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, 2000
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 10, 2000
--------------------------- ----------------------------
Common Stock (no par value) 225,922,308 shares
<PAGE>
FORWARD LOOKING STATEMENTS
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
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 this Quarterly
Report on Form 10-Q and the Exhibits thereto), in its reports to shareholders
(including its 1999 Annual Report) 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, (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 expression, and (iii) statements relating to some
or all of the foregoing which assume the successful conversion of FleetBoston
operating systems, and the retention of former FleetBoston employees and
customers with respect to the FleetBoston acquisition. Although we believe that
the expectations reflected in our forward-looking statements are reasonable,
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, forecasts and projections
(and underlying assumptions) 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 and Sovereign Bank in meeting the
post-closing regulatory requirements with respect to the FleetBoston acquisition
and the ability to timely pay installments of the deferred purchase price in
connection with the acquisition; (7) the impact of changes in financial
services' laws and regulations and the application of such laws and regulations
(including laws concerning taxes, capital, liquidity, proper accounting
treatment, securities and insurance) and the impact of changes in generally
accepted accounting principles; (8) technological changes; (9) changes in
consumer spending and savings habits; (10) the impact of the FleetBoston
acquisition and other acquisitions of Sovereign, including the success of
Sovereign in fully realizing, within the expected time frame, earnings
enhancements from such pending or completed acquisitions, including, without
limitation, the earnings enhancements expected from the acquisition of loans,
deposits and community banking offices from FleetBoston; (11) Sovereign's
<PAGE>
FORWARD LOOKING STATEMENTS
(continued)
ability to successfully integrate the former FleetBoston systems, and
Sovereign's ability to retain FleetBoston customers and employees despite
immense competition; (12) changes over time in the amount, mix, yield, quality,
and other characteristics of the deposits and loans Sovereign assumed and
acquired from FleetBoston; (13) unanticipated regulatory or judicial
proceedings; (14) changes in asset quality; and (15) the success of Sovereign at
managing the risks involved in the foregoing.
Operating earnings and cash operating earnings, as defined, are not a
substitute for other financial measures determined in accordance with generally
accepted accounting principles. Because all companies do not calculate operating
earnings and cash operating earnings in the same fashion, these measures as
presented may not be comparable to other similarly titled measures of other
companies.
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.
<PAGE>
<TABLE>
<CAPTION>
INDEX
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at June 30, 2000
and December 31, 1999 5
Consolidated Statements of Operations for the three-month
and six-month periods ended June 30, 2000 and 1999 6 - 7
Consolidated Statement of Stockholders' Equity for
the six-month period ended June 30, 2000 8
Consolidated Statements of Cash Flows for the six-month
periods ended June 30, 2000 and 1999 9
Notes to Consolidated Financial Statements 10 - 21
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition 22 - 41
PART II. OTHER INFORMATION
Item 6. Reports on Form 8-K 42
PART III. FINANCIAL DATA SCHEDULE 43
SIGNATURES 44
</TABLE>
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
------------ ------------
(Unaudited)
(in thousands, except
per share data)
<S> <C> <C>
ASSETS
Cash and amounts due from
depository institutions $ 824,369 $ 373,996
Interest-earning deposits 334,242 19,238
Investment securities available-for-sale 6,682,629 8,030,212
Investment securities held-to-maturity
(approximate fair value of $2,231,539
and $2,367,025 at June 30, 2000
and December 31, 1999, respectively) 2,245,649 2,362,051
Loans (including loans held for sale
at approximate fair value of $56,823
and $62,439 at June 30, 2000 and
December 31, 1999, respectively) 21,380,579 14,288,465
Allowance for loan losses (200,711) (132,986)
Premises and equipment 262,890 119,201
Other real estate owned
and other repossessed assets 6,737 5,329
Accrued interest receivable 222,302 164,720
Goodwill and other intangible assets 1,027,309 434,078
Other assets 3,074,078 942,808
------------ ------------
TOTAL ASSETS $ 35,860,073 $ 26,607,112
============ ============
LIABILITIES
Deposits and other customer accounts $ 20,024,978 $ 12,012,675
Borrowings:
Short-term 9,739,214 6,609,385
Long-term 3,698,873 5,760,724
Advance payments by borrowers
for taxes and insurance 38,881 28,222
Other liabilities 189,136 58,265
------------ ------------
TOTAL LIABILITIES 33,691,082 24,469,271
------------ ------------
Corporation-obligated mandatorily redeemable capital securities
of subsidiary trust holding solely subordinated debentures of
Sovereign Bancorp, Inc. ("Trust Preferred Securities") 317,819 316,346
------------ ------------
STOCKHOLDERS' EQUITY
Common stock; no par value; 400,000,000 shares authorized;
231,151,082 shares issued at June 30, 2000 and 230,647,896 shares
issued at December 31, 1999 1,256,900 1,254,037
Warrants 91,500 91,500
Unallocated common stock held by the Employee
Stock Ownership Plan at cost;
4,856,254 shares at June 30, 2000
and December 31, 1999 (36,295) (36,295)
Treasury stock at cost; 370,070 shares at
June 30, 2000 and 383,875 shares at
December 31, 1999 (3,461) (3,595)
Accumulated other comprehensive (loss) (162,153) (210,932)
Retained earnings 704,681 726,780
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 1,851,172 1,821,495
------------ ------------
TOTAL LIABILITIES, MINORITY INTERESTS AND STOCKHOLDERS' EQUITY $ 35,860,073 $ 26,607,112
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
-5-
<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,
------------------------ --------------------------
2000 1999 2000 1999
--------- -------- ----------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Interest income:
Interest on interest-earning deposits $ 7,920 $ 1,374 $ 10,198 $ 2,879
Interest and dividends on investment
securities available-for-sale 135,861 129,412 273,607 251,302
Interest and dividends on investment
securities held-to-maturity 38,322 24,191 75,526 52,157
Interest and fees on loans 375,490 222,467 670,143 439,134
--------- -------- ----------- --------
Total interest income 557,593 377,444 1,029,474 745,472
--------- -------- ----------- --------
Interest expense:
Interest on deposits
and other customer accounts 163,945 107,357 282,144 218,760
Interest on borrowings 206,834 122,679 401,264 239,512
--------- -------- ----------- --------
Total interest expense 370,779 230,036 683,408 458,272
--------- -------- ----------- --------
Net interest income 186,814 147,408 346,066 287,200
Provision for loan losses 10,000 7,500 18,000 15,000
--------- -------- ----------- --------
Net interest income after provision for
loan losses 176,814 139,908 328,066 272,200
--------- -------- ----------- --------
Other income:
Retail banking fees 17,894 10,811 31,673 21,870
Mortgage banking revenues 7,384 9,005 12,669 18,951
Loan fees and service charges 4,403 2,005 6,680 3,347
Capital markets revenue 413 -- 4,145 --
Gain/(loss) on loans and investment
securities transactions (58,216) 3,362 (81,088) 6,770
Miscellaneous income 16,400 8,107 35,457 14,656
--------- -------- ----------- --------
Total other income/(loss) (11,722) 33,290 9,536 65,594
--------- -------- ----------- --------
General and administrative expenses:
Compensation and benefits 69,115 38,264 115,224 74,741
Occupancy and equipment expenses 31,043 16,494 51,816 33,800
Outside services 54,940 17,806 77,202 33,155
Other administrative expenses 52,997 13,623 77,731 27,943
--------- -------- ----------- --------
Total general and administrative expenses 208,095 86,187 321,973 169,639
--------- -------- ----------- --------
</TABLE>
-6-
<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,
---------------------- -----------------------
2000 1999 2000 1999
-------- ------- -------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Other operating expenses:
Amortization of goodwill and other intangibles $ 20,461 $ 9,027 $ 30,145 $ 18,055
Trust Preferred Securities expense 9,320 3,049 18,248 6,098
Real estate owned loss/(gain), net (66) 182 (221) 22
-------- ------- -------- --------
Total other operating expenses 29,715 12,258 48,172 24,175
-------- ------- -------- --------
Income/(loss) before income taxes
and extraordinary item (72,718) 74,753 (32,543) 143,980
Income tax provision/(benefit) (24,016) 25,974 (10,766) 49,888
-------- ------- -------- --------
Income/(loss) before extraordinary item (48,702) 48,779 (21,777) 94,092
Gain on sale of FHLB advances
(net of tax of $5,225) -- -- 10,775 --
-------- ------- -------- --------
Net Income/(loss) $(48,702) $48,779 $(11,002) $ 94,092
======== ======= ======== ========
Earnings/(loss) per share
Basic
Income/(loss) before
extraordinary item $ (.22) $ .31 $ (.10) $ .59
Extraordinary item resulting from
gain on sale of FHLB advances -- -- .05 --
-------- ------- -------- --------
Net income/(loss) $ (.22) $ .31 $ (.05) $ .59
======== ======= ======== ========
Diluted
Income/(loss)before
extraordinary item $ (.22) $ .30 $ (.10) $ .58
Extraordinary item resulting from
gain on sale of FHLB advances -- -- .05 --
-------- ------- -------- --------
Net income/(loss) $ (.22) $ .30 $ (.05) .58
======== ======= ======== ========
Dividends declared per common share $ .025 $ .025 $ .050 .050
======== ======= ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
-7-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Common Unallocated
Shares Common Retained Treasury Common Stock
Outstanding Stock Warrants Earnings Stock Held by ESOP
----------- ---------- -------- -------- -------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance,December 31, 1999 225,408 $1,254,037 $91,500 $726,780 $(3,595) $(36,295)
Comprehensive income:
Net income/(loss) - - (11,002) - -
Change in unrecognized loss on
investment securities available-
for-sale, net of tax - - - - - -
Total comprehensive income
Exercise of stock options 175 582 - - - -
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan 328 2,281 - - - -
Dividends paid on common stock - - - (11,097) - -
Treasury stock repurchase (14) - - - (105) -
Treasury stock sold 28 - - - 239 -
------- ---------- ------- -------- ------- --------
Balance, June 30, 2000 225,925 $1,256,900 $91,500 $704,681 $(3,461) $(36,295)
======= ========== ======= ======== ======= ========
</TABLE>
<TABLE>
<CAPTION>
Accumulated Total
Other Stock-
Comprehensive Holders'
Income/(Loss) Equity
------------- -----------
<S> <C> <C>
Balance,December 31, 1999 $(210,932) $1,821,495
Comprehensive income:
Net income/(loss) - (11,002)
Change in unrecognized loss on
investment securities available-
for-sale, net of tax 48,779 48,779
----------
Total comprehensive income 37,777
Exercise of stock options - 582
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan - 2,281
Dividends paid on common stock - (11,097)
Treasury stock repurchase - (105)
Treasury stock sold - 239
--------- ----------
Balance, June 30, 2000 $(162,153) $1,851,172
========= ==========
</TABLE>
See accompanying notes to consolidated financial statements.
-8-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Six-Month Period
Ended June 30,
-----------------------------------
2000 1999
----------- ------------
<S> <C> <C>
Cash Flows from Operating Activities: (in thousands)
Net income/(loss) $ (11,002) $ 94,092
Adjustments to reconcile net income/(loss) to
net cash provided by operating activities:
Provision for loan losses and deferred taxes 18,000 8,631
Depreciation and amortization 39,864 26,203
Net Amortization/(accretion) of investment
securities and loan discounts (35,406) 5,601
(Gain)/loss on sale of loans, investment
securities and real estate owned 80,999 (6,792)
(Gain)/loss on sale of fixed assets (48)
(Gain) on sale of FHLB advances (16,000) -
Net change in:
Loans held for sale 5,616 210,791
Accrued interest receivable (14,586) (515)
Prepaid expenses and other assets (1,282,188) (186,899)
Other liabilities 101,076 (211,829)
----------- ------------
Net cash provided(used) by operating activities $(1,113,675) $ (60,717)
Cash Flows from Investing Activities:
Proceeds from sales of investment securities
available-for-sale 4,846,462 2,329,822
Proceeds from repayments and maturities of
investment securities:
Available-for-sale 474,520 1,184,048
Held-to-maturity 2,439,408 566,293
Purchases of investment securities:
Available-for-sale (3,929,617) (4,786,233)
Held-to-maturity (2,317,893) (21,683)
Proceeds from sales of loans 258,233 837,822
Purchase of loans (890,872) (549,460)
Net change in loans other than purchases and sales 497,004 (966,323)
Proceeds from sales of premises and equipment 19,979 134
Purchases of premises and equipment (113,778) (17,838)
Proceeds from sale of real estate owned 1,752 11,423
Net cash (paid)received due to acquisitions net
of cash acquired (494,826) 112,998
----------- ------------
Net cash provided(used) by investing activities 790,372 (1,298,997)
----------- ------------
Cash Flows from Financing Activities:
Net (decrease)/increase in deposits
and other customer accounts 3,635 (666,305)
Net increase in short-term borrowings 2,563,505 1,513,733
Proceeds from long-term borrowings - 744,996
Repayments of long-term borrowings (569,982) (149,302)
Sale of FHLB advances (911,037) -
Net increase in advance payments by
borrowers for taxes and insurance 10,659 7,838
Cash dividends paid to stockholders (11,097) (7,507)
Proceeds from issuance of common stock 2,863 4,798
Advance to the Employee Stock Ownership Plan (437)
(Purchase)/issuance of treasury stock 134 (43,850)
----------- ------------
Net cash provided(used) by financing activities 1,088,680 1,403,964
----------- ------------
Net change in cash and cash equivalents 765,377 44,250
Cash and cash equivalents at beginning of period 393,234 553,724
----------- ------------
Cash and cash equivalents at end of period $ 1,158,611 $ 597,974
=========== ============
</TABLE>
Supplemental Disclosures:
Income tax payments totaled $6 million for the six-month period ended June 30,
2000 and $62 million for the same period in 1999. Interest payments totaled $677
million for the six-month period ended June 30, 2000 and $433 million for the
same period in 1999. Noncash activity consisted of acquisitions which included
$7 billion of loans and assumption of $8 billion of deposits for the six-month
period ended June 30, 2000 and $551 million of loans and assumptions of $515
million of deposits for the same period in 1999; mortgage or whole loan sales of
$171 million for the six-month period ended June 30, 2000 and $732 million for
the same period in 1999; reclassification of long-term borrowings to short-term
borrowings of $565 million for the six-month period ended June 30, 2000 and $322
million for the same period in 1999; and reclassification of mortgage loans to
real estate owned of $3 million for the six-month period ended June 30, 2000 and
$9 million for the same period in 1999.
See accompanying notes to consolidated financial statements.
-9-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) BASIS OF PRESENTATION AND ACCOUNTING POLICIES
Basis of Presentation
The accompanying financial statements of Sovereign Bancorp, Inc. and
Subsidiaries ("Sovereign") include the accounts of the parent company, Sovereign
Bancorp, Inc. and its wholly-owned subsidiaries: Sovereign Bank, Sovereign
Delaware Investment Corporation, Sovereign Delaware Escrow Corporation,
Sovereign Capital Trust I, Sovereign Capital Trust II 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
including commercial overnight interest-bearing accounts (see Note 6 Deposit
Portfolio Composition) now included in deposits and other customer accounts
previously classified as borrowings. These reclassifications have no effect on
net income.
The results of operations for the three-month and six-month periods ended
June 30, 2000 are not necessarily indicative of the results which may be
expected for the entire year. The consolidated financial statements should be
read in conjunction with Form 10-K for the year ended December 31, 1999.
-10-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(2) EARNINGS PER SHARE
Basic earnings per share is calculated by dividing income before
extraordinary item by the weighted average common shares outstanding, excluding
options and warrants. In calculating diluted earnings per share, the dilutive
effect of options and warrants is calculated using the treasury stock method,
using the average market price for the period.
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,
----------------------- -----------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Basic Earnings Per Share:
Income/(loss) before
extraordinary item $(48,702) $ 48,779 $(21,777) $ 94,092
--------- -------- -------- --------
Average basic shares 225,846 158,413 225,699 159,140
======== ======== ======== ========
Basic earnings/(loss) per share $ (.22) $ .31 $ (.10) $ .59
========= ======== ======== ========
Diluted Earnings Per Share:
Income/(loss) before
extraordinary item $(48,702) $ 48,779 $(21,777) $ 94,092
--------- -------- -------- --------
Average diluted shares 225,846 158,413 225,699 159,140
Dilutive effect of average stock
options, net of shares assumed to
be repurchased under the treasury
stock method - 1,861 - 1,889
--------- -------- -------- --------
Total average diluted shares 225,846 160,274 225,699 161,029
======== ======== ======== ========
Diluted earnings/(loss) per share $ (.22) $ .30 $ (.10) $ .58
========= ======== ======== ========
</TABLE>
-11-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(3) INVESTMENT SECURITIES AVAILABLE-FOR-SALE
The following table presents the composition and fair value of investment
securities available-for-sale at the dates indicated: (dollars in thousands)
<TABLE>
<CAPTION>
June 30, 2000
---------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ ----------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and gov't
agency securities $ 47,174 $ - $ 1,222 $ 45,952
Corporate securities/
Trust Preferred 263,208 3,608 11,594 255,222
Asset backed securities 605,757 - 20,945 584,812
Equities 34,109 18 7,349 26,778
FHLB stock 550,097 - - 550,097
Agency preferred stock 425,888 47 4,990 420,945
Municipal securities 33,062 397 1,268 32,191
Mortgage-backed Securities:
Passthroughs:
U.S. government agencies 629,672 1,837 20,511 610,998
Non-agencies 2,542,946 - 128,837 2,414,109
Collateralized mortgage
obligations 1,798,695 1,593 58,763 1,741,525
---------- ------- -------- ----------
Total investment securities
available-for-sale $6,930,608 $ 7,500 $255,479 $6,682,629
========== ======= ======== ==========
</TABLE>
-12-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(3) INVESTMENT SECURITIES AVAILABLE-FOR-SALE (continued)
<TABLE>
<CAPTION>
December 31, 1999
---------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ ----------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 77,229 $ 2 $ 1,210 $ 76,021
Corporate securities/
Trust Preferred 243,915 650 14,231 230,334
Asset backed securities 685,274 - 21,149 664,125
Equities 32,142 31 11,420 20,753
FHLB stock 524,397 - - 524,397
Agency preferred stock 425,888 4,135 395 429,628
Municipal securities 32,813 745 1,379 32,179
Mortgage-backed Securities:
Passthroughs:
U.S. government agencies 478,462 909 21,004 458,367
Non-agencies 2,688,315 - 132,333 2,555,982
Collateralized mortgage
obligations 3,166,472 2,564 130,610 3,038,426
---------- ------- -------- ----------
Total investment securities
available-for-sale $8,354,907 $ 9,036 $333,731 $8,030,212
========== ======= ======== ==========
</TABLE>
-13-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(4) INVESTMENT SECURITIES HELD-TO-MATURITY
The following table presents the composition and fair value of investment
securities held-to-maturity at the dates indicated: (dollars in thousands)
<TABLE>
<CAPTION>
June 30, 2000
---------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------- ------------ ----------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 46,603 $ - $ 386 $ 46,217
Corporate securities/
Trust Preferred 1,306,437 1,822 6,962 1,301,297
Municipal securities 2,821 135 9 2,947
Mortgage-backed Securities:
Passthroughs:
U.S. government agencies 458,568 1,918 2,236 458,250
Non-agency 46,850 312 416 46,746
Collateralized mortgage
obligations 384,370 581 8,869 376,082
---------- ------ ------- ----------
Total investment securities
held-to-maturity $2,245,649 $ 4,768 $18,878 $2,231,539
========== ======= ======= ==========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1999
----------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------- ------------ ----------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 4,807 $ - $ 109 $ 4,698
Corporate securities/
Trust Preferred 1,326,827 9,852 165 1,336,514
Municipal securities 3,275 96 22 3,349
Mortgage-backed Securities:
Passthroughs:
U.S. government agencies 499,866 2,516 2,365 500,017
Non-agency 52,319 377 224 52,472
Collateralized mortgage
obligations 474,957 2,520 7,502 469,975
---------- ------ ------ ---------
Total investment securities
held-to-maturity $2,362,051 $15,361 $10,387 $2,367,025
========== ======= ======= ==========
</TABLE>
-14-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(5) COMPOSITION OF LOAN PORTFOLIO
The following table presents the composition of the loan portfolio by type
of loan and by fixed and adjustable rates at the dates indicated: (dollars in
thousands)
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
--------------------------- ---------------------------
Amount Percent Amount Percent
----------- ------- ----------- -------
<S> <C> <C> <C> <C>
Residential real estate loans $ 8,341,847 39.0% $ 5,623,295 39.5%
Residential construction loans 53,950 .3 59,264 .4
----------- ------ ----------- ------
Total Residential Loans 8,395,797 39.3 5,682,559 39.9
----------- ------ ----------- ------
Commercial real estate loans 2,383,041 11.1 1,516,953 10.7
Commercial and industrial loans 3,214,218 15.1 1,690,744 11.8
Automotive floor plan loans 1,100,891 5.1 730,623 5.2
Multi-family loans 133,795 .6 137,019 1.0
----------- ------ ----------- ------
Total Commercial Loans 6,831,945 31.9 4,075,339 28.7
----------- ------ ----------- ------
Home equity loans 3,157,186 14.8 1,957,945 13.8
Auto loans 2,276,044 10.6 1,936,980 13.6
Loans to automotive lessors 296,195 1.4 288,636 2.0
Student loans 249,771 1.2 249,279 1.8
Other 173,641 .8 35,802 .2
----------- ------ ----------- ------
Total Consumer Loans 6,152,837 28.8% 4,468,642 31.4%
----------- ------ ----------- ------
Total Loans (1) $21,380,579 100.0% $14,226,540 100.0%
=========== ====== =========== ======
Total Loans with:
Fixed rate $13,266,471 62.0% $ 8,707,951 61.2%
Variable rate 8,114,108 38.0 5,518,589 38.8
----------- ------ ----------- ------
Total Loans (1) $21,380,579 100.0% $14,226,540 100.0%
=========== ====== =========== ======
</TABLE>
-------------------
(1) Loan totals are net of deferred loan fees and unamortized premiums and
discounts of $28.4 million and $24.0 million at June 30, 2000 and December
31, 1999, respectively.
-15-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(6) DEPOSIT PORTFOLIO COMPOSITION
The following table presents the composition of deposits and other customer
accounts at the dates indicated: (dollars in thousands)
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
------------------------- ---------------------------
Weighted Weighted
Average Average
Account Type Amount Percent Rate Amount Percent Rate
------------ ----------- ------- -------- ----------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Demand deposit accounts $ 2,363,142 11.8% - % $ 1,089,472 9.1% - %
NOW accounts 2,929,694 14.6 2.65 1,578,259 13.1 2.24
Savings accounts 2,908,970 14.5 2.41 2,142,708 17.8 2.69
Money market accounts(1) 3,951,315 19.7 4.74 1,638,354 13.7 4.05
Retail certificates 7,294,995 36.5 5.57 4,708,057 39.2 5.00
Jumbo certificates 576,862 2.9 6.24 855,825 7.1 5.56
----------- ------ ----- ----------- ------ ------
Total Deposits $20,024,978 100.0% 3.88% $12,012,675 100.0% 3.68%
=========== ====== ===== =========== ====== ======
</TABLE>
-------------------
(1) Money market accounts include commercial overnight interest-bearing accounts
of $753 million and $293 million at June 30, 2000 and December 31, 1999.
(7) BORROWINGS
The following table presents information regarding borrowings at the dates
indicated: (dollars in thousands)
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
-------------------------- ----------------------------
Weighted Weighted
Average Average
Balance Rate Balance Rate
----------- -------- ----------- --------
<S> <C> <C> <C> <C>
Securities sold under
repurchase agreements $ 796,918 6.65% $ 291,524 5.89%
FHLB advances 10,999,940 6.34 10,484,904 5.43
Other borrowings 1,641,229 10.67 1,593,681 10.74
----------- ------- ----------- ------
Total Borrowings $13,438,087 6.89% $12,370,109 6.12%
=========== ======= =========== ======
</TABLE>
In March, 2000, the Company auctioned $927 million of FHLB advances at a
premium of $16 million. Accordingly, the gain associated with the auction of the
FHLB advances is treated as an extraordinary item on the statement of
operations.
-16-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(8) INTEREST RATE EXCHANGE AGREEMENTS
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, 2000
-----------------------------------------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
---------- ------- ---------- --------
<S> <C> <C> <C> <C>
Non-amortizing interest rate swaps:
Pay variable-receive fixed (1) $ 515,000 $ - $(4,446) 8.5
Pay fixed-receive variable (2) 400,000 - (1,952) 2.3
Interest rate caps/floors/corridors(3) 1,200,000 3,092 (1,366) 2.3
---------- ------- -------
$2,115,000 $ 3,092 $(7,764)
========== ======= =========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1999
-----------------------------------------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
---------- ------- ---------- --------
<S> <C> <C> <C> <C>
Non-amortizing interest rate swaps:
Pay variable-receive fixed (1) $ 252,300 $ - $(6,846) 7.0
Pay fixed-receive variable (2) 200,000 - 8,853 3.1
Interest rate caps/floors
/corridors (3) 1,200,000 4,463 (809) 2.6
---------- -------- -------
$1,652,300 $ 4,463 $ 1,198
========== ======== =======
</TABLE>
--------------------
(1) The weighted average pay rate was 6.63% and 7.24% and the weighted average
receive rate was 7.53% and 7.82% at June 30, 2000 and December 31, 1999,
respectively.
(2) The weighted average pay rate was 7.36% and 5.41% and the weighted average
receive rate was 6.78% and 6.13% at June 30, 2000 and December 31, 1999,
respectively.
(3) The strike price range was 5.25% - 9.00% at March 31, 2000 and
December 31, 1999.
-17-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
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,
1999 Additions Amortization Terminations 2000
----------- ----------- ------------ ------------ ----------
<S> <C> <C> <C> <C> <C>
Non-amortizing interest
rate swaps $ 452,300 $890,000 $127,300 $300,000 915,000
Interest rate
caps/floors/corridors 1,200,000 - - - 1,200,000
---------- ---------- ---------- -------- ----------
$1,652,300 $890,000 $127,300 $300,000 $2,115,000
========== ======== ======== ======== ==========
</TABLE>
Net interest expense resulting from interest rate exchange agreements for
the six-month period ended June 30, 2000 was $182 thousand.
-18-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)(Continued)
(9) ACQUISITIONS
On September 3, 1999, Sovereign entered into a purchase and assumption
agreement with FleetBoston Financial to acquire branch banking offices located
in Connecticut, Massachusetts, New Hampshire and Rhode Island, and related
deposit liabilities, loans and other assets associated with the business of
those branches. On February 28, 2000, Sovereign and FleetBoston Financial agreed
to restructure certain terms of the agreement. In total, Sovereign purchased
approximately $12 billion of deposits, $9 billion of loans and 281 community
banking offices exclusive of 4 locations being resold to a third party as
detailed in the chart below. The acquisition, which resulted in the creation of
Sovereign Bank New England, the third largest bank in New England, included the
following: the former Fleet Bank community banking franchise in eastern
Massachusetts; the entire former BankBoston community banking franchise in Rhode
Island; and select community banking offices of Fleet Bank in Southern New
Hampshire and BankBoston in Connecticut. In addition, Sovereign acquired a
substantial portion of the middle market and small business-lending group from
Fleet in Massachusetts and New Hampshire, and from BankBoston in Rhode Island
and Connecticut. The acquisition included the purchase of fully functioning
business units, with the necessary management, relationship officers, support
staff and other infrastructure for the acquired loans and deposits to be fully
serviced.
Schedule of Completed SBNE Acquisition
Date Completed Divested Units Deposits Branches Loans
-------------- -------------- ------------ -------- -------------
March 24, 2000 RI, CT (BankBoston) $4.2 billion 90 $3.6 billion
June 16, 2000 Eastern MA (Fleet) $3.8 billion 86 $3.5 billion
July 21, 2000 Central MA, NH (Fleet) $4.1 billion 105 $2.0 billion
--- --- ----
$12.1 billion 281 $9.1 billion
Total consideration for the entire consumer and banking franchise is 12% of
acquired deposits less agreed upon reductions, or approximately $0.9 billion.
Included in the 12% premium, Sovereign will pay up to $340 million in periodic
installments between January 2001 and October 2001 if FleetBoston complies with
its non-compete obligations under the agreement and certain other conditions are
met. Sovereign paid a non-refundable deposit of $200 million to FleetBoston
which was credited against amounts due at the final closing.
On March 24, 2000 and June 16, 2000, Sovereign successfully completed the
first and second phases of the purchase and assumption agreement of Sovereign
Bank New England (SBNE) as described in the following paragraphs. Sovereign's
results include the operations of these acquired SBNE branches, assets and
liabilities from acquisition date (March 24, 2000 or June 16, 2000) and
thereafter.
Total deposits transferred through the first two phases of the acquisition
were $8.0 billion. Additionally, loan balances transferred to Sovereign
approximated $7.1 billion, which included $2.1 billion of commercial loans and
leases, $1.5 billion of consumer loans and $3.5 billion of residential
mortgages. Residential mortgage loans of $1.1 billion that were not relationship
assets were subsequently sold as part of Sovereign's asset-liability management
strategy to reduce interest rate risk. Other assets acquired included $90
million of currency, $70 million of premises and equipment, $180 million of
precious metals inventory and $215 million of prepaid and other miscellaneous
assets.
-19-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
ACQUISITIONS (continued)
In the first and second closings Sovereign paid a net premium of $472
million, recorded a fair value reduction on acquired loans of $83 million and
established an initial allowance for loan losses of $68 million. These items
result in total intangibles of $623 million including goodwill of $342 million
and core deposit intangible of $281 million to be amortized over 25 years and 10
years, respectively. These adjustments are based upon preliminary information
and are subject to further revision throughout the year.
The third and final phase of the SBNE acquisition, resulting in the
transfer of $4.1 billion of deposits and $2.0 billion of loans, was successfully
completed as scheduled on July 21, 2000. The aforementioned $200 million
deposit, as well as $1.3 billion of investment securities released from escrow
upon completion of the SBNE acquisition, were used along with cash received in
the final closing and from the July settlement of securities sales executed in
June to reduce short term borrowings by approximately $4 billion, to retire $50
million of 6.75% Senior Notes due July 1, 2000 and to reduce the Senior Secured
Credit Facility, due June 30, 2003, by $50 million on August 3, 2000. All events
discussed in this paragraph occurred subsequent to June 30, 2000 and
accordingly, are not included in financial statements as of and for the periods
ending June 30, 2000.
On June 30, 1999, Sovereign acquired Peoples Bancorp Inc. ("Peoples"), a
$1.4 billion bank holding company headquartered in Lawrenceville, New Jersey
whose principal operating subsidiary operated fourteen (14) community banking
offices in Mercer, Burlington and Ocean counties, New Jersey. The transaction
added investments, loans and deposits to Sovereign of approximately $922
million, $503 million and $515 million, respectively. In accordance with the
merger agreement, Peoples' shareholders received .80 shares of Sovereign common
stock for each outstanding share of Peoples common stock. Sovereign issued
approximately 23.6 million shares of Sovereign common stock in connection with
the transaction, which was accounted for as a purchase. Sovereign recorded total
intangibles of $39.5 million, of which $9.8 million was allocated to a core
deposit intangible and $29.7 million was allocated to goodwill. The goodwill and
core deposit intangible are being amortized over 25 years and 10 years,
respectively. Sovereign's results of operations include the operations of
Peoples from June 30, 1999 and thereafter.
On June 15, 1999, Sovereign acquired The Network Companies ("Network"), a
privately held specialty leasing company headquartered in Commack, New York.
Network provides financing for the purchase or lease of equipment and specialty
vehicles plus other specialty products for businesses throughout the United
States, with transactions ranging from $15,000 to $250,000. The purchase price
of $6 million consisted of $4 million of stock and $2 million of cash. The
acquisition was accounted for as a purchase. Sovereign paid a premium of $6
million, all of which was allocated to goodwill. Network had total assets of
approximately $50 million. The goodwill is being amortized over 25 years.
Sovereign's results of operations include the operations of Network from June
15, 1999 and thereafter.
-20-
<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,
------------------------ -------------------------
2000 1999 2000 1999
-------- -------- --------- --------
<S> <C> <C> <C> <C>
Net income/(loss) $(48,702) $ 48,779 $ (11,002) $ 94,092
--------- -------- --------- --------
Net unrealized (losses)/gains on
securities arising during the period (34,609) (57,551) (5,550) (94,173)
Less reclassification adjustment (39,005) 3,878 (54,329 1,607
--------- -------- -------- --------
Net unrealized (losses)/gains
recognized in other comprehensive
income 4,396 (61,369) 48,779 (95,780)
-------- --------- -------- -------
Comprehensive income/(loss) $(44,306) $ (12,590) $ 37,777 $(1,688)
======== ========= ======== =======
</TABLE>
Accumulated other comprehensive loss, net of related tax, consisted of net
unrealized losses on securities of $162 million at June 30, 2000 and net
unrealized losses on securities of $211 million at December 31, 1999.
-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
Cash earnings for the six-month period ended June 30, 2000 increased 22% to
$132.2 million, or $0.69 per share, up from $108 million, or $0.67 per share,
for the same period in 1999. Operating earnings for 2000 increased 17% to $110.1
million, or $0.57 per share, as compared to $94.1 million, or $0.58 per share,
for 1999.
Operating earnings exclude the following special charges for 2000:
merger-related and integration charges related to acquisitions, as well as the
impact on net interest income and shares outstanding from the early issuance of
certain debt and equity instruments issued to finance Sovereign's pending New
England retail banking and middle market lending acquisition ("Sovereign Bank
New England" or "SBNE"). Special charges for the quarter ended June 30, 2000
were $106 million after tax and are outlined in the Reconciliation of Net Income
to Operating Earnings table on the following page. Cash earnings are operating
earnings excluding amortization of intangible assets and ESOP-related expense.
Net loss, including the special charges noted above, was $11.0 million, or
$(0.05) per share, for the six-month period ended June 30, 2000 including an
extraordinary gain on the sale of FHLB advances (debt extinguishment) of $10.8
million (net of taxes of $5.2 million), or $0.05 per share, as compared to net
income of $94.1 million, $0.58 per share, for the same period in 1999.
Cash return on average equity, cash return on average tangible equity and
cash return on average total assets, excluding special charges discussed above,
were 18.02%, 32.68% and .95% for the six-month period ended June 30, 2000
compared to 15.91%, 27.74% and .84% for the same period in 1999.
-22-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Reconciliation of Net Income to Operating
Earnings (In thousands, except per share data - all
amounts are after tax)
<TABLE>
<CAPTION>
Three-Month Period Six-Month Period
Ended June 30 Ended June 30
-------------------------------------- ---------------------------------------
Total Per Share Total Per Share
-------------------- -------------- --------------------- --------------
2000 1999 2000 1999 2000 1999 2000 1999
-------- -------- ---- ---- -------- -------- ----- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net income/(loss) as reported $(48,702) $ 48,779 $(.22) $.30 $(11,002) $ 94,092 $(.05) $.58
Net negative carry on
escrowed bond proceeds (1) 8,420 - .04 - 17,015 - .07 -
Merger-related and integration
costs recorded during the
period (2) 59,920 - .27 - 68,090 - .30 -
Expense on convertible trust
preferred securities
("PIERS")(1) 2,548 - .01 - 6,368 - .03 -
Loss on securities due to
restructuring of the
balance sheet (4) 38,531 - .17 - 38,531 - .17 -
Assumed interest expense reduction
due to paydown of other borrow-
ings with net proceeds of
common equity and PIERS (1) (3,419) - (.02) - (8,874) - (.04) -
Impact of additional shares out-
standing for 1999 common
stock offerings (3) - - .04 - - - .09 -
Operating earnings (3) $ 57,298 $ 48,779 $.29 $.30 $110,128 $ 94,092 $.57 $.58
-------- -------- ---- ---- -------- -------- ---- ----
Cash earnings (3) $ 71,857 $ 55,340 $.36 $.35 $132,218 $108,003 $.69 $.67
======== ======== ==== ==== ======== ======== ==== ====
Average shares before
adjustment for offering 226,670 160,274 226,612 161,029
======= ========
Average shares after
adjustment for offering (3) 199,711 160,274 191,789 161,029
======= ======== ======== ========
</TABLE>
-------------
(1) As part of the agreement to purchase Sovereign Bank New England, Sovereign
raised $1.8 billion of debt and equity capital in November and December,
1999 of which $1.3 billion of debt proceeds were in escrow with limited
ability to reinvest the proceeds until the acquisition was completed on July
21, 2000. Consequently, the excess of negative carry and trust preferred
expense over interest expense reduction realized on the raised capital
resulted in a net reduction in pre-tax income of $11.3 million ($7.5 million
after tax)and $21.8 million ($14.5 million after tax) comprised of the
following components for the three and six-month periods ending June 30,
2000, respectively: a)a reduction of net interest income of $12.7 million
($8.4 million after-tax) and $25.6 million ($17.0 million after tax),
respectively; b)expense of $3.8 million ($2.5 million after-tax) and $9.5
million ($6.4 million after tax) associated with PIERS issued in November,
1999; c)an assumed $5.1 million ($3.4 million after tax) and $13.3 million
($8.9 million after tax) of interest expense reduction from the assumed
paydown of other borrowings with the proceeds of the Trust Preferred
Securities and the common stock offerings.
(2) See further discussion of general and administrative expenses in
management's discussion and analysis.
(3) Operating earnings per share and cash earnings per share are calculated
using a weighted average number of shares which include, for the three and
six-month periods ended June 30, 2000, a pro rata portion of the shares
issued in November, 1999 in proportion to deposits acquired on March 24,
2000 and June 16, 2000 over total estimated SBNE deposits to be acquired.
(4) See further discussion of other income included in management's discussion
and analysis.
-23-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Successful Formation of Sovereign Bank New England
Sovereign successfully completed the SBNE conversion on March 24, June 16
and July 21, 2000. Sovereign's results include the operations of the
aforementioned branches, assets and liabilities of phases I and II from
conversion on March 24, 2000 and June 16, 2000 and thereafter. The final phase
of the acquisition closed on July 21, 2000. Accordingly, the financial impact of
this final phase will be included in operations beginning July 21, 2000 and
thereafter. The transaction represents the largest branch acquisition in banking
history and created the third largest bank in New England with 281 retail
banking offices, over 550 automated teller machines ("ATMs") and approximately
$12 billion of deposits and $8 billion of commercial, consumer and mortgage
loans net of a $1.1 billion sale of residential mortgages that were not
relationship assets.
Please see Note 9 ACQUISITIONS of the Notes to Consolidated Financial
Statements for a more complete description of the SBNE transactions.
-24-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
CONSOLIDATED AVERAGE BALANCE SHEET / NET INTEREST MARGIN ANALYSIS
SIX MONTH PERIOD ENDED JUNE 30
(in thousands)
<TABLE>
<CAPTION>
2000 1999
-------------------------------------- -------------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate(1) Balance Expense Rate(1)
----------- ---------- -------- ----------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Investments:
Interest earning deposits $ 212,981 $ 10,198 9.52% $ 17,260 $ 2,879 33.50%
Investment securities available-for-sale 7,801,238 273,607 7.14% 7,599,636 251,302 6.74%
Investment securities held-to-maturity 2,283,539 75,526 6.62% 1,502,839 52,157 6.95%
----------- ---------- ---- ----------- -------- -----
Total investments 10,297,758 359,331 7.07% 9,119,735 306,338 6.83%
----------- ---------- ---- ----------- -------- -----
Loans:
Residential loans 6,158,976 231,128 7.50% 5,086,974 180,902 7.12%
Commercial loans 5,141,526 222,868 8.71% 2,577,534 103,949 8.15%
Consumer loans 5,217,072 216,147 8.33% 3,915,045 154,283 7.95%
----------- ---------- ---- ----------- -------- -----
Total loans 16,517,574 670,143 8.14% 11,579,553 439,134 7.63%
Allowance for loan losses (146,235) - - (133,891) - -
----------- ---------- ---- ----------- -------- -----
Net loans 16,371,339 670,143 8.21% 11,445,662 439,134 7.72%
----------- ---------- ---- ----------- -------- -----
Total interest earning assets 26,669,097 1,029,474 7.77% 20,565,397 745,472 7.32%
Non-interest earning assets 2,702,172 - - 2,065,072 - -
----------- ---------- ---- ----------- -------- -----
TOTAL ASSETS $29,371,269 1,029,474 7.06% $22,630,469 745,472 6.65%
=========== ---------- ---- =========== -------- -----
LIABILITIES
Deposits:
Core deposits $ 7,879,523 98,502 2.51% $6,256,819 68,027 2.19%
Time deposits 6,719,265 183,642 5.50% 5,928,485 150,733 5.12%
----------- ---------- ---- ----------- -------- -----
Total deposits 14,598,788 282,144 3.88% 12,185,304 218,760 3.62%
----------- ---------- ---- ----------- -------- -----
Borrowed funds:
FHLB advances 10,108,733 297,880 5.83% 7,798,652 202,179 5.16%
Repurchase agreements 765,735 24,264 6.27% 839,647 22,549 5.42%
Other borrowings 1,628,090 79,120 9.88% 372,322 14,784 7.94%
----------- ---------- ---- ----------- -------- -----
Total borrowed funds 12,502,558 401,264 6.38% 9,010,621 239,512 5.29%
----------- ---------- ---- ----------- -------- -----
Total interest bearing liabilities 27,101,346 683,408 5.04% 21,195,925 458,272 4.36%
Non-interest bearing liabilities 433,498 - - 240,152 - -
----------- ---------- ---- ----------- -------- -----
Total liabilities 27,534,844 683,408 4.96% 21,436,077 458,272 4.28%
STOCKHOLDERS' EQUITY 1,836,425 - - 1,194,392 - -
----------- ---------- ---- ----------- -------- -----
TOTAL LIABILITIES
AND STOCKHOLDERS' EQUITY $29,371,269 683,408 4.65% $22,630,469 458,272 4.05%
=========== ---------- ---- =========== -------- -----
NET INTEREST INCOME $ 346,066 $287,200
========== ========
NET INTEREST SPREAD 2.41% 2.60%
===== =====
NET INTEREST MARGIN 2.65% 2.86%
===== =====
NET INTEREST MARGIN-OPERATING BASIS 2.88% 2.86%
===== =====
</TABLE>
----------------
(1) Tax-equivalent basis
-25-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Net interest income for the three-month and six-month periods ended June
30, 2000 was $187 million and $346 million compared to $147 million and $287
million for the same periods in 1999. This increase was attributable to an
increase in average balances resulting from internal growth and recent
acquisitions. Net interest margin - operating basis (net interest income
adjusted to eliminate the negative impact from escrowed financing proceeds
relating to the acquisition of Sovereign Bank New England, divided by average
interest-earning assets - see Reconciliation of Net Income to Operating
Earnings) was 2.97% and 2.88% for the three-month and six-month periods ended
June 30, 2000 and compared to 2.92% and 2.86% for the same periods in 1999.
Interest on investment securities available-for-sale was $136 million and
$274 million for the three-month and six-month periods ended June 30, 2000
compared to $129 million and $251 million for the same periods in 1999. The
average balance of investment securities available-for-sale was $7.8 billion
with an average tax equivalent yield of 7.14% for the six-month period ended
June 30, 2000 compared to an average balance of $7.6 billion with an average
yield of 6.74% for the same period in 1999. Sovereign took steps at quarter end
to repo-sition its balance sheet as a result of the SBNE acquisition. This
involved the sale of approximately $1.0 billion of investment securities.
Proceeds were used to reduce wholesale borrowings in early July when the trades
settled. Sovereign recorded securities losses for the quarter of $38.5 million
net of tax, which was reflected in stockholders' equity at the end of the first
quarter of 2000 as accumulated other comprehensive (loss).
Interest on investment securities held-to-maturity was $38.3 million and
$75.5 million for the three-month and six-month periods ended June 30, 2000
compared to $24.2 million and $52.2 million for the same periods in 1999. The
average balance of investment securities held-to-maturity was $2.3 billion with
an average yield of 6.62% for the six-month period ended June 30, 2000 compared
to an average balance of $1.5 billion with an average yield of 6.95% for the
same period in 1999. Matured investment securities of $1.3 billion were used to
reduce wholesale borrowings when the funds were released from escrow upon
completion of the SBNE acquisition on July 21, 2000.
Interest and fees on loans were $375 million and $670 million for the
three-month and six-month periods ended June 30, 2000 compared to $222 million
and $439 million for the same periods in 1999. The average balance of loans was
$16.4 billion with an average yield of 8.2% for the six-month period ended June
30, 2000 compared to an average balance of $11.6 billion with an average yield
of 7.63% for the same period in 1999.
Interest on deposits was $164 million and $282 million for the three-month
and six-month periods ended June 30, 2000 compared to $107 million and $219
million for the same periods in 1999. The average balance of deposits was $14.6
billion with an average cost of 3.88% for the six-month period ended June 30,
2000 compared to an average balance of $12.2 billion with an average cost of
3.62% for the same period in 1999.
Interest on borrowings was $207 million and $401 million for the
three-month and six-month periods ended June 30, 2000 compared to $123 million
and $240 million for the same periods in 1999. The average balance of borrowings
was
-26-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
$12.5 billion with an average cost of 6.38% for the six-month period ended June
30, 2000 compared to an average balance of $9.0 billion with an average cost of
5.29% for the same period in 1999. The increase in the average balance and
average cost of borrowings was the result of balance sheet growth being funded
by borrowings, and the additional $1.2 billion in borrowings raised to finance
the Sovereign Bank New England transaction.
Subsequent to June 30, 2000, Sovereign reduced short term borrowings by
approximately $4 billion, retired $50 million of 6.75% Senior Notes due July 1,
2000 and reduced the Senior Secured Credit Facility due June 30, 2003 by $50
million on August 3, 2000. This was accomplished using funds generated from the
$1.0 billion quarter end investment securities sold, $1.3 billion of investment
securities released from escrow and $200 million deposit returned from
FleetBoston upon completion of the SBNE acquisition on July 21, 2000, and with
cash received in the final closing of the SBNE acquisition.
Provision for Possible Loan Losses
The provision for loan loss expense is based upon credit loss experience
and on the estimation of losses inherent in the current loan portfolio. The
provision for loan losses for the three-month and six-month periods ended June
30, 2000 was $10 million and $18 million compared to $7.5 million and $15.0
million for the same periods in 1999. The increase over 1999 is primarily due to
increased loan volumes resulting from internal loan growth and the SBNE
acquisition.
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 periods, 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. The provision recorded
in 2000 of $18 million is consistent with net charge-offs of $18.1 million.
Charge-offs for 1999 included $4.3 million incurred as part of an accelerated
disposition of non-performing residential loans. Excluding these charge-offs,
1999's charge-offs were consistent with provision levels. In Sovereign's
experience, a strategy that involves the accelerated resolution of problem
assets is more appropriate than a long-term workout approach. For additional
information with respect to Sovereign's asset quality, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations - Loan
Portfolio".
Sovereign established initial allowances of $68 million for loans acquired
in the March 24, 2000 and June 16, 2000 phases of the SBNE acquisition. These
initial estimates were established by applying Sovereign's normal methodology to
determine such allowances to the portfolios acquired. A more detailed and in
depth review of the entire SBNE portfolio will be performed upon completion of
the SBNE acquisition. This evaluation is expected to be completed by the fourth
quarter.
-27-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Sovereign's net charge-offs for the six-month period ended June 30, 2000
were $18.1 million and consisted of charge-offs of $28.0 million and recoveries
of $9.9 million. This compared to net charge-offs of $19.4 million consisting of
charge-offs of $30.0 million and recoveries of $10.6 million for the six-month
period ended June 30, 1999. 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 commercial loan charge-offs, the majority of which are
related to Sovereign's strategy to grow commercial portions of its business.
Although net charge-offs are higher than the prior year, net charge-offs as a
percentage of average loans outstanding declined to .23% from .26% (excluding
$4.3 million accelerated disposition of non-performing residential loans in
1999).
The following table presents the activity in the allowance for possible
loan losses for the periods indicated: (dollars in thousands)
Six-month Period Ended June 30,
2000 1999
--------- ---------
Allowance, beginning of period $ 132,986 $ 133,802
Charge-offs:
Residential(1) 2,539 8,793
Commercial Real Estate 76 480
Commercial 6,395 2,117
Consumer 19,008 18,598
--------- ---------
Total Charge-offs 28,018 29,988
--------- ---------
Recoveries:
Residential 974 1,030
Commercial Real Estate 107 453
Commercial 2,203 420
Consumer 6,601 8,667
--------- ---------
Total Recoveries 9,885 10,570
--------- ---------
Charge-offs, net of recoveries 18,133 19,418
Provision for possible loan losses 18,000 15,000
Initial allowance related to
acquisitions 67,858 4,799
--------- ---------
Allowance, end of period $ 200,711 $ 134,183
========= =========
---------------------
(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.
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<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Other Income and Extraordinary Item
Other income/(loss) was $(11.7) million and $9.5 million for the
three-month and six-month periods ended June 30, 2000 compared to $33.3 million
and $65.6 million for the same periods in 1999. Due to a favorable shift into
core and corporate deposit products over the last year and the impact of the
SBNE acquisition, retail banking fees grew to $17.9 million and $31.7 million
for the quarter and six-month periods ended June 30, 2000 as compared to $10.8
million and $21.9 million for the same periods in 1999, representing increases
of 66% and 45%, respectively.
Gain/(loss) on loans and investment securities were $(58.2) million and
$(81.1) million for the three-month and six-month periods ended June 30, 2000
compared to $3.4 million and $6.8 million for the same periods in 1999.
Sovereign sold approximately $1.0 billion of available for sale securities at
quarter end to reposition its balance sheet as a result of the SBNE acquisition.
Proceeds were used to reduce wholesale borrowings in early July when the trades
settled.
Sovereign also sold certain investment securities and FHLB advances and
paid-off certain short-term advances during the first quarter of 2000 as part of
its balance sheet repositioning for SBNE. Upon repayment of the short-term
advances, related swaps hedging these instruments were terminated. These
transactions resulted in securities losses of $23 million included in gain(loss)
on sale of loans and investments, $9.5 million of swap termination gains
included as miscellaneous income, and a $16.0 million gain on sale
(extinguishment) of FHLB advances ($10.8 million net of tax) reported as an
extraordinary item.
Miscellaneous income was $16.4 million and $35.5 million for the
three-month and six-month periods ended June 30, 2000 compared to $8.1 million
and $14.7 million for the same periods in 1999. This increase was due to
additional investment in bank-owned life insurance, the aforementioned swap
termination gains and the addition of new lines of fee-based businesses over the
past year.
General and Administrative Expenses
General and administrative expenses for the three-month and six-month
periods ended June 30, 2000 were $208 million and $322 million, compared to
$86.2 million and $170 million for the same periods in 1999. Included in general
and administrative expenses for the three-month and six-month periods ended June
30, 2000 were $90 million and $102 million of merger-related, integration and
other charges related to all of Sovereign's recent acquisitions. These special
charges related to the real estate transaction described within this 10-Q, costs
that management considered redundant due to separating the closing into three
closings, and other merger-related charges. Excluding these charges, general and
administrative expenses were $118 million and $220 million for the three-month
and six-month periods ended June 30, 2000. Sovereign's efficiency ratio measured
on an operating basis (general and administrative expenses excluding
merger-related and other integration charges from recent acquisitions as a
percentage of net interest margin excluding the negative carry from escrowed
financing proceeds) for the three-month and six-month periods ended June 30,
2000 was 49.05% and 49.74% compared to 47.70% and 48.08% for the same period in
1999.
-29-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Other operating expenses were $29.7 million and $48.2 million for the
three-month and six-month periods ended June 30, 2000 compared to $12.3 million
and $24.2 million for the same periods in 1999. Results for the three-month and
six-month periods ended June 30, 2000 included amortization of goodwill of $20.5
million and $30.1 million compared to $9.0 million and $18.1 million for the
same periods in 1999. The increase in goodwill amortization is a result of the
additional intangibles recorded for the first two phases of the SBNE
acquisition.
Income Tax Provision
The income tax provision/(benefit) was $(24.0) million and $(10.8) million
for the three-month and six-month periods ended June 30, 2000 compared to $26.0
million and $49.9 million for the same periods in 1999. The effective tax rate
for the three-month and six-month periods ended June 30, 2000 was 33.0% and
33.1%, respectively, compared to 34.7% and 34.6% for the same periods in 1999.
The effective tax rate for 2000 is comparable to 33.3% for the full year-ended
December 31, 1999.
-30-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
FINANCIAL CONDITION
Loan Portfolio
Commercial originations generated for the first six-months of 2000 were
$928 million. At June 30, 2000, commercial loans totaled $6.8 billion
representing 31.9% of Sovereign's loan portfolio, compared to $4.1 billion and
28.7% of the loan portfolio at December 31, 1999 and $3.2 billion and 26.0% of
the loan portfolio at June 30, 1999. 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 continue to drive performance in this area. The first
two phases of the SBNE acquisition increased commercial loans by $2.1 billion.
Consumer loans originated during the first six-months of 2000 totaled $1.3
billion. The consumer loan portfolio (including home equity loans and lines of
credit, automobile loans, and other consumer loans) totaled $6.2 billion at June
30, 2000, representing 28.8% of Sovereign's loan portfolio, compared to $4.5
billion and 31.4% of the loan portfolio at December 31, 1999 and $4.2 billion
and 33.6% of the loan portfolio at June 30, 1999. This increase was primarily
the result of strong home equity and auto loan originations during the six-month
period ended June 30, 2000. The first two phases of the SBNE acquisition
increased the consumer loan portfolio by $1.5 billion.
Residential mortgage loans increased $2.7 billion during the quarter to
$8.4 billion and now represent 39.3% of Sovereign's loan portfolio as compared
to 39.9% at December 31, 1999. The first two phases of the SBNE acquisition
increased residential mortgages by $2.4 billion exclusive of $1.1 billion of
loans that were not relationship assets were subsequently sold as part of
Sovereign's asset-liability management strategy to reduce interest rate risk in
the first quarter 2000.
During the six-month period ended June 30, 2000, Sovereign closed $1.3
billion of first mortgage loans of which approximately 23% were fixed rate and
sold in the secondary market. This compares to first mortgage loan closings of
$969 million of which approximately 95% were fixed rate loans and sold during
the same period in 1999.
Non-Performing Assets
At June 30, 2000 Sovereign's non-performing assets were $113.7 million
compared to $84 million at December 31, 1999. This increase was due to
delinquencies in a purchased home equity portfolio and increases in the
residential, commercial, and commercial real estate portfolios. Non-performing
assets as a percentage of total assets was .32% at June 30, 2000 and at
December 31, 1999. At June 30, 2000 75% of non-performing assets consisted of
loans related to real estate, consumer loans or OREO which are secured by
collateral. Sovereign places all loans 90 days or more delinquent (except auto
loans and loans guaranteed by the government) 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%
allowance allocation is assigned.
-31-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table presents the composition of non-performing assets at
the dates indicated: (dollars in thousands)
June 30, December 31,
2000 1999
-------- -----------
Non-Accrual Loans:
Past due 90 days or more
as to interest or principal:
Real estate related $ 41,917 $36,510
Other 61,293 36,923
-------- -------
Total Non-Accrual Loans 103,210 73,433
Other - 1,978
Restructured Loans 3,755 3,755
-------- -------
Total Non-Performing Loans (1) 106,965 79,166
-------- -------
Other Real Estate Owned and Other
Repossessed Assets:
Other real estate owned 5,476 3,567
Other repossessed assets 1,261 1,762
-------- -------
Total Other Real Estate Owned and
Other Repossessed Assets 6,737 5,329
-------- -------
TOTAL NON-PERFORMING ASSETS $113,702 $84,495
======== =======
Past due 90 days or more as to
interest or principal and
accruing interest (2) $ 12,215 $10,238
Non-Performing Assets as a
percentage of Total Assets .32% .32%
Non-Performing Loans as a
percentage of Total Loans .50% .56%
Non-Performing Assets as a
percentage of Total Loans
and Real Estate Owned .53% .59%
Allowance for Loan Losses
as a percentage of
Total Non-Performing Assets 176.5% 157.4%
Allowance for Loan Losses
as a percentage of
Total Non-Performing Loans 187.6% 168.0%
-------------------
(1) Includes impaired loans of $35 million and $12 million at June 30, 2000 and
December 31, 1999, respectively. See following discussion of impaired
loans for more information.
(2) Includes student loans which are government-guaranteed and auto loans past
due between 90 and 120 days.
-32-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Impaired Loans
Impaired loans, as defined by SFAS 114 "Accounting for Creditors for
Impairment of a Loan", totaled $172 million (including $35 million of non
performing and $137 million of non homogeneous potential problem loans) at June
30, 2000, and $108 million (including $12 million of non performing loans and
$96 million of potential problem loans) at December 31, 1999. This increase was
primarily due to seasoning in the existing portfolio and growth in the
commercial loan portfolio. The portion of Sovereign's loan loss allowance
attributable to the impaired loans was $44.8 million and $24.6 million, at June
30, 2000 and December 31, 1999, respectively. Sovereign's impaired loans do not
include large pools of homogeneous loans, such as residential mortgages and
consumer loans, in accordance with SFAS 114.
Potential problem loans amounted to $148 million (including $137 million of
impaired loans and $11 million of residential and consumer loans ) at June 30,
2000 and $96 million all of which were impaired loans at December 31, 1999.
Allowance for Loan Losses
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:
<TABLE>
<CAPTION>
(dollars in thousands)
June 30, 2000 December 31, 1999
-------------------------- ---------------------------
% of Loans % of Loans
to to
Amount Total Loans Amount Total Loans
-------- ----------- -------- -----------
<S> <C> <C> <C> <C>
Allocated allowances:
Commercial loans $103,434 32% $ 58,784 29%
Residential real estate
mortgage loans 26,918 39 19,535 40
Consumer loans 59,773 29 43,455 31
-
Unallocated allowances 10,586 n/a 11,212 n/a
-------- ----- -------- -----
Total allowance for loan losses $200,711 100% $132,986 100%
======== ===== ======== =====
</TABLE>
The adequacy of Sovereign's allowance for loan losses is regularly evaluated.
Management's evaluation of the adequacy of the allowance to absorb loan losses
takes into consideration the risks inherent in the loan portfolio, past loan
loss experience, specific loans which 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 allowance. Along
with higher yields, management believes the shift in loan composition from
residential into commercial and consumer brings higher inherent risk.
-33-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
At June 30, 2000, Sovereign's loan delinquencies (all loans greater than 30
days delinquent) as a percentage of total loans was 2.30% compared to 1.79% at
December 31, 1999. The increase is principally attributable to the loans
acquired in the SBNE acquisition of a purchased home equity portfolio. We
believe that this temporary increase in delinquencies will be mitigated as the
SBNE loan portfolios are subjected to Sovereign's collection methodology.
Sovereign maintains an allowance for loan losses sufficient to absorb
inherent losses in the loan portfolio and believes the current allowance to be
at a level adequate to cover such inherent losses. The Company gives
consideration to other risk indicators when determining the appropriate
allowance level.
The allowance for loan losses consists of two elements: (i) an allocated
allowance, which is comprised of allowances established on specific loans, and
class allowances based on historical loan loss experience and current trends,
and (ii) unallocated allowances based on both general economic conditions and
other risk factors in the Company's individual markets and portfolios, and to
account for a level of imprecision in management's estimation process.
The specific allowance element of the allocated allowance is based on a
regular analysis of criticized loans where internal credit ratings are below a
predetermined classification. This analysis is performed at the relationship
manager level, and periodically reviewed by the loan review department. The
specific allowance established for these criticized loans is based on a careful
analysis of related collateral value, cash flow considerations and, if
applicable, guarantor capacity.
The class allowance element of the allocated allowance is determined by an
internal loan grading process in conjunction with associated allowance factors.
These class allowance factors are updated annually and are based primarily on
actual historical loss experience, consultation with regulatory authorities, and
peer groups loss experience. While this analysis is conducted annually, the
Company has the ability to revise the class allowance factors whenever necessary
in order to address improving or deteriorating credit quality trends or specific
risks associated with a given loan pool classification.
Regardless of the extent of the Company analysis of customer performance,
portfolio evaluations, trends or risk management processes established, certain
inherent, but undetected losses are probable within the loan portfolio. This is
due to several factors including inherent delays in obtaining information
regarding a customer's financial condition or changes in their unique business
conditions; the judgmental nature of individual loan evaluations, collateral
assessments and the interpretation of economic trends; volatility of economic or
customer-specific conditions affecting the identification and estimation of
losses for larger non-homogeneous credits; and the sensitivity of assumptions
utilized to establish allocated allowances for homogeneous groups of loans among
other factors. The Company maintains an unallocated allowance to recognize the
existence of these exposures. These other risk factors are continuously reviewed
and revised by management where conditions indicate that the estimates initially
applied are different from actual results.
-34-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
A comprehensive analysis of the allowance for loan losses is performed by
the Company on a quarterly basis. In addition, a review of allowance levels
based on nationally published statistics is conducted on an annual basis. The
Company has an Asset Review Committee, which has the responsibility of affirming
allowance methodology and assessing the general and specific allowance factors
in relation to estimated and actual net charge-off trends. This Committee is
also responsible for assessing the appropriateness of the allowance for loan
losses for each loan pool classification at Sovereign.
Acquired Portfolio. The Company established an initial allowance for loan
losses of $68 million upon acquisition of the SBNE loan portfolio, that in
Management's judgment, were inherent in the loan portfolio as of the acquisition
date. The $68 million is comprised of $30 million for commercial loans, $24
million for consumer loans, and $8 million for residential mortgages. The
Company utilized its existing allowance for loan loss methodology on the
acquired SBNE loan portfolio, including performing credit reviews on each
significant loan or a sample of credit reviews on pool of homogeneous loans, and
assigning initial risk ratings to such loans or pools of loans. Sovereign also
established an additional $5 million unallocated allowance related to the loans
acquired due to the unfamiliarity of the portfolio acquired, and to account for
a level of imprecision in its original estimate. These initial allowances
adjustments are based upon preliminary information and are subject to further
revision as more detailed information of the loan portfolio becomes known.
Residential Portfolio. The allowance for the residential mortgage portfolio
increased from $19.5 million at December 31, 1999 to $26.9 million at June 30,
2000. The change was due primarily to the acquired SBNE residential portfolio.
Consumer Portfolio. The allowance for the consumer loan portfolio increased
from $43.5 million at December 31, 1999, to $59.8 million at June 30, 2000. This
increase is primarily attributable to the acquired SBNE consumer portfolio.
Commercial Portfolio. The portion of the allowance for loan losses related
to the Commercial portfolio has increased from $58.8 million at December 31,
1999 to $103.4 million at June 30, 2000. This increase is primarily attributable
to the acquired SBNE commercial portfolio.
Unallocated Allowance. The unallocated allowance for loan losses decreased
to $10.6 million at June 30, 2000 from $11.2 million at December 31, 1999.
-35-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
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/IBCA 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 four years or
less. The effective duration of the total investment portfolio at June 30, 2000
was 3.7 years.
At June 30, 2000, total investment securities available-for-sale were $6.7
billion compared to $8.0 billion at December 31, 1999 and investment securities
held-to-maturity were $2.2 billion compared to $2.4 billion at December 31,
1999. For additional information with respect to Sovereign's investment
securities, see Notes 3 and 4 in the Notes to Consolidated Financial Statements.
The decrease in investment securities available-for-sale is due principally to
balance sheet repositioning due to the SBNE acquisition. Additionally, $1.3
billion of maturing investment securities held-to-maturity were used to reduce
wholesale borrowings when they were released from escrow upon completion of the
SBNE acquisition on July 21, 2000.
Goodwill and Other Intangible Assets
Total goodwill and other intangible assets at June 30, 2000 were $1.0
billion compared to $434 million at December 31, 1999. This increase is
primarily attributable to Sovereign's completed SBNE branch acquisition,
partially off-set by normal year-to-date amortization.
Other Assets
Other assets increased by $2 billion from December 31, 1999. This is
primarily attributable to $1 billion of receivables from securities brokers for
investment securities trades executed on June 30, 2000 that settled in July,
$200 million of additional bank owned life insurance, $205 million of precious
metals assets, $480 million of advances due from FleetBoston upon final
settlement.
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.
-36-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Total deposits at June 30, 2000 were $20.0 billion compared to $12.0
billion at December 31, 1999. The increase in deposits of $8.0 billion is
attributable to the SBNE acquisition. Through the use of interest rate swaps,
$515 million of brokered deposits have been effectively converted from fixed
rate to floating rate obligations. 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, 2000 were $13.4 billion of which $9.7 billion
were short-term compared to $12.4 billion of which $6.6 billion were short-term
at December 31, 1999. This increase in borrowings is the result of balance sheet
growth being partially funded by borrowings. During the six-month period ended
June 30, 2000, Sovereign funded its balance sheet growth through borrowings as
the cost of certain 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, $400 million of FHLB advances at
June 30, 2000 have been effectively converted from variable rate obligations to
fixed rate obligations. In addition, at June 30, 2000, $700 million of
borrowings have been protected from upward repricing through the use of interest
rate caps, floors and corridors.
Subsequent to June 30, 2000, Sovereign reduced short term borrowings by
approximately $4 billion, retired $50 million of 6.75% Senior Notes due July 1,
2000 and reduced the Senior Secured Credit Facility due June 30, 2003 by $50
million on August 3, 2000. This was accomplished using funds generated from the
$1.0 billion quarter end investment securities sold, $1.3 billion of investment
securities released from escrow and $200 million deposit returned from
FleetBoston upon completion of the SBNE acquisition on July 21, 2000, and with
cash received in the final closing of the SBNE acquisition.
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, 2000 was 38.8%.
-37-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
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 $95 million per
month. 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, 2000, cash and cash equivalents
increased $765 million. Net cash used for operating activities for the six-month
period ended June 30, 2000 was $1.1 billion. Net cash provided by investing
activities for the six-month period ended June 30, 2000 was $790 million and
consisted primarily of proceeds from the sale of investment securities
available-for-sale offset by the purchase of investment securities
available-for-sale. Net cash provided by financing activities for the six-month
period ended June 30, 2000 was $1.1 billion and consisted mainly of an increase
of short-term borrowings offset by the extraordinary sale of FHLB advances in
the first quarter and the repayment of long-term borrowings.
Real Estate Leases
On June 30, 2000, Sovereign executed a sale/leaseback transaction involving
a portion of its owned real estate and a long-term lease arrangement for certain
real estate to be used by SBNE. The total transaction was valued at $308 million
and included the sale and leasing of 127 of its and former Fleet community
banking offices and other facilities.
The transaction is expected to be neutral to Sovereign's future earnings.
Total expenses related to the transaction were approximately $17 million pre-tax
and were principally recorded as merger-related charges during the second
quarter, as discussed above.
Capital
The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA"),
requires institutions regulated by the Office of Thrift Supervision (OTS) to
have a minimum leverage capital ratio equal to 3% of tangible assets and 4% of
risk-adjusted assets, and a risk-based capital ratio equal to 8%. The Federal
Deposit Insurance Corporation Improvement Act ("FDICIA") requires OTS regulated
institutions to have a minimum tangible capital equal to 2% of total tangible
assets.
At June 30, 2000, 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.
-38-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Although OTS capital regulations do not apply to savings and loan holding
companies, the OTS Order approving Sovereign Bank's acquisition and assumption
of assets and deposits in New England from FleetBoston requires Sovereign
Bancorp to maintain a certain level of capital. At June 30, 2000, Sovereign
Bancorp met or exceeded this capital requirement. Capital ratios presented below
for Sovereign Bancorp are computed using average quarterly tangible assets which
is consistent with the method used by bank holding companies.
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA")
established five (5) capital tiers: well-capitalized, adequately-capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. A depository institution's capital tier depends upon its
capital levels in relation to various relevant capital measures, which include
leverage and risk- based capital measures and certain other factors. Depository
institutions that are not classified as well-capitalized or
adequately-capitalized are subject to various restrictions regarding capital
distributions, payment of management fees, acceptance of brokered deposits and
other operating activities. Although Sovereign Bancorp is not subject to OTS
capital requirements, depending upon the specific facts regarding a proposed
acquisition, the OTS could determine that the pro forma financial condition of a
savings and loan holding company may be inadequate and therefore condition
approval on making proscribed capital levels.
The following table sets forth the capital ratios of Sovereign Bancorp and
Sovereign Bank and the current regulatory requirements at June 30, 2000:
<TABLE>
<CAPTION>
Sovereign
Sovereign Bank Bancorp
------------------------------------------- ---------
Well
June 30, Minimum Capitalized June 30,
2000 Requirement Requirement 2000
-------- ----------- ----------- --------
<S> <C> <C> <C> <C>
Stockholders' equity to
total assets 9.24% None None 5.16%
Tangible capital to tangible
assets 6.96 2.00% None 2.67
Leverage (core) capital to
tangible assets 6.96 3.00 5.00 4.23
Leverage (core) capital to
risk adjusted assets 10.67 4.00 6.00 5.68
Risk-based capital to risk
adjusted assets 11.55 8.00 10.00 6.98
</TABLE>
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.
-39-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Sovereign measures interest rate risk utilizing three tools: net interest
income simulation analysis in multiple interest rate environments, instantaneous
parallel interest rate shocks and lastly, gap analysis, which is a schedule
measuring the difference between assets, liabilities and off-balance sheet
positions which will mature or reprice within specific terms. Income simulation
considers not only the impact of changing market interest rates on forecasted
net income, but also other factors, such as yield curve relationships, the
volume and mix of assets and liabilities, customer preferences and general
market conditions.
Sovereign manages the impact to net interest income in a +/- 200 basis
point instantaneous parallel rate shock environment to be generally within a 10%
variance. At June 30, 2000, Sovereign estimates that if interest rates decline
by 200 basis points, net interest income would decrease by $65.5 million or
5.8%; conversely, if interest rates increase by 200 basis points, net interest
income would decrease by $5.2 million for the six-month period ended June 30,
2000, or 0.5%. At December 31, 1999, if interest rates increased by 200 basis
points, net interest income would have decreased by $76 million or 7.6%. This
change in sensitivity was primarily related to a decrease in short-term,
variable rate borrowings.
On a pro forma basis after the closing on the acquisition of assets and
liabilities from Fleet BankBoston, Sovereign's interest rate risk position is
expected to be approximately neutral. The addition of core deposits and variable
rate loans from the acquisition is expected to offset liability sensitivity that
is evident in the June 30, 2000 analysis. The reduction in wholesale funding of
over $4 billion is expected to also improve the liability sensitivity. Pro
forma, net interest income will fall .53% in an instantaneous upward shock of
200 basis points and is expected to fall 6.25% in an instantaneous downward
shock of 200 basis points.
Sovereign manages the one year interest rate gap within +/- 10% range. 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 estimates its one
year gap position was a negative 15.1% at June 30, 2000, resulting from
positioning for the July 21, 2000 addition of $4.1 billion of deposits from the
third phase of the SBNE acquisition. On a pro forma basis, the one year gap is
projected to be a negative 6.8% at September 30, 2000.
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.
Interest rate swaps are generally used to convert fixed rate assets and
liabilities to variable rate assets and liabilities and vice versa. Sovereign
utilizes interest rate swaps that have a high degree of correlation to the
related financial instrument. At June 30, 2000 Sovereign's principal off-balance
sheet transactions were to convert liabilities from fixed rate to floating rate
to reduce the cost of funds.
-40-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
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 a 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. Deposits were significantly increased with the first two phases of
Sovereign Bank New England. The first two phases of the transaction added
approximately $8.0 billion to deposits at June 30, 2000. The remaining phase of
the transaction closed on July 21, 2000 and added an additional $4.1 billion in
deposits. 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.
-41-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Items 1 through 3 not applicable or the responses are negative.
Item 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The 2000 annual meeting of the shareholders of Sovereign Bancorp was
held April 27, 2000. The following is a brief description of each matter
voted on at the meeting.
PROPOSAL 1 - ELECTION OF DIRECTORS
The following directors were nominated for election to the Board of
Directors as Class I Directors for a term of three (3) years:
Brian Hard and Cameron C. Troilo, Sr.
PROPOSAL 2 - INDEPENDENT AUDITORS
Shareholders were presented with a proposal to ratify the appointment of
Ernst & Young LLP, independent certified public accountants, to audit
the consolidated financial statements of Sovereign Bancorp and its
subsidiaries for the year ending December 31, 2000.
PROPOSAL 3 - SHAREHOLDER PROPOSAL
Shareholders were presented with a proposal from a shareholder
recommending that the Board of Directors of Sovereign Bancorp take
necessary steps to achieve a sale or merger of the Company on terms
which will maximize shareholder value.
<TABLE>
<CAPTION>
SHARES
BROKER
PROPOSAL FOR AGAINST WITHHELD ABSTENTIONS NON-VOTES
-------- ----------- --------- -------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
1. Election of Directors
Brian Hard 198,018,103 N/A 7,445,844 N/A -0-
Cameron C. Troilo, Sr. 197,468,785 N/A 7,995,162 N/A -0-
2. Independent Auditors 201,833,899 2,822,480 N/A 807,568 -0-
3. Shareholder proposal 25,512,393 108,995,131 N/A 3,621,889 67,334,534
</TABLE>
Item 5 - Not applicable
Item 6 - Exhibits Reports on Form 8-K.
(a) Exhibits
(3.1) Articles of Incorporation, as amended and restated, of
Sovereign Bancorp, Inc. (Incorporated by reference to
Exhibit 3.2 to Sovereign's Annual Report on Form 10-K for the
fiscal year ended December 31, 1998.)
(3.2) By-Laws of Sovereign Bancorp, Inc. (Incorporated by reference
to Exhibit 3.2 to Sovereign's Annual Report on Form 10-K for
year ended December 31, 1998.)
(27) Financial Data Schedule
(b) Reports on Form 8-K
None
-42-
<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 14, 2000 /s/ Dennis S. Marlo
------------------- ----------------------------------------
Dennis S. Marlo
Chief Financial Officer
(Authorized Officer & Principal
Financial Officer)
Date August 14, 2000 /s/ Mark R. McCollom
------------------- ----------------------------------------
Mark R. McCollom
Chief Accounting Officer
-44-
