that was paid on September 6,
1996.
(3) Assets Available for Sale
Assets available for sale at February 27, 1998 and March 31, 1997,
consisted of the following (in thousands):
<TABLE>
<CAPTION>
Eleven-month period ended February 27, 1998 Year ended March 31, 1997
--------------------------------------------- ------------------------------------------
Gross Gross Carrying Gross Gross Carrying
unrealized unrealized (fair) unrealized unrealized (fair)
Securities Cost gains (losses) value Cost gains (losses) value
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-related, debt and equity
securities:
Mortgage-related securities:
FHLMC $ 313,938 3,177 (318) 316,797 304,638 -- (933) 303,705
FNMA 145,805 1,592 (213) 147,184 79,725 729 -- 80,454
GNMA 186,447 1,084 (554) 186,977 131,580 -- (983) 130,597
Privately-issued 14,295 9 (58) 14,246 21,250 -- (65) 21,185
Debt securities:
Asset Management
Funds for Financial
Institutions, Inc. 13,847 -- (298) 13,549 13,030 -- (660) 12,370
U.S. government
agency debentures 31,238 406 (20) 31,624 23,890 -- (360) 23,530
Equity securities 1,714 1,340 -- 3,054 18,817 1,193 -- 20,010
Trust preferred securities 19,026 4,391 -- 23,417 5,974 -- -- 5,974
- ------------------------------------------------------------------------------------------------------------------------------
$726,310 11,999 (1,461) 736,848 598,904 1,922 (3,001) 597,825
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Eleven-month period
ended February 27, 1998 Year ended March 31, 1997
--------------------------------------- --------------------------------------------
Gross Gross Gross Gross
Carrying unrealized unrealized Fair Carrying unrealized unrealized Fair
Loans value gains (losses) value value gains (losses) value
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans receivable:
Residential $ 273,198 -- -- 273,198 93,103 -- -- 93,103
Consumer-education 14,344 -- -- 14,344 11,605 -- -- 11,605
- -----------------------------------------------------------------------------------------------------------------
$ 287,542 -- -- 287,542 104,708 -- -- 104,708
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
(Continued)
10
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The amortized cost and estimated market value of investment securities at
February 27, 1998 by contractual maturity, are shown below.
<TABLE>
<CAPTION>
Estimated
Amortized market
cost value
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Available for sale
Due in one year or less $ -- --
Due after one year through five years 34,459 32,394
Due after five years through ten years 4,299 4,296
Due after ten years 654,741 660,498
No stated maturity 34,811 39,660
- ---------------------------------------------------------------------------------------
Total available for sale $728,310 736,848
- ---------------------------------------------------------------------------------------
</TABLE>
Expected maturities may differ from contractual maturities because
borrowers generally have the right to call or prepay obligations without
prepayment penalties.
Proceeds from sales of assets available for sale during the eleven-month
period ended February 27, 1998, were $25.6 million. Gross gains of $2.0
million and gross losses of $16 thousand were realized on those sales.
Proceeds from sales of assets available for sale during the year ended
March 31, 1997, were $682.3 million. Gross gains of $35.5 million and gross
losses of $28.2 million were realized on those sales.
Proceeds from sales of assets available for sale during the year ended
March 31, 1996 were $719.4 million. Gross gains of $6.3 million and gross
losses of $4.8 million were realized on those sales.
As of February 27, 1998, the U.S. government agency debt securities have
scheduled maturities of $20.0 million due after one year but within five
years and none due after five years but within ten years.
Accrued interest receivable on assets available for sale was $5.6 million
and $4.9 million at February 27, 1998 and March 31, 1997, respectively.
(Continued)
11
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(4) Investments
Investments at February 27, 1998 and March 31, 1997, consisted of the
following (in thousands):
<TABLE>
<CAPTION>
February 27, 1998 March 31, 1997
----------------------------------------------- ----------------------------------------------
Gross Gross Gross Gross
Carrying unrealized unrealized Market Carrying unrealized unrealized Market
value gains losses value value gains losses value
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Equity securities:
Federal Home $
Loan Bank
stock 32,453 -- -- 32,453 21,878 -- -- 21,878
Other 515 -- -- 515 258 -- -- 258
Debt securities:
U.S. government
agency notes 27,356 79 416 27,019 9,935 -- 341 9,594
- ------------------------------------------------------------------------------------------------------------------------
$60,324 79 416 59,987 32,071 -- 341 31,730
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
Proceeds from the sales of investment securities during the year
eleven-month period ended February 27, 1998 and the years ended March 31,
1997 and 1996, were $8.2 million, $14.8 million and $12.9 million,
respectively. Such proceeds resulted from mandatory redemption of FHLB
stock. No gains or losses were realized on those sales.
The FHLB maintains a blanket lien on investment securities as collateral
for borrowings from the FHLB.
Accrued interest receivable on investment securities was $327,775 and
$174,000 at February 27, 1998, and March 31, 1997 and 1996, respectively.
(Continued)
12
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(5) Mortgage-Related Securities
Mortgage-related securities at February 27, 1998 and March 31, 1997 and
1996, consisted of the following (in thousands):
<TABLE>
<CAPTION>
February 27, 1998 March 31, 1997
-------------------------------------------- --------------------------------------------
Gross Gross Gross Gross
Carrying unrealized unrealized Market Carrying unrealized unrealized Market
value gains losses value value gains losses value
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-backed
securities:
Federal Home
Loan Mortgage
Corporation (FHLMC) $105,214 1,171 370 106,015 125,205 -- 2,015 123,190
Federal National Mortgage
Association (FNMA) 103,787 1,507 350 104,944 124,433 -- 1,513 122,920
Government National
Mortgage Association
(GNMA) 6,041 230 -- 6,271 7,130 142 -- 7,272
Privately issued 14,044 97 14 14,127 19,740 -- 79 19,661
Collateralized mortgage
obligations 99,694 66 563 99,197 108,785 -- 1,782 107,003
- -----------------------------------------------------------------------------------------------------------------------------
$328,780 3,071 1,297 330,554 385,293 142 5,389 380,046
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
There were no sales of mortgage-related securities during the eleven-month
period ended February 27, 1998 and the years ended March 31, 1997 and 1996.
Certain mortgage-related securities are pledged to secure financing as
described in notes 9 and 10. Privately issued mortgage-backed securities
are rated AA or better by bond rating agencies. The loans which
collateralize the mortgage-related securities are geographically disbursed
throughout the United States.
Collateralized mortgage obligations and mortgage-backed securities totaling
$95.4 million and $70 million were pledged as additional collateral for
municipal jumbo certificate deposits at February 27, 1998 and March 31,
1997, respectively.
Accrued interest receivable on mortgage-related securities was $2.3 million
and $2.7 million at February 27,1998 and March 31, 1997, respectively.
(Continued)
13
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The amortized cost and estimated market value of investment securities at
February 27, 1998 by contractual maturity, are shown below.
Estimated
Amortized market
cost value
- -------------------------------------------------------------------------------
Held to maturity:
Due in one year or less $ -- --
Due after one year through five years -- --
Due after five years through ten years 62,573 62,143
Due after ten years 293,563 295,430
No stated maturity 32,968 32,968
- -------------------------------------------------------------------------------
Total held to maturity $389,104 390,541
- -------------------------------------------------------------------------------
The above assets represent values reflected in notes 4 and 5.
Expected maturities may differ from contractual maturities because
borrowers generally have the right to call or prepay obligations without
prepayment penalties.
(Continued)
14
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(6) Loans Receivable
Loans receivable at February 27, 1998 and March 31, 1997, consisted of the
following (in thousands):
February 27, March 31,
1998 1997
- --------------------------------------------------------------------------------
Real estate loans:
One- to four-family $274,948 310,456
Construction and land:
Residential 100,737 90,618
Commercial 54,078 38,913
Commercial real estate 149,095 130,017
Multi-family 16,008 12,411
- --------------------------------------------------------------------------------
Total real estate loans 594,866 582,415
- --------------------------------------------------------------------------------
Other loans:
Consumer:
Home equity and equity lines of credit 156,427 131,699
Other 12,240 10,990
Commercial 146,901 84,034
- --------------------------------------------------------------------------------
Total other loans 315,568 226,723
- --------------------------------------------------------------------------------
Loans receivable, gross 910,434 809,138
- --------------------------------------------------------------------------------
Loans in process (construction loans) (72,504) (59,916)
Deferred loan fees (4,655) (3,954)
Allowance for loan losses (19,370) (14,733)
- --------------------------------------------------------------------------------
Loans receivable, net $813,905 730,535
- --------------------------------------------------------------------------------
Included in loans receivable are loans past due 90 days or more in the
amounts of $7.3 million, $9.4 million, $8.4 million at February 27, 1998,
and March 31, 1997 and 1996, respectively, that are not accruing interest.
Interest income that would have been recognized on these nonaccrual loans
had they been current in accordance with their original terms is $696,900,
$583,000, and $1.1 million, respectively. Interest income that was
recognized on these nonaccrual loans was $132,000, and $96,000, at March
31, 1997 and 1996, respectively. There was no interest income recognized on
these nonaccrual loans at February 27, 1998.
The Company is principally a local lender and, therefore, has a significant
concentration of loans to borrowers who reside in and/or which are
collateralized by real estate located in the suburban Philadelphia area. In
addition, the Company has a concentration of residential and commercial
construction real estate loans to 6 local real estate developers totaling
approximately $37 million in additional commitments outstanding and
approximately $47.1 million in outstanding balances at February 27, 1998
and March 31, 1997.
(Continued)
15
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Activity in the allowance for loan losses for the eleven-month period ended
February 27, 1998 and the years ended March 31, 1997 and 1996 consisted of
the following (in thousands):
<TABLE>
<CAPTION>
Eleven-month
period ended Year ended March 31,
February 27, ---------------------
1998 1997 1996
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, beginning of year $14,733 13,124 9,111
Provision for loan losses 3,080 5,310 4,000
Charge-offs (650) (3,791) (1,188)
Recoveries 884 90 181
Allowance acquired 1,323 -- 1,020
- ---------------------------------------------------------------------------------------
Balance, end of year $19,370 14,733 13,124
- ---------------------------------------------------------------------------------------
</TABLE>
As of February 27, 1998 and March 31, 1997 and 1996, the recorded
investment in the loans for which impairment has been recognized is $1.8
million, $3.3 million, and $3.7 million, respectively. The average
investment in such impaired loans was $2.5 million, $4.6 million and $4.2
million for the eleven-month period ended February 27, 1998 and the years
ended March 31, 1997 and 1996, respectively. As of February 27, 1998, there
was a $752,700 ($500,000 specific) allowance for loan losses pertaining to
impaired loans. During the years ended March 31, 1997 and 1996, there was
no allowance for loan losses pertaining to these impaired loans because the
Company provided and charged-off $312,000 and $346,000 of such loans.
An analysis of the activity of loans to directors and officers follows (in
thousands):
<TABLE>
<CAPTION>
Eleven-month
period ended Year ended
February 27, March 31,
1998 1997
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Balance, beginning of year $504 674
Increase (decrease) due to change in qualifying officers -- (117)
New loans and line of credit advances 165 97
Repayments (100) (150)
- ------------------------------------------------------------------------------------------
Balance, end of year $569 504
- ------------------------------------------------------------------------------------------
</TABLE>
Accrued interest receivable on loans receivable was $6.7 million and $4.6
million at February 27, 1998, and March 31, 1997, respectively.
(Continued)
16
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(7) Mortgage Servicing Activities
A summary of mortgage servicing rights activity follows (in thousands):
Eleven-month
period ended Year ended March 31,
February 27, ----------------------
1998 1997 1996
- --------------------------------------------------------------------------------
Balance, beginning of year $49,721 21,865 12,823
Purchases 10,405 32,780 11,985
Originated servicing rights 4,259 3,061 760
Amortization (9,695) (7,985) (3,703)
- --------------------------------------------------------------------------------
Balance, end of year $54,690 49,721 21,865
- --------------------------------------------------------------------------------
During the eleven-month period ended February 27, 1998 and the years ended
March 31, 1997 and 1996 the Company purchased the servicing rights of whole
loans with balances of $625.2 million, $2.2 billion, and $858.4 million,
respectively.
Activity in the valuation allowance for mortgage servicing rights for the
eleven-month period ended February 27, 1998, and the years ended March 31,
1997 and 1996, consisted of the following (in thousands):
Eleven-month
period ended Year ended March 31,
February 27, ----------------------
1998 1997 1996
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Balance, beginning of year $2,200 1,200 330
Provision for mortgage
servicing rights in excess
of fair value 1,095 1,000 870
- --------------------------------------------------------------------------------
Balance, end of year $3,295 2,200 1,200
- --------------------------------------------------------------------------------
The Company services real estate loans for investors which are not included
in the consolidated financial statements. The total amount of such loans
serviced for others was approximately $4.6 billion, $4.4 billion, and $2.4
billion at February 27, 1998, and March 31, 1997 and 1996, respectively.
The Company is required to remit to investors the monthly principal
collected and scheduled interest payments on most mortgages, including
those for which no interest payments have been received due to delinquency.
As of February 27, 1998 and March 31, 1997, approximately $55,224 and
$469,800, respectively, had been advanced on delinquent serviced loans.
Substantially all of these loans were sold without recourse and are
guaranteed by FHLMC or FNMA.
(Continued)
17
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(8) Customer Accounts
The major types of customer accounts by weighted interest rates, amounts,
and the percentages of such types to total customer accounts are as follows
(dollars in thousands):
<TABLE>
<CAPTION>
February 27, 1998 March 31, 1997
--------------------------------- ----------------------------------
Weighted Weighted
interest % of interest % of
rate Amount total rate Amount total
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing
accounts 0.00% $ 190,540 18.62% 0.00% $118,836 13.61%
Money market and
NOW accounts 2.20 179,611 17.55 2.46 156,325 17.90
Passbook and statement
savings accounts 2.08 93,933 9.18 2.14 88,574 10.14
- ----------------------------------------------------------------------------------------------
1.27 464,084 45.35 1.58 363,735 41.65
Certificates of deposit 5.53 502,646 49.12 5.61 469,073 53.71
Repurchase agreements
with customers 3.42 56,624 5.53 4.59 40,549 4.64
- ----------------------------------------------------------------------------------------------
3.48% $1,023,354 100.0% 3.88% $873,357 100.0%
- ----------------------------------------------------------------------------------------------
</TABLE>
A summary of certificates by maturity is as follows (in thousands):
February 27, March 31,
1998 1997
- -------------------------------------------------------------------------------
Within one year $348,320 337,081
One to two years 131,345 53,453
Two to three years 13,645 42,778
Three to four years 7,358 18,817
Four to five years 707 13,433
Thereafter 1,271 3,511
- -------------------------------------------------------------------------------
$502,646 469,073
- -------------------------------------------------------------------------------
Interest expense on customer accounts is as follows (in thousands):
<TABLE>
<CAPTION>
Eleven-month
period ended Year ended March 31,
February 27, ----------------------
1998 1997 1996
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
Money market deposits and NOW accounts $ 3,588 3,861 3,548
Passbook and statement savings accounts 1,782 1,874 1,933
Certificate accounts 25,324 26,327 26,304
Repurchase agreements with customers 1,772 1,561 770
- -------------------------------------------------------------------------------------
Total interest expense $32,466 33,623 32,555
- -------------------------------------------------------------------------------------
</TABLE>
Included in customer accounts as of February 27, 1998 and March 31, 1997
are accounts greater than $100,000 of approximately $127.2 million and
$175.4 million, respectively.
(Continued)
18
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(9) Advances from Federal Home Loan Bank
Under the terms of its collateral agreement with the FHLB, the Company
maintains otherwise unencumbered qualifying assets in an amount at least as
much as its advances from the FHLB. The Company's FHLB stock is also
pledged to secure these advances. At February 27, 1998 and March 31, 1997,
such advances mature as follows (dollars in thousands):
<TABLE>
<CAPTION>
Eleven-month
Weighted period ended Weighted Year ended
average February 27, average March 31,
Due by February 27, interest rate 1998 interest rate 1997
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1998 -- % $ -- 6.15% $247,918
1999 5.85 289,741 6.08 27,750
2000 5.83 30,000 5.81 27,000
2001 -- -- -- --
2002 5.67 112,000 5.68 110,000
Thereafter 6.05 114,750 7.45 24,750
- --------------------------------------------------------------------------------------------
5.85% $546,491 6.08% $437,418
- --------------------------------------------------------------------------------------------
</TABLE>
The Company has entered into a warehouse loan participation program for
residential mortgage loan originations. The available line of credit from
this program totaled $132 million at February 27, 1998, of which $75
million and $31.8 million were outstanding at February 27, 1998 and March
31, 1997, respectively. The rate paid is determined by a daily variable
advance rate in effect at the FHLB and was 6.02% at February 27, 1998.
(Continued)
19
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(10) Securities Sold Under Agreements to Repurchase
The Company entered into sales of securities under agreements to repurchase
(the Agreements), which are treated as financings. Information relating to
the Agreements as of February 27, 1998 and March 31, 1997, is summarized as
follows (dollars in thousands):
<TABLE>
<CAPTION>
February 27, 1998
-------------------------------------------------------------
Loan Asset Asset Weighted
maturity carrying market Loan average
Asset date value value amount loan rate
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FNMA and FHLMC certificates Within 30 days $184,863 187,187 187,767 5.57%
FNMA and FHLMC certificates From 31-90 days 31,047 31,200 38,721 5.75
FNMA, FHLMC and GNMA certificates Over 90 days 369,240 373,147 308,931 5.80
- -------------------------------------------------------------------------------------------------
$585,150 591,534 535,419 5.71%
- -------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
March 31, 1997
-------------------------------------------------------------
Loan Asset Asset Weighted
maturity carrying market Loan average
Asset date value value amount loan rate
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FNMA and FHLMC certificates Within 30 days $192,867 193,623 182,192 5.43%
FNMA and FHLMC certificates From 31-90 days 48,964 49,272 40,000 6.25
FNMA, FHLMC and GNMA certifices Over 90 days 263,066 263,325 234,093 5.63
- -------------------------------------------------------------------------------------------------
$504,897 506,220 456,285 5.60%
- -------------------------------------------------------------------------------------------------
</TABLE>
The maximum amount outstanding at any month end of the Agreements during
the eleven-months ended February 27, 1998 and the year ended March 31, 1997
was $561.3 million and $516.6 million, respectively. The average amount of
outstanding Agreements during these same periods was $525.4 million and
$444.8 million, respectively.
(Continued)
20
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(11) Fair Value of Financial Instruments
Fair value estimates, methods, and assumptions are set forth below for the
Company's financial instruments whether or not recognized on the balance
sheet, for which it is practicable to estimate that value. The fair values
may not represent actual values of the financial instruments that could
have been realized as of year end or that will be realized in the future.
Cash and Cash Equivalents. For these short-term instruments, the carrying
amount is a reasonable estimate of fair value.
Investments and Mortgage-related Securities and Assets Available for Sale.
The fair value of investments and mortgage-related securities is estimated
based on bid prices published in financial newspapers or bid quotations
received from securities dealers. The carrying amounts of stocks with no
stated maturity approximate fair value because shares may be redeemed at
par. The fair value of loans available for sale is estimated based on
forward commitments to sell.
Loans Receivable. The fair value of performing loans receivable is
estimated by discounting future cash flows using rates as of February 27,
1998 and March 31, 1997 for which similar loans would be made to borrowers
with similar credit history and maturities.
The fair value for non-performing loans was derived through a discounted
cash flow analysis, which includes the opportunity costs of carrying a
nonperforming asset. Estimated discount rates were based on the probability
of loss and the expected time to recovery. Loans with a higher probability
of loss were assigned higher risk premiums and were discounted over longer
periods of time, resulting in lower values.
Mortgage Servicing Rights. The fair value of capitalized excess servicing
fees, originated mortgage servicing rights, and purchased mortgage
servicing rights are estimated by discounting the future cash flows at
current market rates adjusting for prepayments.
Accrued Interest Payable and Accrued Interest Receivable. The fair value
for accrued interest payable and accrued interest receivable approximates
fair value.
Customer Accounts. The fair value of customer accounts with no stated
maturity, such as non-interest-bearing accounts, savings and NOW accounts,
and money market and checking accounts is equal to the amount payable on
demand as of February 27, 1998 and March 31, 1997. The fair value of
certificates of deposit is based on the present value of contractual cash
flows. The discount rates used to compute present values are estimated
using the rates currently offered for customer accounts of similar
maturities in the Company's marketplace.
Borrowed Funds. Rates available to the Company for debt with similar terms
and remaining maturities at the dates presented are used to estimate the
fair value of existing debt.
(Continued)
21
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Commitments to Extend Credit and Standby Letters of Credit. The Company
does not normally charge fees for commitments to extend credit. Interest
rates on commitments to extend credit are normally committed for periods of
less than one month. Fees charged on standby letters of credit and other
financial guarantees are deemed to be immaterial and these guarantees are
expected to be settled at face amount or expire unused. It is impracticable
to assign any fair value to these commitments.
The carrying amount and estimated fair value of the Company's financial
instruments are as follows (in thousands):
<TABLE>
<CAPTION>
February 27, 1998 March 31, 1997
------------------------ ------------------------
Carrying Fair Carrying Fair
amount value amount value
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash $ 31,933 31,933 17,744 17,744
Investments and mortgage-related
securities 389,104 390,541 417,364 411,776
Assets available for sale 1,024,390 1,024,390 702,533 702,533
Loans receivable, net 813,905 832,644 730,535 722,840
Mortgage servicing rights 54,690 55,517 49,721 54,423
Accrued interest receivable 14,931 14,931 12,591 12,591
Accrued interest payable 12,565 12,565 5,960 5,960
Financial liabilities:
Customer accounts 1,023,354 1,028,270 873,357 876,984
Borrowed funds 1,081,910 1,085,855 893,703 885,089
- -------------------------------------------------------------------------------------------------
</TABLE>
(12) Income Taxes
Income tax expense (benefit) for the eleven-month period ended February 27,
1998 and the years ended March 31, 1997 and 1996, is comprised of the
following (in thousands):
Eleven-month
period ended Years ended March 31,
February 27, ----------------------
1998 1997 1996
- --------------------------------------------------------------------------------
Current:
Federal $13,397 4,790 7,812
State 1,504 443 --
Total current tax expense 14,901 5,233 7,812
Deferred:
Federal (4,200) (3,757) (1,396)
State 23 429 (144)
Total deferred tax expense (4,177) (3,328) (1,540)
- --------------------------------------------------------------------------------
Income tax expense $10,724 1,905 6,272
- --------------------------------------------------------------------------------
(Continued)
22
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The effective income tax rates of 39%, 12%, and 35%, for the eleven-month
period ended February 27, 1998, and the years ended March 31, 1997 and
1996, respectively, vary from the applicable statutory federal income tax
rate of 35%, 35%, and 35%, respectively, for the following reasons (in
thousands).
<TABLE>
<CAPTION>
Eleven-month
period ended Year ended March 31,
February 27, ---------------------
1998 1997 1996
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
Computed expected tax expense $ 9,545 5,500 6,262
Increase (decrease) resulting from:
Decrease in valuation allowance
for deferred tax assets -- -- (700)
Tax-exempt income (780) (801) (584)
State tax (benefit) expense,
net of federal impact 1,001 717 (144)
Subsidiary related items -- -- 1,007
Reversal of tax bad debt reserve recapture -- (4,129) --
Nondeductible ESOP expense 732 296 214
Other, net 226 322 217
- -------------------------------------------------------------------------------------
Income tax expense $10,724 1,905 6,272
- -------------------------------------------------------------------------------------
</TABLE>
The significant components of deferred income tax (benefit) attributable to
income for the eleven-month period ended February 27, 1998 and the years
ended March 31, 1997 and 1996, are as follows (in thousands):
<TABLE>
<CAPTION>
Eleven-month
period ended Year ended March 31,
February 27, ---------------------
1998 1997 1996
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Deferred tax expense (benefit)
(exclusive of the effects of
the components listed below) $(4,200) (3,757) (840)
Decrease in beginning of year balance of the
valuation allowance for deferred tax assets -- -- (700)
Adjustment to deferred tax assets and
liabilities for change in tax rates -- -- --
State tax net operating loss utilization 23 429 --
- -----------------------------------------------------------------------------------------
$(4,177) (3,328) (1,540)
- -----------------------------------------------------------------------------------------
</TABLE>
The Small Business Job Protection Act of 1996 ("Act"), enacted on August
20, 1996, provides for the repeal of the tax bad debt deduction computed
under the percentage of taxable income method. The repeal of the use of
this method is effective for tax years beginning after December 31, 1995.
Prior to the change in law, the Bank had qualified under the provisions of
the Internal Revenue Code which permitted it to deduct from taxable income
an allowance for bad debts based on 8% of taxable income.
(Continued)
23
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Upon repeal, the Bank is required to recapture into income, over a six-year
period, the portion of its tax bad debt reserves that exceed its base year
reserves (i.e., tax reserves for tax years beginning before 1988). The base
year tax reserves, which may be subject to recapture if the Bank ceases to
qualify as a bank for federal income tax purposes, are restricted with
respect to certain distributions. The Bank's total tax bad debt reserves at
February 27, 1998 and March 31, 1997, are approximately $ 20.0 million, of
which $11.8 million represents the base year amount and $8.2 is subject to
recapture.
The Company had previously established a deferred tax liability during its
fiscal year ended March 31, 1994, related to the base year bad debt
reserves in anticipation of changing the Bank's charter to that of a
commercial bank. As a result of the signing of the Act, the Company
recognized $3.8 million of after-tax income (net of state tax expense) in
the year ended March 31, 1997 due to the reversal of the base year bad debt
liability. Additionally, the Company has previously recorded a deferred tax
liability for the excess base year reserves to be recaptured; therefore,
this recapture did not impact the statement of operations.
On September 8, 1997, the Company acquired Penncore Financial Services in a
tax-free acquisition. As a result of this acquisition, the Company was able
to record net deferred tax assets of $955,000.
(Continued)
24
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
February 27, 1998 and March 31, 1997, are presented below (in thousands):
<TABLE>
<CAPTION>
February 27, March 31,
1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Uncollected interest $ 184 217
Employee benefits 2,593 706
Real estate valuation allowance 50 174
Book bad debt reserves 6,605 4,876
Purchased mortgage servicing rights 5,364 2,079
Other reserves 425 398
Federal tax net operating loss carryforwards 1,393 1,499
State tax net operating loss carryforwards -- 23
Depreciation 452 220
Other 63 315
- ---------------------------------------------------------------------------------------
Total deferred tax assets 17,129 10,507
- ---------------------------------------------------------------------------------------
Deferred tax liabilities:
Tax bad debt reserve recapture (2,888) (2,888)
Prepaid expenses (352) (603)
Loss on mortgages sold (767) (855)
Originated mortgage servicing rights (2,678) (1,398)
Purchase accounting - deposits (242) --
Net unrealized gain on securities available for sale (2,379) (206)
Other (748) (441)
- ---------------------------------------------------------------------------------------
Total deferred tax liabilities (10,054) (6,391)
- ---------------------------------------------------------------------------------------
Net deferred tax asset (liability) $ 7,075 4,116
- ---------------------------------------------------------------------------------------
</TABLE>
In order to fully realize the net deferred tax asset at February 27, 1998
and March 31, 1997, the Company will need to generate future taxable
income. Based upon the Company's tax history and the anticipated level of
future taxable income, management of the Company believes the existing net
deductible temporary differences will, more likely than not, reverse in
future periods in which the Company generates net taxable income. There can
be no assurance, however, that the Company will generate any earnings or
any specific level of continuing earnings.
For federal tax purposes, the Company has approximately $4.0 million and
$4.3 million of net operating loss carryforwards as of February 27, 1998
and March 31, 1997, respectively. The net operating loss carryforward will
expire March 31, 2010 if not utilized.
For state tax purposes, the Company has approximately $0 and $330,000 of
net operating loss carryforwards as of February 27, 1998 and March 31,
1997, respectively. The $330,000 of the net operating loss carryforward was
fully utilized in the eleven-month period ended February 27, 1998.
(Continued)
25
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(13) Employee Benefits
Pension Plan. During the fiscal year ended March 31, 1995, the Company
restructured its defined benefit pension plan ("Pension Plan") by
withdrawing from a multi-employer Pension Plan and starting a
single-employer Pension Plan.
Effective August 1, 1994, each active participant was given the option to
transfer their accrued benefit to the new Pension Plan or leave it in the
multi-employer Pension Plan. For those electing to transfer their benefits,
additional benefits would accrue under the new Pension Plan for future
service. Assets accumulated for the past and future benefits of those
transferring benefits were calculated and a schedule determined for
transfer into the new Pension Plan.
Employees hired by the Company on or after August 1, 1993, were not
eligible to participate in the new Pension Plan, however, effective April
1, 1995, the Company began accepting new participants.
The Pension Plan provides retirement benefits based on years of service and
average compensation during the years of plan participation. The Company's
funding policy is to contribute an amount which meets the minimum funding
requirements of ERISA and which can be deducted for Federal Income Tax
purposes.
(Continued)
26
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The following table sets forth the Company's plan accumulated funded status
for the eleven-month period ended February 27, 1998 and the years ended
March 31, 1997, and the amounts recognized in the consolidated balance
sheet as of February 27, 1998 and March 31, 1997 (in thousands):
<TABLE>
<CAPTION>
February 27, March 31,
1998 1997
- --------------------------------------------------------------------------------------
<S> <C> <C>
Projected benefit obligation:
Accumulated benefit obligation total (all vested) $2,323 1,923
Effect of projected future compensation levels -- 220
- --------------------------------------------------------------------------------------
Projected benefit obligation total 2,323 2,143
Plan assets at fair value 3,579 3,080
- --------------------------------------------------------------------------------------
Projected plan assets in excess of
benefit obligation 1,256 937
Unrecognized transition asset 1,299 1,391
Unrecognized prior service costs (51) (54)
Unrecognized gain (loss) 325 (59)
Accrued pension cost included on
consolidated balance sheet 317 341
- --------------------------------------------------------------------------------------
</TABLE>
Net pension cost for the eleven-month period ended February 27, 1998 and
the year ended March 31, 1997, includes the following components (in
thousands):
<TABLE>
<CAPTION>
Eleven-month
period ended Year ended March 31,
February 27, ---------------------
1998 1997 1996
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost $143 252 217
Interest cost 147 133 99
Actual return on plan assets (555) (287) (383)
Amortization of transition asset (93) (101) (101)
Amortization of prior service costs 3 4
Asset gain 331 62 184
- -------------------------------------------------------------------------------------
Net pension cost $(24) 63 16
- -------------------------------------------------------------------------------------
</TABLE>
In determining the estimated costs of the Pension Plan, the weighted
average discount rate used was 7.5% and the weighted average rate of
increase in compensation levels was zero and 5.5%, respectively compounded
annually for the eleven-month period ended February 27, 1998 and the years
ended March 31, 1997 and 1996. The weighted average expected long-term rate
of return on Pension Plan assets used in determining net periodic pension
cost was 8.00% for each of these periods. The Pension Plan's assets consist
primarily of bond and stock funds administered by an independent asset
manager.
(Continued)
27
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Employee 401(k) Savings Plan. Certain subsidiaries of the Company maintain
a qualified plan in which employees may participate. Participants in the
plan may elect to direct a portion of their wages into investment accounts
which include professionally managed mutual and money market funds and the
Company's common stock. The principal and earnings thereon are tax deferred
until withdrawn, generally.
Common Stock Acquired By The Employee Stock Ownership Plan ("ESOP"). In
connection with the Conversion, the Company established the ESOP for the
benefit of eligible employees. The Company purchased 1,018,332 shares of
common stock on behalf of the ESOP in the Conversion of which, as of
February 27, 1998, 455,437 shares were committed to be released and
allocated to participants. The Company recognizes compensation expense
equal to the fair value of the ESOP shares during the periods in which they
become committed to be released. To the extent that the fair value of ESOP
shares differs from the cost of such shares, this differential will be
charged or credited to equity. Management expects the recorded amount of
expense to fluctuate as continuing adjustments are made to reflect changes
in the fair value of the ESOP shares. The Company recorded compensation and
employee benefit expense related to the ESOP of $3.0 million, $1.9 million,
and $1.4 million for the eleven-month period ended February 27, 1998 and
the years ended March 31, 1997, and 1996, respectively. The fair market
value of the unallocated ESOP shares on February 27, 1998, amounted to
$17.6 million.
Common Stock Acquired By the Recognition and Retention Plan and Trust
("RRP"). An aggregate of 376,760 shares, net of forfeitures, have been
awarded to the Company's Board of Directors and executive officers as of
February 27, 1998, subject to vesting and other provisions of the RRP.
At February 27, 1998, the deferred cost of unearned RRP shares totaled $2.4
million and is to be recorded as a charge against stockholders' equity.
Compensation expense will be recognized ratably over the five year vesting
period only for those shares awarded. The Company recorded compensation and
employee benefit expense related to the RRP of $459,441, $617,420, and
$829,000 for the eleven-month period ended February 27, 1998 and the years
ended March 31, 1997 and 1996, respectively.
(Continued)
28
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Stock Option Plan. Common stock totaling 1,454,760 shares has been reserved
for issuance for the 1994 Option Plan. An aggregate of 1,113,633 stock
options, net of forfeitures, have been granted and are exercisable to the
Bank's executive officers, nonemployee directors, and other key employees
through February 27, 1998. The exercise price per share ranges from $15.88
to $28.31; $11.97 to $17.38; and $9.50 to $11.94 for the plan years 1998,
1997, and 1996, respectively.
The following table summarizes the stock options outstanding and
exercisable for the Option Plan as of February 27, 1998:
<TABLE>
<CAPTION>
Eleven-month period
ended February 27, Years ended March 31,
---------------------- -----------------------------------------------
1998 1997 1996
- ---------------------------------------------------- --------------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of year 1,337,400 $8.4585 1,184,200 $7.7704 1,120,000 $7.4688
Granted 169,300 $18.0642 154,000 $13.7445 91,000 $11.3935
Exercised (343,467) $7.6398 (800) $7.4688 (19,600) $7.4688
Canceled (49,600) $7.4688 -- -- (7,200) $7.4688
- --------------------------------------------------------------------------------------------------------
Outstanding at end of year 1,113,633 $10.2309 1,337,400 $8.4585 1,184,200 $7.7704
Weighted remaining average
contractual life (years) -- 8 -- 10 -- 9
Exercisable at end of year 1,113,633 $10.2309 634,600 $7.6748 439,600 $7.6605
- --------------------------------------------------------------------------------------------------------
Weighted-average fair
value of options granted -- -- 11,312,398 -- 9,201,708 -- $
- --------------------------------------------------------------------------------------------------------
</TABLE>
As a result of the merger of ML Bancorp into Sovereign Bancorp at February
27, 1998, all shares became exercisable under the 1994 Stock Option Plan
due to the change of control in ownership. The fair market value of the 1.1
million exercisable shares amounted to $34.8 million ($31.25 per share)
based upon the last day of trading for ML Bancorp stock (February 27,
1998).
The Black-Scholes option-pricing model was used to determine the grant-date
fair-value of options. Significant assumptions used in the model included a
weighted average risk-free rate of return of 6.00% and 6.74%; expected
option life of 6 years; expected stock price volatility of 84.0%; and
expected dividends of 2.29% and 2.42%, respectively, for the eleven-month
period ended February 27, 1998, and the year ended March 31, 1997.
(Continued)
29
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
In October 1995 FASB issued SFAS No. 123, Accounting for Stock-based
Compensation ("SFAS 123"). This statement encourages, but does not require,
the adoption of fair-value accounting for stock-based compensation to
employees. The Company, as permitted, has elected not to adopt the fair
value accounting provisions of SFAS 123, and has instead continued to apply
APB Opinion 25 and related Interpretations in accounting for plans and
provide the required pro forma disclosures of SFAS 123. Had the grant-date
fair-value provisions been adopted, the Corporation would have recognized
$1,942,852 and $1,458,747 in compensation expense related to its Option
Plan for the eleven-month period ended February 27, 1998, and the year
ended March 31, 1997. As a result, net income of the Company would have
been $15.4 million and $13.0 million; basic earnings per share would have
been $1.41 and $1.17, and diluted earnings per share would have been $1.33
and $1.13 for the eleven-month period ended February 27, 1998, and the year
ended March 31, 1997.
The effects on net income and earnings per share of applying the disclosure
requirement of SFAS 123 may not be representative of the future pro forma
effects on net income and earnings per share due to the vesting provisions
of the options and future awards that are available to be granted.
Deferred Compensation Plan (DCP). The Company's Board of Directors has
adopted a DCP to restore retirement benefits that executives lose due to
the Internal Revenue Code limitation on compensation and tax-qualified
retirement plans, such as the ESOP and Pension Plan. For the years ending
March 31, 1996 and 1997 the limitation is $150,000, however, this
limitation increased to $160,000 effective April 1, 1997.
The DCP provides that each affected executive shall receive an annual
allocation of stock units representing shares of the Company's common stock
equal to the difference between the annual allocation of shares that would
have been made to him or her in the ESOP without regard to the dollar
limitation, minus the number of shares actually allocated under the DCP at
February 27, 1998.
In addition, the DCP provides a lump sum dollar accrual for each year equal
to the difference between the value of the Pension Plan benefit which would
have been earned without regard to the dollar limitation and the value of
the accrual actually earned. The cumulative accrual amount to be allocated
to the participants at February 27, 1998.
(14) Commitments and Contingencies
As of February 27, 1998, the Company is committed to the funding of certain
loans. Approximately $57.5 million is committed to fixed rate loans and
$10.9 million committed to variable rate loans. These commitments are
generally outstanding for 45 days.
The Company has commitments outstanding of $161.3 million at February 27,
1998, to sell fixed rate mortgage loans.
(Continued)
30
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The Company had the following off-balance-sheet financial instruments (in
thousands):
<TABLE>
<CAPTION>
February 27, March 31,
1998 1997
- ----------------------------------------------------------------------------------------
<S> <C> <C>
Amounts representing credit risk:
Secured consumer lines of credit $62,865 55,549
Unsecured consumer lines of credit 6,193 9,405
Commercial lines of credit 37,811 18,573
Commercial letters of credit 1,624 1,115
Notional or contract amounts of off-balance-sheet financial
instruments not constituting credit risk:
Forward commitments to sell in the secondary market 161,285 53,922
- ----------------------------------------------------------------------------------------
</TABLE>
In the past, the Company pooled and sold with recourse certain mortgage
backed securities through federal agencies which were collateralized
substantially by residential mortgage loans. At February 27, 1998 and March
31, 1997, the remaining outstanding balance subject to recourse was $3.8
million and $2.5 million, respectively.
The Company is party to certain claims and litigation arising in the
ordinary course of business. In the opinion of management, the resolution
of such claims and litigation will not materially affect the Company's
consolidated financial position or results of operations.
Derivative Financial Instruments. The Company has limited involvement with
derivative financial instruments and does not use them for trading
purposes. Derivatives, such as forward commitments to sell in the secondary
market, are primarily used to manage well-defined interest rate risks.
In the ordinary course of business, the Company may expose a portion of its
available for sale mortgage loan portfolio, including its pipeline to
interest rate risk, as volume and market conditions warrant. This exposure
represents those loans which have closed or are expected to close which are
not hedged at a given point in time. At February 27, 1998, the Company's
exposure was $32.9 million and the maximum exposure position authorized by
the Company is $40.0 million.
The Company produces a daily exposure report summarizing the exposure which
is reviewed and to the extent considered necessary by management,
adjustments are made.
(Continued)
31
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(15) Premises and Equipment
Premises and equipment are comprised of the following at February 27, 1998
and March 31, 1997 (in thousands):
February 27, March 31,
1998 1997
- --------------------------------------------------------------------------------
Premises owned $ 14,445 11,778
Furniture and fixtures 18,847 17,051
Leasehold improvements 4,720 5,063
Accumulated depreciation (19,996) (16,904)
- --------------------------------------------------------------------------------
$ 18,016 16,988
- --------------------------------------------------------------------------------
The Company has entered into operating leases for several of its branch
facilities. The minimum annual rental payments under these leases at
February 27, 1998, are as follows (in thousands):
Minimum
lease
Year payments
-----------------------------------------------------
1999 $1,716
2000 1,598
2001 1,418
2002 1,240
2003 and after 9,725
-----------------------------------------------------
The Company opened or acquired five new business centers resulting in
increased rent expense during the 1998 fiscal year. Rent expense under
these leases was $2.1 million, $1.4 million, and $487,000 for the
eleven-month period ended February 27, 1998, and the years ended March 31,
1997 and 1996, respectively.
The Company has executed various operating leases covering portions of its
buildings with various unrelated lessees. Annual minimum lease payments to
be received by the Company at February 27, 1998, are as follows (in
thousands):
Minimum
lease
Year payments
----------------------------------------------------
1999 $315
2000 200
2001 189
2002 106
2003 and after 646
----------------------------------------------------
(Continued)
32
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(16) Parent Company Financial Information
Condensed financial statements of ML Bancorp, Inc. (parent company) are
shown below. The parent company has no significant operating activities.
Condensed Statement of Financial Condition
Dollars in Thousands
February 27, March 31,
Assets 1998 1997
- -------------------------------------------------------------------------------
Cash $ 60 3
Equity securities available for sale 60 --
Investment in subsidiaries 243,709 183,426
Other assets 8,433 3,959
- -------------------------------------------------------------------------------
Total assets $252,262 187,388
- -------------------------------------------------------------------------------
Liabilities and Equity
- -------------------------------------------------------------------------------
Other borrowed money $ 51,547 51,547
Other liabilities 11 137
- -------------------------------------------------------------------------------
Total liabilities 51,558 51,684
- -------------------------------------------------------------------------------
Stockholders' equity 200,704 135,704
- -------------------------------------------------------------------------------
Total liabilities and stockholders' equity $252,262 187,388
- -------------------------------------------------------------------------------
(Continued)
33
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Condensed Statement of Operations
Dollars in Thousands
<TABLE>
<CAPTION>
Eleven-month
period ended Year ended March 31,
February 27, --------------------
1998 1997 1996
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Income:
Dividends from subsidiaries $ 8,000 28,000 21,201
Gain on sales of securities available for sale -- 106 197
Other 151 142 54
- --------------------------------------------------------------------------------------------
Total income 8,151 28,248 21,452
- --------------------------------------------------------------------------------------------
Expenses:
Professional fees 253 361 389
Other 4,918 495 250
- --------------------------------------------------------------------------------------------
Total expenses 5,171 856 639
- --------------------------------------------------------------------------------------------
Income before equity in undistributed income
of subsidiaries and income tax benefit 2,980 27,392 20,813
Income tax (benefit) expense (1,750) (175) (124)
- --------------------------------------------------------------------------------------------
Income before equity in undistributed
income of subsidiaries 4,730 27,567 20,937
Equity in undistributed income
of subsidiaries 11,818 (13,757) (9,317)
- --------------------------------------------------------------------------------------------
Net income $16,548 13,810 11,620
- --------------------------------------------------------------------------------------------
</TABLE>
(Continued)
34
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Condensed Statement of Cash Flows
Dollars in Thousands
<TABLE>
<CAPTION>
Eleven-month
period ending Years ended March 31,
February 27, ---------------------
1998 1997 1996
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating activities:
Net income $16,548 13,810 11,620
Adjustments to reconcile net
income to net cash provided by
operating activities:
Return of (equity in) income of subsidiaries (11,818) 13,757 9,317
Amortization of common stock acquired
by stock benefit plans 3,615 2,812 2,326
Net gain on sale of equity securities
available for sale -- (106) (197)
Increase in investment in subsidiaries (46,091) (84,418) (22,596)
(Decrease) increase in liabilities (126) (38) (1,634)
Increase in other assets (4,474) (3,431) (527)
- ------------------------------------------------------------------------------------------------
Net cash (used in) provided by operating activities (42,346) (57,614) (1,691)
- ------------------------------------------------------------------------------------------------
Investing activities:
Purchase of assets available for sale 60 (1,094) (2,890)
Proceeds from sales of assets available for sale -- 1,161 1,477
Dividends received from subsidiaries 8,000 28,000 21,201
- ------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 8,060 28,067 19,788
- ------------------------------------------------------------------------------------------------
Financing activities:
Net proceeds from issuance of debentures -- 50,000 --
Net proceeds from issuance of common stock -- -- --
Common stock acquired by stock benefit plans -- -- --
Sale (purchase) of treasury stock 34,729 (16,616) (15,035)
Exercise of stock options 2,948 -- --
Dividends paid (3,334) (4,116) (3,194)
- ------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities 34,343 29,268 (18,229)
- ------------------------------------------------------------------------------------------------
Net (decrease) increase in cash 57 (279) (132)
Cash, beginning of period 3 282 414
- ------------------------------------------------------------------------------------------------
Cash, end of period $ 60 3 282
- ------------------------------------------------------------------------------------------------
</TABLE>
(Continued)
35
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(17) Capital Securities
During the year ended March 31, 1997, the Company issued $50.0 million of
trust preferred securities at an interest rate of 9.875%. with a scheduled
maturity of March 1, 2027. The securities were issued by ML Bancorp's
recently formed subsidiary, ML Capital Trust I, and proceeds from the issue
were invested in Junior Subordinated Debentures issued by ML Bancorp.
Interest of $2.47 million is payable semi-annually, commencing on September
1, 1997. The Company has the option, subject to required regulatory
approval, to prepay the securities beginning March 1, 2007.
The securities are shown on the liability side of the balance sheet as
"Corporation-obligated mandatorily redeemable capital securities of
subsidiary trust holding solely junior subordinated debentures of the
Corporation." The interest cost associated with this issue is treated as a
noninterest expense on the consolidated statement of operations rather than
interest expense.
(18) Regulatory Matters
The Company is required to maintain certain daily reserve balances in
accordance with Federal Reserve Board requirements. Aggregate reserves (in
the form of vault cash) were maintained to satisfy federal regulatory
requirements at February 27, 1998.
Retained earnings are substantially restricted in connection with
regulations related to the insurance of savings accounts, which require the
Company to maintain certain statutory reserves.
The Company may not declare or pay cash dividends on or repurchase any of
its share of common stock if the effect thereof would cause equity to be
reduced below applicable regulatory capital maintenance requirements or if
such declaration and payment would otherwise violate regulatory
requirements.
Dividends payable to the Company by the Bank are subject to certain
regulatory limitations. The payment of dividends in any year without
regulatory permission is limited to the net profits (as defined for
regulatory purposes) for that year plus the retained net profits for the
preceding two calendar years. Accordingly, as of February 27, 1998,
dividends in excess of those already declared from the Bank to the Company
are limited to $23.3 million.
Under the Office of Thrift Supervision capital regulations, savings
institutions must maintain "tangible" capital equal to 1.5% of adjusted
total assets, "core" capital equal to 3.0% of adjusted total assets, Tier I
capital equal to 4.0% of adjusted total assets, and "risk-based" capital
equal to 8.0% of risk-weighted assets. At February 27, 1998, the Bank was
in compliance with all such regulatory requirements.
(Continued)
36
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The following sets forth the Bank's compliance with each of the regulatory
capital requirements at February 27, 1998 and March 31, 1997 (Dollars in
thousands).
<TABLE>
<CAPTION>
February 27, 1998 March 31, 1997 (1)
-------------------------------------------- -------------------------------------------
Tangible Core Tier I Risk-Based Tangible Core Tier I Risk-Based
Capital Capital Capital Capital Capital Capital Capital Capital
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total Regulatory Capital 126,490 126,490 126,490 140,434 116,611 116,611 116,611 128,119
Minimum Required
Regulatory Capital 34,816 69,633 44,424 88,849 29,498 59,019 78,495 73,458
Excess Regulatory Capital 91,674 56,857 82,066 51,585 87,113 57,592 18,116 54,661
Regulatory Capital as a
Percentage of Assets 5.45% 5.45% 11.39% 12.64% 5.93% 5.93% 5.93% 13.95%
Minimum Capital Required
as a Percentage of Assets 1.50 3.00 4.00 8.00 1.50 3.00 4.00 8.00
Excess Regulatory Capital
as a Percentage of Assets 3.95% 2.45% 7.39% 4.64% 4.43% 2.93% 1.93% 5.95%
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Tangible and core capital requirements are computed as a percentage of
adjusted total assets of $2.32 billion. Tier I and Risk-based capital
requirements are computed as a percentage of total risk-weighted assets of
$1.11 billion.
(19) SFAS No. 128, "Earnings Per Share"
In February 1997 the Financial Accounting Standards Board (FASB) issued
Statement No. 128 (SFAS No. 128), Earnings per Share. SFAS No. 128 replaced
the calculation of primary and fully diluted earnings per share with basic
and diluted earnings per share. Unlike primary earnings per share, basic
earnings per share excludes any dilutive effects of options and is computed
by dividing net income by the weighted average number of shares outstanding
during the period. Diluted earnings per share gives effect to all dilutive
potential common shares that were outstanding during the period. All
earnings per share amounts for all periods have been presented to conform
to SFAS No. 128 requirements.
(Continued)
37
<PAGE>
ML BANCORP, INC.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1 The following table sets forth the computation of basic and diluted
earnings per share (share and per share data not in thousands):
<TABLE>
<CAPTION>
March 31,
February 27, -------------------------
1998 1997 1996
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Numerator for basic and diluted earnings
per share -- net income $ 16,548 13,810 11,620
- ---------------------------------------------------------------------------------------------------
Denominator for basic earnings per share -- weighted
average shares outstanding 10,925,662 11,096,383 12,375,689
Effect of dilutive securities employee stock option 608,946 408,022 252,997
- ---------------------------------------------------------------------------------------------------
Denominator for diluted earnings per share -- adjusted
weighted average shares outstanding 11,534,608 11,504,405 12,628,686
- ---------------------------------------------------------------------------------------------------
Earnings per share -- basic 1.51 1.24 0.94
Earnings per share -- diluted $ 1.43 1.20 0.92
- ---------------------------------------------------------------------------------------------------
</TABLE>
(20) Penncore Acquisition
On September 8, 1997, the Company completed its acquisition of Penncore
Financial Services Corporation of Bucks County, Pennsylvania. As a result
of the acquisition, ML Bancorp, Inc. added approximately $130.0 million in
assets and $90.0 million in deposits. Commonwealth State Bank, a wholly
owned subsidiary of Penncore, merged into Main Line Bank, a wholly owned
subsidiary of ML Bancorp, Inc. Penncore shareholders received $36.56 in
cash or a combination of cash and common shares of ML Bancorp, Inc. stock
for each of their shares.
- --------------------------------------------------------------------------------
38
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 No. 33-20186, Form S-8 No. 33-29038, Form S-8 No. 33-39453, Form S-8
No. 33-44108, Form S-8 No. 33-89526, Form S-8 No. 33-89592, Form S-8 No.
333-05251, Form S-8 No. 333-05309, Form S-3 No. 33-46870, and Form S-3 No.
333-39113) of Sovereign Bancorp, Inc. of our report dated March 2, 1998, with
respect to the consolidated financial statements of Sovereign Bancorp, Inc.
included in its Current Report on Form 8-K filed on or about June 22, 1998, with
the Securities and Exchange Commission.
/s/ Ernst & Young LLP
Harrisburg, Pennsylvania
June 19, 1998
The Board of Directors
Sovereign Bancorp, Inc.
We consent to the incorporation by reference and to the reference to our firm
under the heading "Experts" in the Registration Statements (Form 8-K; Form S-4
No. 333-51813; and Form S-4 No. 333-50569) of Sovereign Bancorp, Inc. of our
report dated June 15, 1998, relating to the consolidated statements of financial
condition of ML Bancorp, Inc. and subsidiaries as of February 27, 1998, and
March 31, 1997, and the related consolidated statements of operations, cash
flows and changes in stockholders' equity for the eleven-month period ended
February 27, 1998 and for each year in the two-year period ended March 31, 1997.
KPMG Peat Marwick LLP
Philadelphia, Pennsylvania
June 19, 1998
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Sovereign Bancorp, Inc.
(Successor to Bankers Corp.):
We consent to the incorporation by reference in the Registration Statement on
Form 8-K of Sovereign Bancorp, Inc. and in the related prospectus of our report
dated January 31, 1997, except as to Note 2, which is as of February 5, 1997,
relating to the consolidated statement of condition of Bankers Corp. and
subsidiary as of December 31, 1996 and the related consolidated statements of
income, changes in stockholders' equity and cash flows for each of the years in
the two-year period ended December 31, 1996, which report appears in the 1997
annual report on Form 10-K of Sovereign Bancorp, Inc.
KPMG Peat Marwick LLP
Short Hills, New Jersey
June 22, 1998
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Sovereign Bancorp, Inc.
(Successor to First State Financial Services, Inc.):
We consent to the incorporation by reference in the Registration Statement on
Form 8-K of Sovereign Bancorp, Inc. and in the related prospectus of our report
dated November 26, 1996 relating to the consolidated balance sheet of First
State Financial Services, Inc. and subsidiaries as of September 30, 1996 and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the years in the two-year period ended September 30, 1996,
which report appears in the 1997 annual report on Form 10-K of Sovereign
Bancorp, Inc.
KPMG Peat Marwick LLP
Short Hills, New Jersey
June 22, 1998
