WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934
For the quarter ended March 31, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission File Number: 34-16533
--------
SOVEREIGN BANCORP, INC.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2453088
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1130 Berkshire Boulevard, Wyomissing, Pennsylvania 19610
- -------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (610) 320-8400
--------------
N/A
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X . No .
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at May 13, 1998
- --------------------------- ---------------------------
Common Stock (no par value) 133,757,967 shares
Preferred Stock (no par value) 1,908,591 shares
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 1998
and December 31, 1997 3
Consolidated Statements of Operations for the three-
month periods ended March 31, 1998 and 1997 4 - 5
Consolidated Statement of Stockholders' Equity for
the three-month period ended March 31, 1998 6
Consolidated Statements of Cash Flows for the three-
month periods ended March 31, 1998 and 1997 7
Notes to Consolidated Financial Statements 8 - 21
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 22 - 37
PART II. OTHER INFORMATION
Item 6. Reports on Form 8-K 38
PART III. FINANCIAL DATA SCHEDULE 39 - 40
SIGNATURES 41
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
------------ ------------
(Unaudited) (Note)
(in thousands, except
per share data)
<S> <C> <C>
ASSETS
Cash and amounts due from
depository institutions $ 241,159 $ 219,143
Interest-earning deposits 121,545 14,502
Loans held for sale (approximate fair
value of $294,373 and $310,440 at
March 31, 1998 and December 31, 1997,
respectively) 294,001 310,368
Investment available-for-sale 3,229,384 1,795,060
Investment and mortgage-backed securities
held-to-maturity (approximate fair value
of $3,100,189 and $3,238,197 at March 31,
1998 and December 31, 1997, respectively) 3,072,949 3,209,966
Loans 10,410,727 10,756,785
Allowance for possible loan losses (111,908) (110,251)
Premises and equipment 88,661 85,194
Real estate owned 11,760 10,631
Accrued interest receivable 104,978 102,043
Goodwill and other intangible assets 126,534 125,816
Other assets 506,331 166,514
------------ ------------
TOTAL ASSETS $ 18,096,121 $ 16,685,771
============ ============
LIABILITIES
Deposits $ 9,247,612 $ 8,913,275
Borrowings:
Short-term 5,672,298 5,263,874
Long-term 1,487,264 1,309,591
Advance payments by borrowers
for taxes and insurance 45,156 41,431
Other liabilities 527,552 55,699
------------ ------------
TOTAL LIABILITIES 16,979,882 15,583,870
------------ ------------
Corporation-obligated mandatorily redeemable
capital securities of subsidiary trust holding
solely subordinated debentures of Sovereign
Bancorp, Inc. ("Trust Preferred Securities") 128,985 128,972
------------ ------------
STOCKHOLDERS' EQUITY
Preferred stock; no par value; $50 liquidation
preference; 7,500,000 shares authorized;
1,995,617 shares issued and outstanding
at March 31, 1998 and 1,996,467 shares issued
and outstanding at December 31, 1997 96,235 96,276
Common stock; no par value; 200,000,000 shares
authorized; 137,547,559 shares issued at
March 31, 1998 and 136,833,840 shares issued
at December 31, 1997 491,889 478,797
Unallocated common stock held by the Employee
Stock Ownership Plan at cost;
4,611,132 shares at March 31, 1998 and
5,984,934 shares at December 31, 1997 (31,194) (37,211)
Treasury stock at cost; 11,104 shares at March 31,
1998 and 13,210 shares at December 31, 1997 (171) (185)
Accumulated other comprehensive income 8,969 18,680
Retained earnings 421,526 416,572
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 987,254 972,929
------------ ------------
TOTAL LIABILITIES, MINORITY INTERESTS
AND STOCKHOLDERS' EQUITY $ 18,096,121 $ 16,685,771
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
Note: The balance sheet at December 31, 1997 is taken from Sovereign's audited
financial statements at that date, plus additions necessary to reflect
Sovereign's February 28, 1998 acquisition of ML Bancorp, Inc. ("ML Bancorp"),
which was accounted for as a pooling-of-interests, but does not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements.
-3-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three-Month Period Ended
March 31,
------------------------
1998 1997
-------- --------
(in thousands, except
per share data)
Interest income:
Interest on interest-earning deposits $ 1,346 $ 2,734
Interest and dividends on investment
and mortgage-backed securities
available-for-sale 34,331 18,809
Interest and dividends on investment
and mortgage-backed securities
held-to-maturity 57,769 63,648
Interest and fees on loans 212,315 170,254
-------- --------
Total interest income 305,761 255,445
-------- --------
Interest expense:
Interest on deposits 94,909 82,173
Interest on borrowings 98,253 79,121
-------- --------
Total interest expense 193,162 161,294
-------- --------
Net interest income 112,599 94,151
Provision for possible loan losses (1) 6,500 10,900
-------- --------
Net interest income after provision for
possible loan losses 106,099 83,251
-------- --------
Other income:
Other loan fees and service charges 2,886 1,629
Deposit fees 5,380 4,338
Mortgage banking gains 4,875 4,263
Gain on sale of loans and investment
and mortgage-backed securities
available-for-sale 3,451 273
Miscellaneous income 5,708 1,811
-------- --------
Total other income 22,300 12,314
-------- --------
General and administrative expenses:
Salaries and employee benefits 28,486 22,994
Occupancy and equipment expenses 12,106 8,789
Outside services 6,319 5,525
Deposit insurance premiums 1,084 1,075
Advertising 1,844 2,066
Other administrative expenses 10,398 8,203
-------- --------
Total general and administrative expenses 60,237 48,652
-------- --------
-4-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(continued)
Three-Month Period Ended
March 31,
-------------------------
1998 1997
-------- --------
(in thousands, except
per share data)
Other operating expenses:
One-time, merger-related charge (1) 39,529 7,955
Amortization of goodwill and other intangibles 3,155 3,144
Trust Preferred Securities expense 3,379 1,425
Real estate owned (gain)/loss, net (75) 278
-------- --------
Total other operating expenses 45,988 12,802
-------- --------
Income before income taxes 22,174 34,111
Income tax provision 9,147 14,037
-------- --------
Net Income (2) $ 13,027 $ 20,074
======== ========
Net Income Applicable to Common Stock $ 11,468 $ 18,512
======== ========
Earnings per share (2)(3) $ .09 $ .14
======== ========
Dividends per share (3) $ .017 $ .036
======== ========
(1) Results for the three-month period ended March 31, 1998 include a one-time,
merger charge of $39.5 million ($25.8 million after-tax) related to
Sovereign's acquisition of ML Bancorp during the first quarter of 1998.
Results for the three-month period ended March 31, 1997 include a one-time,
merger charge of $15.9 million ($10.7 million after-tax) related to
Sovereign's acquisition of First State Financial Services, Inc. ("First
State") during the first quarter of 1997 of which $7.9 million (pre-tax) is
classified as provision for possible loan losses.
(2) Results for the three-month periods ended March 31, 1998 and 1997 include
the one-time, merger-related charges described in Note 1 above. Excluding
the one-time, merger-related charges, net income for the three-month periods
ended March 31, 1998 and 1997 was $38.9 million and $30.8 million,
respectively and diluted earnings per share for the same periods were $.26
and $.21, respectively.
(3) Per share amounts have been adjusted to reflect all stock dividends and
stock splits.
See accompanying notes to consolidated financial statements.
-5-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Common Preferred
Shares Shares Common Preferred Retained Treasury
Outstanding Outstanding Stock Stock Earnings Stock
----------- ----------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 130,836 1,996 $478,797 $ 96,276 $416,572 $ (185)
Net income - - - - 13,027 -
Exercise of stock options 643 - 2,688 - - -
Cash in lieu of fractional shares - - (5) - - -
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan 65 - 1,075 - - -
Dividends paid on common stock,
$.017 per share - - - - (2,286) -
Dividends paid on preferred stock,
$.781 per share - - - - (1,559) -
Treasury stock repurchase (4) - - - - (59)
Treasury stock sale 6 - - - - 73
Other comprehensive income -
unrecognized loss on investment
and mortgage-backed securities
available-for-sale, net of tax - - - - - -
Conversion of Preferred stock 6 - 41 (41) - -
Allocation of shares under Employee
Stock Ownership Plan 1,373 - 9,293 - - -
Adjustment for ML Bancorp's
different fiscal year end - - - - (4,228) -
--------- -------- -------- --------- ---------- --------
Balance, March 31, 1998 132,925 1,996 $491,889 $ 96,235 $421,526 $ (171)
========= ======== ======== ========= ======== ========
<CAPTION>
Accumulated Total
Unallocated Other Stock-
Common Stock Comprehensive Holders'
Held by ESOP Income Equity
----------- ------------- --------
<S> <C> <C> <C>
Balance, December 31, 1997 $ (37,211) $ 18,680 $972,929
Net income - - 13,027
Exercise of stock options - - 2,688
Cash in lieu of fractional shares - - (5)
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan - - 1,075
Dividends paid on common stock,
$.017 per share - - (2,286)
Dividends paid on preferred stock,
$.781 per share - - (1,559)
Treasury stock repurchase - - (59)
Treasury stock sale - - 73
Other comprehensive income -
unrecognized loss on investment
and mortgage-backed securities
available-for-sale, net of tax - (8,919) (8,919)
Conversion of Preferred stock - - -
Allocation of shares under Employee
Stock Ownership Plan 6,017 - 15,310
Adjustment for ML Bancorp's
different fiscal year end - (792) (5,020)
---------- ---------- --------
Balance, March 31, 1998 $ (31,194) $ 8,969 $987,254
========== ========= ========
</TABLE>
-6-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three-Month Period
Ended March 31,
-------------------------------
1998 1997
----------- -----------
(in thousands)
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 13,027 $ 20,074
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for possible loan losses and deferred taxes 11,192 29,274
Depreciation 721 2,931
Amortization (2,473) 4,667
Gain on sale of loans, investment and
mortgage-backed securities and real estate owned (3,526) (1,847)
Allocation of Employee Stock Ownership Plan 15,310 694
Net change in:
Loans held for sale 16,367 (50,232)
Accrued interest receivable (2,935) (3,437)
Prepaid expenses and other assets (297,957) (5,786)
Other liabilities 471,853 247,117
----------- -----------
Net cash provided by operating activities $ 221,579 $ 243,455
----------- -----------
Cash Flows from Investing Activities:
Proceeds from sales of investment and mortgage-backed
securities available-for-sale 755,828 57,485
Proceeds from repayments and maturities of investment
and mortgage-backed securities:
Available-for-sale 88,997 41,854
Held-to-maturity 542,038 263,702
Purchases of investment and mortgage-backed securities:
Available-for-sale (2,372,222) (183,309)
Held-to-maturity (320,424) (735,757)
Proceeds from sales of loans 3,783 8,385
Purchase of loans (91,049) (80,925)
Net change in loans other than purchases and sales 391,409 250,671
Proceeds from sales of premises and equipment 6,252 3,444
Purchases of premises and equipment (10,495) (2,349)
Proceeds from sale of real estate owned (5,733) 4,112
Net cash received in business combinations -- (5,208)
Other, net (4,228) --
----------- -----------
Net cash used by investing activities (1,015,844) (377,895)
----------- -----------
Cash Flows from Financing Activities:
Net increase/(decrease) in deposits 334,622 173,950
Net increase in short-term borrowings 85,050 (110,318)
Proceeds from long-term borrowings 500,000 94,672
Net increase in advance payments by
borrowers for taxes and insurance 3,725 10,593
Proceeds from issuance of Trust Preferred Securities -- --
Cash dividends paid to stockholders (3,845) (6,054)
Proceeds from issuance of common stock 3,758 1,132
Purchase of treasury stock 14 (61)
----------- -----------
Net cash provided by financing activities 923,324 163,914
----------- -----------
Net change in cash and cash equivalents 129,059 29,474
Cash and cash equivalents at beginning of period 233,645 151,270
----------- -----------
Cash and cash equivalents at end of period $ 362,704 $ 180,744
=========== -----------
Reconciliation of Cash and Cash Equivalents to Consolidated
Balance Sheets:
Cash and amounts due from depository institutions $ 241,159 $ 125,601
Interest-earning deposits 121,545 55,143
----------- -----------
Cash and cash equivalents at end of period $ 362,704 $ 180,744
=========== ===========
</TABLE>
Supplemental Disclosures:
Income tax payments totaled $18.9 million for the three-month period ended March
31, 1998 and $1.2 million for the same period in 1997. Interest payments totaled
$188.1 million for the three-month period ended March 31, 1998 and $155.7
million for the same period in 1997. Noncash activity consisted of mortgage loan
securitization of $124.5 million for the three-month period ended March 31, 1998
and $70.6 million for the same period in 1997; reclassification of long-term
borrowings to short-term borrowings of $322.2 million for the three-month period
ended March 31, 1998 and $245.0 million for the same period in 1997; and
reclassification of mortgage loans to real estate owned of $2.2 million for the
three-month period ended March 31, 1998 and $6.3 million for the same period in
1997.
See accompanying notes to consolidated financial statements.
-7-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) GENERAL
The accompanying financial statements of Sovereign Bancorp, Inc. and
Subsidiaries ("Sovereign") include the accounts of the parent company, Sovereign
Bancorp, Inc. and its wholly-owned subsidiaries: Sovereign Bank, Sovereign
Capital Trust I, ML Capital Trust I and ML Bancorp of Delaware. All material
intercompany balances and transactions have been eliminated in consolidation.
These financial statements have been prepared in accordance with the
instructions for Form 10-Q and therefore do not include certain information or
footnotes necessary for the presentation of financial condition, results of
operations, stockholders' equity, and cash flows in conformity with generally
accepted accounting principles. However, in the opinion of management, the
consolidated financial statements reflect all adjustments (which consist of
normal recurring accruals) necessary for a fair presentation of the results for
the unaudited periods. The financial statements include the consolidated
accounts of ML Bancorp, Inc. ("ML Bancorp") which was acquired on February 28,
1998 in a transaction accounted for under the pooling-of-interests method of
accounting (see Note 9 "Acquisitions" hereof). The preparation of these
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.
The results of operations for the three-month period ended March 31, 1998
are not necessarily indicative of the results which may be expected for the
entire year.
-8-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(2) EARNINGS PER SHARE
The following table presents the computation of earnings per share based on
the provisions of Statement of Financial Accounting Standard ("SFAS") No. 128
for the periods indicated (in thousands, except per share data). For additional
information with respect to SFAS No. 128, see Note 10 "Accounting Changes"
hereof.
Three-Month Period
Ended March 31,
-----------------------
1998 1997
-------- --------
Basic Earnings Per Share:
Net income attributable to common stock (1) $ 11,468 $ 18,512
-------- --------
Average basic shares outstanding
at end of period (3) $132,484 $125,730
======== ========
Basic earnings per share (2) (3) $ .09 $ .15
======== ========
Diluted Earnings Per Share:
Net income (1) $ 13,027 $ 20,074
-------- --------
Average diluted shares outstanding
at end of period (3) 146,825 140,098
Dilutive effect of average stock options,
net of shares assumed to be repurchased
under the treasury stock method (3) 3,296 3,657
-------- --------
Total average diluted shares outstanding
at end of period (3) 150,121 143,755
======== ========
Diluted earnings per share (2)(3) $ .09 $ .14
======== ========
(1) Results for the three-month period ended March 31, 1998 include a one-time,
merger charge of $25.8 million (after-tax) related to Sovereign's
acquisition of ML Bancorp during the first quarter of 1998. Results for the
three-month period ended March 31, 1997 include a one-time, merger charge
of $10.7 million (after-tax) related to Sovereign's acquisition of First
State during the first quarter of 1997.
(2) Results for the three-month periods ended March 31, 1998 and 1997 include
the one-time, merger-related charges described in Note 1 above. Excluding
the one-time, merger-related charges, basic earnings per share for the
three-month periods ended March 31, 1998 and 1997 were $.28 and $.23,
respectively and diluted earnings per share for the same periods were $.26
and $.21, respectively.
(3) All per share data have been adjusted to reflect all stock dividends and
stock splits.
-9-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(3) INVESTMENT AND MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE
The following table presents the composition and fair value of investments
available-for-sale at the dates indicated: (dollars in thousands)
<TABLE>
<CAPTION>
March 31, 1998
----------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 37,444 $ -- $ 7 $ 37,437
Equity securities 694,208 14,724 22 708,910
Other securities 18,525 4,392 -- 22,917
Mortgage-backed Securities:
FHLMC 170,358 1,145 819 170,684
FNMA 78,518 836 97 79,257
GNMA 179,699 458 1,022 179,135
Collateralized mortgage
obligations 2,037,621 215 6,792 2,031,044
Other securities -- -- -- --
---------- ------- ------ ----------
Total investment and
mortgage-backed securities
available-for-sale $3,216,373 $21,770 $8,759 $3,229,384
========== ======= ====== ==========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997
----------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 19,988 $ 2 $ -- $ 19,990
Equity securities 631,692 18,768 39 650,421
Other securities 32,873 4,391 298 36,966
Mortgage-backed Securities:
FHLMC 403,913 3,184 375 406,722
FNMA 198,719 1,597 375 199,941
GNMA 247,149 1,498 554 248,093
Collateralized mortgage
obligations 218,113 747 179 218,681
Other securities 14,295 9 58 14,246
---------- ------- ------ ----------
Total investment and
mortgage-backed securities
available-for-sale $1,766,742 $30,196 $1,878 $1,795,060
========== ======= ====== ==========
</TABLE>
-10-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(4) INVESTMENT AND MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY
The following table presents the composition and fair value of investment
and mortgage-backed securities held-to-maturity at the dates indicated: (dollars
in thousands)
<TABLE>
<CAPTION>
March 31, 1998
----------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 26,315 $ 137 $ 3 $ 26,449
Corporate securities 1,050 24 -- 1,074
Other securities 59,062 4,018 197 62,883
Mortgage-backed Securities:
FHLMC 307,600 6,282 670 313,212
FNMA 224,897 4,028 457 228,468
GNMA 381,353 8,933 -- 390,286
RTC -- -- -- --
Private issues 100,959 1,100 22 102,037
Collateralized mortgage
obligations 1,971,713 7,192 3,125 1,975,780
---------- ------- ------ ----------
Total investment and
mortgage-backed securities
held-to-maturity $3,072,949 $31,714 $4,474 $3,100,189
========== ======= ====== ==========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997
----------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 39,483 $ 136 $ 430 $ 39,189
Corporate securities 1,050 24 -- 1,074
Other securities 51,797 3,832 150 55,479
Mortgage-backed Securities:
FHLMC 350,775 7,447 445 357,777
FNMA 220,265 3,603 397 223,471
GNMA 392,312 8,309 -- 400,621
RTC 411 -- 1 410
Private issues 119,350 963 82 120,231
Collateralized mortgage
obligations 2,034,523 8,038 2,616 2,039,945
---------- ------- ------ ----------
Total investment and
mortgage-backed securities
held-to-maturity $3,209,966 $32,352 $4,121 $3,238,197
========== ======= ====== ==========
</TABLE>
-11
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(5) COMPOSITION OF LOAN PORTFOLIO
The following table presents the composition of the loan portfolio by type
of loan and by fixed and adjustable rates at the dates indicated: (dollars in
thousands)
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
---------------------------- --------------------------
Amount Percent Amount Percent
----------- ------- ----------- -------
<S> <C> <C> <C> <C>
Residential real estate loans $ 5,997,881 57.6% $ 6,400,715 59.5%
Residential construction loans
(net of loans in process of
$41,813 and $46,523, respectively) 132,084 1.3 134,926 1.2
----------- ------ ----------- ------
Total Residential Loans 6,129,965 58.9 6,535,641 60.7
----------- ------ ----------- ------
Multi-family loans 106,150 1.0 106,108 1.0
Commercial real estate loans 471,072 4.5 458,786 4.3
Commercial loans 326,402 3.1 302,515 2.8
Automotive floor plan loans 340,219 3.3 279,757 2.6
----------- ------ ----------- ------
Total Commercial Loans 1,243,843 11.9 1,147,166 10.7
----------- ------ ----------- ------
Automobile loans 1,510,854 14.5 1,548,383 14.4
Home equity loans 1,022,062 9.8 1,003,404 9.3
Loans to automotive lessors 259,923 2.5 267,033 2.5
Student loans 184,927 1.8 190,440 1.8
Credit cards 50,014 .5 54,887 .5
Other 9,139 .1 9,831 .1
----------- ------ ----------- ------
Total Consumer Loans 3,036,919 29.2% 3,073,978 28.6%
----------- ------ ----------- ------
Total Loans $10,410,727 100.0% $10,756,785 100.0%
=========== ====== =========== ======
Total Loans with: (1)
Fixed rates $ 4,081,861 39.2% $ 4,181,538 38.9%
Variable rates 6,328,866 60.8 6,575,247 61.1
----------- ------ ----------- ------
Total Loans $10,410,727 100.0% $10,756,785 100.0%
=========== ====== =========== ======
</TABLE>
(1) Loan totals do not reflect the impact of off-balance sheet interest rate
swaps used for interest rate risk management as discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Loan Portfolio."
-12-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(6) DEPOSIT PORTFOLIO COMPOSITION
The following table presents the composition of deposits at the dates
indicated: (dollars in thousands)
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
--------------------------------------- --------------------------------------
Weighted Weighted
Average Average
Account Type Amount Percent Rate Amount Percent Rate
------------ ---------- ------- -------- ---------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Demand deposit accounts $ 647,985 7.0% - % $ 547,394 6.1% - %
NOW accounts 688,791 7.4 1.32 671,228 7.5 1.28
Savings accounts 1,839,618 19.9 2.90 1,777,603 20.0 2.90
Money market accounts 837,758 9.1 4.03 802,438 9.0 4.06
Retail certificates 4,583,114 49.6 5.54 4,576,224 51.3 5.54
Jumbo certificates 650,346 7.0 5.42 538,388 6.1 5.49
---------- ----- ---- ---------- ----- ----
Total Deposits $9,247,612 100.0% 4.17% $8,913,275 100.0% 4.22%
========== ===== ==== ========== ===== ====
</TABLE>
(7) BORROWINGS
The following table presents information regarding borrowings at the dates
indicated: (dollars in thousands)
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
---------------------------- ----------------------------
Weighted Weighted
Average Average
Balance Rate Balance Rate
---------- -------- ---------- --------
<S> <C> <C> <C> <C>
Securities sold under
repurchase agreements $ 534,943 5.90% $ 965,476 5.80%
FHLB advances 6,439,103 5.72 5,419,838 5.93
Other borrowings 185,516 5.96 188,151 5.88
---------- --- ---------- ----
Total Borrowings $7,159,562 5.74% $6,573,465 5.91%
========== ==== ========== ====
</TABLE>
-13-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(8) INTEREST RATE EXCHANGE AGREEMENTS
Amortizing and non-amortizing interest rate swaps are generally used to
convert fixed rate assets and liabilities to variable rate assets and
liabilities and vice versa. Interest rate caps are generally used to limit the
exposure from the repricing and maturity of liabilities. Interest rate floors
are generally used to limit the exposure from repricing and maturity of assets.
Interest rate caps and floors are also used to limit the exposure created by
other interest rate swaps. In certain cases, interest rate caps and floors are
simultaneously bought and sold to create a range of protection (interest rate
corridors) against changing interest rates while limiting the cost of that
protection. The following table presents information regarding interest rate
exchange agreements at the dates indicated: (dollars in thousands)
<TABLE>
<CAPTION>
March 31, 1998
------------------------------------------------------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
---------- ------ ---------- --------
<S> <C> <C> <C> <C>
Amortizing interest rate swaps:
Pay variable-receive fixed (1) $ 211,230 $ - $ 1,997 4.1
Pay fixed-receive variable (2) 199,820 - (95) 1.1
Non-amortizing interest rate swaps:
Pay variable-receive fixed (3) - - - -
Pay fixed-receive variable (4) 3,675,000 - 3,356 4.5
Interest rate caps/floors(5) 1,200,000 9,285 (4,557) 3.7
---------- ------ -------
$5,286,050 $9,285 $ 701
========== ====== =======
</TABLE>
<TABLE>
<CAPTION>
March 31, 1998
------------------------------------------------------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
---------- ------ ---------- --------
<S> <C> <C> <C> <C>
Amortizing interest rate swaps:
Pay variable-receive fixed (1) $ 602,116 $ - $ 1,436 2.8
Pay fixed-receive variable (2) 208,761 - (9) 1.3
Non-amortizing interest rate swaps:
Pay variable-receive fixed (3) 28,499 - (561) 2.7
Pay fixed-receive variable (4) 2,750,000 - (9,290) 2.3
Interest rate caps/floors (5) 1,200,000 9,963 (4,434) 4.0
---------- ------ --------
$4,789,376 $9,963 $(12,858)
========== ====== ========
</TABLE>
-14-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(1) The weighted average pay rate was 5.65% and 5.58% and the weighted average
receive rate was 6.89% and 5.97% at March 31, 1998 and December 31, 1997,
respectively.
(2) The weighted average pay rate was 6.87% and 6.87% and the weighted average
receive rate was 6.80% and 6.80% at March 31, 1998 and December 31, 1997,
respectively.
(3) The weighted average pay rate was 7.28% and the weighted average receive
rate was 6.75% at December 31, 1997.
(4) The weighted average pay rate was 5.57% and 5.89% and the weighted average
receive rate was 5.66% and 4.47% at March 31, 1998 and December 31, 1997,
respectively.
(5) The weighted average strike price range was 5.25% - 9.00% at March 31, 1998
and 5.25% - 7.50% at December 31, 1997.
The following table summarizes by notional amounts the activity of
Sovereign's interest rate exchange agreements: (dollars in thousands)
<TABLE>
<CAPTION>
Balance Balance
December 31, Maturities/ March 31,
1997 Additions Amortization Terminations 1998
------------ ---------- ------------ ------------ -----------
<S> <C> <C> <C> <C> <C>
Amortizing interest
rate swaps $ 810,877 $ - $ 10,816 $389,011 $ 411,050
Non-amortizing interest
rate swaps 2,778,499 1,300,000 100,000 303,499 3,675,000
Interest rate
caps/floors 1,200,000 - - - 1,200,000
---------- ---------- --------- --------- ----------
$4,789,376 $ 600,000 $110,816 $692,510 $5,286,050
========== ========== ========= ======== ==========
</TABLE>
At March 31, 1998, Sovereign's balance sheet included a net deferred loss
of $1.0 million related to interest rate exchange agreements terminated in
September 1997 and January 1998 which were originally accounted for as hedges.
Of this net deferred loss, $646,000 will amortize into interest expense during
1998 and $389,000 will amortize into interest expense in 1999.
Net interest income resulting from interest rate exchange agreements
includes $1.4 million of income and $1.4 million of expense for the three-month
period ended March 31, 1998.
-15-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(9) ACQUISITIONS
On February 28, 1998, Sovereign acquired ML Bancorp, a $2.3 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 1.944 shares of Sovereign common stock in exchange for
each share of ML Bancorp common stock. Approximately 24.6 million new shares 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 results of operations previously reported by the separate enterprises
and the combined amounts presented in the accompanying consolidated financial
statements are summarized below:
Years Ended December 31,
--------------------------------
1997 1996
-------- --------
Net interest income
Sovereign $340,849 $304,121
ML Bancorp (1) 59,593 54,179
-------- --------
Combined $400,442 $358,300
======== ========
Net income:
Sovereign $ 77,640 $ 70,139
ML Bancorp (1) 16,553 13,810
-------- -------
Combined $ 94,193 $ 83,949
======== ========
- --------------------
(1) Reflects ML Bancorp's results of operations for the eleven-month period
ended February 28, 1998 and for the year-ended March 31, 1997,
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. Consequently, a net decrease to Sovereign's stockholders' equity of $5.0
million has been made to reflect ML Bancorp's activity for the two-month period
ended February 28, 1998. That activity consisted of net income of
-16-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
$4.2 million and a net change in accumulated other comprehensive income of
$792,000 Sovereign's consolidated results of operations for the three-month
period ended March 31, 1997 include ML Bancorp's results of operations for the
three-month period ended June 30, 1997. ML Bancorp's total interest income, net
interest income and net income for the two-month period ended February 28, 1998
was $27.9 million, $11.6 million and $4.2 million, respectively.
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.
On December 19, 1997, Sovereign executed a Definitive Agreement to acquire
First Home Bancorp, Inc. ("First Home"), a $531 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 late in the second quarter or early in
the third quarter of 1998. All per share information concerning this transaction
has been restated to reflect all subsequent stock dividends and stock splits.
On December 15, 1997, Sovereign executed a Definitive Agreement to acquire
Carnegie Bancorp ("Carnegie"), a $432 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
-17-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
$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 late in the second quarter or early in
the third quarter of 1998. All per share information concerning this transaction
has been restated to reflect all subsequent stock dividends and stock splits.
(10) ACCOUNTING CHANGES
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS 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
is currently evaluating the impact SFAS No. 131's additional disclosure
requirements is expected to have on its consolidated financial statements.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." Sovereign adopted SFAS No. 130 on January 1, 1998. The overall
objective of SFAS No. 130 is to provide new rules for the reporting and display
of comprehensive income and its components; however, the adoption of this
statement had no impact on Sovereign's net income or stockholders' equity. SFAS
No. 130 requires unrealized gains or losses on Sovereign's available-for-sale
securities and foreign currency translation adjustments, which prior to adoption
were reported separately in stockholders' equity, to be included in other
comprehensive income. Prior year financial statements have been restated to
conform to the provisions of SFAS No. 130.
-18-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
The following table presents the components of comprehensive income, net of
related tax, based on the provisions of SFAS No. 130 for the periods indicated:
(dollars in thousands)
Three-Month Period
Ended March 31,
--------------------------
1998 1997
------- -------
Net income $13,027 $20,074
Unrealized (losses) gains on securities
arising during the year (11,089) 3,455
Less reclassification adjustment (1) (2,170) -
------- -------
Net unrealized gain recognized
in other comprehensive income (8,919) 3,455
------- -------
Comprehensive income (2) $ 4,108 $23,529
======= =======
(1) Sovereign has not calculated the reclassification adjustment for the
three-month period ended March 31, 1997.
(2) Excluding one-time, merger-related charges, comprehensive income for the
three-month periods ended March 31, 1998 and 1997 was $29.9 million and
$34.2 million, respectively.
Accumulated other comprehensive income, net of related tax, at March 31,
1998 and December 31, 1997 consisted of unrealized gains on securities of $9.0
million and $18.7 million, respectively.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share." This
statement supersedes APB Opinion No. 15, "Earnings per Share" and FASB Statement
No. 85, "Yield Test for Determining whether a Convertible Security Is a Common
Stock Equivalent." The overall objective of SFAS No. 128 is to simplify the
calculation of earnings per share and achieve comparability with the recently
issued International Accounting Standard No. 33, "Earnings Per Share." SFAS No.
128 is effective for all periods ending after December 15, 1997.
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
-19-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
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.
(11) RECENT DEVELOPMENTS
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.
-20-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
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.
-21-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RESULTS OF OPERATIONS
General
Net operating income for the three-month period ended March 31, 1998 was
$38.9 million, an increase of 26% when compared to net operating income of $30.8
million for the same period in 1997. Diluted operating earnings per share for
the three-month periods ended March 31, 1998 and 1997 were $.26 and $.21,
respectively. The amounts presented for the three-month period ended March 31,
1998 exclude a one-time, merger charge of $25.8 million (after-tax) related to
Sovereign's acquisition of ML Bancorp, Inc. ("ML Bancorp") during the first
quarter of 1998. Results for the three-month period ended March 31, 1997 exclude
a one-time, merger charge of $10.7 million (after-tax) related to Sovereign's
acquisition of First State Financial Services, Inc. ("First State") during the
first quarter of 1997.
Reported net income for the three-month periods ended March 31, 1998 and
1997, including the impact of the one-time, merger-related charges discussed
above were $13.0 million and $20.1 million, respectively and diluted earnings
per share for the same periods were $.09 and $.14, respectively. All per share
amounts presented have been adjusted to reflect all stock dividends and stock
splits.
Return on average equity, return on average total assets, and average
equity to average total assets, excluding the one-time, merger-related charges
discussed above were 16.03%, .91% and 5.69%, respectively, for the three-month
period ended March 31, 1998 compared to 14.39%, .84% and 5.82%, respectively,
for the same period in 1997.
Net Interest Income
Net interest income for the three-month period ended March 31, 1998 was
$112.6 million compared to $94.2 million for the same period in 1997. This
increase is attributable to an increase in average balances resulting from
internal growth and Sovereign's acquisition of Fleet Financial Group Inc.'s
("Fleet") Automobile Finance Division ("AFD") in September 1997. Sovereign's net
interest margin (net interest income divided by average interest-earning assets)
was 2.86% for the three-month period ended March 31, 1998 compared to 2.71% for
the same period in 1997.
Interest on interest-earning deposits for the three-month period ended
March 31, 1998 was $1.3 million compared to $2.7 million for the same period in
1997. The average balance of interest-earning deposits was $34.9 million with an
average yield of 15.61% for the three-month period ending March 31, 1998
compared to an average balance of $163.8 million with an average yield of 6.69%
for the same period in 1997. The high yields on Sovereign's interest-earning
deposits are the result of a contractual arrangement whereby a third-party
vendor performed check processing and reconcilement functions for Sovereign's
-22-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
disbursement accounts. Under the agreement, the vendor is required to pay
Sovereign interest on disbursed funds during the two to three day float period,
effectively producing interest income with no corresponding asset balance. This
agreement will continue to favorably impact the yield on Sovereign's
interest-earning deposits in 1998 and future years.
Interest on investment and mortgage-backed securities available-for-sale
was $34.3 million for the three-month period ended March 31, 1998 compared to
$18.8 million for the same period in 1997. The average balance of investment and
mortgage-backed securities available-for-sale was $2.09 billion with an average
yield of 6.93% for the three-month period ended March 31, 1998 compared to an
average balance of $1.12 billion with an average yield of 6.90% for the same
period in 1997.
Interest on investment and mortgage-backed securities held-to-maturity was
$57.8 million for the three-month period ended March 31, 1998 compared to $63.6
million for the same period in 1997. The average balance of investment and
mortgage-backed securities held-to-maturity was $3.15 billion with an average
yield of 7.33% for the three-month period ended March 31, 1998 compared to an
average balance of $3.62 billion with an average yield of 7.04% for the same
period in 1997.
Interest and fees on loans were $212.3 million for the three-month period
ended March 31, 1998 compared to $170.3 million for the same period in 1997. The
average balance of loans was $10.86 billion with an average yield of 7.87% for
the three-month period ended March 31, 1998 compared to an average balance of
$9.10 billion with an average yield of 7.51% for the same period in 1997. The
increases in the average balance of loans and in the interest and fees on loans
are primarily due to Sovereign's AFD acquisition in September 1997 and continued
growth in Sovereign's commercial lending division.
Interest on deposits was $94.9 million for the three-month period ended
March 31, 1998 compared to $82.2 million for the same period in 1997. The
average balance of deposits was $9.02 billion with an average cost of 4.26% for
the three-month period ended March 31, 1998 compared to an average balance of
$8.15 billion with an average cost of 4.09% for the same period in 1997.
Interest on borrowings was $98.3 million for the three-month period ended
March 31, 1998 compared to $79.1 million for the same period in 1997. The
average balance of borrowings was $6.75 billion with an average cost of 5.82%
for the three-month period ended March 31, 1998 compared to an average balance
of $5.42 billion with an average cost of 5.85% for the same period in 1997. The
increase in the average balance of borrowings is the result of balance sheet
growth being partially funded by borrowings.
-23-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Provision for Possible Loan Losses
The provision for possible loan losses was $6.5 million for the three-month
period ended March 31, 1998 compared to $10.9 million for the same period in
1997. This decrease is primarily attributable to additional reserves of $7.9
million taken during the first quarter of 1997 as part of the one-time, merger
charges related to Sovereign's acquisition of First State in February 1997.
Excluding this one-time, merger-related charge, Sovereign's loan loss provision
increased by 117% from $3.0 million at March 31, 1997 to $6.5 million at March
31, 1998. These additional reserves were taken as a result of Sovereign's
conservative approach with respect to an accelerated workout plan for certain
non-performing assets acquired from First State.
Over the past two years, Sovereign has diversified its lending efforts and
increased its emphasis on providing its customers with small business loans and
an expanded line of consumer products, such as asset based lending and
automobile loans. Management recognizes the increased risk inherent in these
loan products and as a result, on a comparative basis, Sovereign's first quarter
1998 loan loss provision increased by 117% over first quarter 1997 levels. In
addition, as part of a goodwill adjustment related to Sovereign's AFD
acquisition from Fleet in September 1997, Sovereign added an additional $3.7
million to the allowance for possible loan losses. This adjustment, which is
permitted during the one-year period following a transaction, reflects a
refinement of Sovereign's estimate of the fair market value of the assets
acquired and liabilities assumed as of the date of the combination. As Sovereign
continues to place emphasis on small business and consumer lending in 1998 and
future years, management will continually evaluate its loan portfolio and record
additional loan loss reserves as is necessary. For additional information with
respect to Sovereign's asset quality, see "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Loan Portfolio."
During the three-month period ended March 31, 1998, Sovereign charged-off
$9.0 million compared to $3.6 million for the same period in 1997. The increased
level of charge-offs for the first quarter of 1998 was partially off-set by
recoveries of $2.5 million, resulting in net charge-offs of $6.5 million for the
first quarter of 1998. This compares to recoveries of $1.2 million and net
charge-offs of $2.4 million for the same period in 1997. Sovereign's increased
level of charge-offs for the first quarter of 1998 is primarily the result of
increased consumer loan charge-offs, the majority of which are related to
Sovereign's newly acquired AFD portfolio. Historically, non-residential lending
will typically result in higher charge-off levels than other types of lending;
however, recoveries and income potential will also be greater.
-24-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table presents the activity in the allowance for possible
loan losses for the periods indicated: (dollars in thousands)
Three-Month Period
Ended March 31,
--------------------------
1998 1997
-------- --------
Allowance, beginning of period $110,251 $ 67,422
Charge-offs:
Residential 1,808 2,463
Commercial Real Estate -- 154
Commercial 106 367
Consumer 7,064 613
-------- --------
Total Charge-offs 8,978 3,597
-------- --------
Recoveries:
Residential 279 290
Commercial Real Estate 2 922
Commercial 64 4
Consumer 2,158 21
-------- --------
Total Recoveries 2,503 1,237
-------- --------
Charge-offs, net of recoveries 6,475 2,360
Provision for possible loan losses 6,500 10,900
Other 1,632 (2,674)
-------- --------
Allowance, end of period $111,908 $ 73,288
======== ========
Other Income
Other income was $22.3 million for the three-month period ended March 31,
1998 compared to $12.3 million for the same period in 1997.
Other loan fees and service charges were $2.9 million for the three-month
period ended March 31, 1998 compared to $1.6 million for the same period in
1997. The increase in other loan fees and service charges is directly
attributable to fees earned on Sovereign's AFD portfolio which was acquired in
September 1997. Other loan fees and service charges result primarily from
Sovereign's loan servicing portfolio. Sovereign serviced $8.84 billion of its
own loans and $6.31 billion of loans for others at March 31, 1998 compared to
$6.98 billion of its own loans and $6.09 billion of loans for others at March
31, 1997.
-25-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Deposit fees were $5.4 million for the three-month period ended March 31,
1998 compared to $4.3 million for the same period in 1997. This increase is
primarily the result of an increase in the number of Sovereign's transaction
accounts and a larger retail customer base over the last year.
Mortgage banking gains were $4.9 million for the three-month period ended
March 31, 1998 compared to $4.3 million for the same period in 1997. Mortgage
banking gains have increased as interest rates have declined and loan volumes
have accelerated in 1998 compared to 1997.
Gains on sales of loans and investment and mortgage-backed securities
available-for-sale were $3.5 million for the three-month period ended March 31,
1998 compared to $273,000 for the same period in 1997. This increase is
primarily attributable to gains of $2.4 million resulting from the liquidation
of $477.1 million of investment and mortgage-backed securities acquired from ML
Bancorp during the first quarter of 1998.
Miscellaneous income was $5.7 million for the three-month period ended
March 31, 1998 compared to $1.8 million for the same period in 1997. This
increase is primarily due to Sovereign's investment in Bank Owned Life Insurance
("BOLI") which was made during the first quarter of 1998, the sale of certain
fixed assets acquired from Bankers and increased inter-change income resulting
from growth in the number of Sovereign's debit cards and credit cards over the
last year.
General and Administrative Expenses
Total general and administrative expenses were $60.2 million for the
three-month period ended March 31, 1998 compared to $48.7 million for the same
period in 1997. The ratio of general and administrative expenses to average
assets for the three-month period ended March 31, 1998 was 1.41% compared to
1.34% for the same period in 1997. Sovereign's efficiency ratio (all general and
administrative expenses as a percentage of net interest income and recurring
non-interest income) for the three-month period ended March 31, 1998 was 46.2%
compared to 45.8% for the same period in 1997. The increase in total general and
administrative expenses and the resulting increase in Sovereign's expense ratios
is a direct result of the AFD acquired from Fleet in September 1997 and the
investment in people and other needed infrastructure to further Sovereign's
transformation to a Super Community Bank.
Other operating expenses were $46.0 million for the three-month period
ended March 31, 1998 compared to $12.8 million for the same period in 1997.
Results for the three-month period ended March 31, 1998 include one-time, merger
charges of $39.5 million related to Sovereign's acquisition of ML Bancorp during
the first quarter of 1998. Expenses included as part of the one-time charge were
human resources related costs and other expenses, including investment banker
fees and legal expenses. Results for the three-month period ended March 31, 1997
include one-time, merger charges of $8.0 million.
-26-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Income Tax Provision
The income tax provision was $9.1 million for the three-month period ended
March 31, 1998 compared to $14.0 million for the same period in 1997. The
effective tax rate for the three-month period ended March 31, 1998 was 41.3%
compared to 41.2% for the same period in 1997. The higher than usual effective
tax rate for the three-month periods ended March 31, 1998 and 1997 is primarily
attributable to certain non-deductible expenses incurred in conjunction with
Sovereign's acquisitions during each of these periods. Excluding these one-time,
merger-related charges, Sovereign's effective tax rate for the three-month
periods ended March 31, 1998 and 1997 was 37.0% and 38.4%, respectively.
FINANCIAL CONDITION
Loan Portfolio
Sovereign's loan portfolio at March 31, 1998 was $10.4 billion compared to
$10.8 billion at December 31, 1997. This slight decrease is primarily due to a
decline in Sovereign's residential mortgage loan portfolio of approximately $414
million resulting from the refinance environment and Sovereign's lessened
emphasis on portfolio lending.
Continuing its transition to a mortgage banking franchise, during the
three-month period ended March 31, 1998, Sovereign closed $449.8 million of
first mortgage loans of which approximately 80% were fixed rate and sold in the
secondary market. This compares to first mortgage loan closings of $300.1
million and approximately 56% of fixed rate loans for the same period in 1997.
Over the past two years, Sovereign has increased its emphasis on commercial
and consumer loan originations. As a result, during the three-month period ended
March 31, 1998, Sovereign closed $176.9 million of commercial loans compared to
$38.5 million of commercial loans during the same period in 1997. This increase
is due to strong business loan demand in Sovereign's market area resulting from
a strong economy and the pending acquisition of CoreStates by First Union.
Sovereign closed $310.9 million of consumer loans during the three-month
period ended March 31, 1998 compared to $151.2 million of consumer loans during
the same period in 1997. This increase is primarily the result of Sovereign's
newly acquired AFD which originated $127.3 million of indirect auto loans during
the first quarter of 1998.
Sovereign's primary residential loan products are variable rate mortgage
loans on owner-occupied residential real estate. As a result, at March 31, 1998,
70% of Sovereign's total loan portfolio was secured by residential real estate
and 61% of the total loan portfolio was comprised of variable rate loans.
However, as a result of Sovereign's use of interest rate swaps for interest rate
risk management, at March 31, $199.8 million of intermediate variable rate
mortgage loans (loans with a five-year fixed rate period) have effectively been
converted to a variable rate loan over the fixed rate period.
-27-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
At March 31, 1998, Sovereign's total loan portfolio included $6.00 billion
of first mortgage loans secured primarily by liens on owner-occupied one-to-four
family residential properties. With its increased focus on non-residential
lending and the AFD acquisition, at March 31, 1998, Sovereign's total loan
portfolio also included $1.24 billion of commercial loans and $3.04 billion of
consumer loans, including $1.51 billion of auto loans and $1.02 billion of
outstanding home equity loans (excluding $462.4 million of additional unused
commitments for home equity lines of credit) secured primarily by second
mortgages on owner-occupied one-to-four family residential properties.
At March 31, 1998, Sovereign's non-performing assets were $108.0 million
compared to $98.6 million at December 31, 1997. Non-performing assets as a
percentage of total assets were .60% at March 31, 1998 compared to .59% at
December 31, 1997. At March 31, 1998, 69% of non-performing assets consisted of
loans or REO related to residential real estate compared to 74% at December 31,
1997. This decrease is the result of Sovereign's increased focus on
non-residential lending and the AFD acquisition. The remainder of Sovereign's
non-performing assets consist principally of commercial REO; most of which have
been acquired through recent acquisitions. Non-performing assets at March 31,
1998 included $11.8 million of REO which is carried at lower of cost or
estimated fair value less estimated costs to sell. Sovereign places all loans 90
days or more delinquent (except auto loans and loans guaranteed by the
government or secured by deposit accounts) on non-performing status. Sovereign's
auto loans continue to accrue interest until they are 120 days delinquent, at
which time they are placed on non-accrual status. At March 31, 1998, the
allowance for possible loan losses as a percentage of non-performing assets was
95.82% compared to 107.35% at December 31, 1997.
-28-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table presents the composition of non-performing assets at
the dates indicated: (dollars in thousands)
March 31, December 31,
1998 1997
--------- ------------
Non-Accrual Loans:
Past due 90 days or more
as to interest or principal:
Real estate related $ 63,118 $62,397
Other 18,303 18,208
Past due less than 90 days
as to interest and principal:
Real estate related 549 555
Other 5,255 --
-------- -------
Total Non-Accrual Loans 87,225 81,160
Other 8,742 6,524
Restructured Loans 315 327
-------- -------
Total Non-Performing Loans 96,282 88,011
-------- -------
Real Estate Owned:
Real estate related 10,769 9,921
Other 996 710
-------- -------
Total Real Estate Owned 11,765 10,631
-------- -------
TOTAL NON-PERFORMING ASSETS $108,047 $98,642
======== =======
Past due 90 days or more as to
interest or principal and
accruing interest (1) $ 5,104 $ 6,672
Non-Performing Assets as a
percentage of Total Assets .60% .59%
Non-Performing Loans as a
percentage of Total Loans .90% .80%
Non-Performing Assets as a
percentage of Total Loans
and Real Estate Owned 1.06% .95%
Allowance for Possible Loan
Losses as a percentage of
Total Non-Performing Assets 95.82% 107.35%
Allowance for Possible Loan
Losses as a percentage of
Total Non-Performing Loans 107.53% 120.32%
-29-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
(1) Represents student loans which are government-guaranteed and Sovereign
retains minimal risk of credit losses related to these loans.
The adequacy of Sovereign's allowance for possible loan losses is
constantly being evaluated. Management's evaluation of the adequacy of the
allowance to absorb potential future loan losses takes into consideration the
risks inherent in the loan portfolio, past loan loss experience, specific loans
which could have loss potential, geographic and industry concentrations,
delinquency trends, economic conditions and other relevant factors. At March 31,
1998, the allowance for possible loan losses was $111.9 million or 1.05% of
total loans compared to $110.3 million or 1.00% of total loans at December 31,
1997.
The following table presents the allocation of the allowance for possible
loan losses and the percentage of such allocation to each loan type for the
dates indicated: (dollars in thousands)
Balance at End of March 31, 1998 December 31, 1997
------------------ -------------------
Period Attributable to Amount Percent Amount Percent
- ---------------------- -------- ------- -------- -------
Residential real estate $ 31,605 28.3% $ 34,745 31.5%
Commercial real estate 6,081 5.4 19,368 17.6
Commercial 19,294 17.2 8,007 7.3
Consumer 28,971 25.9 23,097 20.9
Unallocated 25,957 23.2 25,034 22.7
-------- ----- -------- -----
Total $111,908 100.0% $110,251 100.0%
======== ===== ======== =====
Potential problem loans (consisting of loans as to which management has
serious concerns as to the ability of such borrowers to comply with present
repayment terms, although not currently classified as non-performing loans)
amounted to approximately $31.0 million at March 31, 1998 and consisted
principally of commercial real estate loans.
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.
-30-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Impaired loans are summarized as follows (in thousands):
March 31, December 31,
1998 1997
--------- ------------
Impaired loans without a related reserve $15,238 $ 7,435
Impaired loans with a related reserve 31,016 12,153
------- -------
Total impaired loans $46,254 $19,588
======= =======
Reserve for impaired loans $12,183 $ 5,325
======= =======
The average balance of impaired loans for the three-month periods ended
March 31, 1998 and 1997 was $32.9 million and $27.4 million, respectively.
Investment and Mortgage-backed Securities
Investment securities consist primarily of U.S. Treasury and government
agency securities, corporate debt securities and stock in the Federal Home Loan
Bank of Pittsburgh ("FHLB"). Mortgage-backed securities consist of collateral
mortgage obligations issued by FHLMC, FNMA, GNMA, RTC or private label issues.
Sovereign's mortgage-backed securities are generally either guaranteed as to
principal and interest by the issuer or have ratings of "AAA" by Standard and
Poor's and Fitch at the date of issuance. The classes are backed by single
family residential loans which are primary residences geographically dispersed
throughout the United States. Sovereign purchases classes which are senior
positions backed by subordinate classes. The subordinate classes absorb the
losses and must be completely eliminated before any losses flow through the
senior positions. Sovereign's strategy is to purchase classes which have an
average life of three years or less. At March 31, 1998, four securities, or
approximately 1.5% of Sovereign's total investment portfolio were classified as
high risk as defined by the FFIEC Policy Statement on securities activities. The
effective duration of the total investment portfolio at March 31, 1998 was 1.8
years.
At March 31, 1998, total investment and mortgage-backed securities
available-for-sale were $3.21 billion compared to $1.74 billion at December 31,
1997 and investment and mortgage-backed securities held-to-maturity were $3.10
billion compared to $3.26 billion at December 31, 1997. For additional
information with respect to Sovereign's investment and mortgage-backed
securities, see Notes 3 and 4 in the Notes to Consolidated Financial Statements.
-31-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Long-Lived Assets
In March 1995, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed of", which requires impairment losses to be
recorded on long-lived assets used in operations when indicators of impairment
are present and the undiscounted cash flows estimated to be generated by those
assets are less than the assets' carrying amount. SFAS No. 121 also addresses
the accounting for long-lived assets that are expected to be disposed of.
Sovereign adopted SFAS No. 121 in the first quarter of 1996 and the effect of
adoption was not material.
Goodwill and Other Intangible Assets
Total goodwill and other intangible assets at March 31, 1998 were $126.5
million compared to $125.8 million at December 31, 1997. As an adjustment made
in connection with its AFD acquisition from Fleet in September 1997, during the
first quarter of 1998, Sovereign added $5.5 million to goodwill. This
adjustment, which is permitted during the one-year period following a
transaction, reflects a refinement of Sovereign's estimate of the fair market
value of the assets acquired and liabilities assumed as of the date of the
combination. This increase to goodwill was off-set by a reduction of $1.8
million taken as part of the one-time, merger-related charge during the first
quarter of 1998 and normal year-to-date amortization.
Deposits
Deposits are attracted from within Sovereign's primary market area through
the offering of various deposit instruments including NOW accounts, money market
accounts, savings accounts, certificates of deposit and retirement savings
plans.
Total deposits at March 31, 1998 were $9.25 billion compared to $8.91
billion at December 31, 1997. For additional information with respect to
Sovereign's deposit portfolio composition, see Note 6 in the Notes to
Consolidated Financial Statements.
Borrowings
Sovereign utilizes borrowings as a source of funds for its asset growth and
its asset/liability management. Collateralized advances are available from the
FHLB provided certain standards related to creditworthiness have been met.
Another source of funds for Sovereign is reverse repurchase agreements. Reverse
repurchase agreements are short-term obligations collateralized by securities
fully guaranteed as to principal and interest by the U.S. Government or an
agency thereof.
-32-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Total borrowings at March 31, 1998 were $7.16 billion of which $5.67
billion were short-term compared to $6.57 billion of which $5.26 billion were
short-term at December 31, 1997. This increase in borrowings is the result of
balance sheet growth being partially funded by borrowings. For additional
information with respect to Sovereign's borrowings, see Note 7 in the Notes to
Consolidated Financial Statements.
Through the use of interest rate swaps, $3.68 billion of FHLB advances at
March 31, 1998 have been effectively converted from variable rate obligations to
fixed rate obligations. In addition, at March 31, 1998, $1.2 billion of
borrowings have been protected from upward repricing through the use of interest
rate caps and floors.
Stockholders' Equity
Total stockholders' equity at March 31, 1998 was $978.0 million compared to
$972.9 million at December 31, 1997. This increase is primarily attributable to
the retention of earnings less dividends paid to shareholders, net of
unallocated common stock held by ESOP and an adjustment to stockholders' equity
to reflect ML Bancorp's activity for the two-month period ended February 28,
1998 resulting from the differing fiscal year end of ML Bancorp as previously
discussed in Note 9 in the Notes to Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Sovereign's banking subsidiaries are required under applicable federal
regulations to maintain specified levels of "liquid" investments in cash and
U.S. Treasury and other qualifying investments. Regulations currently in effect
require Sovereign's banking subsidiaries to maintain liquid assets of not less
than 5% of its net withdrawable accounts plus short-term borrowings. These
levels are changed from time to time by the OTS to reflect economic conditions.
The liquidity ratio of Sovereign Bank for March 31, 1998 was 44.7%.
Sovereign's primary financing sources are deposits obtained in its own
market area and borrowings in the form of securities sold under repurchase
agreements and advances from the FHLB. While the majority of Sovereign's
certificate of deposit accounts are expected to mature within a one year period,
historically, the retention rate has been approximately 70%. If a significant
portion of maturing certificates would not renew at maturity, the impact on
Sovereign's operations and liquidity would be minimal due to cash flows produced
by Sovereign's investment portfolio which approximate $115.0 million per month.
At March 31, 1998, Sovereign had $4.75 billion in unpledged investments and
mortgage-backed securities which could be used to collateralize additional
borrowings. Sovereign Bank can also borrow from the FHLB, subject to required
collateralization. Other sources of funds include operating activities,
repayments of principal on investment and mortgage-backed securities, repayment
of principal on loans and other investing activities.
-33-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
For the three-month period ended March 31, 1998, cash and cash equivalents
increased $129.1 million. Net cash provided by operating activities was $221.6
million for the three-month period ended March 31, 1998. Net cash used by
investing activities for the three-month period ended March 31, 1998 was $1.02
billion consisting primarily of purchases of mortgage-backed securities which
are classified available-for-sale, partially offset by proceeds from sales and
repayments of investment and mortgage-backed securities. Net cash provided by
financing activities for the three-month period ended March 31, 1998 was $923.3
million which includes an increase in deposits of $335.6 million and an increase
in proceeds from long-term borrowings of $500.0 million.
The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA"),
requires the OTS to prescribe uniformly applicable capital standards for all
savings associations. These standards require savings associations to maintain a
minimum tangible capital ratio of not less than 1.5%, a minimum leverage capital
ratio of not less than 3% of tangible assets and not less than 4% of risk
adjusted assets and a minimum risk-based capital ratio (based upon credit risk)
of not less than 8%. In all cases, these standards are to be no less stringent
than the capital standards that are applicable to national banks. The OTS has
issued a regulation that requires a minimum leverage capital requirement of 3%
for associations rated composite "1" under the OTS MACRO rating system. For all
other savings associations, the minimum leverage capital requirement will be 3%
plus at least an additional 100 to 200 basis points.
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA"),
established five capital tiers: well capitalized, adequately capitalized, under
capitalized, significantly under capitalized and critically under capitalized. A
depository institution's capital tier depends upon its capital levels in
relation to various relevant capital measures, which include leverage and
risk-based capital measures and certain other factors. Depository institutions
that are not classified as well capitalized are subject to various restrictions
regarding capital distributions, payment of management fees, acceptance of
brokered deposits and other operating activities.
At March 31, 1998, 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.
-34-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table sets forth the capital ratios of Sovereign Bancorp and
Sovereign Bank and the current regulatory requirements at March 31, 1998:
<TABLE>
<CAPTION>
Well
Sovereign Sovereign Minimum Capitalized
Bancorp (1) Bank Requirement Requirement
----------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Stockholders' equity to
total assets 5.40% 5.84% None None
Tangible capital to tangibl
assets 4.70 5.11 1.50% None
Leverage (core) capital to
tangible assets 5.71 5.38 3.00 5.00%
Leverage (core) capital to
risk adjusted assets 9.98 9.50 4.00 6.00
Risk-based capital to risk
adjusted assets 12.58 10.58 8.00 10.00
</TABLE>
(1) OTS capital regulations do not apply to savings and loan holding companies.
These ratios are computed as if those regulations did apply to Sovereign
Bancorp.
ASSET AND LIABILITY MANAGEMENT
The objective of Sovereign's asset and liability management is to identify,
measure and control its interest rate risk in order to produce consistent
earnings that are not contingent upon favorable trends in interest rates.
Sovereign manages its assets and liabilities to attain a stable net interest
margin across a wide spectrum of interest rate environments. This is attained by
monitoring the levels of interest rates, the relationships between the rates
earned on assets and the rates paid on liabilities, the absolute amount of
assets and liabilities which reprice or mature over similar periods, off-balance
sheet positions and the effect of all of these factors on the estimated level of
net interest income.
There are a number of industry standards used to measure an institution's
interest rate risk position. Most common among these is the one year gap which
is the ratio representing the difference between assets, liabilities and
off-balance sheet positions which will mature or reprice within one year
expressed as a percentage of total assets. Using management's estimates of asset
prepayments, core deposit decay and core deposit repricing in its computation,
Sovereign estimates that its cumulative one year gap position was a positive
6.94% at March 31, 1998.
-35-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Sovereign manages the one year interest rate gap within +/- 10%. A positive
gap position implies that the bank is asset sensitive which could cause net
interest income to decrease if interest rates fall. Conversely, a negative gap
position implies that the bank is liability sensitive which could cause net
interest income to decrease if interest rates rise. Sovereign manages the impact
to net interest income in a +200 basis point instantaneous parallel rate shock
environment to be within a 10% loss. At March 31, 1998, Sovereign estimates that
if interest rates rise by 200 basis points, net interest income would increase
by $33.3 million or 7.49%.
Sovereign also utilizes income simulation modeling in measuring its
interest rate risk and managing its interest rate sensitivity. Income simulation
considers not only the impact of changing market interest rates on forecasted
net interest income, but also other factors such as yield curve relationships,
the volume and mix of assets and liabilities, customer preferences and general
market conditions.
Pursuant to its interest rate risk management strategy, Sovereign enters
into off-balance sheet transactions which involve interest rate exchange
agreements (swaps, caps and floors) for interest rate risk management purposes.
Sovereign's objective in managing its interest rate risk is to provide
sustainable levels of net interest income while limiting the impact that changes
in interest rates have on net interest income. For additional information on
interest rate exchange agreements, see Note 8 in the Notes to Consolidated
Financial Statements.
Amortizing and non-amortizing interest rate swaps are generally used to
convert fixed rate assets and liabilities to variable rate assets and
liabilities and vice versa. Sovereign utilizes amortizing interest rate swaps to
convert discounted adjustable rate loans to fixed rate for a period of time. The
amortization of the notional amount of the interest rate swaps are tied to the
level of an index such as the One Year Treasury Constant Maturity, LIBOR, or a
prepayment rate of a pool of mortgage-backed securities. In order for interest
rate swaps to achieve the desired objective, Sovereign selects interest rate
swaps that will have a high degree of correlation to the related financial
instrument. Sovereign generally utilizes non-amortizing swaps to convert fixed
rate liabilities to floating, and floating rate liabilities to fixed, to reduce
Sovereign's overall cost of funds.
Interest rate caps are generally used to limit the exposure from the
repricing and maturity of liabilities and interest rate floors are generally
used to limit the exposure from repricing and maturity of assets. Interest rate
caps and floors are also used to limit the exposure created by other interest
rate swaps. In certain cases, interest rate caps or floors are simultaneously
bought and sold to create a range of protection against changing interest rates
while limiting the cost of that protection.
-36-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Due to competitive conditions, Sovereign originates fixed rate residential
mortgages. It sells the majority of these loans to FHLMC, FNMA and private
investors. The loans are exchanged for cash or marketable fixed rate
mortgage-backed securities which are generally sold. This helps insulate
Sovereign from the interest rate risk associated with these fixed rate assets.
Sovereign uses forward sales, cash sales and options on mortgage-backed
securities as means of hedging loans in the mortgage pipeline which are
originated for sale.
Sovereign's primary funding source is deposits obtained in its own
marketplace. Deposit programs at Sovereign are priced to meet management's
asset/liability objectives, while taking into account the rates available on
investment opportunities and also considering the cost of alternative funding
sources. Borrowings are also a significant funding source for Sovereign and have
primarily been in the form of securities sold under repurchase agreements and
advances from the FHLB. Since borrowings are not subject to the market
constraints to which deposits are, Sovereign uses borrowings to add flexibility
to its interest rate risk position.
-37-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Items 1 through 5 are not applicable or the responses are negative.
Item 6 - Reports on Form 8-K.
Report on Form 8-K, dated April 20, 1998 (date of earliest event -
April 14, 1998), contained a press release announcing Sovereign's
expected earnings for the first quarter of 1998.
Report on Form 8-K, dated April 20, 1998 (date of earliest event -
April 15, 1998), contained a press release announcing the resignation
of Karl D. Gerhart as Sovereign's Chief Financial Officer and the
appointment of Dennis S. Marlo as Sovereign's new Chief Financial
Officer.
Report on Form 8-K, dated February 20, 1998 (date of earliest event
- January 20, 1998), contained a press release announcing Sovereign's
earnings for the year ended December 31, 1997.
Report on Form 8-K, dated February 19, 1998 (date of earliest event -
January 20, 1998), contained a press release announcing Sovereign's
earnings for the year ended December 31, 1997.
-38-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SOVEREIGN BANCORP, INC.
-----------------------------------
(Registrant)
Date May 13, 1998 /s/ Dennis S. Marlo
------------ -------------------------------
Dennis S. Marlo
Chief Financial Officer
Date May 13, 1998 /s/ Mark R. McCollom
------------ -------------------------------
Mark R. McCollom
Chief Accounting Officer
-41-
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