WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934
For the quarter ended September 30, 1999
OR
_____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________________ to ____________________
Commission File Number: 34-16533
--------------------------
SOVEREIGN BANCORP, INC.
----------------------------------------------------
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2453088
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1130 Berkshire Boulevard, Wyomissing, Pennsylvania 19610
- -------------------------------------------------- -----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (610) 320-8400
N/A
----------------------------------------------------------------
(Former name, former address and former fiscal year, if changed
since last report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X]. No [_].
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at November 10, 1999
- --------------------------- --------------------------------
Common Stock (no par value) 181,196,064 shares
<PAGE>
FORWARD-LOOKING STATEMENTS
Sovereign Bancorp, Inc. ("Sovereign") may from time to time make
"forward-looking statements," including statements contained in Sovereign's
filings with the Securities and Exchange Commission (including its Annual Report
on Form 10-K and the Exhibits thereto), in its reports to shareholders and in
other communications by Sovereign, which are made in good faith by Sovereign,
pursuant to the "safe harbor" provisions of the Private Securities Litigation
Reform Act of 1995.
These forward-looking statements include statements with respect to
Sovereign's vision, mission, strategies, goals, beliefs, plans, objectives,
expectations, anticipations, estimates, intentions, financial condition, results
of operations, future performance and business of Sovereign, including: (i)
statements relating to Sovereign's expectations and goals with respect to (a)
growth in earnings per share; (b) return on equity; (c) return on assets; (d)
efficiency ratio; (e) tier 1 leverage ratio; (f) annualized net charge-offs and
other asset quality measures; (g) fee income as a percentage of total revenue;
(h) tangible equity to assets; (i) book value and tangible book value per share;
(j) loan and deposit portfolio compositions, and (ii) statements preceded by,
followed by or that include the words "may," "could," "should," "pro forma,"
"looking forward," "would," "believe," "expect," "anticipate," "estimate,"
"intend," "plan," or similar expressions. These forward-looking statements
involve risks and uncertainties which are subject to change based on various
important factors (some of which, in whole or in part, are beyond Sovereign's
control). The following factors, among others, could cause Sovereign's financial
performance to differ materially from the goals, plans, objectives, intentions
and expectations expressed in such forward-looking statements: (1) the strength
of the United States economy in general and the strength of the regional and
local economies in which Sovereign conducts operations; (2) the effects of, and
changes in, trade, monetary and fiscal policies and laws, including interest
rate policies of the Board of Governors of the Federal Reserve System; (3)
inflation, interest rate, market and monetary fluctuations; (4) the timely
development of competitive new products and services by Sovereign and the
acceptance of such products and services by customers; (5) the willingness of
customers to substitute competitors' products and services and vice versa; (6)
the success of Sovereign in gaining regulatory approval of its products and
services, when required; (7) the impact of changes in financial services' laws
and regulations (including laws concerning taxes, banking, proper accounting
treatment, securities and insurance); (8) technological changes; (9) changes in
consumer spending and savings habits; (10) the impact of pending and completed
acquisitions of Sovereign, including the success of Sovereign in fully
realizing, within the expected time frame, expected cost savings and/or revenue
enhancements from such pending or completed acquisitions, including, without
limitation, the expected cost savings and revenue enhancements expected from the
acquisition of Peoples Bancorp, Inc.; (11) unanticipated regulatory or judicial
proceedings; (12) unanticipated results of its efforts to be Year 2000
compliant; (13) the success of Sovereign at managing the risks involved in the
foregoing; (14) our successful completion and integration of the acquisition of
the Fleet/BankBoston branches, and related financings.
-2-
<PAGE>
FORWARD-LOOKING STATEMENTS
(continued)
Sovereign cautions that the foregoing list of important factors is not
exclusive, and neither such list nor any such forward-looking statement takes
into account the impact that any future acquisition may have on Sovereign and
any such forward-looking statement. Sovereign does not undertake to update any
forward-looking statement, whether written or oral, that may be made from time
to time by or on behalf of Sovereign.
-3-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at September 30, 1999
and December 31, 1998 5
Consolidated Statements of Operations for the three-month
and nine-month periods ended September 30, 1999 and 1998 6 - 7
Consolidated Statement of Stockholders' Equity for
the nine-month period ended September 30, 1999 8
Consolidated Statements of Cash Flows for the nine-month
periods ended September 30, 1999 and 1998 9
Notes to Consolidated Financial Statements 10 - 23
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 24 - 40
PART II. OTHER INFORMATION
Item 6. Reports on Form 8-K 41
PART III. FINANCIAL DATA SCHEDULE 42 - 43
SIGNATURES 44
-4-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------ ------------
(Unaudited) (Note)
(in thousands, except
per share data)
<S> <C> <C>
ASSETS
Cash and amounts due from
depository institutions $ 359,682 $ 471,074
Interest-earning deposits 16,004 82,650
Loans held for sale (approximate fair
value of $50,572 and $297,414 at
September 30, 1999 and December 31, 1998,
respectively) 50,326 296,930
Investment securities available-for-sale 8,760,232 6,662,427
Investment securities held-to-maturity
(approximate fair value of $1,132,970
and $1,860,583 at September 30, 1999
and December 31, 1998, respectively) 1,142,649 1,839,655
Loans 13,420,525 11,285,840
Allowance for loan losses (134,573) (133,802)
Premises and equipment 111,737 98,491
Other real estate owned
and other repossessed assets 9,833 15,584
Accrued interest receivable 161,802 147,441
Goodwill and other intangible assets 456,401 425,925
Other assets 889,098 721,658
------------ ------------
TOTAL ASSETS $ 25,243,716 $ 21,913,873
============ ============
LIABILITIES
Deposits $ 11,883,101 $ 12,322,716
Borrowings:
Short-term 6,203,991 3,921,684
Long-term 5,490,958 3,978,908
Advance payments by borrowers
for taxes and insurance 21,838 27,655
Other liabilities 70,642 329,792
------------ ------------
TOTAL LIABILITIES 23,670,530 20,580,755
------------ ------------
Corporation-obligated mandatorily redeemable
capital securities of subsidiary
trust holding solely subordinated
debentures of Sovereign Bancorp, Inc.
("Trust Preferred Securities") 129,115 129,050
------------ ------------
STOCKHOLDERS' EQUITY
Common stock; no par value; 400,000,000 shares
authorized; 186,473,300 shares issued at
September 30, 1999 and 164,146,353 shares
issued at December 31, 1998 916,189 649,341
Unallocated common stock held by Employee
Stock Ownership Plans at cost;
5,063,798 shares at September 30, 1999 and
4,340,572 shares at December 31, 1998 (35,662) (26,892)
Treasury stock at cost; 354,654 shares at
September 30, 1999 and 78,626 shares at
December 31, 1998 (4,384) (1,086)
Accumulated other comprehensive (loss)/income (134,434) 18,120
Retained earnings 702,362 564,585
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 1,444,071 1,204,068
------------ ------------
TOTAL LIABILITIES, MINORITY INTERESTS
AND STOCKHOLDERS' EQUITY $ 25,243,716 $ 21,913,873
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
Note: The balance sheet at December 31, 1998 is taken from Sovereign's audited
financial statements at that date, but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
-5-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three-Month Period Nine-Month Period
Ended September 30, Ended September 30,
--------------------------- --------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
(in thousands, except
per share data)
<S> <C> <C> <C> <C>
Interest income:
Interest on interest-earning deposits $ 972 $ 2,029 $ 3,851 $ 5,360
Interest and dividends on investment
securities available-for-sale 144,268 85,396 395,570 187,806
Interest and dividends on investment
securities held-to-maturity 20,759 38,345 72,916 148,053
Interest and fees on loans 249,955 215,998 689,089 656,521
---------- ---------- ---------- ----------
Total interest income 415,954 341,768 1,161,426 997,740
---------- ---------- ---------- ----------
Interest expense:
Interest on deposits 106,960 112,893 320,556 319,230
Interest on borrowings 147,126 107,628 391,802 317,614
---------- ---------- ---------- ----------
Total interest expense 254,086 220,521 712,358 636,844
---------- ---------- ---------- ----------
Net interest income 161,868 121,247 449,068 360,896
Provision for loan losses 7,500 7,001 22,500 20,961
---------- ---------- ---------- ----------
Net interest income after provision for
loan losses 154,368 114,246 426,568 339,935
---------- ---------- ---------- ----------
Other income:
Retail banking fees 13,779 7,914 35,649 21,714
Mortgage banking revenues 7,374 6,354 26,325 20,974
Loan fees and service charges 2,667 1,792 6,014 4,985
Gain on sale of loans and investment
securities (299) 6,262 6,471 12,389
Miscellaneous income 11,430 3,424 26,086 13,243
---------- ---------- ---------- ----------
Total other income 34,951 25,746 100,545 73,305
---------- ---------- ---------- ----------
General and administrative expenses:
Compensation and benefits 38,955 30,166 113,696 89,811
Occupancy and equipment expenses 15,958 13,767 49,758 40,113
Outside services 14,717 11,823 47,872 31,258
Other administrative expenses 21,173 10,650 49,118 34,546
---------- ---------- ---------- ----------
Total general and administrative expenses 90,803 66,406 260,444 195,728
---------- ---------- ---------- ----------
</TABLE>
-6-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(continued)
<TABLE>
<CAPTION>
Three-Month Period Nine-Month Period
Ended September 30, Ended September 30,
------------------------ ------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
(in thousands, except
per share data)
<S> <C> <C> <C> <C>
Other operating expenses:
Merger-related charges (1) $ -- $ 10,860 $ -- $ 49,932
Amortization of goodwill and other intangibles 9,953 4,950 28,008 11,347
Trust Preferred Securities expense 3,049 3,051 9,147 9,478
Real estate owned loss/(gain), net 38 (243) 60 (256)
--------- --------- --------- ---------
Total other operating expenses 13,040 18,618 37,215 70,501
--------- --------- --------- ---------
Income before income taxes 85,476 54,968 229,454 147,011
Income tax provision 29,488 20,178 79,376 54,227
--------- --------- --------- ---------
Net Income (1)(2) $ 55,988 $ 34,790 $ 150,078 $ 92,784
========= ========= ========= =========
Net Income Applicable to Common Stock $ 55,988 $ 34,790 $ 150,078 $ 91,288
========= ========= ========= =========
Earnings per share (2)(3) $ .31 $ .22 $ .89 .58
========= ========= ========= =========
Dividends paid per common share (3) $ .027 $ .020 $ .074 .063
========= ========= ========= =========
</TABLE>
(1) Results for the three-month period ended September 30, 1998 include merger
charges of $10.9 million ($7.8 million after-tax) related to Sovereign's
acquisitions of Carnegie and First Home during the third quarter of 1998.
Results of the nine-month period ended September 30, 1998 include the
aforementioned charges along with merger charges of $39.1 million ($25.5
million after-tax) and losses from non-recurring sales of held-to-maturity
securities of $0.5 million ($0.3 million after-tax) related to Sovereign's
acquisition of ML Bancorp during the first quarter of 1998.
(2) Results for the three-month and nine-month period ended September 30, 1998
include the merger-related and special charges described in Note 1 above.
Excluding the merger-related and special charges, net income for the
three-month and nine-month periods ended September 30, 1998 were $42.8
million and $126 million, respectively. Earnings per share for these same
periods were $.27 and $.79.
(3) Per share amounts have been adjusted to reflect all stock dividends and
stock splits.
See accompanying notes to consolidated financial statements.
-7-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Accumulated Total
Common Unallocated Other Stock-
Shares Common Retained Treasury Common Stock Comprehensive Holders'
Outstanding Stock Earnings Stock Held by ESOP Income/(Loss) Equity
----------- ----- -------- ----- ------------ ------------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998 159,727 $649,341 $564,585 $(1,086) $ (26,892) $ 18,120 $1,204,068
Comprehensive income:
Net income - - 150,078 - - - 150,078
Change in unrecognized loss on
investment securities available-
for-sale, net of tax - - - - - (152,554) (152,554)
-------
Total comprehensive loss (2,476)
Exercise of stock options 502 4,483 - - - - 4,483
Cash in lieu of fractional shares - (6) - - - - (6)
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan 262 3,200 - - - - 3,200
Dividends paid on common stock - - (12,301) - - - (12,301)
Treasury stock repurchase (3,316) - - (46,873) - - (46,873)
Treasury stock sold 21 - - 217 - - 217
Acquisition of Network Companies 235 4,000 - (1,000) - - 3,000
Acquisition of People's Bancorp, Inc. 23,624 255,171 - 44,358 (8,770) - 290,759
------- -------- -------- ------- -------- --------- ----------
Balance, September 30, 1999 181,055 $916,189 $702,362 $(4,384) $(35,662) $(134,434) $1,444,071
======= ======== ======== ======= ======== ========= ==========
</TABLE>
See accompanying notes to consolidated financial statements.
-8-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine-Month Period
Ended September 30,
-----------------------------
1999 1998
---- ----
(in thousands)
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 150,078 $ 92,784
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses and deferred taxes 20,953 15,443
Depreciation 15,923 10,368
Amortization 55,166 6,925
Gain on sale of loans, investment securities
and real estate owned (6,531) (12,754)
Allocation of Employee Stock Ownership Plan -- 15,310
Net change in:
Loans held for sale 246,604 90,621
Accrued interest receivable (6,344) (107,454)
Prepaid expenses and other assets (279,188) (415,077)
Other liabilities (281,882) 214,224
----------- -----------
Net cash used for operating activities $ (85,221) $ (89,610)
----------- -----------
Cash Flows from Investing Activities:
Proceeds from sales of investment securities:
Available-for-sale 3,727,661 937,327
Held-to-maturity 13,647 --
Proceeds from repayments and maturities of investment securities:
Available-for-sale 1,361,003 620,740
Held-to-maturity 721,882 1,724,905
Purchases of investment securities:
Available-for-sale (6,541,381) (5,331,746)
Held-to-maturity (25,685) (456,601)
Proceeds from sales of loans 1,053,573 22,711
Purchase of loans (1,457,291) (1,629,666)
Net change in loans other than purchases and sales (1,171,502) 1,524,915
Proceeds from sales of premises and equipment 1,608 13,131
Purchases of premises and equipment (25,234) (21,909)
Proceeds from sale of real estate owned 13,327 14,764
Net cash received from business combinations 112,998 (302,808)
Other, net -- (4,228)
----------- -----------
Net cash used for investing activities (2,215,393) (2,888,465)
----------- -----------
Cash Flows from Financing Activities:
Assumption of deposits -- 2,231,149
Net (decrease)/increase in deposits (954,393) 566,356
Net increase in short-term borrowings 1,464,031 (661,446)
Proceeds from long-term borrowings 1,819,994 1,404,842
Repayments of long-term borrowing (149,302) --
Net increase in advance payments by
borrowers for taxes and insurance (5,816) (16,324)
Cash dividends paid to stockholders (12,301) (11,098)
Proceeds from issuance of preferred stock -- (6)
Proceeds from issuance of common stock 7,456 12,787
Advance to the Employee Stock Ownership Plan (437) --
(Purchase)/issuance of treasury stock (46,656) 53
----------- -----------
Net cash provided by financing activities 2,122,576 3,526,313
----------- -----------
Net change in cash and cash equivalents (178,038) 548,238
Cash and cash equivalents at beginning of period 553,724 255,937
----------- -----------
Cash and cash equivalents at end of period $ 375,686 $ 804,175
=========== -----------
Reconciliation of Cash and Cash Equivalents to
Consolidated Balance Sheets:
Cash and amounts due from depository institutions $ 359,682 $ 648,342
Interest-earning deposits 16,004 155,833
----------- -----------
Cash and cash equivalents at end of period $ 375,686 $ 804,175
=========== ===========
</TABLE>
Supplemental Disclosures:
Income tax payments totaled $83.5 million for the nine-month period ended
September 30, 1999 and $56.0 million for the same period in 1998. Interest
payments totaled $687 million for the nine-month period ended September 30, 1999
and $615 million for the same period in 1998. Noncash activity consisted of
mortgage or whole loan sales of $920 million for the nine-month period ended
September 30, 1999 and $708 million for the same period in 1998;
reclassification of long-term borrowings to short-term borrowings of $397
million for the nine-month period ended September 30, 1999 and $563 million for
the same period in 1998; and reclassification of mortgage loans to real estate
owned of $10.9 million for the nine-month period ended September 30, 1999 and
$13.5 million for the same period in 1998.
See accompanying notes to consolidated financial statements.
-9-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) BASIS OF PRESENTATION AND ACCOUNTING POLICIES
Basis of Presentation
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
Delaware Investment Corporation, Sovereign Capital Trust I and ML Capital Trust
I. All material intercompany balances and transactions have been eliminated in
consolidation. These financial statements have been prepared in accordance with
the instructions for Form 10-Q and therefore do not include certain information
or footnotes necessary for the presentation of financial condition, results of
operations, stockholders' equity, and cash flows in conformity with generally
accepted accounting principles. However, in the opinion of management, the
consolidated financial statements reflect all adjustments (which consist of
normal recurring accruals) necessary for a fair presentation of the results for
the unaudited periods. The preparation of these financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. 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.
The financial statements for all periods presented include the consolidated
accounts of ML Bancorp, Inc. ("ML Bancorp") which was acquired on February 28,
1998, Carnegie Bancorp ("Carnegie") and First Home Bancorp Inc. ("First Home")
which were both acquired on July 31, 1998. These transactions were each
accounted for under the pooling-of-interests method of accounting. The financial
statements for the period ended September 30, 1999 include the consolidated
accounts of Peoples Bancorp, Inc. ("Peoples") and The Network Companies
("Network") which were each accounted for as a purchase during June 1999. The
results of operations for the nine-month period ended September 30, 1999 are not
necessarily indicative of the results which may be expected for the entire year.
The consolidated financial statements should be read in conjunction with Form
10-K/A for the year ended December 31, 1998.
Allowance for Loan Losses
The adequacy of Sovereign's allowance for loan losses is regularly
evaluated. Management's evaluation of the adequacy of the allowance to absorb
loan losses takes into consideration the risks inherent in the loan portfolio,
past loan loss experience, specific loans which are currently criticized,
geographic and industry concentrations, delinquency trends, economic conditions,
the level of originations and other relevant factors. Management also considers
loan quality, changes in the size and character of the loan portfolio,
consultation with regulatory authorities, the amount of non-performing loans,
delinquency trends, economic conditions and industry trends when determining the
unallocated allowance. For additional information on Sovereign's allowance for
loan losses, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Allowance for Loan Losses."
-10-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(2) 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. In
calculating diluted earnings per share, the dilutive effect of options and
warrants is calculated using the treasury stock method, which uses the average
market price for the period. The dilutive effect of preferred stock continues to
be calculated using the if-converted method. On May 15, 1998, Sovereign redeemed
all outstanding shares of its 6 1/4% Cumulative Convertible Preferred Stock,
Series B.
The following table presents the computation of earnings per share for the
periods indicated (in thousands, except per share data).
<TABLE>
<CAPTION>
Three-Month Period Nine-Month Period
Ended September 30, Ended September 30,
---------------------- ----------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Basic Earnings Per Share:
Net income attributable to
common stock(1) $ 55,988 $ 34,790 $150,078 $ 91,288
-------- -------- -------- --------
Average basic shares outstanding
at end of period (3) 180,902 158,907 166,548 150,711
======== ======== ======== ========
Basic earnings per share (2) (3) $ .31 $ .22 $ .90 $ .61
======== ======== ======== ========
Diluted Earnings Per Share:
Net income (1) $ 55,988 $ 34,790 $150,078 $ 92,784
-------- -------- -------- --------
Average diluted shares outstanding
at end of period (3) 180,902 158,907 166,548 157,765
Dilutive effect of average stock
options, net of shares assumed to
be repurchased under the treasury
stock method (3) 1,876 2,617 2,134 3,348
-------- -------- -------- --------
Total average diluted shares
outstanding at end of period (3) 182,778 161,524 168,682 161,113
======== ======== ======== ========
Diluted earnings per share (2)(3) $ .31 $ .22 $ .89 $ .58
======== ======== ======== ========
</TABLE>
(1) Results for the three-month and nine-month periods ended September 30, 1998
include a one-time, merger charge of $7.8 million (after-tax) related to
Sovereign's acquisitions of Carnegie and First Home during the third quarter
of 1998. Results for the nine-month period ended September 30, 1998 also
include a merger-related charge of $25.5 million (after-tax) and losses from
non-recurring sales of held-to-maturity securities of $0.3 million
(after-tax) related to Sovereign's acquisition of ML Bancorp during the
first quarter of 1998.
(2) Results for the three-month and nine-month periods ended September 30, 1998
include, merger-related charges described in Note 1 above. Excluding the
merger-related charges, basic earnings per share for the three-month and
nine-month periods ended September 30, 1998 were $.27 and $.83, and diluted
earnings per share for the same periods were $.27 and $.79.
(3) All share data has been adjusted to reflect all stock dividends and stock
splits.
-11-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(3) INVESTMENT SECURITIES AVAILABLE-FOR-SALE
The following table presents the composition and fair value of investment
securities available-for-sale at the dates indicated: (dollars in thousands)
<TABLE>
<CAPTION>
September 30, 1999
--------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
--------- ------------ ------------ -----
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 76,390 $ 4 $ 731 $ 75,663
Non-U.S. Treasury and
government agency
securities -- -- -- --
Corporate securities 226,295 3,700 6,252 223,743
Asset backed securities 720,016 467 10,911 709,572
Equities 34,812 82 5,781 29,113
FHLB stock 425,237 -- -- 425,237
Agency preferred stock 425,888 3,515 -- 429,403
Municipal securities 32,619 454 1,273 31,800
Mortgage-backed Securities:
Passthroughs:
U.S. government agencies 491,104 1,062 15,288 476,878
Non-agencies 2,911,412 3,382 108,160 2,806,634
Collateralized mortgage
obligations 3,623,211 5,118 76,140 3,552,189
---------- ---------- ---------- ----------
Total investment and
mortgage-backed securities
available-for-sale $8,966,984 $ 17,784 $ 224,536 $8,760,232
========== ========== ========== ==========
</TABLE>
-12-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(3) INVESTMENT SECURITIES AVAILABLE-FOR-SALE (continued)
<TABLE>
<CAPTION>
December 31, 1998
-----------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ ----------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 23,480 $ 1 $ -- $ 23,481
Non-U.S. Treasury and
government agency
securities 12,000 -- 63 11,937
Corporate securities 40,784 1,627 121 42,290
Asset backed securities 193,154 45 897 192,302
Equities 54,383 5,381 9,654 50,110
FHLB stock 345,324 -- -- 345,324
Agency preferred stock 456,861 9,856 5 466,712
Municipal securities 34,609 1,066 629 35,046
Mortgage-backed Securities:
Passthroughs:
U.S. government agencies 168,840 1,951 335 170,456
Non-agencies 1,969,322 15,976 5,510 1,979,788
Collateralized mortgage
obligations 3,335,794 11,168 1,981 3,344,981
---------- ---------- ---------- ----------
Total investment and
mortgage-backed securities
available-for-sale $6,634,551 $ 47,071 $ 19,195 $6,662,427
========== ========== ========== ==========
</TABLE>
-13-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(4) INVESTMENT SECURITIES HELD-TO-MATURITY
The following table presents the composition and fair value of investment
securities held-to-maturity at the dates indicated: (dollars in thousands)
<TABLE>
<CAPTION>
September 30, 1999
----------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ ----------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 500 $ -- $ 3 $ 497
Non-U.S. Treasury and
government agency
securities 1,000 2 -- 1,002
Corporate securities 38,379 2,244 2 40,621
Municipal securities 3,872 114 18 3,968
Mortgage-backed Securities:
Passthroughs:
U.S. government agencies 531,195 3,315 749 533,761
Non-agency 54,148 1,165 136 55,177
Collateralized mortgage
obligations 513,555 1,373 16,984 497,944
---------- ---------- ---------- ----------
Total investment securities
held-to-maturity $1,142,649 $ 8,213 $ 17,892 $1,132,970
========== ========== ========== ==========
<CAPTION>
December 31, 1989
----------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ ----------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 17,196 $ 32 $ 78 $ 17,150
Non-U.S. Treasury and
government agency
securities 13,983 119 -- 14,102
Corporate securities 42,249 3,526 26 45,749
Municipal securities 8,064 165 -- 8,229
Mortgage-backed Securities:
Passthroughs:
U.S. government agencies 715,558 14,113 285 729,386
Non-agency 74,523 1,165 136 75,552
Collateralized mortgage
obligations 968,082 4,541 2,208 970,415
---------- ---------- ---------- ----------
Total investment securities
held-to-maturity $1,839,655 $ 23,661 $ 2,733 $1,860,583
========== ========== ========== ==========
</TABLE>
-14-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(5) COMPOSITION OF LOAN PORTFOLIO
The following table presents the composition of the loan portfolio by type
of loan and by fixed and adjustable rates at the dates indicated: (dollars in
thousands)
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
--------------------------- --------------------------
Amount Percent Amount Percent
------ ------- ------ -------
<S> <C> <C> <C> <C>
Residential real estate loans $ 5,535,876 41.2% $ 5,113,537 45.3%
Residential construction loans 59,115 .4 62,536 .6
----------- ------ ----------- ------
Total Residential Loans 5,594,991 41.6 5,176,073 45.9
----------- ------ ----------- ------
Commercial real estate loans 1,237,148 9.2 887,938 7.9
Commercial and industrial loans 1,296,099 9.6 717,440 6.4
Automotive floor plan loans 835,944 6.2 578,147 5.1
Multi-family loans 128,075 1.0 115,195 1.0
----------- ------ ----------- ------
Total Commercial Loans 3,497,266 26.0 2,298,720 20.4
----------- ------ ----------- ------
Home equity loans 1,888,351 14.1 1,750,883 15.5
Auto loans 1,880,827 14.0 1,510,676 13.4
Loans to automotive lessors 275,589 2.1 252,856 2.2
Student loans 248,227 1.9 256,744 2.3
Other 35,274 .3 39,888 .3
----------- ------ ----------- ------
Total Consumer Loans 4,328,268 32.4% 3,811,047 33.7%
----------- ------ ----------- ------
Total Loans (1) $13,420,525 100.0% $11,285,840 100.0%
=========== ====== =========== ======
Total Loans with: (2)
Fixed rates $ 8,196,644 61.1% $ 5,798,158 51.4%
Variable rates 5,223,881 38.9 5,487,682 48.6
----------- ------ ----------- ------
Total Loans (1) $13,420,525 100.0% $11,285,840 100.0%
=========== ====== =========== ======
</TABLE>
(1) Loan totals are net of deferred loan fees and unamortized premiums and
discounts of $25.0 million at September 30, 1999 and $16.9 million at
December 31, 1998.
(2) Loan totals do not reflect the impact of off-balance sheet interest rate
swaps used for interest rate risk management as discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Loan Portfolio."
-15-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(6) DEPOSIT PORTFOLIO COMPOSITION
The following table presents the composition of deposits at the dates
indicated: (dollars in thousands)
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
--------------------------------- ------------------------------------
Weighted Weighted
Average Average
Account Type Amount Percent Rate Amount Percent Rate
------------ ------ ------- -------- ------ ------- --------
<S> <C> <C> <C> <C>
Demand deposit accounts $ 1,055,830 8.9% - % $ 1,104,170 9.0% - %
NOW accounts 1,668,028 14.0 2.36 1,281,516 10.4 1.24
Savings accounts 2,125,547 17.9 2.58 2,295,448 18.6 2.83
Money market accounts 1,332,247 11.2 3.84 1,545,634 12.5 3.78
Retail certificates 4,769,210 40.1 4.91 5,172,196 42.0 5.24
Jumbo certificates 932,239 7.9 5.37 923,752 7.5 5.40
----------- ----- ---- ----------- ----- ----
Total Deposits $11,883,101 100.0% 3.61% $12,322,716 100.0% 3.73%
=========== ===== ==== =========== ===== ====
</TABLE>
(7) BORROWINGS
The following table presents information regarding borrowings at the dates
indicated: (dollars in thousands)
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
----------------------- ----------------------
Weighted Weighted
Average Average
Balance Rate Balance Rate
------- -------- ------- --------
<S> <C> <C> <C> <C>
Securities sold under
repurchase agreements $ 2,809,376 5.47% $ 655,540 5.46%
FHLB advances 8,493,382 5.25 6,901,505 5.14
Other borrowings 392,191 7.54 343,547 8.19
----------- ----- ---------- -----
Total Borrowings $11,694,949 5.38% $7,900,592 5.30%
=========== ===== ========== =====
</TABLE>
-16-
<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 primarily used to limit the
exposure from the repricing and maturity of liabilities. Interest rate floors
are primarily used to limit the exposure from repricing and maturity of assets.
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>
September 30, 1999
-----------------------------------------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
-------- ----- ---------- ---------
<S> <C> <C> <C>
Amortizing interest rate swaps:
Pay fixed-receive variable $ -- $ -- $ -- --
Non-amortizing interest rate swaps:
Pay variable-receive fixed (1) 232,300 -- 8,039 6.6
Pay fixed-receive variable (2) 500,000 -- (3,455) 1.9
Interest rate caps/floors(4) 1,200,000 5,156 (1,673) 2.7
---------- ------ -------
$1,932,300 $5,156 $ 2,911
========== ====== =======
<CAPTION>
December 31, 1998
-----------------------------------------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
-------- ----- ---------- ---------
<S> <C> <C> <C>
Amortizing interest rate swaps:
Pay fixed-receive variable (3) $ 175,164 $ -- $ (617) .3
Non-amortizing interest rate swaps:
Pay variable-receive fixed -- -- --
Pay fixed-receive variable (2) 2,780,000 -- (48,382) 4.8
Interest rate caps/floors (4) 1,200,000 7,213 ( 6,756) 3.2
---------- ------ ---------
$4,155,164 $7,213 $(55,755)
========== ====== =========
</TABLE>
-17-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(1) The weighted average pay rate was 6.97% and the weighted average receive
rate was 7.83% at September 30, 1999.
(2) The weighted average pay rate was 5.60% and 5.42% and the weighted average
receive rate was 5.36% and 5.26% at September 30, 1999 and December 31,
1998, respectively.
(3) The weighted average pay rate was 6.87% and the weighted average receive
rate was 5.99% at December 31, 1998.
(4) The strike price range was 5.25% - 9.00% at September 30, 1999 and 5.25% -
9.00% at December 31, 1998.
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/ September 30,
1998 Additions Amortization Terminations 1999
----------- ----------- ------------ ------------ --------------
<S> <C> <C> <C> <C> <C>
Amortizing interest
rate swaps $ 175,164 $ -- $ 175,164 $ -- $ --
Non-amortizing interest
rate swaps 2,780,000 332,300 370,000 2,010,000 732,300
Interest rate
caps/floors 1,200,000 -- -- -- 1,200,000
---------- ---------- ---------- ---------- ----------
$4,155,164 $ 332,300 $ 545,164 $2,010,000 $1,932,300
========== ========== ========== ========== ==========
</TABLE>
Net interestexpense resulting from interest rate exchange agreements for
the three and nine-month periods ended September 30, 1999 was $1.4 million and
$8.0 million, respectively.
-18-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(9) ACQUISITIONS
On September 4, 1998, Sovereign acquired 93 former CoreStates Financial
Corp. ("CoreStates") branch offices from First Union Corporation ("First
Union"). The former CoreStates offices are located throughout Pennsylvania and
New Jersey and added approximately $2.2 billion of commercial bank deposits and
$725 million of commercial and consumer loans to Sovereign's balance sheet. The
transaction was accounted for as a purchase. Sovereign paid a premium of $325
million for the CoreStates branches, of which $226 million was allocated to a
core deposit intangible and of which $99 million was allocated to goodwill.
Additionally, Sovereign established an initial loan loss reserve of $20.5
million in connection with the loans acquired from CoreStates. The goodwill and
core deposit intangible are being amortized over approximately 25 years and 10
years, respectively. Sovereign's results of operations include the operations of
the aforementioned branches from September 4, 1998 and thereafter.
On June 30, 1999, Sovereign acquired Peoples Bancorp, Inc. ("Peoples"), a
$1.4 billion bank holding company headquartered in Lawrenceville, New Jersey
whose principal operating subsidiary operated 14 community banking offices in
Mercer, Burlington and Ocean counties, New Jersey. The transaction added
investments, loans, deposits and stockholders' equity to Sovereign of
approximately $922 million, $503 million, $515 million and $291 million,
respectively. In accordance with the merger agreement, Peoples' shareholders
received .80 shares of Sovereign common stock for each outstanding share of
Peoples common stock. Sovereign issued approximately 23.6 million shares of
Sovereign common stock in connection with the transaction, which was accounted
for as a purchase. In connection with the transaction, Sovereign recorded total
intangibles of $49.0 million, of which $9.8 million was allocated to a core
deposit intangible and $39.2 million was allocated to goodwill.
On June 15, 1999, Sovereign acquired The Network Companies ("Network"), a
privately held specialty leasing company headquartered in Commack, New York.
Network provides financing for the purchase or lease of equipment and specialty
vehicles plus other specialty products for businesses throughout the United
States, with transactions ranging from $15,000 to $250,000. The purchase price
of $6 million consisted of $4 million of stock and $2 million of cash. The
acquisition was accounted for as a purchase for reporting purposes and became a
division of Sovereign Bank. Network had total assets of approximately $50
million.
On September 7, 1999, Sovereign announced its pending acquisition of $11.9
billion in deposits and 268 branches from Fleet Boston. Also included in the
transaction are $8.0 billion of loans, the lending and operating personnel to
run the branches and loan businesses as well as the operating infrastructure
necessary to maintain the business base. On a pro forma basis including this
acquisition, Sovereign will have the third largest market share in New England
and among the largest small business lenders in the region. Sovereign is
acquiring virtually all of the Fleet Boston offices in the eastern half of
Massachusetts and southern New Hampshire (189 offices), the community banking
network of the former Rhode Island Hospital Trust in Rhode Island (47 offices)
and 32 offices of Fleet Boston in the Hartford, New Haven and Waterbury
communities of Connecticut. Sovereign expects the transaction to be completed by
midway through the year 2000.
-19-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(10) COMPREHENSIVE INCOME
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)
<TABLE>
<CAPTION>
Three-Month Period Nine-Month Period
Ended September 30, Ended September 30,
------------------------- -------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net income $ 55,988 $ 34,790 $ 150,078 $ 92,784
--------- --------- --------- ---------
Unrealized losses on
securities during the year (56,110) (6,095) (150,283) (3,367)
Less reclassification adjustment 664 (2,411) 2,271 (241)
--------- --------- --------- ---------
Net unrealized (losses)
recognized in other comprehensive
income (56,774) (3,684) (152,554) (3,126)
--------- --------- --------- ---------
Comprehensive income/(loss) (1) $ (786) $ 31,106 $ (2,476) $ 89,658
========= ========= ========= =========
</TABLE>
(1) Excluding merger-related and special charges, comprehensive income for the
three-month and nine-month periods ended September 30, 1998 was $39.1
million and $123.50 million, respectively.
Accumulated other comprehensive income, net of related tax, consisted of
net unrealized losses on securities of $134 million at September 30, 1999 and
net unrealized gains on securities of $18.1 million at December 31, 1998.
-20-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(11) RECENT DEVELOPMENTS
The Year 2000 Computer Issue. The Year 2000 ("Y2K") computer issue refers
to the inability of many computers, computer-based systems, related software,
and other electronics to process dates accurately during the year 2000 and
beyond. Many of these computers, systems, software programs and devices use only
two digits to indicate the year. For example, the year 1998 is input, stored and
calculated as "98." The year 2000 will in many systems and software programs be
represented as "00," but "00" can also be read as 1900. This ambiguity may cause
errors which may cause the computer, system or device to fail completely, cause
programs to operate incorrectly, or slowly corrupt or contaminate data over
time. These problems may arise both in information systems used for data storage
and processing, and in connection with mechanical systems such as bank vaults,
elevators, escalators, heating, ventilating and air conditioning systems, and
other systems which use embedded microprocessors as timers or for other
purposes.
Sovereign's State of Readiness. Sovereign's Y2K readiness project has five
phases:
Inventory - identification of the computers, software, systems and
devices used by Sovereign and the business applications to which such
computers, programs, systems and devices are devoted.
Assessment - analyzing those computers, software, systems, devices and
related applications with a view to determining if they store or process
date information in a manner which will avoid millennial errors of the type
described above, the risks resulting from any such errors and prioritizing
them based on how critical they are to Sovereign's business operations.
Remediation - modification or replacement of deficient computers,
programs, systems and devices to the extent such deficiency poses material
risk to Sovereign.
Testing - the modified or new computers, software or systems are
tested to determine if they operate and interoperate in a manner which
should reduce risk to an acceptable level. Items are addressed in
accordance with the priorities given to them in the Assessment Phase.
Implementation - bringing the new or changed computers, software,
systems and electronics on line.
Sovereign is currently in the implementation phase. Sovereign had
substantially completed testing of its internal mission-critical items as of
December 31, 1998 and had substantially completed testing of its external
mission critical items as of March 31, 1999. "Internal" items would include
software developed by Sovereign or the remediation of which is controlled by
Sovereign, whereas external items would include software provided by others, and
systems provided by Sovereign's service providers. As of June 30, 1999,
Sovereign had completed the implementation phase for all mission-critical items,
and as of September 30, 1999, Sovereign is performing additional testing on
certain non-mission-critical systems.
-21-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
The description set forth above applies to both information technology
("IT") systems and non-IT systems, such as embedded microprocessors.
As part of its Y2K project, Sovereign has also endeavored to analyze the
risks posed to it by its material borrowers according to regulatory guidelines.
Borrowers whose businesses have been determined by Sovereign to be subject to
material levels of risk from Y2K computer problems have been questioned
regarding their own state of readiness. Sovereign has similarly questioned
providers of funds and substantial vendors and suppliers. Vendors whom Sovereign
considers to be critical to Sovereign's operations have been asked, in addition,
to provide Sovereign with assurances and other evidence as to their Y2K
readiness.
Costs. Sovereign has established a budget for its Y2K project costs, which
covers the estimated costs of remediation, including modification or replacement
of systems and software, utilization of outside consultants, and costs of
internal personnel. Based on Sovereign's current assessment of its Y2K project
status, the amount of this budget is $13.5 million for fiscal 1998 and 1999.
Sovereign is using its internal funds for this project.
Sovereign's expenditures with regard to its Y2K project are substantially
in accordance with its current budget. Through October 10, 1999, Sovereign's
cash outlay was approximately $13.1 million of its $13.5 million budget.
Sovereign's estimates are, of necessity, judgmental and subject to revision
based on the results of the testing referred to above and other changed facts or
circumstances, including changes in Sovereign's assessment of the state of
readiness and contingency plans of its principal outside service providers.
Risks. Sovereign believes, based on the advice of its consultants, that the
most reasonably likely worst case Y2K scenario relates to its principal outside
service providers, substantially all of which are large, seasoned, national
companies experienced in serving financial institutions. Sovereign depends on
these service providers for substantially all of its data processing needs
relating to its account processing, item processing and other important
functions. Sovereign is requiring material providers to provide evidence and
other assurance of this compliance and/or their progress towards compliance, as
well as their contingency plans. Certain of these service providers are also
subject to the jurisdiction of the regulatory bodies which have jurisdiction
over Sovereign. Those regulatory bodies are examining the service providers with
respect to Y2K readiness using the same standards and deadlines as the
regulators use to examine financial institutions and Sovereign has reviewed the
results of certain of these examinations to assist in assessing the state of
readiness and contingency plans of such providers. Based on all of the
foregoing, Sovereign believes that (i) its providers will be substantially Y2K
compliant and (ii) have adequate contingency plans to address compliance.
Notwithstanding the foregoing, no assurances can be given that a service
providers' system or software will not fail and, if not, that such failure will
not have a material adverse effect on Sovereign or its business. Sovereign is
presently in the process of developing contingency plans to deal with issues
relating to the failure of system segments.
-22-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
In addition, utility services, which are generally beyond Sovereign's
control, may present a significant Y2K risk. In particular, disruption of
telecommunication and electric utility service because of a Y2K related problem
(or otherwise) could interfere significantly with Sovereign's operations, even
if Sovereign and its service providers and customers, and their computers,
systems, and software, are fully Y2K compliant.
The foregoing is a summary of the steps which Sovereign has taken as of
September 30, 1999 and proposed to take as of that date with respect to the Y2K
issue, and the risks which Sovereign, at this time, believes the Y2K issues are
likely to present. Sovereign is using good faith efforts, which it believes are
reasonable, to prepare for the Y2K issue and avoid disruption in its business.
Nonetheless, the Y2K issue presents an unprecedented challenge to the financial
services industry, an industry characterized by a high degree of interdependence
among financial institutions and those who deal with and service them, such as
outside data processing services, computer network system providers, local and
long distance telecommunications companies, utilities, and ATM terminal service
providers. Whether these outside parties are ready for the year 2000 is largely
beyond Sovereign's control. Accordingly, there can be no assurance that (i)
Sovereign's assessment of the Y2K risks will prove to be correct; (ii) the steps
Sovereign is taking will be sufficient to avoid disruption to its business and
other material risks; (iii) the foregoing will not ultimately have a material
adverse effect on Sovereign and its business.
On November 8 and 9, 1999, Sovereign secured the following financing in
connection with its pending acquisition of $11.9 billion in deposits and 268
branches from Fleet Boston.
On November 8, 1999, Sovereign issued 38,095,238 shares of Sovereign common
stock resulting in net proceeds to Sovereign of $288.8 million.
On November 8, 1999, Sovereign issued $250 million of trust preferred
income equity redeemable securities ("Trust Preferred") at an interest rate of
7 1/2%, with a scheduled maturity of January 15, 2030 resulting in net proceeds
to Sovereign of $242.5 million. Each Trust Preferred unit consists of a
preferred security issued by Sovereign Capital Trust II (the "Trust"), having a
stated liquidation amount of $50, representing an undivided beneficial ownership
interest in the assets of the Trust, which assets consist solely of debentures
issued by Sovereign. In addition, each Trust Preferred unit consists of a
warrant to purchase at any time prior to November 20, 2029, 5.3355 shares,
subject to antidilution adjustments, of Sovereign common stock.
On November 9, 1999, Sovereign issued $200 million of 10 1/4% senior notes
due 2004 and $500 million of 10 1/2% senior notes due 2006 resulting in net
proceeds to Sovereign of $682.5 million. The senior notes are unsecured senior
obligations of Sovereign and will rank equally with all existing and future
senior indebtedness.
On December 3, 1999, Sovereign will issue $500 million of a floating rate
senior secured credit facility resulting in net proceeds to Sovereign of $493
million. The senior facility will mature on the date six months prior to the
maturity date of the senior notes, but in no event later than June 30, 2003, and
will amortize in quarterly installments over such period.
-23-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
RESULTS OF OPERATIONS
General
Net income for the three-month period ended September 30, 1999 was $56
million compared to net income of $34.8 million for the same period in 1998.
Diluted earnings per share for the three-month periods ended September 30, 1999
and 1998 were $.31 and $.22, respectively. Net income for the nine-month periods
ended September 30, 1999 and 1998, was $150 million and $92.8 million,
respectively and diluted earnings per share for the same periods were $.89 and
$.58, respectively.
Net operating income, defined as net income before the after-tax effect of
merger-related and special charges described below, for the three-month and
nine-month periods ended September 30, 1999 was $56 million and $150 million
compared to net operating income of $42.8 million and $126 million for the same
periods in 1998. Diluted operating earnings per share for the three-month and
nine-month periods ended September 30, 1999 and 1998 were $.31 and $.89 and $.27
and $.79, respectively. Merger-related charges of $10.9 million ($7.8 million
after-tax) related to Sovereign's acquisition of Carnegie Bancorp and First Home
Bancorp were incurred during the third quarter of 1998. Merger related charges
of $39.1 million ($25.5 million after-tax) and losses from non-recurring sales
of held-to-maturity securities of $0.5 million ($0.3 million after-tax) related
to Sovereign's acquisition of ML Bancorp, Inc. were incurred during the first
quarter of 1998. Expenses included as part of the merger-related charges
consisted of human resources-related costs and other expenses, including
investment banking fees and legal expenses.
Return on average equity, return on average tangible equity and return on
average total assets, excluding the merger-related and special charges discussed
above were 15.73%, 25.68% and .86% for the nine-month period ended September 30,
1999 compared to 15.87%, 19.20% and .90% for the same period in 1998. Average
equity to average total assets for the nine-month period ended September 30,
1999 and 1998 was 5.48% and 5.66%, respectively.
Net Interest Income
Net interest income for the three-month and nine-month periods ended
September 30, 1999 was $162 million and $449 million compared to $121 million
and $361 million for the same periods in 1998. This increase was attributable to
an increase in average balances resulting from internal commercial and consumer
loan growth and recent acquisitions. Sovereign's net interest margin (net
interest income divided by average interest-earning assets) for the three-month
and nine-month periods ended September 30, 1999 was 2.95% and 2.88% compared to
2.73% and 2.80% for the same periods in 1998.
-24-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Interest on investment securities available-for-sale was $144 million and
$396 million for the three-month and nine-month periods ended September 30, 1999
compared to $85.4 million and $187.8 million for the same periods in 1998. The
average balance of investment securities available-for-sale was $7.9 billion
with an average yield of 6.78% for the nine-month period ended September 30,
1999 compared to an average balance of $3.8 billion with an average yield of
6.78% for the same period in 1998. The increase in the average balance of
investment securities available-for-sale was partially due to a decision by
management to increase balance sheet flexibility by placing more investments
into available-for-sale.
Interest on investment securities held-to-maturity was $20.8 million and
$72.9 million for the three-month and nine-month periods ended September 30,
1999 compared to $38.3 million and $148 million for the same periods in 1998.
The average balance of investment securities held-to-maturity was $1.4 billion
with an average yield of 6.98% for the nine-month period ended September 30,
1999 compared to an average balance of $2.7 billion with an average yield of
7.26% for the same period in 1998.
Interest and fees on loans were $250 million and $689 million for the
three-month and nine-month periods ended September 30, 1999 compared to $216
million and $657 million for the same periods in 1998. The average balance of
loans was $12.0 billion with an average yield of 7.64% for the nine-month period
ended September 30, 1999 compared to an average balance of $11.1 billion with an
average yield of 7.87% for the same period in 1998.
Interest on deposits was $107 million and $321 million for the three-month
and nine-month periods ended September 30, 1999 compared to $113 million and
$319 million for the same periods in 1998. The average balance of deposits was
$12.0 billion with an average cost of 3.56% for the nine-month period ended
September 30, 1999 compared to an average balance of $10.2 billion with an
average cost of 4.20% for the same period in 1998. The increase in average
balance and the decrease in the average cost of deposits was primarily the
result of Sovereign's acquisition of approximately $2.2 billion of low-cost
deposits from the CoreStates branch acquisition during the third quarter of 1998
and strong internal core deposit growth in NOW accounts, with major emphasis on
attracting lower-cost deposits from corporations, governmental units and
consumers.
-25-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Interest on borrowings was $147 million and $392 million for the
three-month and nine-month periods ended September 30, 1999 compared to $108
million and $318 million for the same periods in 1998. The average balance of
borrowings was $9.8 billion with an average cost of 5.32% for the nine-month
period ended September 30, 1999 compared to an average balance of $7.4 billion
with an average cost of 5.69% for the same period in 1998. The increase in the
average balance and the decrease in the average cost of borrowings was the
result of balance sheet growth being funded by borrowings, and balance sheet
restructuring made in advance of the pending acquisition of assets and
liabilities from Fleet Boston. During the nine-month period ended September 30,
1999, Sovereign funded its balance sheet growth through borrowings as its cost
of borrowings was lower than the overall cost of retail certificates of deposit.
Net interest expense of $1.4 million and $8.0 million was recorded for the
three and nine-month periods ended September 30, 1999 as a result of interest
rate exchange agreements.
Provision for Possible Loan Losses
Over the last few years, through several strategic acquisitions and
internal restructuring initiatives, Sovereign has diversified its lending
efforts and increased its emphasis on providing its customers with small
business loans and an expanded line of commercial and consumer products, such as
asset-based lending, cash management services and automobile loans. As a result
of the increased risk inherent in these loan products and as Sovereign continues
to place emphasis on small business and consumer lending in future years,
management will regularly evaluate its loan portfolio and record additional loan
loss reserves as is necessary. Historically, Sovereign's additions to its loan
loss reserve (through income statement charges and acquisition accounting) have
been sufficient to absorb the incremental credit risk in its loan portfolio.
Excluding charge-offs of $4.3 million incurred as part of an accelerated
disposition of non-performing residential loans during the second quarter of
1999, provisioning is in excess of net charge-offs for the nine-month period
ended September 30, 1999. In Sovereign's experience, a strategy that involves
the accelerated resolution of problem assets is more appropriate than a
long-term workout approach. 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."
Sovereign's net charge-offs for the nine-month period ended September 30,
1999 were $26.5 million and consisted of charge-offs of $41.5 million and
recoveries of $14.9 million. This compared to net charge-offs of $24.6 million,
or .29% of average loans (on an annualized basis), consisting of charge-offs of
$33.4 million and recoveries of $8.8 million for the nine-month period ended
September 30, 1998. Excluding the accelerated disposition mentioned above,
Sovereign's net charge-offs for the nine-month period ended September 30, 1999
were $22.2 million, or .25% of average loans (on an annualized basis), and
consisted of charge-offs of $37.2 million and recoveries of $14.9 million.
Sovereign's higher level of net charge-offs during 1998 versus 1999 was
primarily the result of higher indirect automobile loan charge-offs,
substantially all of which are related to Sovereign's acquisition of Fleet
Financial Group, Inc.'s Auto Finance Division during 1997.
-26-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The provision for loan losses for the three-month and nine-month periods
ended September 30, 1999 was $7.5 million and $22.5 million compared to $7.0
million and $21.0 million for the same periods in 1998. Management believes the
increase in provision for loan losses for the three and nine-month periods ended
September 30, 1999 was sufficient for the following reasons: (1) delinquency and
net charge-off levels related to Sovereign's indirect automobile portfolio are
at lower levels in 1999 versus 1998; (2) changes in Sovereign's underwriting and
audit monitoring processes has enhanced the credit quality of certain
portfolios; and (3) a higher percentage in 1999 versus 1998 of Sovereign's
indirect auto and commercial loan portfolios represent internally generated
loans underwritten using Sovereign's credit policies.
-27-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table presents the activity in the allowance for possible
loan losses for the periods indicated: (dollars in thousands)
Nine-month Period Ended September 30,
1999 1998
-------------------------------------
Allowance, beginning of period $ 133,802 $ 116,823
Charge-offs:
Residential(1) 10,682 5,139
Commercial Real Estate 680 625
Commercial 2,366 1,485
Consumer(2) 27,742 26,137
--------- ---------
Total Charge-offs 41,470 33,386
--------- ---------
Recoveries:
Residential 1,469 693
Commercial Real Estate 458 51
Commercial 426 144
Consumer(2) 12,589 7,935
--------- ---------
Total Recoveries 14,942 8,823
--------- ---------
Charge-offs, net of recoveries 26,528 24,563
Provision for possible loan losses 22,500 20,961
Other 4,799 22,661
--------- ---------
Allowance, end of period $ 134,573 $ 135,882
========= =========
- ---------------------
(1) Results for the nine-month period ended September 30, 1999 include
charge-offs of $4.3 million related to a June 1999 accelerated disposition
of non-performing residential loans.
(2) Includes indirect auto loans and home equity lines of credit.
Other Income
Other income was $35.0 million and $101 million for the three-month and
nine-month periods ended September 30, 1999 compared to $25.7 million and $73.3
million for the same periods in 1998.
-28-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Retail banking fees were $13.8 million and $35.6 million for the
three-month and nine-month periods ended September 30, 1999 compared to $7.9
million and $21.7 million for the same periods in 1998. This increase was
primarily due to an increase in the number of Sovereign's transaction accounts
and active fee collection efforts due in part to customer relationships acquired
in the CoreStates and Peoples acquisitions.
Mortgage banking revenues were $7.4 million and $26.3 million for the
three-month and nine-month periods ended September 30, 1999 compared to $6.4
million and $21.0 million for the same periods in 1998. Sovereign serviced $10.2
billion of its own loans and $6.5 billion of loans for others at September 30,
1999 compared to $9.3 billion of its own loans and $6.2 billion of loans for
others at September 30, 1998.
Loan fees and service charges were $2.7 million and $6.0 million for the
three-month and nine-month periods ended September 30, 1999 compared to $1.8
million and $5.0 million for the same periods in 1998. Loan fees and service
charges relate primarily to Sovereign's non-residential loan portfolios, and the
growth period to period is the result in the commercial and consumer loan
portfolios.
Gains/(losses) on sales of loans and investment securities
available-for-sale were $(.3) million and $6.5 million for the three-month and
nine-month periods ended September 30, 1999 compared to $6.3 million and $12.4
million for the same periods in 1998.
Miscellaneous income was $11.4 million and $26.1 million for the
three-month and nine-month periods ended September 30, 1999 compared to $3.4
million and $13.2 million for the same periods in 1998. This increase was
primarily due to an additional investment in bank-owned life insurance ("BOLI")
which was made during the first quarter of 1999, and a interest rate swap
termination gain of approximately $2.3 million recorded during the third quarter
of 1999 as a result of refinancing certain borrowings.
General and Administrative Expenses
Total general and administrative expenses were $90.8 million and $260
million for the three-month and nine-month periods ended September 30, 1999
compared to $66.4 million and $196 million for the same periods in 1998.
Sovereign's efficiency ratio (all general and administrative expenses as a
percentage of net interest income and recurring non-interest income) for the
three-month and nine-month periods ended September 30, 1999 was 46.3% and 47.5%
compared to 45.2% and 45.5% for the same periods in 1998. The increase in
general and administrative expenses for the three-month and nine-month periods
ended September 30, 1999 was primarily due to Sovereign's franchise growth and
included the effect of the CoreStates acquisition for the full nine-months ended
September 30, 1999 as well as the acquisition of Peoples and Network during the
third quarter of 1999. These acquisitions significantly impacted Sovereign's
compensation and occupancy expenses. The remaining expenses are related to
Sovereign's Year 2000 and other technology initiatives and expansion in its
corporate banking business line.
-29-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Other operating expenses were $13.0 million and $37.2 million for the
three-month and nine-month periods ended September 30, 1999 compared to $18.6
million and $70.5 million for the same periods in 1998. Results for the
three-month and nine-month periods ended September 30, 1999 included
amortization of goodwill of $10.0 million and $28.0 million compared to $5.0
million and $11.3 million for the same periods in 1998. Results for the
three-month period ended September 30, 1998 included merger-related charges of
$10.9 million related to Sovereign's acquisition of First Home Bancorp and
Carnegie Bancorp during the quarter. Results of the nine-month period ended
September 30, 1998 included merger-related charges of $49.9 million related to
Sovereign's acquisition of ML Bancorp during the first quarter of 1998 and of
First Home Bancorp and Carnegie Bancorp during the third quarter of 1998.
Income Tax Provision
The income tax provision was $29.5 million and $79.4 million for the
three-month and nine-month periods ended September 30, 1999 compared to $20.2
million and $54.2 million for the same periods in 1998. The effective tax rate
for the three-month and nine-month periods ended September 30, 1999 was 34.5%
and 34.6%, respectively, compared to 36.7% and 36.9% for the same periods in
1998. The decrease in the effective tax rate for 1999 versus 1998 was primarily
attributable to the favorable impact of Sovereign's additional investment in
BOLI during the first quarter of 1999.
FINANCIAL CONDITION
Loan Portfolio
At September 30, 1999, Sovereign's total loan portfolio included $5.5
billion of first mortgage loans secured primarily by liens on owner-occupied
one-to-four family residential properties compared to $5.1 billion at December
31, 1998. With its increased focus on non-residential lending and certain
acquisition activity, Sovereign's total loan portfolio also included $3.5
billion of commercial loans and $4.3 billion of consumer loans at September 30,
1999. Consumer loans included $1.9 billion of outstanding home equity loans
(excluding $582 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 and $1.9 billion of auto loans. This compares to
$2.3 billion of commercial loans and $3.8 billion of consumer loans, including
$1.8 billion of outstanding home equity loans and $1.5 billion of auto loans at
December 31, 1998.
Over the past few years, Sovereign has increased its emphasis on commercial
and consumer loan originations. As a result, during the nine-month period ended
September 30, 1999, Sovereign originated $2.3 billion of commercial loans
(including lines of credit) compared to $800 million of commercial loans during
the same period in 1998. This increase was due to strong business loan demand in
Sovereign's market area resulting from a strong regional economy, recent bank
mergers affecting the region, and significant staffing increases in Sovereign's
commercial banking unit.
-30-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Sovereign originated $1.7 billion of consumer loans during the nine-month
period ended September 30, 1999 compared to $1.5 million of consumer loans
during the same period in 1998. This increase was primarily the result of strong
home equity and auto loan originations during the nine-month period ended
September 30, 1999.
During the nine-month period ended September 30, 1999, Sovereign closed
$2.3 million of first mortgage loans of which approximately 95% were fixed rate
and sold in the secondary market. This compares to first mortgage loan closings
of $1.5 million and approximately 91% of fixed rate loans for the same period in
1998.
At September 30, 1999, Sovereign's non-performing assets were $96.9 million
compared to $116 million at December 31, 1998 and non-performing assets as a
percentage of total assets were .38% at September 30, 1999 compared to .53% at
December 31, 1998.
At September 30,1999, 51% of non-performing assets consisted of loans
related to real estate or OREO. Another 6% of non-performing assets consisted of
indirect auto loans and other repossessed assets. The remainder of Sovereign's
non-performing assets consist principally of consumer loans, the majority of
which are secured by collateral. 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 and a 100% reserve allocation is assigned.
Repossessed autos carry a reserve allocation of 50%. At September 30, 1999, the
allowance for loan losses as a percentage of non-performing assets was 138%
compared to 112% at December 31, 1998.
-31-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table presents the composition of non-performing assets at
the dates indicated: (dollars in thousands)
September 30, December 31,
1999 1998
------------- ------------
Non-Accrual Loans:
Past due 90 days or more
as to interest or principal:
Real estate related $ 42,870 $ 63,258
Other 37,700 33,297
--------- ---------
Total Non-Accrual Loans 80,570 96,555
Other 2,757 3,404
Restructured Loans 3,755 141
--------- ---------
Total Non-Performing Loans 87,082 100,100
--------- ---------
Other Real Estate Owned and Other
Repossessed Assets:
Other real estate owned 6,761 12,812
Other repossessed assets 3,071 2,772
--------- ---------
Total Other Real Estate Owned and
Other Repossessed Assets 9,832 15,584
--------- ---------
TOTAL NON-PERFORMING ASSETS $ 96,914 $ 115,684
========= =========
Past due 90 days or more as to
interest or principal and
accruing interest (1) $ 7,930 $ 6,571
Non-Performing Assets as a
percentage of Total Assets .38% .53%
Non-Performing Loans as a
percentage of Total Loans .65% .86%
Non-Performing Assets as a
percentage of Total Loans
and Real Estate Owned .78% 1.05%
Allowance for Loan Losses
as a percentage of
Total Non-Performing Assets 138% 112%
Allowance for Loan Losses
as a percentage of
Total Non-Performing Loans 154% 129%
(1) Represents student loans which are government-guaranteed and Sovereign
retains minimal risk of credit losses related to these loans.
Amount excludes $1.0 million and $3.0 million at September 30, 1999 and
December 31, 1998 of auto loans past due between 90 and 120 days.
-32-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
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 $58.9 million at September 30, 1999 and consisted
principally of commercial and commercial real estate loans.
Sovereign closely monitors delinquencies as a means of maintaining high
asset quality. Collection efforts begin within 15 days after a loan payment is
missed. A predictive dialer is used to assist collection efforts in the early
stages of delinquency on the entire retail portfolio. An attempt is made to
contact all borrowers and to offer a variety of loss mitigation alternatives. If
these attempts fail, Sovereign will proceed to gain control of any and all
collateral in a timely manner in order to minimize losses. While liquidation and
recovery efforts continue, officers continue to work with the borrowers, if
appropriate, to recover all monies owed to Sovereign. Legal counsel is retained
when necessary. Sovereign monitors delinquency trends at 30, 60, and 90 days
past due. These trends are discussed at monthly Asset Review meetings.
The adequacy of Sovereign's allowance for loan losses is regularly
evaluated. Management's evaluation of the adequacy of the allowance to absorb
potential loan losses takes into consideration the risks inherent in the loan
portfolio, past loan loss experience, specific loans which have loss potential,
geographic and industry concentrations, delinquency trends, economic conditions,
the level of originations and other relevant factors. At September 30, 1999, the
allowance for loan losses was $135 million or 1.00% of total loans compared to
$134 million or 1.19% of total loans at December 31, 1998.
The following table presents the allocation of the allowance for loan
losses and the percentage of such allocation to each loan type at the dates
indicated: (dollars in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
---------------------------------------------------------
Percent Percent
Amount of Loans Amount of Loans
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Class allowances:
Commercial loans $ 22,242 17% $ 14,549 13%
Residential and commercial
real estate loans 18,652 51 13,690 54
Consumer loans 53,655 32 40,866 33
-------- --------
Total class allowances 94,549 69,105
Specific allowances:
Commercial loans 15,840 -- 16,191 --
Residential and commercial
real estate loans 13,483 -- 16,351 --
Consumer loans 6,495 -- 7,217 --
-------- --------
Total specific allowances 35,818 39,759
Unallocated allowances 4,206 -- 24,938 --
-------- ----- -------- -----
Total allowance for loan losses $134,573 100% $133,802 100%
======== ====== ======== ======
</TABLE>
-33-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Sovereign periodically reviews its loan portfolio and assigns a risk-rating
based on loan type, collateral value, financial condition of the borrower and
payment history. Delinquent mortgage and consumer loans are reviewed monthly and
assigned a rating based on their payment history, financial condition of the
borrower and collateral values. Specific mortgage and consumer loans are also
reviewed in conjunction with the previously described review of any related
commercial loan.
The following is a discussion on the different components of the allowance
for loan losses:
Class Allowance - The class allowance for September 30, 1999 and December
31, 1998 was a general allowance for "Pass" rated loans and was determined by
applying specific risk percentages to each "Pass" rated loan. The risk
percentages are determined by Sovereign in consultation with regulatory
authorities, actual loss experience, peer group loss experience and are adjusted
for current economic conditions. The risk percentages are considered a prudent
measurement of the risk of Sovereign's loan portfolio. Such risk percentages are
applied to individual loans based on loan type.
Residential Portfolio - Class reserves for the residential portfolio are 15
basis points of the portfolio and based on the fact that historical loan loss
risk associated with this product type has been minimal.
Consumer Portfolio - Consumer Portfolio class reserves are between the
range of 50 basis points of that portion of the consumer portfolio fully secured
by real estate and 150 basis points for the higher risk portions of its
portfolio. The class reserve for Sovereign's indirect auto loan portfolio
increased during 1998 due to higher than expected net charge-offs. In response
to the higher charge-offs, in the latter half of 1998 Sovereign revised its
indirect auto underwriting guidelines to reflect a more conservative lending
philosophy.
Commercial Portfolio - In addition to the specific reserves established for
loans within the commercial loan portfolio, Sovereign reserves in the range of
75 to 150 basis points of its remaining commercial loan portfolio, based on
product type and collateral value.
Specific Allowance - Sovereign determines the specific portion of its
allowance for loan losses for all criticized loans, or those classified as
special mention, sub-standard, doubtful, or loss. Risk percentages are applied
to each class of criticized commercial, consumer and residential loans to
determine the specific allowance. Additionally, specific reserves are
established for certain impaired commercial loans based on expected shortfalls
in future cash flows and inadequate collateral value. Management believes this
periodic review provides a mechanism that results in loans being rated in the
proper category and accordingly, assigned the proper risk loss percentage in
computing the class or specific reserve.
-34-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Unallocated Allowance - The unallocated allowance for loan losses decreased
$20.7 million to $4.2 million at September 30, 1999 from $24.9 million at
December 31, 1998. This decrease can be attributed to the aforementioned reasons
discussed in "Management's Discussion and Analysis of Financial Condition and
Operations - Provision for loan loss."
Impaired loans are summarized as follows (in thousands):
September 30, December 31,
1999 1998
------------- ------------
Impaired loans without a related reserve $ -- $ --
Impaired loans with a related reserve 73,166 63,296
--------- ---------
Total impaired loans $ 73,166 $ 63,296
========= =========
Reserve for impaired loans $ 16,296 $ 18,582
========= =========
The average balance of impaired loans for the nine-month periods ended
September 30, 1999 and 1998 was $73.7 million and $56.3 million, respectively.
Investment 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"). Investment securities asset backed securities also
include mortgage-backed securities which consist of vixed rate and adjustable
rate passthroughs and collateralized mortgage obligations issued by federal
agencies 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. The effective duration of the
total investment portfolio at September 30, 1999 was 3.8 years.
At September 30, 1999, total investment securities available-for-sale were
$8.8 billion compared to $6.7 billion at December 31, 1998 and investment
securities held-to-maturity were $1.1 billion compared to $1.8 billion at
December 31, 1998. For additional information with respect to Sovereign's
investment securities, see Notes 3 and 4 in the Notes to Consolidated Financial
Statements.
-35-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Goodwill and Other Intangible Assets
Total goodwill and other intangible assets at September 30, 1999 were $456
million compared to $426 million at December 31, 1998. This increase is
primarily attributable to Sovereign's acquisitions of Peoples and Network during
the second quarter of 1999, partially off-set by 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 September 30, 1999 were $11.9 billion compared to $12.3
billion at December 31, 1998. For additional information with respect to
Sovereign's deposit portfolio composition, see Note 6 in the Notes to
Consolidated Financial Statements.
Borrowings
Sovereign utilizes borrowings as a source of funds for its asset growth and
its asset/liability management. Collateralized advances are available from the
FHLB provided certain standards related to creditworthiness have been met.
Another source of funds for Sovereign is reverse repurchase agreements. Reverse
repurchase agreements are short-term obligations collateralized by securities
fully guaranteed as to principal and interest by the U.S. Government or an
agency thereof.
Total borrowings at September 30, 1999 were $11.7 billion of which $6.2
billion were short-term compared to $7.9 billion of which $3.9 billion were
short-term at December 31, 1998. This increase in borrowings is the result of
balance sheet growth being funded by borrowings. During the nine-month period
ended September 30, 1999, Sovereign funded its balance sheet growth through
borrowings as the cost of borrowings was lower than the overall cost of retail
certificates of deposit. 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, $500 million of FHLB advances at
September 30, 1999 have been effectively converted from variable rate
obligations to fixed rate obligations. In addition, at September 30, 1999, $1.2
billion of borrowings have been protected from upward repricing through the use
of interest rate caps and floors.
-36-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
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 4% of its net withdrawable accounts plus short-term borrowings. These
levels are changed from time to time by the Office of Thrift Supervision ("OTS")
to reflect economic conditions. The liquidity ratio of Sovereign Bank for
September 30, 1999 was 50.0%.
Sovereign's primary financing sources are deposits obtained in its own
market area, 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 currently approximate $150 million per
month. At September 30, 1999, Sovereign had $6.6 billion in unpledged investment
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 securities, repayment of principal on loans and other investing
activities. Sovereign also maintains strong relationships with numerous
investment banking firms, and has the ability to access capital markets through
a variety of products and structures, should liquidity or capital needs arise.
For the nine-month period ended September 30, 1999, cash and cash
equivalents decreased $178 million. Net cash used for operating activities was
$85.2 million for the nine-month period ended September 30, 1999. Net cash used
for investing activities for the nine-month period ended September 30, 1999 was
$2.2 billion consisting primarily of purchases of investment securities which
are classified available-for-sale, partially offset by proceeds from repayments
of investment securities and loans. Net cash provided by financing activities
for the nine-month period ended September 30, 1999 was $2.1 billion, which
includes proceeds from short-term borrowings of $1.5 billion and proceeds from
long-term borrowings of $1.8 million, partially offset by a decrease in
deposits.
-37-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA"),
requires the OTS to prescribe uniformly applicable capital standards for all
savings associations. These standards require savings associations to maintain a
minimum tangible capital ratio of not less than 1.5%, a minimum leverage capital
ratio of not less than 3% of tangible assets and not less than 4% of risk
adjusted assets and a minimum risk-based capital ratio (based upon credit risk)
of not less than 8%. In all cases, these standards are to be no less stringent
than the capital standards that are applicable to national banks. The OTS has
issued a regulation that requires a minimum leverage capital requirement of 3%
for associations rated composite "1" under the OTS MACRO rating system. For all
other savings associations, the minimum leverage capital requirement will be 3%
plus at least an additional 100 to 200 basis points.
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA"),
established five capital tiers: well-capitalized, adequately capitalized,
under-capitalized, significantly under-capitalized and critically
under-capitalized. A depository institution's capital tier depends upon its
capital levels in relation to various relevant capital measures, which include
leverage and risk-based capital measures and certain other factors. Depository
institutions that are not classified as well-capitalized are subject to various
restrictions regarding capital distributions, payment of management fees,
acceptance of brokered deposits and other operating activities.
At September 30, 1999, Sovereign Bank was classified as well-capitalized
and in compliance with all capital requirements. Management anticipates that
Sovereign Bank will continue to be classified as well-capitalized and will be in
compliance with all regulatory capital requirements.
The following table sets forth the capital ratios of Sovereign Bancorp and
Sovereign Bank and the current regulatory requirements at September 30, 1999:
<TABLE>
<CAPTION>
Well
Sovereign Sovereign Minimum Capitalized
Bancorp(1) Bank Requirement(1) Requirement
---------- --------- -------------- -----------
<S> <C> <C> <C> <C>
Stockholders' equity to
total assets 5.72% 7.20% None None
Tangible capital to tangible
assets 4.51 5.91 1.50% None
Leverage (core) capital to
tangible assets 5.14 5.91 3.00 5.00%
Leverage (core) capital to
risk adjusted assets 8.55 10.20 4.00 6.00
Risk-based capital to risk
adjusted assets 12.14 11.13 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.
-38-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
ASSET AND LIABILITY MANAGEMENT
The objective of Sovereign's asset and liability management is to identify,
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 negative
21.04% at September 30, 1999.
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 generally within a 10% loss. At September 30, 1999,
Sovereign estimates that if interest rates decline by 200 basis points, net
interest income would decrease by $37.2 million or 4.13%; conversely, if
interest rates increase by 200 basis points, net interest income would decrease
by $30.6 million or 4.57%. At December 31, 1998, if interest rates increased by
200 basis points, net interest income would have increased by $22.1 million or
3.59%. This change in sensitivity was primarily related to an increase in
short-term, variable rate borrowings.
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.
-39-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Amortizing and non-amortizing interest rate swaps are generally used to
convert fixed rate assets and liabilities to variable rate assets and
liabilities and vice versa. Sovereign at times 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 Constant Maturity Treasury,
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 interest rate
swaps to convert fixed rate liabilities to floating, and floating rate
liabilities to fixed, to reduce Sovereign's overall cost of funds. At September
30, 1999, Sovereign's principal off-balance sheet transactions were pay
fixed-receive variable non-amortizing interest rate swaps with a total notional
amount of $500 million, which are being used to hedge Sovereign's short-term
borrowing portfolio.
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.
As part of its mortgage banking strategy, Sovereign originates fixed rate
residential mortgages. It sells the majority of these loans to FHLMC, FNMA and
private investors. The loans are exchanged for cash or marketable fixed rate
mortgage-backed securities which are generally sold. This helps insulate
Sovereign from the interest rate risk associated with these fixed rate assets.
Sovereign uses forward sales, cash sales and options on mortgage-backed
securities as 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.
-40-
<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 of Form 8-K/A, dated September 23, 1999 (date of earliest event
- September 3, 1999) contained the revised Schedule 9.8(b) to Purchase
and Assumption Agreement dated September 3, 1999 between Fleet
Financial, BankBoston, N.A., and Sovereign Bancorp, Inc.
Report on Form 8-K, dated September 10, 1999 (date of earliest event -
September 3, 1999) contained (1) Purchase and Assumption Agreement,
between Fleet Financial, Inc., BankBoston N.A., and Sovereign Bancorp,
Inc. (2) Letter agreement, between Fleet Financial, Inc., BankBoston,
N.A., and Sovereign Bancorp, Inc. (3) Press Release announcing the
agreement with Fleet and BankBoston to acquire 278 branches.
Report on Form 8-K, dated April 16, 1999 (date of earliest event -
April 7, 1999), contained three press releases announcing (1)
Sovereign's stock repurchase program to repurchase up to 10% of its
outstanding shares; (2) Sovereign's expected earnings for the first
quarter of 1999; and (3) Sovereign's technology initiatives which
include plans for forming a separate Internet Bank.
Report on Form 8-K, dated March 19, 1999 (date of earliest event -
March 18, 1999), contained Sovereign's 1998 audited financial
statements and the related Notes thereto, and Management's Discussion
and Analysis of Financial Condition and Results of Operations.
-41-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SOVEREIGN BANCORP, INC.
-----------------------
(Registrant)
Date November 11, 1999 /s/ Dennis S. Marlo
----------------- ----------------------------
Dennis S. Marlo
Chief Financial Officer
Date November 11, 1999 /s/ Mark R. McCollom
----------------- ----------------------------
Mark R. McCollom
Chief Accounting Officer
-42-
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<CURRENCY> U.S.$
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-1-1999
<PERIOD-END> SEP-30-1999
<EXCHANGE-RATE> 1000
<CASH> 359,682
<INT-BEARING-DEPOSITS> 16,004
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 8,760,232
<INVESTMENTS-CARRYING> 1,142,649
<INVESTMENTS-MARKET> 1,132,970
<LOANS> 13,420,525
<ALLOWANCE> (134,573)
<TOTAL-ASSETS> 25,243,716
<DEPOSITS> 11,883,101
<SHORT-TERM> 6,203,991
<LIABILITIES-OTHER> 221,595
<LONG-TERM> 5,490,958
0
0
<COMMON> 880,527
<OTHER-SE> 563,544
<TOTAL-LIABILITIES-AND-EQUITY> 25,243,716
<INTEREST-LOAN> 689,089
<INTEREST-INVEST> 472,337
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 1,161,426
<INTEREST-DEPOSIT> 320,556
<INTEREST-EXPENSE> 712,358
<INTEREST-INCOME-NET> 449,068
<LOAN-LOSSES> 22,500
<SECURITIES-GAINS> 32,796
<EXPENSE-OTHER> 37,215
<INCOME-PRETAX> 229,454
<INCOME-PRE-EXTRAORDINARY> 229,454
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 150,078
<EPS-BASIC> 0.90
<EPS-DILUTED> 0.89
<YIELD-ACTUAL> 2.88
<LOANS-NON> 80,570
<LOANS-PAST> 7,930
<LOANS-TROUBLED> 3,755
<LOANS-PROBLEM> 58,877
<ALLOWANCE-OPEN> 133,802
<CHARGE-OFFS> 41,470
<RECOVERIES> 14,942
<ALLOWANCE-CLOSE> 134,573
<ALLOWANCE-DOMESTIC> 130,367
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 4,206
</TABLE>
