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 June 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 August 13, 1999
- --------------------------- ------------------------------
Common Stock (no par value) 180,852,592 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.
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.
-2-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<S> <C> <C>
Consolidated Balance Sheets at June 30, 1999
and December 31, 1998 4
Consolidated Statements of Operations for the three-month
and six-month periods ended June 30, 1999 and 1998 5 - 6
Consolidated Statement of Stockholders' Equity for
the six-month period ended June 30, 1999 7
Consolidated Statements of Cash Flows for the six-month
periods ended June 30, 1999 and 1998 8
Notes to Consolidated Financial Statements 9 - 21
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 22 - 37
PART II. OTHER INFORMATION
Item 6. Reports on Form 8-K 38
PART III. FINANCIAL DATA SCHEDULE 39 - 40
SIGNATURES 41
</TABLE>
-3-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---------- ------------
(Unaudited) (Note)
(in thousands, except
per share data)
<S> <C> <C>
ASSETS
Cash and amounts due from
depository institutions $ 472,780 $ 471,074
Interest-earning deposits 125,194 82,650
Loans held for sale (approximate fair
value of $86,519 and $297,414 at
June 30, 1999 and December 31, 1998,
respectively) 86,139 296,930
Investment securities available-for-sale 8,688,200 6,662,427
Investment securities held-to-maturity
(approximate fair value of $1,319,194
and $1,860,583 at June 30, 1999
and December 31, 1998, respectively) 1,307,881 1,839,655
Loans 12,476,997 11,285,840
Allowance for loan losses (134,183) (133,802)
Premises and equipment 113,708 98,491
Other real estate owned
and other repossessed assets 7,545 15,584
Accrued interest receivable 155,973 147,441
Goodwill and other intangible assets 434,848 425,925
Other assets 858,955 721,658
----------- -----------
TOTAL ASSETS $24,594,037 $21,913,873
=========== ===========
LIABILITIES
Deposits $12,170,470 $12,322,716
Borrowings:
Short-term 6,415,627 3,921,684
Long-term 4,252,858 3,978,908
Advance payments by borrowers
for taxes and insurance 35,492 27,655
Other liabilities 140,695 329,792
----------- -----------
TOTAL LIABILITIES 23,015,142 20,580,755
----------- ----------
Corporation-obligated mandatorily redeemable capital securities
of subsidiary trust holding solely subordinated debentures
of Sovereign Bancorp, Inc. ("Trust Preferred Securities") 129,094 129,050
----------- ------------
STOCKHOLDERS' EQUITY
Common stock; no par value; 400,000,000 shares authorized;
186,164,360 shares issued at June 30, 1999 and 164,146,353
shares issued at December 31, 1998 913,531 649,341
Unallocated common stock held by the Employee
Stock Ownership Plan at cost;
5,063,798 shares at June 30, 1999 and
4,340,572 shares at December 31, 1998 (35,662) (26,892)
Treasury stock at cost; 123,658 shares at
June 30, 1999 and 78,626 shares at
December 31, 1998 (1,578) (1,086)
Accumulated other comprehensive (loss)/income (77,660) 18,120
Retained earnings 651,170 564,585
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 1,449,801 1,204,068
----------- -----------
TOTAL LIABILITIES, MINORITY INTERESTS
AND STOCKHOLDERS' EQUITY $24,594,037 $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.
-4-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three-Month Period Six-Month Period
Ended June 30, Ended June 30,
------------------------ -----------------------
1999 1998 1999 1998
--------- --------- --------- ----------
(in thousands, except
per share data)
<S> <C> <C> <C> <C>
Interest income:
Interest on interest-earning deposits $ 1,374 $ 1,973 $ 2,879 $ 3,331
Interest and dividends on investment
securities available-for-sale 129,412 65,312 251,302 102,410
Interest and dividends on investment
securities held-to-maturity 24,191 48,518 52,157 109,708
Interest and fees on loans 222,467 216,057 439,134 440,523
--------- --------- --------- ---------
Total interest income 377,444 331,860 745,472 655,972
--------- --------- --------- ---------
Interest expense:
Interest on deposits 104,248 104,558 213,596 206,337
Interest on borrowings 125,788 108,270 244,676 209,986
--------- --------- --------- ---------
Total interest expense 230,036 212,828 458,272 416,323
--------- --------- --------- ---------
Net interest income 147,408 119,032 287,200 239,649
Provision for loan losses 7,500 7,200 15,000 13,960
--------- --------- --------- ---------
Net interest income after provision for
loan losses 139,908 111,832 272,200 225,689
--------- --------- --------- ---------
Other income:
Retail banking fees 10,811 7,190 21,870 13,800
Mortgage banking revenues 9,005 8,287 18,951 14,620
Loan fees and service charges 2,005 1,647 3,347 3,193
Gain on sale of loans and investment
securities 3,362 3,075 6,770 6,127
Miscellaneous income 8,107 4,994 14,656 9,819
--------- --------- --------- ---------
Total other income 33,290 25,193 65,594 47,559
--------- --------- --------- ---------
General and administrative expenses:
Compensation and benefits 38,264 28,677 74,741 59,645
Occupancy and equipment expenses 16,494 13,200 33,800 26,346
Outside services 17,806 10,476 33,155 19,435
Other administrative expenses 13,623 11,687 27,943 23,896
--------- --------- --------- ---------
Total general and administrative expenses 86,187 64,040 169,639 129,322
--------- --------- --------- ---------
</TABLE>
-5-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(continued)
<TABLE>
<CAPTION>
Three-Month Period Six-Month Period
Ended June 30, Ended June 30,
------------------------ -----------------------
1999 1998 1999 1998
--------- --------- --------- ----------
(in thousands, except
per share data)
<S> <C> <C> <C> <C>
Other operating expenses:
Merger-related charges (1) $ - $ - $ - $ 39,072
Amortization of goodwill and other intangibles 9,027 3,213 18,055 6,397
Trust Preferred Securities expense 3,049 3,048 6,098 6,427
Real estate owned loss/(gain), net 182 (19) 22 (13)
--------- ---------- --------- ----------
Total other operating expenses 12,258 6,242 24,175 51,883
--------- --------- --------- ---------
Income before income taxes 74,753 66,743 143,980 92,043
Income tax provision 25,974 23,849 49,888 34,049
--------- --------- --------- ---------
Net Income (1)(2) $ 48,779 $ 42,894 $ 94,092 $ 57,994
========= ========= ========= =========
Net Income Applicable to Common Stock $ 48,779 $ 42,894 $ 94,092 $ 56,498
========= ========= ========= =========
Earnings per share (2)(3) $ .30 $ .27 $ .58 .36
========= ========= ========= =========
Dividends paid per common share (3) $ .026 $ .020 $ .047 .043
========= ========= ========= =========
</TABLE>
(1) Results for the six-month period ended June 30, 1998 include 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 six-month period ended June 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 six-month period
ended June 30, 1998 was $83.5 million and earnings per share for the same
period was $.52.
(3) Per share amounts have been adjusted to reflect all stock dividends and
stock splits.
See accompanying notes to consolidated financial statements.
-6-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Common
Shares Common Retained Treasury
Outstanding Stock Earnings Stock
----------- ------ -------- --------
<S> <C> <C> <C> <C>
Balance, December 31, 1998 159,727 $ 649,341 $ 564,585 $ (1,086)
Comprehensive income:
Net income -- -- 94,092 --
Change in unrecognized loss on
investment securities available-
for-sale, net of tax -- -- -- --
Total comprehensive income
Exercise of stock options 286 2,650 -- --
Cash in lieu of fractional shares -- (1) -- --
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan 169 2,149 -- --
Dividends paid on common stock -- -- (7,507) --
Treasury stock repurchase (3,080) -- -- (43,998)
Treasury stock sold 16 -- -- 148
Acquisition of Network Companies 235 4,000 -- (1,000)
Acquisition of People's Bancorp, Inc. 23,624 255,392 -- 44,358
------- ----------- ----------- -----------
Balance, June 30, 1999 180,977 $ 913,531 $ 651,170 $ (1,578)
======= =========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
Accumulated Total
Unallocated Other Stock-
Common Stock Comprehensive Holders'
Held by ESOP Income/(Loss) Equity
------------ ------------- --------
<S> <C> <C> <C>
Balance, December 31, 1998 (26,892) $ 18,120 $ 1,204,068
Comprehensive income:
Net income -- -- 94,092
Change in unrecognized loss on
investment securities available-
for-sale, net of tax -- (95,780) (95,780)
-----------
Total comprehensive income (1,688)
Exercise of stock options -- -- 2,650
Cash in lieu of fractional shares -- -- (1)
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan -- -- 2,149
Dividends paid on common stock -- -- (7,507)
Treasury stock repurchase -- -- (43,998)
Treasury stock sold -- -- 148
Acquisition of Network Companies -- -- 3,000
Acquisition of People's Bancorp, Inc. (8,770) -- 294,980
----------- ----------- -----------
Balance, June 30, 1999 $ (35,662) $ (77,660) $ 1,449,801
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
-7-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Six-Month Period
Ended June 30,
-----------------------------------
1999 1998
----------- -----------
(in thousands)
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 94,092 $ 57,994
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses and deferred taxes 8,631 12,974
Depreciation 8,148 6,834
Amortization 23,656 4,699
Gain on sale of loans, investment securities
and real estate owned (6,792) (6,284)
Allocation of Employee Stock Ownership Plan -- 15,310
Net change in:
Loans held for sale 210,791 3,942
Accrued interest receivable (515) (23,443)
Prepaid expenses and other assets (186,899) (554,392)
Other liabilities (211,829) 209,259
----------- -----------
Net cash used for operating activities $ (60,717) $ (273,107)
----------- -----------
Cash Flows from Investing Activities:
Proceeds from sales of investment securities
available-for-sale 2,329,822 768,765
Proceeds from repayments and maturities of
investment securities:
Available-for-sale 1,184,048 303,435
Held-to-maturity 566,293 1,359,878
Purchases of investment securities:
Available-for-sale (4,786,233) (4,044,128)
Held-to-maturity (21,683) (337,911)
Proceeds from sales of loans 837,822 8,211
Purchase of loans (549,460) (322,725)
Net change in loans other than purchases and sales (966,323) 938,334
Proceeds from sales of premises and equipment 134 12,915
Purchases of premises and equipment (17,838) (12,511)
Proceeds from sale of real estate owned 11,423 9,844
Net cash paid for Network Companies (1,696) --
Net cash received from Peoples Bancorp, Inc. 114,694 --
Other, net -- (4,228)
----------- -----------
Net cash used for investing activities (1,298,997) (1,320,121)
----------- -----------
Cash Flows from Financing Activities:
Net (decrease)/increase in deposits (666,305) 409,337
Net increase in short-term borrowings 1,513,733 87,916
Proceeds from long-term borrowings 744,996 1,348,000
Repayments of long-term borrowing (149,302) (4,425)
Net increase in advance payments by
borrowers for taxes and insurance 7,838 5,824
Cash dividends paid to stockholders (7,507) (7,873)
Redemption of preferred stock -- 147
Proceeds from issuance of common stock 4,798 7,262
Advance to the Employee Stock Ownership Plan (437) --
(Purchase)/issuance of treasury stock (43,850) 36
----------- -----------
Net cash provided by financing activities 1,403,964 1,846,224
----------- -----------
Net change in cash and cash equivalents 44,250 252,996
Cash and cash equivalents at beginning of period 553,724 255,937
----------- -----------
Cash and cash equivalents at end of period $ 597,974 $ 508,933
=========== -----------
Reconciliation of Cash and Cash Equivalents to
Consolidated Balance Sheets:
Cash and amounts due from depository institutions $ 472,780 $ 384,021
Interest-earning deposits 125,194 124,912
----------- -----------
Cash and cash equivalents at end of period $ 597,974 $ 508,933
=========== ===========
</TABLE>
Supplemental Disclosures:
Income tax payments totaled $62.1 million for the six-month period ended June
30, 1999 and $34.5 million for the same period in 1998. Interest payments
totaled $433 million for the six-month period ended June 30, 1999 and $427
million for the same period in 1998. Noncash activity consisted of mortgage or
whole loan sales of $732 million for the six-month period ended June 30, 1999
and $394 million for the same period in 1998; reclassification of long-term
borrowings to short-term borrowings of $322 million for the six-month period
ended June 30, 1999 and $436 million for the same period in 1998; and
reclassification of mortgage loans to real estate owned of $8.7 million for the
six-month period ended June 30, 1999 and $7.5 million for the same period in
1998.
See accompanying notes to consolidated financial statements.
-8-
<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 June 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. Since the Peoples'
acquisition was accounted for at the close of business on June 30, 1999,
Sovereign's consolidated results of operations for the three-month and six-month
periods ended June 30, 1999 do not include Peoples' results of operations. The
results of operations for the six-month period ended June 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
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. Management also considers
loan quality, changes in the size and character of the loan portfolio,
consultation with regulatory authorities, 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."
-9-
<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 Six-Month Period
Ended June 30, Ended June 30,
----------------------- -----------------------
1999 1998 1999 1998
---- ---- ------- ------
<S> <C> <C> <C> <C>
Basic Earnings Per Share:
Net income attributable to
common stock(1) $ 48,779 $ 42,894 $ 94,092 $ 56,498
-------- -------- -------- --------
Average basic shares outstanding
at end of period (3) 158,413 150,829 159,140 146,481
======== ======== ======== ========
Basic earnings per share (2) (3) $ .31 $ .28 $ .59 $ .39
======== ======== ======== ========
Diluted Earnings Per Share:
Net income (1) $ 48,779 $ 42,894 $ 94,092 $ 57,994
-------- -------- -------- --------
Average diluted shares outstanding
at end of period (3) 158,413 157,993 159,140 157,176
Dilutive effect of average stock
options, net of shares assumed to
be repurchased under the treasury
stock method (3) 1,861 3,543 1,889 3,730
-------- -------- -------- --------
Total average diluted shares
outstanding at end of period (3) 160,274 161,536 161,029 160,906
======== ======== ======== ========
Diluted earnings per share (2)(3) $ .30 $ .27 $ .58 $ .36
======== ======== ======== ========
</TABLE>
(1) Results for the six-month period ended June 30, 1998 include merger charges
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 six-month period ended June 30, 1998 include the
merger-related and special charges described in Note 1 above. Excluding the
merger-related and special charges, basic earnings per share and diluted
earnings per share for the six-month period ended June 30, 1998 were $.56
and $.52, respectively.
(3) All share data has been adjusted to reflect all stock dividends and stock
splits.
-10-
<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>
June 30, 1999
-------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ -----
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 65,843 $ 16 $ 265 $ 65,594
Corporate securities 829,997 942 18,314 812,625
Equity securities 928,402 13,471 9,033 932,840
Other securities 71,279 1,094 945 71,428
Mortgage-backed Securities:
FHLMC 161,402 716 5,830 156,288
FNMA 272,390 393 2,158 270,625
GNMA 115,564 407 2,865 113,106
Collateralized mortgage
Obligations 3,425,714 1,491 38,340 3,388,865
Other securities 2,937,376 -- 60,547 2,876,829
---------- ---------- ---------- ----------
Total investment securities
available-for-sale $8,807,967 $ 18,530 $ 138,297 $8,688,200
========== ========== ========== ==========
</TABLE>
<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 $ 35,480 $ 1 $ 64 $ 35,417
Corporate securities 38,784 1,413 121 40,076
Equity securities 881,817 15,545 10,381 886,981
Other securities 8,360 972 -- 9,332
Mortgage-backed Securities:
FHLMC 85,761 867 264 86,364
FNMA 40,645 335 57 40,923
GNMA 42,434 749 14 43,169
Collateralized mortgage
obligations 3,531,948 11,214 2,785 3,540,377
Other securities 1,969,322 15,976 5,510 1,979,788
---------- --------- --------- ----------
Total investment securities
available-for-sale $6,634,551 $ 47,072 $ 19,196 $6,662,427
========== ========= ========= ==========
</TABLE>
-11-
<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>
June 30, 1999
--------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ -----
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 22,331 $ 8 $ 322 $ 22,017
Corporate securities - - - -
Other securities 51,683 2,439 138 53,984
Mortgage-backed Securities:
FHLMC 199,317 2,860 267 201,910
FNMA 137,637 2,053 159 139,531
GNMA 240,243 2,686 49 242,880
Private issues 59,990 564 95 60,459
Collateralized mortgage
obligations 596,680 4,009 2,276 598,413
---------- ---------- ---------- ----------
Total investment securities
held-to-maturity $1,307,881 $ 14,619 $ 3,306 $1,319,194
========== ========== ========== ==========
</TABLE>
<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 $ 31,180 $ 151 $ 78 $ 31,253
Corporate securities - - - -
Other securities 54,481 3,691 122 58,050
Mortgage-backed Securities:
FHLMC 242,558 4,733 104 247,187
FNMA 176,167 3,371 85 179,453
GNMA 292,664 6,009 - 298,673
Private issues 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>
-12-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(5) COMPOSITION OF LOAN PORTFOLIO
The following table presents the composition of the loan portfolio by type
of loan and by fixed and adjustable rates at the dates indicated: (dollars in
thousands)
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
-------------------------- --------------------------
Amount Percent Amount Percent
<S> <C> <C> <C> <C>
Residential real estate loans $ 4,985,060 40.0% $ 5,113,537 45.3%
Residential construction loans 56,249 .4 62,536 .6
----------- ------ ----------- ------
Total Residential Loans 5,041,309 40.4 5,176,073 45.9
----------- ------ ----------- ------
Commercial real estate loans 1,258,277 10.1 887,938 7.9
Commercial loans 813,833 6.5 717,440 6.4
Automotive floor plan loans 946,129 7.6 578,147 5.1
Multi-family loans 220,517 1.8 115,195 1.0
----------- ------ ----------- ------
Total Commercial Loans 3,238,756 26.0 2,298,720 20.4
----------- ------ ----------- ------
Home Equity loans 1,720,125 13.8 1,750,883 15.5
Auto loans 1,887,233 15.1 1,510,676 13.4
Loans to automotive lessors 307,937 2.4 252,856 2.2
Student loans 248,380 2.0 256,744 2.3
Other 33,257 .3 39,888 .3
----------- ------ ----------- ------
Total Consumer Loans 4,196,932 33.6% 3,811,047 33.7%
----------- ------ ----------- ------
Total Loans (1) $12,476,997 100.0% $11,285,840 100.0%
=========== ====== =========== ======
Total Loans with: (2)
Fixed rates $ 7,240,187 58.0% $ 5,798,158 51.4%
Variable rates 5,236,810 42.0 5,487,682 48.6
----------- ------ ----------- ------
Total Loans (1) $12,476,997 100.0% $11,285,840 100.0%
=========== ====== =========== ======
</TABLE>
(1) Loan totals are net of deferred loan fees and unamortized premiums and
discounts of $16.8 million at June 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."
-13-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(6) DEPOSIT PORTFOLIO COMPOSITION
The following table presents the composition of deposits at the dates
indicated: (dollars in thousands)
<TABLE>
<CAPTION>
June 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 $ 1,186,092 9.7% - % $ 1,104,170 9.0% - %
NOW accounts 1,646,758 13.5 2.11 1,281,516 10.4 1.24
Savings accounts 2,241,930 18.4 2.49 2,295,448 18.6 2.83
Money market accounts 1,419,832 11.7 3.49 1,545,634 12.5 3.78
Retail certificates 5,085,495 41.8 4.93 5,172,196 42.0 5.24
Jumbo certificates 590,363 4.9 5.00 923,752 7.5 5.40
----------- ------ ------ ----------- ------ ------
Total Deposits $12,170,470 100.0% 3.45% $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>
June 30, 1999 December 31, 1998
--------------------------- ----------------------------
Weighted Weighted
Average Average
Balance Rate Balance Rate
----------- -------- ---------- --------
<S> <C> <C> <C> <C>
Securities sold under
repurchase agreements $ 1,322,018 5.20% $ 655,540 5.46%
FHLB advances 8,948,460 5.05 6,901,505 5.14
Other borrowings 398,007 7.55 343,547 8.19
----------- ------- ---------- ------
Total Borrowings $10,668,485 5.16% $7,900,592 5.30%
=========== ======= ========== ======
</TABLE>
-14-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(8) INTEREST RATE EXCHANGE AGREEMENTS
Amortizing and non-amortizing interest rate swaps are generally used to
convert fixed rate assets and liabilities to variable rate assets and
liabilities and vice versa. Interest rate caps are 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.
Interest rate caps and floors are also used to limit the exposure created by
other interest rate swaps. In certain cases, interest rate caps and floors are
simultaneously bought and sold to create a range of protection (interest rate
corridors) against changing interest rates while limiting the cost of that
protection. The following table presents information regarding interest rate
exchange agreements at the dates indicated: (dollars in thousands)
<TABLE>
<CAPTION>
June 30, 1999
---------------------------------------------------------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
---------- -------- ----------- --------
<S> <C> <C> <C> <C>
Amortizing interest rate swaps:
Pay fixed-receive variable (1) $ - $ - $ -
Non-amortizing interest rate swaps:
Pay variable-receive fixed (2) 85,000 - (2,204) 13.5
Pay fixed-receive variable (3) 920,000 - 7,828 1.5
Interest rate caps/floors(4) 1,200,000 5,850 (2,585) 2.9
---------- -------- -----------
$2,205,000 $ 5,850 $ 3,039
========== ======== ===========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1998
---------------------------------------------------------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
---------- -------- ----------- --------
<S> <C> <C> <C> <C>
Amortizing interest rate swaps:
Pay fixed-receive variable (1) $ 175,164 $ - $ (617) .3
Non-amortizing interest rate swaps:
Pay variable-receive fixed (2) - - -
Pay fixed-receive variable (3) 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>
-15-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(1) The weighted average pay rate was 6.87% and the weighted average receive
rate was 5.99% at December 31, 1998.
(2) The weighted average pay rate was 5.08% and the weighted average receive
rate was 7.07% at June 30, 1999.
(3) The weighted average pay rate was 5.70% and 5.42% and the weighted average
receive rate was 5.13% and 5.26% at June 30, 1999 and December 31, 1998,
respectively.
(4) The strike price range was 5.79% - 6.08% at June 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/ June 30,
1998 Additions Amortization Terminations 1999
----------- ---------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C>
Amortizing interest $ 175,164 $ - $ 175,164 $ - $ -
rate swaps
Non-amortizing interest
rate swaps 2,780,000 185,000 - 1,960,000 1,005,000
Interest rate
caps/floors 1,200,000 - - - 1,200,000
---------- ---------- ---------- ----------- ----------
$4,155,164 $ 185,000 $ 175,164 $ 1,960,000 $2,205,000
========== ========== ========== =========== ==========
</TABLE>
Net interest expense resulting from interest rate exchange agreements for
the six-month period ended June 30, 1999 was $6.6 million.
-16-
<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 completed its acquisition of 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' common
stock 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. The allocation of the purchase price for
the Peoples' acquisition as of June 30, 1999, is preliminary and Sovereign
expects to finalize the allocation in the third quarter of 1999. Sovereign does
not expect a material difference between the preliminary and final purchase
price allocation. The pro forma effect of this acquisition on operations was not
material for the second quarter.
On June 24, 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. The pro forma effect of this acquisition on operations was not material
for the second quarter.
-17-
<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 Six-Month Period
Ended June 30, Ended June 30,
----------------------- -----------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income $ 48,779 $ 42,894 $ 94,092 $ 57,994
-------- -------- -------- --------
Unrealized (losses)/gains on
securities arising during the year (57,551) 9,633 (94,173) 2,728
Less reclassification adjustment 3,818 -- 1,607 2,170
-------- -------- -------- --------
Net unrealized (losses)/gains
recognized in other comprehensive
income (61,369) 9,633 (95,780) 558
-------- -------- -------- --------
Comprehensive (loss)/income (1) $(12,590) $ 52,527 $ (1,688) $ 58,552
========= ======== ========= ========
</TABLE>
(1) Excluding merger-related and special charges, comprehensive income for the
six-month period ended June 30, 1998 was $84.1 million.
Accumulated other comprehensive income, net of related tax, consisted of
net unrealized losses on securities of $77.7 million at June 30, 1999 and net
unrealized gains on securities of $18.1 million at December 31, 1998.
-18-
<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 has completed the implementation phase for all mission-critical items.
-19-
<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 August 10, 1999, Sovereign's cash
outlay was approximately $12.5 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.
-20-
<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
June 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.
-21-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
RESULTS OF OPERATIONS
General
Net income for the three-month period ended June 30, 1999 was $48.8
million, an increase of 14% when compared to net income of $42.9 million for the
same period in 1998. Diluted earnings per share for the three-month periods
ended June 30, 1999 and 1998 were $.30 and $.27, respectively.
Net operating income, defined as net income before the after-tax effect of
merger-related and special charges described below, for the six-month period
ended June 30, 1999 was $94.1 million, an increase of 13% when compared to net
operating income of $83.5 million for the same period in 1998. Diluted operating
earnings per share for the six-month periods ended June 30, 1999 and 1998 were
$.58 and $.52, respectively. 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, Inc. ("ML Bancorp") 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.
Net income for the six-month periods ended June 30, 1999 and 1998,
including the impact of the merger charges and losses from non-recurring sales
of held-to-maturity securities discussed above was $94.1 million and $58.0
million, respectively and diluted earnings per share for the same periods were
$.58 and $.36, respectively. All per share amounts presented have been adjusted
to reflect all stock dividends and stock splits.
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 15.91%, 27.74% and .84% for the six-month period ended June 30, 1999
compared to 15.96%, 19.19% and .91% for the same period in 1998. Average equity
to average total assets for the six-month period ended June 30, 1999 and 1998
was 5.28% and 5.72%, respectively.
Net Interest Income
Net interest income for the three-month and six-month periods ended June
30, 1999 was $147 million and $287 million compared to $119 million and $240
million for the same periods in 1998. This increase was attributable to an
increase in average balances resulting from internal growth and recent
acquisitions. Sovereign's net interest margin (net interest income divided by
average interest-earning assets) for the three-month and six-month periods ended
June 30, 1999 was 2.92% and 2.86% compared to 2.78% and 2.84% for the same
periods in 1998.
-22-
<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 $129 million and
$251 million for the three-month and six-month periods ended June 30, 1999
compared to $65.3 million and $102 million for the same periods in 1998. The
average balance of investment securities available-for-sale was $7.6 billion
with an average yield of 6.74% for the six-month period ended June 30, 1999
compared to an average balance of $3.1 billion with an average yield of 6.87%
for the same period in 1998. The increase in the average balance of investment
securities available-for-sale was due to an active decision by management to
increase balance sheet flexibility by placing more investments into
available-for-sale.
Interest on investment securities held-to-maturity was $24.2 million and
$52.2 million for the three-month and six-month periods ended June 30, 1999
compared to $48.5 million and $110 million for the same periods in 1998. The
average balance of investment securities held-to-maturity was $1.5 billion with
an average yield of 6.95% for the six-month period ended June 30, 1999 compared
to an average balance of $3.0 billion with an average yield of 7.34% for the
same period in 1998.
Interest and fees on loans were $222 million and $439 million for the
three-month and six-month periods ended June 30, 1999 compared to $216 million
and $441 million for the same periods in 1998. The average balance of loans was
$11.6 billion with an average yield of 7.63% for the six-month period ended June
30, 1999 compared to an average balance of $11.2 billion with an average yield
of 7.89% for the same period in 1998.
Interest on deposits was $104 million and $214 million for the three-month
and six-month periods ended June 30, 1999 compared to $105 million and $206
million for the same periods in 1998. The average balance of deposits was $12.0
billion with an average cost of 3.59% for the six-month period ended June 30,
1999 compared to an average balance of $9.8 billion with an average cost of
4.23% 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 with major emphasis on attracting lower-cost
deposits from corporations, governmental units and consumers.
-23-
<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 $126 million and $245 million for the
three-month and six-month periods ended June 30, 1999 compared to $108 million
and $210 million for the same periods in 1998. The average balance of borrowings
was $9.2 billion with an average cost of 5.30% for the six-month period ended
June 30, 1999 compared to an average balance of $7.3 billion with an average
cost of 5.73% 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 partially funded by borrowings and a general decline in
interest rates between the two periods. During the six-month period ended June
30, 1999, Sovereign funded its balance sheet growth through borrowings as the
cost of borrowings was lower than the cost of retail certificates of deposit.
Provision for Possible Loan Losses
The provision for loan losses for the three-month and six-month periods
ended June 30, 1999 was $7.5 million and $15 million compared to $7.2 million
and $14.0 million for the same periods in 1998.
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 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, provisioning is sufficiently in excess of net charge-offs for
the periods presented. Management believes that an increase in provision for the
six-month period ended June 30, 1999 versus June 30, 1998 was warranted due to
the changing composition and increased risk in the loan portfolio, as discussed
above. 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 six-month period ended June 30, 1999
were $19.4 million and consisted of charge-offs of $30.0 million and recoveries
of $10.6 million. This compared to net charge-offs of $14.9 million consisting
of charge-offs of $20.2 million and recoveries of $5.3 million for the six-month
period ended June 30, 1998. Excluding the accelerated disposition mentioned
above, Sovereign's net charge-offs for the six-month period ended June 30, 1999
were $15.1 million and consisted of charge-offs of $25.7 million and recoveries
of $10.6 million. Sovereign's increased level of net charge-offs was primarily
the result of increased consumer and commercial loan charge-offs, the majority
of which are related to Sovereign's acquisition activity over the past two
years, and an accelerated disposition of $37.0 million of non-performing
residential loans. In Sovereign's experience, a strategy that involves the
accelerated resolution of problem assets is more appropriate than a long-term
workout approach.
-24-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table presents the activity in the allowance for possible
loan losses for the periods indicated: (dollars in thousands)
<TABLE>
<CAPTION>
Six-month Period Ended June 30,
1999 1998
--------------------------------------
<S> <C> <C>
Allowance, beginning of period $ 133,802 $ 116,823
Charge-offs:
Residential(1) 8,793 3,415
Commercial Real Estate 480 -
Commercial 2,117 591
Consumer(2) 18,598 16,243
--------- ---------
Total Charge-offs 29,988 20,249
--------- ---------
Recoveries:
Residential 1,030 529
Commercial Real Estate 453 31
Commercial 420 120
Consumer(2) 8,667 4,627
--------- ---------
Total Recoveries 10,570 5,307
--------- ---------
Charge-offs, net of recoveries 19,418 14,942
Provision for possible loan losses 15,000 13,960
Other 4,799 2,161
--------- ---------
Allowance, end of period $ 134,183 $ 118,002
========= =========
</TABLE>
- ---------------------
(1) Results for the six-month period ended June 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 $33.3 million and $65.6 million for the three-month and
six-month periods ended June 30, 1999 compared to $25.2 million and $47.6
million for the same periods in 1998.
-25-
<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 $10.8 million and $21.9 million for the
three-month and six-month periods ended June 30, 1999 compared to $7.2 million
and $13.8 million for the same periods in 1998. This increase was primarily due
to an increase in the number of Sovereign's transaction accounts, an increase in
inter-change income resulting from growth in the number and transaction volume
of Sovereign's debit cards and a larger retail customer base over the last year.
Mortgage banking revenues were $9.0 million and $19.0 million for the
three-month and six-month periods ended June 30, 1999 compared to $8.3 million
and $14.6 million for the same periods in 1998. This increase was primarily
attributable to a favorable external interest rate environment and heavy
refinancing activity. Sovereign serviced $9.8 billion of its own loans and $6.5
billion of loans for others at June 30, 1999 compared to $9.0 billion of its own
loans and $6.3 billion of loans for others at June 30, 1998.
Loan fees and service charges were $2.0 million and $3.3 million for the
three-month and six-month periods ended June 30, 1999 compared to $1.6 million
and $3.2 million for the same periods in 1998. Loan fees and service charges
relate primarily to Sovereign's non-residential loan portfolios.
Gains on sales of loans and investment securities available-for-sale were
$3.4 million and $6.8 million for the three-month and six-month periods ended
June 30, 1999 compared to $3.1 million and $6.1 million for the same periods in
1998.
Miscellaneous income was $8.1 million and $14.7 million for the three-month
and six-month periods ended June 30, 1999 compared to $5.0 million and $9.8
million for the same periods in 1998. This increase was primarily due to
Sovereign's additional investment in bank-owned life insurance ("BOLI") which
was made during the first quarter of 1999.
General and Administrative Expenses
Total general and administrative expenses were $86.2 million and $170
million for the three-month and six-month periods ended June 30, 1999 compared
to $64.0 million and $129 million for the same periods in 1998. The ratio of
general and administrative expenses to average assets for the three-month and
six-month periods ended June 30, 1999 was 1.51% and 1.50% compared to 1.35% and
1.40% 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 six-month periods ended June 30,
1999 was 47.7% and 48.1% compared to 45.3% and 45.7% for the same periods in
1998. The increase in general and administrative expenses for the three-month
and six-month periods ended June 30, 1999 was primarily due to Sovereign's
franchise growth and included the effect of Sovereign's purchase of 93 branch
offices and related commercial and consumer loans from CoreStates during the
third quarter of 1998. This acquisition 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.
-26-
<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 $12.3 million and $24.2 million for the
three-month and six-month periods ended June 30, 1999 compared to $6.2 million
and $51.9 million for the same periods in 1998. Results for the three-month and
six-month periods ended June 30, 1999 included amortization of goodwill of $9.0
million and $18.1 million compared to $3.2 million and $6.4 million for the same
periods in 1998. Results for the six-month period ended June 30, 1998 included
merger charges of $39.1 million related to Sovereign's acquisition of ML Bancorp
during the first quarter of 1998.
Income Tax Provision
The income tax provision was $26.0 million and $49.9 million for the
three-month and six-month periods ended June 30, 1999 compared to $23.8 million
and $34.0 million for the same periods in 1998. The effective tax rate for the
three-month and six-month periods ended June 30, 1999 was 34.7% and 34.6%,
respectively, compared to 35.7% and 37.0% 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 June 30, 1999, Sovereign's total loan portfolio included $5.0 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 Sovereign's acquisition
activity over the past few years, at June 30, 1999, Sovereign's total loan
portfolio also included $3.2 billion of commercial loans and $4.2 billion of
consumer loans, including $1.7 billion of outstanding home equity loans
(excluding $597 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 six-month period ended
June 30, 1999, Sovereign closed $1.3 billion of commercial loans compared to
$393 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.
-27-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Sovereign closed $1.2 billion of consumer loans during the six-month period
ended June 30, 1999 compared to $898 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 six-month period ended June 30, 1999.
During the six-month period ended June 30, 1999, Sovereign closed $969
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
$933 million and approximately 80% of fixed rate loans for the same period in
1998.
During the three-month period ended June 30, 1999, Sovereign determined
that an accelerated disposition of approximately $37 million of non-performing
residential loans would be the most cost-effective strategy to reduce
non-performing assets while significantly increasing key asset quality ratios.
As a result, at June 30, 1999, Sovereign's non-performing assets were $89.3
million compared to $116 million at December 31, 1998 and non-performing assets
as a percentage of total assets were .36% at June 30, 1999 compared to .53% at
December 31, 1998.
At June 30,1999, 49% of non-performing assets consisted of loans related to
real estate or OREO. Another 3% 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, many 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 June 30, 1999, the allowance for loan
losses as a percentage of non-performing assets was 148% compared to 112% at
December 31, 1998.
-28-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table presents the composition of non-performing assets at
the dates indicated: (dollars in thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
--------- ------------
<S> <C> <C>
Non-Accrual Loans:
Past due 90 days or more
as to interest or principal:
Real estate related $ 36,992 $ 63,258
Other 39,185 33,297
--------- ---------
Total Non-Accrual Loans 76,177 96,555
Other 1,827 3,404
Restructured Loans 3,755 141
--------- ---------
Total Non-Performing Loans 81,759 100,100
--------- ---------
Other Real Estate Owned and Other
Repossessed Assets:
Other real estate owned 6,710 12,812
Other repossessed assets 835 2,772
--------- ---------
Total Other Real Estate Owned and
Other Repossessed Assets 7,545 15,584
--------- ---------
TOTAL NON-PERFORMING ASSETS $ 89,304 $ 115,684
========= =========
Past due 90 days or more as to
interest or principal and
accruing interest (1) $ 6,313 $ 6,571
Non-Performing Assets as a
percentage of Total Assets .36% .53%
Non-Performing Loans as a
percentage of Total Loans .66% .89%
Non-Performing Assets as a
percentage of Total Loans
and Real Estate Owned .77% 1.08%
Allowance for Loan Losses
as a percentage of
Total Non-Performing Assets 148% 112%
Allowance for Loan Losses
as a percentage of
Total Non-Performing Loans 162% 129%
</TABLE>
(1) Represents student loans which are government-guaranteed and Sovereign
retains minimal risk of credit losses related to these loans.
-29-
<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 $43.8 million at June 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 June 30, 1999, the
allowance for loan losses was $134 million or 1.07% 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>
June 30, December 31,
1999 1998
------------------------ -------------------------
Percent Percent
Amount of Loans Amount of Loans
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Class allowances:
Commercial loans $ 18,681 15% $ 14,549 13%
Residential and commercial
real estate loans 15,580 51 13,690 54
Consumer loans 44,528 34 40,866 33
-------- --------
Total class allowances 78,789 69,105
Specific allowances:
Commercial loans 17,012 - 16,191 -
Residential and commercial
real estate loans 14,658 - 16,351 -
Consumer loans 6,103 - 7,217 -
-------- --------
Total specific allowances 37,773 39,759
Unallocated allowances 17,621 - 24,938 -
-------- ----- -------- -----
Total allowance for loan losses $134,183 100% $133,802 100%
======== ===== ======== =====
</TABLE>
-30-
<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 June 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, additional 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.
-31-
<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
$7.3 to $17.6 million at June 30, 1999 from $24.9 million at December 31, 1998.
This slight decrease can be attributed to an increase in class reserves to $78.8
million at June 30, 1999 compared to $69.1 million at December 31, 1998.
Impaired loans are summarized as follows (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
--------- ------------
<S> <C> <C>
Impaired loans without a related reserve $ - $ -
Impaired loans with a related reserve 90,313 63,296
--------- ---------
Total impaired loans $ 90,313 $ 63,296
========= =========
Reserve for impaired loans $ 21,079 $ 18,582
========= =========
</TABLE>
The average balance of impaired loans for the six-month periods ended June
30, 1999 and 1998 was $73.9 million and $50.3 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 also include mortgage-backed
securities which consist of 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. Sovereign's strategy is to
purchase classes which have an average life of three years or less. The
effective duration of the total investment portfolio at June 30, 1999 was 3.8
years.
At June 30, 1999, total investment securities available-for-sale were $8.7
billion compared to $6.7 billion at December 31, 1998 and investment securities
held-to-maturity were $1.3 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.
-32-
<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 June 30, 1999 were $435
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 June 30, 1999 were $12.2 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 June 30, 1999 were $10.7 billion of which $6.4 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 partially funded by borrowings. During the six-month period ended
June 30, 1999, Sovereign funded its balance sheet growth through borrowings as
the cost of borrowings was lower than the 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, $920 million of FHLB advances at
June 30, 1999 have been effectively converted from variable rate obligations to
fixed rate obligations. In addition, at June 30, 1999, $1.2 billion of
borrowings have been protected from upward repricing through the use of interest
rate caps and floors.
-33-
<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 June
30, 1999 was 64.1%.
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 $275 million per
month. At June 30, 1999, Sovereign had $8.8 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 six-month period ended June 30, 1999, cash and cash equivalents
increased $44.3 million. Net cash used for operating activities was $60.7
million for the six-month period ended June 30, 1999. Net cash used for
investing activities for the six-month period ended June 30, 1999 was $1.3
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 six-month period ended June 30, 1999 was $1.4 billion, which includes an
increase in short-term borrowings of $1.5 billion and an increase in proceeds
from long-term borrowings of $745 million, partially offset by a decrease in
deposits.
-34-
<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 June 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 June 30, 1999:
<TABLE>
<CAPTION>
Well
Sovereign Sovereign Minimum Capitalized
Bancorp(1) Bank Requirement Requirement(1)
---------- --------- ----------- --------------
<S> <C> <C> <C> <C>
Stockholders' equity to
total assets 5.89% 7.39% None None
Tangible capital to tangible
assets 4.50 5.89 1.50% None
Leverage (core) capital to
tangible assets 5.42 6.35 3.00 5.00%
Leverage (core) capital to
risk adjusted assets 8.70 10.37 4.00 6.00
Risk-based capital to risk
adjusted assets 12.42 11.32 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.
-35-
<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
18.65% at June 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 June 30, 1999, Sovereign
estimates that if interest rates decline by 200 basis points, net interest
income would decrease by $71.5 million or 10.67%; 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.
-36-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Amortizing and non-amortizing interest rate swaps are generally used to
convert fixed rate assets and liabilities to variable rate assets and
liabilities and vice versa. Sovereign utilizes amortizing interest rate swaps to
convert discounted adjustable rate loans to fixed rate for a period of time. The
amortization of the notional amount of the interest rate swaps are tied to the
level of an index such as the One Year 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 June 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 $920
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.
-37-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Items 1 through 5 are not applicable or the responses are negative.
Item 6 - Reports on Form 8-K.
Report on Form 8-K, dated April 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.
-38-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SOVEREIGN BANCORP, INC.
-----------------------------------
(Registrant)
Date August 13, 1999 /s/ Dennis S. Marlo
--------------------- -----------------------------------
Dennis S. Marlo
Chief Financial Officer
Date August 13, 1999 /s/ Mark R. McCollom
--------------------- -----------------------------------
Mark R. McCollom
Chief Accounting Officer
-39-
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