<PAGE>
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
----- EXCHANGE ACT OF 1934
For the quarter ended September 30, 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 November 13, 2000
------------------------------- ---------------------------------
Common Stock (no par value) 226,095,649 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. 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 related to non-solicitations
agreement 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) unanticipated regulatory or
judicial proceedings; (11) changes in asset quality; and (12) the success of
Sovereign at managing the risks involved in the foregoing.
Operating earnings and cash 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
<PAGE>
FORWARD LOOKING STATEMENTS
(continued)
earnings and cash 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>
INDEX
<TABLE>
<CAPTION>
Page
PART I. FINANCIAL INFORMATION
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets at September 30, 2000
and December 31, 1999 5
Consolidated Statements of Operations for the three-month
and nine-month periods ended September 30, 2000 and 1999 6 - 7
Consolidated Statement of Stockholders' Equity for
the nine-month period ended September 30, 2000 8
Consolidated Statements of Cash Flows for the nine-month
periods ended September 30, 2000 and 1999 9
Notes to Consolidated Financial Statements 10 - 20
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 21 - 38
PART II. OTHER INFORMATION
Item 6. Reports on Form 8-K 39
PART III. FINANCIAL DATA SCHEDULE 40
SIGNATURES 41
</TABLE>
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------ ------------
(Unaudited)
(in thousands, except
per share data)
<S> <C> <C>
ASSETS
Cash and amounts due from
depository institutions $ 898,780 $ 373,996
Interest-earning deposits 63,968 19,238
Investment securities available-for-sale 5,447,636 8,030,212
Investment securities held-to-maturity
(approximate fair value of $1,504,850_
and $2,367,025 at September 30, 2000
and December 31, 1999, respectively) 1,541,095 2,362,051
Loans (including loans held for sale
at approximate fair value of $54,320_
and $62,439 at September 30, 2000 and
December 31, 1999, respectively) 23,046,643 14,288,465
Allowance for loan losses (242,442) (132,986)
Premises and equipment 286,593 119,201
Other real estate owned
and other repossessed assets 5,697 5,329
Accrued interest receivable 236,793 164,720
Goodwill and other intangible assets ($968,817 and
$309,843 net of tax, respectively) 1,449,580 434,078
Other assets 1,913,161 942,808
------------ ------------
TOTAL ASSETS $ 34,647,504 $ 26,607,112
============ ============
LIABILITIES
Deposits and other customer accounts $ 24,470,306 $ 12,012,675
Borrowings:
Short-term 2,912,145 6,609,385
Long-term 4,661,946 5,760,724
Advance payments by borrowers
for taxes and insurance 22,535 28,222
Other liabilities 222,911 58,265
------------ ------------
TOTAL LIABILITIES 32,289,843 24,469,271
------------ ------------
Mandatorily redeemable capital securities
("Trust Preferred Securities") and other
minority interest of subsidiaries 455,491 316,346
------------ ------------
STOCKHOLDERS' EQUITY
Common stock; no par value; 400,000,000 shares
authorized; 231,318,004 shares
issued at September 30, 2000 and 230,647,896 shares
issued at December 31, 1999 1,258,137 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 September 30, 2000
and December 31, 1999 (36,295) (36,295)
Treasury stock at cost; 406,606 shares at
September 30, 2000 and 383,875 shares at
December 31, 1999 (3,695) (3,595)
Accumulated other comprehensive loss (90,700) (210,932)
Retained earnings 683,223 726,780
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 1,902,170 1,821,495
------------ ------------
TOTAL LIABILITIES, MINORITY INTERESTS
AND STOCKHOLDERS' EQUITY $ 34,647,504 $ 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 Nine-Month Period
Ended September 30, Ended September 30,
----------------------------- -----------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
(in thousands, except
per share data)
<S> <C> <C> <C> <C>
Interest income:
Interest on interest-earning deposits $ 8,478 $ 972 $ 18,676 $ 3,851
Interest and dividends on investment
securities available-for-sale 117,989 144,268 391,596 395,570
Interest and dividends on investment
securities held-to-maturity 24,235 20,759 99,761 72,916
Interest and fees on loans 484,052 249,955 1,154,195 689,089
----------- ----------- ----------- -----------
Total interest income 634,754 415,954 1,664,228 1,161,426
----------- ----------- ----------- -----------
Interest expense:
Interest on deposits
and other customer accounts 217,831 110,516 499,975 329,276
Interest on borrowings 162,514 143,570 563,778 383,082
----------- ----------- ----------- -----------
Total interest expense 380,345 254,086 1,063,753 712,358
----------- ----------- ----------- -----------
Net interest income 254,409 161,868 600,475 449,068
Provision for loan losses 10,000 7,500 28,000 22,500
----------- ----------- ----------- -----------
Net interest income after provision for
loan losses 244,409 154,368 572,475 426,568
----------- ----------- ----------- -----------
Other income:
Retail banking fees 28,083 13,779 59,756 35,649
Mortgage banking revenues 4,362 7,374 17,031 26,325
Loan fees and service charges 4,641 2,667 11,321 6,014
Capital markets revenue 1,377 -- 5,522 --
Gain/(loss) on loans and investment
securities transactions (45,052) (299) (126,140) 6,471
Miscellaneous income 21,151 11,430 56,608 26,086
----------- ----------- ----------- -----------
Total other income 14,562 34,951 24,098 100,545
----------- ----------- ----------- -----------
General and administrative expenses:
Compensation and benefits 81,711 38,955 196,935 113,696
Occupancy and equipment expenses 49,785 15,958 101,601 49,758
Outside services 54,320 14,717 131,522 47,872
Other administrative expenses 37,893 21,173 115,624 49,118
----------- ----------- ----------- -----------
Total general and administrative expenses 223,709 90,803 545,682 260,444
----------- ----------- ----------- -----------
</TABLE>
-6-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(continued)
<TABLE>
<CAPTION>
Three-Month Period Nine-Month Period
Ended September 30, Ended September 30,
------------------------- -------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
(in thousands, except
per share data)
<S> <C> <C> <C> <C>
Other operating expenses:
Amortization of goodwill and other intangibles $ 32,630 $ 9,953 $ 62,775 $ 28,008
Non-solicitation expense 47,854 -- 47,854 --
Trust Preferred Securities and
other minority interest expense 11,458 3,049 29,706 9,147
Real estate owned loss/(gain), net 94 38 (127) 60
--------- --------- --------- ---------
Total other operating expenses 92,036 13,040 140,208 37,215
--------- --------- --------- ---------
Income/(loss) before income taxes
and extraordinary item (56,774) 85,476 (89,317) 229,454
Income tax provision/(benefit) (40,859) 29,488 (51,625) 79,376
--------- --------- --------- ---------
Income/(loss) before extraordinary item (15,915) 55,988 (37,692) 150,078
Gain on sale of FHLB advances
(net of tax of $5,225) -- -- 10,775 --
--------- --------- --------- ---------
Net Income/(loss) $ (15,915) $ 55,988 $ (26,917) $ 150,078
========= ========= ========= =========
Earnings/(loss) per share
Basic
Income/(loss) before
extraordinary item $ (.07) $ .31 $ (.17) $ .90
Extraordinary item resulting from
gain on sale of FHLB advances -- -- .05 --
--------- --------- --------- ---------
Net income/(loss) $ (.07) $ .31 $ (.12) $ .90
========= ========= ========= =========
Diluted
Income/(loss)before
extraordinary item $ (.07) $ .31 $ (.17) $ .89
Extraordinary item resulting from
gain on sale of FHLB advances -- -- .05 --
--------- --------- --------- ---------
Net income/(loss) $ (.07) $ .31 $ (.12) .89
========= ========= ========= =========
Dividends declared per common share $ .025 $ .025 $ .075 .075
========= ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
-7-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Accumulated Total
Common Unallocated Other Stock-
Shares Common Retained Treasury Common Stock Comprehensive Holders'
Outstanding Stock Warrants Earnings Stock Held by ESOP Income/(Loss) Equity
----------- ----- -------- -------- ----- ------------ ------------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1999 225,408 $1,254,037 $ 91,500 $ 726,780 $ (3,595) $ (36,295) $ (210,932) $1,821,495
Comprehensive income:
Net income/(loss) -- -- -- (26,917) -- -- -- (26,917)
Change in unrecognized loss on
investment securities available-
for-sale, net of tax -- -- -- -- -- -- 120,232 120,232
----------
Total comprehensive income 93,315
Exercise of stock options 196 678 -- -- -- -- -- 678
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan 473 3,422 -- -- -- -- -- 3,422
Dividends paid on common stock -- -- -- (16,640) -- -- -- (16,640)
Treasury stock repurchase (56) -- -- -- (379) -- -- (379)
Treasury stock sold 34 -- -- -- 279 -- -- 279
--------- ---------- --------- --------- --------- ----------- ----------- ----------
Balance, September 30, 2000 226,055 $1,258,137 $ 91,500 $ 683,223 $ (3,695) $ (36,295) $ (90,700) $1,902,170
========= ========== ========= ========= ========= =========== =========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
-8-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine-Month Period
Ended September 30,
--------------------------------
2000 1999
---- ----
(in thousands)
<S> <C> <C>
Cash Flows from Operating Activities:
Net income/(loss) $ (26,917) $ 150,078
Adjustments to reconcile net income/(loss) to
net cash provided by operating activities:
Provision for loan losses 28,000 22,500
Deferred taxes 12,084 (1,547)
Depreciation and amortization 79,578 43,931
Net Amortization/(accretion) of investment
securities and loan discounts (37,245) 27,158
(Gain)/loss on sale of loans, investment
securities and real estate owned 125,957 (6,531)
(Gain)/loss on sale of fixed assets (55) (112)
(Gain) on sale of FHLB advances (16,000) --
Net change in:
Loans held for sale 3,108 246,604
Accrued interest receivable (18,108) (6,344)
Prepaid expenses and other assets (847,827) (279,188)
Other liabilities 128,808 (281,882)
----------- -----------
Net cash provided(used) by operating activities $ (568,617) $ (85,333)
----------- -----------
Cash Flows from Investing Activities:
Proceeds from sales of investment securities
Available-for-sale 7,115,299 3,727,661
Held-to-maturity -- 13,647
Proceeds from repayments and maturities of investment securities:
Available-for-sale 680,516 1,361,003
Held-to-maturity 4,145,542 721,882
Purchases of investment securities:
Available-for-sale (5,092,830) (6,541,381)
Held-to-maturity (2,702,207) (25,685)
Proceeds from sales of loans 442,479 1,053,573
Purchase of loans (1,216,376) (1,457,291)
Net change in loans other than purchases and sales 444,275 (1,171,502)
Proceeds from sales of premises and equipment 47,919 1,721
Purchases of premises and equipment (163,859) (25,234)
Proceeds from sale of real estate owned 2,906 13,327
Net cash (paid)received due to acquisitions net
of cash acquired 1,916,345 112,998
----------- -----------
Net cash provided(used) by investing activities 5,620,009 (2,215,281)
----------- -----------
Cash Flows from Financing Activities:
Net (decrease)/increase in deposits
and other customer accounts 181,939 (954,393)
Net increase/(decrease) in short-term borrowings (4,315,211) 1,464,031
Proceeds from long-term borrowings 1,013,068 1,819,994
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 (5,687) (5,816)
Proceeds from the issuance of preferred
stock by subsidiary 137,672 --
Cash dividends paid to stockholders (16,640) (12,301)
Proceeds from issuance of common stock 4,100 7,456
Advance to the Employee Stock Ownership Plan -- (437)
(Purchase)/issuance of treasury stock (100) (46,656)
----------- -----------
Net cash provided(used) by financing activities (4,481,878) 2,122,576
----------- -----------
Net change in cash and cash equivalents 569,514 (178,038)
Cash and cash equivalents at beginning of period 393,234 553,724
----------- -----------
Cash and cash equivalents at end of period $ 962,748 $ 375,686
=========== ===========
</TABLE>
<PAGE>
Supplemental Disclosures:
Income tax payments totaled $6.1 million for the nine-month period ended
September 30, 2000 and $83.5 million for the same period in 1999. Interest
payments totaled $1.1 billion for the nine-month period ended September 30, 2000
and $687 million for the same period in 1999. Noncash activity consisted of
acquisitions which included $9.1 billion of loans and assumption of $12.3
billion of deposits for the nine-month period ended September 30, 2000 and $551
million of loans and assumptions of $515 million of deposits for the same period
in 1999; FHLMC securitization of mortgage loans of $623 million for the nine
month period ended September 30, 2000; and reclassification of long-term
borrowings to short-term borrowings of $615 million for the nine-month period
ended September 30, 2000 and $397 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
(dissolved July 21, 2000), 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. These
reclassifications have no effect on net income.
The results of operations for the three-month and nine-month periods
ended September 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.
Included in goodwill and other intangibles on the consolidated balance
sheet are amounts which are deductible for federal and state income tax
purposes. The parenthetical amounts presented on the face of the statement
reflect the amounts of goodwill and other intangibles, after reducing such
amounts for the future tax benefits to be received as these amounts are
amortized against future earnings.
-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 Nine-Month Period
Ended September 30, Ended September 30,
---------------------------- ---------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Basic Earnings Per Share:
Income/(loss) before
extraordinary item $ (15,915) $ 55,988 $ (37,692) $ 150,078
--------- --------- --------- ---------
Average basic shares 225,987 180,902 225,795 166,548
========= ========= ========= =========
Basic earnings/(loss) per share
before extraordinary item $ (.07) $ .31 $ (.17) $ .90
========= ========= ========= =========
Diluted Earnings Per Share:
Income/(loss) before
extraordinary item $ (15,915) $ 55,988 $ (37,692) $ 150,078
--------- --------- --------- ---------
Average diluted shares 225,987 180,902 225,795 166,549
Dilutive effect of average stock
options, net of shares assumed to
be repurchased under the treasury
stock method -- 1,876 -- 2,134
--------- --------- --------- ---------
Total average diluted shares 225,987 182,778 225,795 168,683
========= ========= ========= =========
Diluted earnings/(loss) per share
before extraordinary item $ (.07) $ .31 $ (.17) $ .89
========= ========= ========= =========
</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>
September 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 $ 52,085 $ 7 $ 751 $ 51,341
Corporate securities/
trust preferred 300,213 9,689 6,626 303,276
Asset backed securities 562,695 -- 18,315 544,380
Equities 23,196 27 5,408 17,815
FHLB stock 298,397 -- -- 298,397
Agency preferred stock 425,888 192 3,575 422,505
Municipal securities 37,678 1,936 789 38,825
Mortgage-backed Securities:
Passthroughs:
U.S. government agency 637,174 1,657 14,870 623,961
Non-agency 2,468,338 -- 95,402 2,372,936
Collateralized mortgage
obligations 781,445 1,333 8,578 774,200
---------- ---------- ---------- ----------
Total investment securities
available-for-sale $5,587,109 $ 14,841 $ 154,314 $5,447,636
========== ========== ========== ==========
</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 $ 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 agency 478,462 909 21,004 458,367
Non-agency 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>
-12-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(4) INVESTMENT SECURITIES HELD-TO-MATURITY
The following table presents the composition and fair value of investment
securities held-to-maturity at the dates indicated: (dollars in thousands)
<TABLE>
<CAPTION>
September 30, 2000
---------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---- ------------ ------------ -----
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Treasury and
government agency
securities $ 47,217 $ 1 $ 959 $ 46,259
Corporate securities/
trust preferred 37,501 2,284 6 39,779
Municipal securities 885 134 7 1,012
Mortgage-backed Securities:
Passthroughs:
U.S. government agency 1,058,419 3,264 32,727 1,028,956
Non-agency 41,102 286 269 41,119
Collateralized mortgage
obligations 355,971 370 8,616 347,725
---------- ---------- ---------- ----------
Total investment securities
held-to-maturity $1,541,095 $ 6,339 $ 42,584 $1,504,850
========== ========== ========== ==========
</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 agency 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>
-13-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(5) COMPOSITION OF LOAN PORTFOLIO
The following table presents the composition of the loan portfolio by type
of loan and by fixed and adjustable rates at the dates indicated: (dollars in
thousands)
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
----------------------------- -----------------------------
Amount Percent Amount Percent
------ ------- ------ -------
<S> <C> <C> <C> <C>
Residential real estate loans $ 8,505,225 36.9% $ 5,685,220 39.8%
Residential construction loans 54,029 .2 59,264 .4
----------- ------- ----------- -------
Total Residential Loans 8,559,254 37.1 5,744,484 40.2
----------- ------- ----------- -------
Commercial real estate loans 2,787,401 12.1 1,516,953 10.6
Commercial and industrial loans 4,108,695 17.8 1,690,744 11.8
Automotive floor plan loans 1,027,249 4.5 730,623 5.1
Multi-family loans 129,220 .6 137,019 1.0
----------- ------- ----------- -------
Total Commercial Loans 8,052,565 35.0 4,075,339 28.5
----------- ------- ----------- -------
Home equity loans 3,415,101 14.8 1,957,945 13.7
Auto loans 2,267,052 9.8 1,936,980 13.6
Loans to automotive lessors 308,032 1.3 288,636 2.0
Student loans 246,955 1.1 249,279 1.7
Other 197,684 .9 35,802 .3
----------- ------- ----------- -------
Total Consumer Loans 6,434,824 27.9% 4,468,642 31.3%
----------- ------- ----------- -------
Total Loans (1) $23,046,643 100.0% $14,288,465 100.0%
=========== ======= =========== =======
Total Loans with:
Fixed rate $14,642,520 63.5% $ 8,769,876 61.4%
Variable rate 8,404,123 36.5 5,518,589 38.6
----------- ------- ----------- -------
Total Loans (1) $23,046,643 100.0% $14,288,465 100.0%
=========== ======= =========== =======
</TABLE>
(1) Loan totals include deferred loan fees and unamortized premiums and
discounts. These fees, premiums and discounts resulted in a net decrease in
loans of $37.9 million at September 30, 2000 and a net increase of $24.0
million at December 31, 1999.
-14-
<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>
September 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 $ 3,351,515 13.7% - % $ 1,089,472 9.1% - %
NOW accounts 4,119,375 16.8 2.57 1,871,288 15.6 2.44
Savings accounts 3,103,725 12.7 2.35 2,142,708 17.8 2.69
Money market accounts 4,457,714 18.2 4.38 1,345,325 11.2 4.17
Retail certificates 8,389,170 34.3 5.75 4,708,057 39.2 5.00
Jumbo certificates 1,048,807 4.3 6.55 855,825 7.1 5.56
----------- ------ ----- ----------- ------ ------
Total Deposits $24,470,306 100.0% 3.78% $12,012,675 100.0% 3.68%
=========== ====== ===== =========== ====== ======
</TABLE>
(7) BORROWINGS
The following table presents information regarding -borrowings at the dates
indicated: (dollars in thousands)
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
--------------------------- ----------------------------
Weighted Weighted
Average Average
Balance Rate Balance Rate
------- -------- ------- ---------
<S> <C> <C> <C> <C>
Securities sold under
repurchase agreements $1,041,020 6.68% $ 291,524 5.89%
FHLB advances 5,050,784 5.74 10,484,904 5.43
Other borrowings 1,482,287 10.80 1,593,681 10.74
---------- ------ ----------- ------
Total Borrowings $7,574,091 6.86% $12,370,109 6.12%
========== ====== =========== ======
</TABLE>
In March, 2000, the Company auctioned $927 million of FHLB advances at a
premium of $16 million pre-tax. Accordingly, the gain associated with the
auction of the FHLB advances is treated as an extraordinary item on the
statement of operations.
<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>
September 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) $ 828,294 $ - $ 2,448 5.9
Pay fixed-receive variable (2) 400,000 - (5,371) 2.0
Interest rate caps/floors
/corridors(3) 500,000 1,482 885 3.0
---------- ------- -------
$1,728,294 $ 1,482 $(2,038)
========== ======= =======
</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>
-16-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(1) The weighted average pay rate was 6.59% and 7.24% and the weighted average
receive rate was 7.31% and 7.82% at September 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 6.66% and 6.13% at September 30, 2000 and December 31,
1999, respectively.
(3) The strike price range was 6.00% - 6.66% at September 30, 2000 and 5.25% -
9.00% at December 31, 1999.
The following table summarizes by notional amounts the activity of
Sovereign's interest rate exchange agreements: (dollars in thousands)
<TABLE>
<CAPTION>
Balance Balance
December 31, Maturities/ September 30,
1999 Additions Amortization Terminations 2000
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Non-amortizing interest
rate swaps $ 452,300 $1,230,945 $ 127,300 $ 327,651 $1,228,294
Interest rate
caps/floors/corridors 1,200,000 -- -- 700,000 500,000
---------- ---------- ---------- ---------- ----------
$1,652,300 $1,230,945 $ 127,300 $1,027,651 $1,728,294
========== ========== ========== ========== ==========
</TABLE>
Net interest income resulting from interest rate exchange agreements
for the nine-month period ended September 30, 2000 was $2.9 million.
(9) INCOME TAXES
The nine-months ended effective tax rate (before extraordinary item)
differs from the statutory rate of 35% as follows:
<TABLE>
<CAPTION>
Nine-Months Ended September 30,
2000 1999
---- ----
<S> <C> <C>
Federal income tax (benefit) expense
at statutory rate (35.0%) 35.0%
Increase(decrease) in taxes resulting from:
Tax-exempt interest (12.4%) (5.0%)
State income taxes, net of federal
tax benefit 0.1% 0.3%
Amortization of intangible assets and
other purchase accounting adjustments 2.3% 0.7%
Non-deductible merger-related costs - 0.2%
Minority interest (14.6%) -
Other 1.8% 3.4%
------- -----
(57.8%) 34.6%
======= =====
</TABLE>
-17-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)(Continued)
(10) 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 ("SBNE"), 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.
Summary of Completed SBNE Acquisition
Date Completed Divested Units Deposits Branches Loans
-------------- ---------------------- ------------- -------- -------------
March 24, 2000 RI, CT (BankBoston) $ 4.2 billion 90 $2.5 billion
June 16, 2000 Eastern MA (Fleet) $ 3.8 billion 86 $3.5 billion
July 21, 2000 Central MA, NH (Fleet) $ 4.3 billion 105 $2.0 billion
----- --- ----
$12.3 billion 281 $8.0 billion
Sovereign successfully completed each of the three phases of the
purchase and assumption agreement of SBNE as described in the table above and
following. Sovereign's results include the operations of these acquired SBNE
branches, assets and liabilities from their respective acquisition dates, and
thereafter. Total deposits transferred through the acquisition were $12.3
billion. Additionally, loan balances transferred to Sovereign approximated $9.1
billion, which included $3.1 billion of commercial loans and leases, $1.7
billion of consumer loans and $4.3 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 and are not included in the loans acquired in the
above table. Other assets acquired included $85 million of currency, $68 million
of premises and equipment, $180 million of precious metals inventory and $213
million of prepaid and other miscellaneous assets.
Total consideration for the entire consumer and banking franchise was
12% of acquired deposits less agreed upon reductions, or approximately $0.9
billion. Included in the 12% premium, Sovereign will pay up to $333 million in
periodic installments between January 2001 and October 2001 if FleetBoston
complies with its non-solicitation obligations under the agreement and certain
other conditions are met.
-18-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(10) ACQUISITIONS (continued)
For the entire acquisition, Sovereign paid a net premium of $848
million, recorded a fair value reduction on acquired loans of $147 million and
established an initial allowance for loan losses of $118 million. These items
result in total intangibles of $1.1 billion including goodwill of $685 million
and core deposit intangible of $428 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.
Sovereign reduced total borrowings by $5.9 billion during the quarter.
Proceeds from the $1.3 billion of held-to-maturity investment securities
released from escrow, the cash received in the final closing and proceeds of
approximately $2.0 billion from the two investment security deleveraging
transactions were used to accomplish this reduction. Sovereign pre-paid $150
million of its $500 million Senior Secured Credit Facility due November 14,
2003, and $50 million of its 6.75% Senior Notes which matured on August 3, 2000
and reduced FHLB advances and other borrowings by $5.7 billion.
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.
-19-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(11) COMPREHENSIVE INCOME
The following table presents the components of comprehensive income,
net of related tax, based on the provisions of SFAS No. 130 for the periods
indicated: (dollars in thousands)
<TABLE>
<CAPTION>
Three-Month Period Nine-Month Period
Ended Sept 30, Ended Sept 30,
------------------------- -------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net income/(loss) $ (15,915) $ 55,988 $ (26,917) $ 150,078
--------- --------- --------- ---------
Net unrealized (losses)/gains on
securities arising during the period 42,169 (56,968) 38,241 (148,349)
Less reclassification adjustment (29,284) (194) (81,991) 4,206
--------- --------- --------- ---------
Net unrealized (losses)/gains
recognized in other comprehensive
income 71,453 (56,774) 120,232 (152,554)
--------- --------- --------- ---------
Comprehensive income/(loss) $ 55,538 $ (786) $ 93,315 $ (2,476)
========= ========= ========= =========
</TABLE>
Accumulated other comprehensive loss, net of related tax, consisted of
net unrealized losses on securities of $90.7 million at September 30, 2000 and
net unrealized losses on securities of $211 million at December 31, 1999.
(12) IMPACT OF RECENTLY ISSUED ACCOUNTING STATEMENTS
Statement of Financial Accounting Standards No. 133: Accounting for
Derivative Instruments and Hedging Activities establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. SFAS 133 was subsequently
amended to delay to the effective for all fiscal quarters of all fiscal years
beginning after June 15, 2000, with earlier application encouraged. The Company
does not believe that adoption of this statement will have a material impact on
its financial statements.
-20-
<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, as defined below, for the nine-month period ended
September 30, 2000 increased 51% to $96.0 million, or $0.43 per share, up from
$63.7 million, or $0.35 per share, for the same period in 1999. Operating
earnings for 2000 increased 32% to $74.1 million, or $0.33 per share, as
compared to $56.0 million, or $0.31 per share, for 1999.
Operating earnings include certain one-time tax benefits and 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 New England retail banking and middle market
lending acquisition ("Sovereign Bank New England" or "SBNE"). Special charges
for the quarter ended September 30, 2000 were $72.0 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 $26.9 million,
or $.12 per share, for the nine-month period ended September 30, 2000, as
compared to net income of $150 million, or $.89 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 18.93%, 41.85% and 1.01% for the nine-month period ended September
30, 2000 compared to 17.99%, 26.75% and .99% for the same period in 1999.
Successful Formation of Sovereign Bank New England
Sovereign successfully completed the SBNE conversion in three phases on
March 24, June 16 and July 21, 2000. Sovereign's results include the operations
of these acquired SBNE branches, assets and liabilities from their respective
acquisition dates, 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 $12.3 billion of deposits and $8.0 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.
-21-
<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 Nine-Month Period
Ended September 30 Ended September 30
------------------ ------------------
2000 1999 2000 1999 2000 1999 2000 1999
---- ---- ---- ---- ---- ---- ---- ----
Total Per Share Total Per Share
---------------------- ---------------- -------------------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net income/(loss) as reported $ (15,915) $ 55,988 $ (.07) $ .31 $ (26,917) $150,078 $ (.12) $ .89
Net negative carry on
escrowed bond proceeds (1) 1,574 -- .01 -- 18,589 -- .08 --
Merger-related and integration
costs recorded during the
period (2) 28,974 -- .13 -- 97,063 -- .43 --
Expense on convertible trust
preferred securities
("PIERS")(1) 133 -- .00 -- 6,502 -- .03 --
Loss on securities due to
restructuring of the
balance sheet (4) 28,426 -- .12 -- 66,956 -- .29 --
Non-compete covenant expense 31,105 -- .13 -- 31,105 -- .14 --
Assumed interest expense reduction
due to paydown of other
borrowings with net proceeds of
common equity and PIERS (1) (176) -- .00 -- (9,051) -- (.04) --
Impact of additional shares
outstanding for 1999 common
stock offerings (3) -- -- .01 -- -- -- .10 --
Operating earnings (3) $ 74,121 $ 55,988 $ .33 $ .31 $ 184,247 $150,078 $ .91 $ .89
--------- --------- ------ ------ --------- -------- ------- -----
Cash earnings (3) $ 95,977 $ 63,708 $ .43 $ .35 $ 228,193 $171,711 $ 1.13 $1.02
========= ========= ====== ====== ========= ======== ======= =====
Average shares before
adjustment for offering 225,987 182,778 225,795 168,683
========= ========= ========= ========
Average shares after
adjustment for offering (3) 223,779 182,778 202,551 168,683
========= ========= ========= ========
</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 $2.9 million ($1.5
million after tax) and $24.7 million ($16.0 million after tax) comprised of
the following components for the three and nine-month periods ending
September 30, 2000, respectively: a)a reduction of net interest income of
$3.1 million ($1.6 million after-tax) and $28.6 million ($18.6 million
after tax), respectively; b)expense of $.5 million ($.1 million after-tax)
and $10.0 million ($6.5 million after tax) associated with PIERS issued in
November, 1999; c)an assumed $.6 million ($.2 million after tax) and $13.9
million ($9.1 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
nine-month periods ended September 30, 2000, a pro rata portion of the
shares issued in November, 1999 in proportion to deposits acquired on March
24, 2000, June 16, 2000 and July 21, 2000 over total estimated SBNE
deposits acquired in each phase of the SBNE acquisition.
(4) See further discussion of other income included in management's discussion
and analysis.
-22-
<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
THREE AND NINE MONTH PERIODS ENDED September 30, 2000
(in thousands)
<TABLE>
<CAPTION>
Three Months Nine Months
----------------------------------------- -------------------------------------------
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 $ 95,510 $ 8,478 35.28% $ 173,538 $ 18,676 14.22%
Investment securities available-for-sale
6,447,445 117,989 7.46% 7,346,830 391,596 7.24%
Investment securities held-to-maturity
1,363,544 24,235 7.12% 1,974,635 99,761 6.74%
------------ ------------ ----- ------------ ------------ -----
Total investments 7,906,499 150,702 7.74% 9,495,003 510,033 7.26%
------------ ------------ ----- ------------ ------------ -----
Loans:
Residential loans 8,845,712 173,751 7.85% 7,061,092 404,880 7.64%
Commercial loans 7,656,118 174,940 9.09% 5,985,842 397,809 8.87%
Consumer loans 6,334,960 135,361 8.51% 5,592,422 351,506 8.39%
------------ ------------ ----- ------------ ------------ -----
Total loans 22,836,790 484,052 8.45% 18,639,356 1,154,195 8.26%
Allowance for loan losses (212,228) -- -- (168,393) -- --
------------ ------------ ----- ------------ ------------ -----
Net loans 22,624,562 484,052 8.53% 18,470,963 1,154,195 8.34%
------------ ------------ ----- ------------ ------------ -----
Total interest earning assets 30,531,061 634,754 8.32% 27,965,966 1,664,228 7.97%
Non-interest earning assets 4,657,712 -- -- 3,358,627 -- --
------------ ------------ ----- ------------ ------------ -----
TOTAL ASSETS $ 35,188,773 634,754 7.23% $ 31,324,593 1,664,228 7.12%
============ ------------ ----- ============ ------------ -----
LIABILITIES
-----------
Deposits:
Core deposits $ 14,282,306 88,418 2.46% $ 10,029,363 186,920 2.49%
Time deposits 8,916,525 129,413 5.77% 7,457,031 313,055 5.60%
------------ ------------ ----- ------------ ------------ -----
Total deposits 23,198,831 217,831 3.74% 17,486,394 499,975 3.82%
------------ ------------ ----- ------------ ------------ -----
Borrowed funds:
FHLB advances 6,543,111 98,826 5.90% 8,911,517 395,542 5.84%
Repurchase agreements 1,520,122 25,068 6.46% 1,045,837 50,719 6.37%
Other borrowings 1,484,289 38,620 10.38% 1,553,003 117,517 10.10%
------------ ------------ ----- ------------ ------------ -----
Total borrowed funds 9,547,522 162,514 6.69% 11,510,357 563,778 6.46%
------------ ------------ ----- ------------ ------------ -----
Total interest bearing liabilities 32,746,353 380,345 4.60% 28,996,751 1,063,753 4.87%
Non-interest bearing liabilities 582,511 -- -- 483,433 -- --
------------ ------------ ----- ------------ ------------ -----
Total liabilities 33,328,864 380,345 4.51% 29,480,184 1,063,753 4.78%
STOCKHOLDERS' EQUITY 1,859,909 -- -- 1,844,409 -- --
-------------------- ------------ ------------ ----- ------------ ------------ -----
TOTAL LIABILITIES
AND STOCKHOLDERS' EQUITY $ 35,188,773 $ 380,345 4.28% $ 31,324,593 $ 1,063,753 4.50%
============ ------------ ----- ============ ------------ -----
NET INTEREST INCOME $ 254,409 $ 600,475
============ ============
NET INTEREST SPREAD 2.95% 2.61%
===== =====
NET INTEREST MARGIN 3.40% 2.93%
===== =====
NET INTEREST MARGIN-OPERATING BASIS 3.47% 3.10%
===== =====
</TABLE>
(1) Tax-equivalent basis
-23-
<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 nine-month periods ended
September 30, 2000 was $254 million and $600 million compared to $162 million
and $449 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 3.47% and 3.10% for the three-month and nine-month periods ended
September 30, 2000 and compared to 2.95% and 2.88% for the same periods in 1999.
Interest on investment securities available-for-sale was $118 million
and $392 million for the three-month and nine-month periods ended September 30,
2000 compared to $144 million and $396 million for the same periods in 1999. The
average balance of investment securities available-for-sale was $7.3 billion
with an average tax equivalent yield of 7.24% for the nine-month period ended
September 30, 2000 compared to an average balance of $7.9 billion with an
average yield of 6.78% for the same period in 1999. The decrease in average
investment securities available for sale from the prior year reflects the
deleveraging transactions accomplished in June and September.
Interest on investment securities held-to-maturity was $24.2 million and
$99.8 million for the three-month and nine-month periods ended September 30,
2000 compared to $20.8 million and $72.9 million for the same periods in 1999.
The average balance of investment securities held-to-maturity was $2.0 billion
with an average yield of 6.74% for the nine-month period ended September 30,
2000 compared to an average balance of $1.4 billion with an average yield of
6.98% 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 $484 million and $1.2 billion for the
three-month and nine-month periods ended September 30, 2000 compared to $250
million and $689 million for the same periods in 1999. The average balance of
loans was $18.6 billion with an average yield of 8.26% for the nine-month period
ended September 30, 2000 compared to an average balance of $12.1 billion with an
average yield of 7.64% for the same period in 1999.
Interest on deposits was $218 million and $500 million for the three-month
and nine-month periods ended September 30, 2000 compared to $111 million and
$329 million for the same periods in 1999. The average balance of deposits was
$17.5 billion with an average cost of 3.82% for the nine-month period ended
September 30, 2000 compared to an average balance of $12.2 billion with an
average cost of 3.59% for the same period in 1999.
Interest on borrowings was $163 million and $564 million for the
three-month and nine-month periods ended September 30, 2000 compared to $144
million and $383 million for the same periods in 1999. The average balance of
borrowings was
-24-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
$11.5 billion with an average cost of 6.46% for the nine-month period ended
September 30, 2000 compared to an average balance of $9.6 billion with an
average cost of 5.32% 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 offset slightly by the
repayment of borrowings in the third quarter of 2000.
Sovereign reduced total borrowings by $5.9 billion during the quarter.
Proceeds from the $1.3 billion of held-to-maturity investment securities
released from escrow, the cash received in the final closing and proceeds of
approximately $2.0 billion from the two investment security transactions settled
in July and September of 2000 were used to accomplish this reduction. Sovereign
pre-paid $150 million of its $500 million Senior Secured Credit Facility due
November 14, 2003, and $50 million of its 6.75% Senior Notes which matured on
August 3, 2000 and reduced FHLB advances and other borrowings by $5.7 billion.
Provision for 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 nine-month
periods ended September 30, 2000 was $10.0 million and $28.0 million compared to
$7.5 million and $22.5 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 the first nine months of 2000 of $28 million, plus the loan loss reserves
added through acquisition accounting of $118 million related to SBNE, exceeded
net charge-offs of $36.1 million. A portion of net charge-offs recorded during
the first nine months of 2000 related to loans acquired during the period. 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 $118 million for loans
acquired in the SBNE acquisition. These initial estimates were established by
applying Sovereign's existing methodology to determine such allowances to the
portfolios acquired. A detailed and in depth review of the entire SBNE portfolio
is in process and is expected to be completed in the fourth quarter.
-25-
<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 nine-month period ended September
30, 2000 were $36.1 million and consisted of charge-offs of $50.6 million and
recoveries of $14.5 million. This compared to net charge-offs of $26.5 million
consisting of charge-offs of $41.4 million and recoveries of $14.9 million for
the nine-month period ended September 30, 1999. Sovereign's increased level of
net charge-offs was primarily the result of higher overall loan balances and a
general seasoning of recent loan portfolio acquisitions. Although net
charge-offs for the first nine months of 2000 are higher than the prior year,
net charge-offs as a percentage of average loans outstanding declined from .28%
to .26%.
The following table presents the activity in the allowance for possible
loan losses for the periods indicated: (dollars in thousands)
<TABLE>
<CAPTION>
Nine-month Period Ended September 30,
2000 1999
--------------------------------------
<S> <C> <C>
Allowance, beginning of period $ 132,986 $ 133,802
Charge-offs:
Residential 4,679 10,682
Commercial Real Estate 76 680
Commercial 16,720 2,366
Consumer 29,200 27,742
--------- ---------
Total Charge-offs 50,675 41,470
--------- ---------
Recoveries:
Residential 1,146 1,469
Commercial Real Estate 107 458
Commercial 2,757 426
Consumer 10,521 12,589
--------- ---------
Total Recoveries 14,531 14,942
--------- ---------
Charge-offs, net of recoveries 36,144 26,528
Provision for possible loan losses 28,000 22,500
Initial allowance related to
acquisitions 117,600 4,799
--------- ---------
Allowance, end of period $ 242,442 $ 134,573
========= =========
</TABLE>
-26-
<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 was $14.6 million and $24.1 million for the three-month
and nine-month periods ended September 30, 2000 compared to $35.0 million and
$101 million for the same periods in 1999. Excluding securities transactions,
other income for the three and nine month periods ended September 30, 2000 was
$59.6 and $150.2, respectively.
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 $28.1 million and $59.8 million for the quarter and nine-month periods ended
September 30, 2000 as compared to $13.8 million and $35.6 million for the same
periods in 1999, representing increases of 104% and 68%, respectively.
Gain/(loss) on loans and investment securities were $(45.1) million and
$(126) million for the three-month and nine-month periods ended September 30,
2000 compared to $(.3) million and $6.5 million for the same periods in 1999.
During the third quarter of 2000, Sovereign sold $1.0 billion of
available-for-sale mortgage-backed securities, resulting in a loss of $45.4
million. The net impact of the sale on equity was minimal as these losses were
previously reflected as unrealized losses included as a reduction of
stockholders' equity in accordance with SFAS 115. A similar transaction was
completed in the second quarter of 2000, in which $1.0 billion of
mortgage-backed securities were sold at a loss of $49.7 million.
During the first quarter of 2000 Sovereign also sold certain investment
securities and FHLB advances and paid-off certain short-term advances as part of
its balance sheet repositioning in preparation 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 $21.2 million and $56.6 million for the
three-month and nine-month periods ended September 30, 2000 compared to $11.4
million and $26.1 million for the same periods in 1999. This increase was
principally 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 nine-month
periods ended September 30, 2000 were $224 million and $546 million, compared to
$90.8 million and $260 million for the same periods in 1999. Included in general
and administrative expenses for the three-month and nine-month periods ended
September 30, 2000 were $47.0 million and $149 million of merger-related,
integration and other charges related to all of Sovereign's recent acquisitions.
These special charges are related to the real estate transaction described
within this 10-Q, costs that management considered redundant due to separating
the SBNE acquisition from a single closing into three closings, and other
merger-related
-27-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
charges. Excluding these charges, general and administrative expenses were $177
million and $397 million for the three-month and nine-month periods ended
September 30, 2000.
Operating expense run-rate has been and will continue to be higher over
the final quarter of 2000 than is expected in 2001 as Sovereign has consciously
maintained operating units throughout our franchise at higher capacity levels
than present volume dictates. Sovereign is currently conducting an internal
initiative to determine the proper revenue/expense ratios for the combined
franchise and expects that Sovereign will return to more normal efficiency
ratios over the next few quarters.
Other operating expenses were $92.0 million and $140 million for the
three-month and nine-month periods ended September 30, 2000 compared to $13.0
million and $37.2 million for the same periods in 1999. Results for the
three-month and nine-month periods ended September 30, 2000 included
amortization of goodwill of $32.6 million and $62.8 million compared to $10.0
million and $28.0 million for the same periods in 1999. The increase in goodwill
amortization is a result of the additional intangibles recorded for the SBNE
acquisition. The three and nine month periods ended September 30, 2000, include
$47.9 million of non-compete expense related to the non-solicitation provisions
of the SBNE purchase and assumption agreement.
Income Tax Provision
The income tax provision/(benefit) was $(40.9) million and $(51.6)
million for the three-month and nine-month periods ended September 30, 2000
compared to $29.5 million and $79.4 million for the same periods in 1999. The
effective tax rate (or tax benefit rate) for the three-month and nine-month
periods ended September 30, 2000 was 72.0% and 57.8%, respectively, compared to
34.5% and 34.6% for the same periods in 1999. The current year tax benefit rate
differs from the statutory rate of 35% due to the high proportion of non-taxable
income compared to the Company's net loss, and a permanent benefit recorded in
the quarter. Management expects that the effective tax rate on an operating
basis in the fourth quarter and beyond will be more comparable to the historic
rate of 33%. See Footnote 9_to the September 30, 2000 financial statements for
additional detail related to the effective tax rate.
-28-
<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 nine-months of 2000
were $1.6 billion. At September 30, 2000, commercial loans totaled $8.1 billion
representing 35.0% of Sovereign's loan portfolio, compared to $4.1 billion and
40.2% of the loan portfolio at December 31, 1999 and $3.5 billion and 26.0% of
the loan portfolio at September 30, 1999. The SBNE acquisition increased
commercial loans by $3.1 billion. On October 24, 2000 Sovereign securitized and
sold $579 million of automotive floor plan loans. Proceeds were used to reduce
bank borrowings.
Consumer loans originated during the first nine-months of 2000 totaled
$1.7 billion. The consumer loan portfolio (including home equity loans and lines
of credit, automobile loans, and other consumer loans) totaled $6.4 billion at
September 30, 2000, representing 27.9% of Sovereign's loan portfolio, compared
to $4.5 billion and 31.4% of the loan portfolio at December 31, 1999 and $4.3
billion and 32.4% of the loan portfolio at September 30, 1999. This increase was
primarily the result of the SBNE acquisition of $1.7 billion and strong home
equity and auto loan originations during the nine-month period ended September
30, 2000.
Residential mortgage loans increased $163 billion during the quarter to
$8.6 billion and now represent 37.1% of Sovereign's loan portfolio as compared
to 40.2% at December 31, 1999. The SBNE acquisition increased residential
mortgages by $3.2 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.
Non-Performing Assets
---------------------
At September 30, 2000 Sovereign's non-performing assets were $136
million compared to $84 million at December 31, 1999. This increase was due
primarily to residential, consumer and commercial loans purchased from
FleetBoston and commercial loans secured by real estate in Sovereign's
previously existing portfolio. Non-performing assets as a percentage of total
assets was .39% at September 30, 2000, up from .32% at December 31, 1999. At
September 30, 2000 76% of non-performing assets consisted of loans related to
real estate, consumer loans or OREO which are primarily 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.
-29-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table presents the composition of non-performing assets
at the dates indicated: (dollars in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------ ------------
<S> <C> <C>
Non-accrual loans:
Residential $ 51,986 $ 32,374
Commercial real estate 12,550 4,110
Commercial 27,612 12,668
Consumer 34,525 26,259
-------- --------
Total non-accrual loans 126,673 75,411
-------- --------
Restructured loans 3,755 3,755
-------- --------
Total non-performing loans 130,428 79,166
-------- --------
Other real estate owned 3,298 3,567
Other repossessed assets 2,399 1,762
-------- --------
Total Non-performing Assets $136,125 $ 84,495
======== ========
Past due 90 days or more as to interest
or principal and accruing interest (1) $ 13,263 $ 10,238
Non-performing assets as a percentage
of total assets .39% .32%
Non-performing loans as a percentage
of total loans .57% .56%
Non-performing assets as a percentage of
total loans and real estate owned .59% .59%
Allowance for loan losses as a percentage
of total non-performing assets 178.1% 157.4%
Allowance for loan losses as a percentage
of total non-performing loans 185.9% 168.0%
</TABLE>
(1) Includes student loans which are government-guaranteed and auto loans past
due between 90 and 120 days.
In addition to the non-performing loans included in the non-performing
assets table above, there were $185 million and $96 million of potential problem
loans at September 30, 2000 and December 31, 1999, respectively. While these
loans were performing, management was aware of information about possible credit
problems which raise doubts as to the ability of the borrowers to comply fully
with present loan repayment terms. Total non-performing assets and potential
problem loans as a percentage of total loans outstanding increased to 1.39% at
September 30, 2000 from 1.26% at 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)
Allowance for Loan Losses
-------------------------
The following table presents the allocation of the allowance for loan
losses and the percentage of each loan type of total loans at the dates
indicated:
<TABLE>
<CAPTION>
(dollars in thousands)
September 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 $114,884 35% $ 58,784 29%
Residential real estate
mortgage loans 31,481 37 19,535 40
Consumer loans 65,447 28 43,455 31
-
Unallocated allowance 30,630 n/a 11,212 n/a
-------- ------ -------- ------
Total allowance for loan losses $242,442 100% $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.
At September 30, 2000, Sovereign's loan delinquencies (all loans greater
than 30 days delinquent) as a percentage of total loans was 2.20% compared to
1.79% at December 31, 1999. The increase is principally attributable to the
loans acquired in the SBNE acquisition including a purchased home equity
portfolio and residential real estate loans.
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.
-31-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
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 group 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.
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 $118 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 Company utilized its existing allowance for loan loss methodology for
acquired portfolios 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. This initial allowance adjustment is based upon preliminary information
and is subject to further revision as more detailed information of the loan
portfolio becomes known.
-32-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Residential Portfolio. The allowance for the residential mortgage
portfolio increased from $19.5 million at December 31, 1999 to $31.5 million at
September 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 $65.4 million at September
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 $114.9 million at September 30, 2000. This increase is primarily
attributable to the acquired SBNE commercial portfolio.
Unallocated Allowance. The unallocated allowance for loan losses increased to
$30.6 million at September 30, 2000 from $11.2 million at December 31, 1999.
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. The effective
duration of the total investment portfolio at September 30, 2000 was 4.0 years.
At September 30, 2000, total investment securities available-for-sale
were $5.4 billion compared to $8.0 billion at December 31, 1999 and investment
securities held-to-maturity were $1.5 billion compared to $2.4 billion at
December 31, 1999. The decrease in investment securities available for sale is
due primarily to the two balance sheet deleveraging transactions in June and
September 2000, in which $1.0 billion and $969 million of collateralized
mortgage obligations were sold. 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. For additional information with respect to Sovereign's investment
securities, see Notes 3 and 4 in the Notes to Consolidated Financial Statements.
-33-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Goodwill and Other Intangible Assets
------------------------------------
Total goodwill and other intangible assets at September 30, 2000 were
$1.5 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 and a reduction of
goodwill associated with certain assets held for sale at September 30, 2000.
Other Assets
------------
Other assets increased by $1 billion from December 31, 1999. This is
primarily attributable to $225 million of additional bank owned life insurance,
$195 million of precious metals assets associated with SBNE, $220 million of
advances due from FleetBoston upon final settlement of the SBNE acquisition
completed in October.
Deposits
--------
Deposits are attracted from within Sovereign's primary market area
through the offering of various deposit instruments including NOW accounts,
money market accounts, savings accounts, certificates of deposit and retirement
savings plans.
Total deposits at September 30, 2000 were $24.5 billion compared to
$12.0 billion at December 31, 1999. The increase in deposits is primarily due to
the SBNE acquisition of $11.9 billion, net of deposit runoff of approximately
$400 million, resulting in a retention rate of 97%. In addition, Sovereign's
existing franchise experienced deposit growth of approximately $600 million.
Through the use of interest rate swaps, $828 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 September 30, 2000 were $7.6 billion of which $2.9
billion were short-term compared to $12.4 billion of which $6.6 billion were
short-term at December 31, 1999. This decrease in borrowings is primarily the
result of repayments using the cash realized from the SBNE acquisition and the
proceeds of the related balance sheet deleveraging transactions. For additional
information with respect to Sovereign's borrowings, see Note 7 in the Notes to
Consolidated Financial Statements.
-34-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Through the use of interest rate swaps, $400 million of FHLB advances
at September 30, 2000 have been effectively converted from variable rate
obligations to fixed rate obligations. In addition, at September 30, 2000, $500
million of borrowings have been protected from upward repricing through the use
of interest rate caps, floors and corridors.
Sovereign reduced total borrowings by $5.9 billion during the quarter.
Proceeds from the $1.3 billion of held-to-maturity investment securities
released from escrow, the cash received in the final closing and proceeds of
approximately $2.0 billion from the two investment security transactions settled
in July and September of 2000 were used to accomplish this reduction. Sovereign
pre-paid $150 million of its $500 million Senior Secured Credit Facility due
November 14, 2003, and $50 million of its 6.75% Senior Notes which matured on
August 3, 2000 and reduced FHLB advances and other borrowings by $5.7 billion.
Liquidity and Capital Resources
-------------------------------
Sovereign's banking subsidiaries are required under applicable federal
regulations to maintain specified levels of "liquid" investments in cash and
U.S. Treasury and other qualifying investments. Regulations currently in effect
require Sovereign's banking subsidiaries to maintain liquid assets of not less
than 4% of its net withdrawable accounts plus short-term borrowings. These
levels are changed from time to time by the Office of Thrift Supervision ("OTS")
to reflect economic conditions. The liquidity ratio of Sovereign Bank for
September 30, 2000 was 41.3%.
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 $85.8 million
per month. Other sources of funds include operating activities, repayments of
principal on investment securities, repayment of principal on loans and other
investing activities. Sovereign also maintains strong relationships with
numerous investment banking firms, and has the ability to access capital markets
through a variety of products and structures, should liquidity or capital needs
arise.
For the nine-month period ended September 30, 2000, cash and cash
equivalents increased $570 million. Net cash used for operating activities for
the nine-month period ended September 30, 2000 was $569 million. Net cash
provided by investing activities for the nine-month period ended September 30,
2000 was $5.6 billion and consisted primarily of proceeds from the sale,
repayment and maturity of investment securities offset by the purchase of
additional investment securities. Net cash used by financing activities for the
nine-month period ended September 30, 2000 was $4.5 billion and consisted mainly
of the repayment of short-term borrowings.
-35-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Sale of Preferred Shares of Sovereign Real Estate Investment Trust
------------------------------------------------------------------
During the quarter, Sovereign received approximately $140 million of
net proceeds from the issuance of preferred stock in Sovereign Real Estate
Investment Trust ("SREIT"), a subsidiary of Sovereign which holds primarily
residential real estate loans. The offering was made exclusively to
institutional investors; however, by mid-2001 these SREIT preferred shares will
be registered to be offered to other investors. The proceeds of this offering
were principally used to repay corporate debt.
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.
Dealer Floor Plan Securitization and Sale
-----------------------------------------
On October 24, 2000 Sovereign Dealer Finance, Inc., a newly formed and
wholly-owned subsidiary, securitized and sold $579 million of automotive floor
plan loans to institutional investors. This transaction is expected to be
neutral to Sovereign's future earnings and improves risk-based capital. Proceeds
of the offering were used to reduce bank borrowings.
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 September 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.
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 September 30, 2000,
Sovereign Bancorp met or exceeded this requirement.
-36-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
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 prescribed capital levels.
The following table sets forth the capital ratios of Sovereign Bank and
the current regulatory requirements at September 30, 2000:
<TABLE>
<CAPTION>
Sovereign Bank
--------------------------------------------------
Well
Sept 30, Minimum Capitalized
2000 Requirement Requirement
---- ----------- -----------
<S> <C> <C> <C>
Stockholders' equity to total assets 9.34% None None
Tangible capital to tangible assets 6.04 2.00% None
Leverage (core) capital to
tangible assets 6.04 3.00 5.00%
Leverage (core) capital to
risk adjusted assets 8.97 4.00 6.00
Risk-based capital to risk
adjusted assets 10.01 8.00 10.00
</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.
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.
-37-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Sovereign manages the impact to net interest income in a +/- 100 basis
point instantaneous parallel rate shock environment to be generally within a 5%
variance. At September 30, 2000, Sovereign estimates that if interest rates
decline by 100 basis points, net interest income, over the next twelve months,
would decrease by $38.7 million or 3.7%; conversely, if interest rates increase
by 100 basis points, net interest income would decrease by $27.6 million, or
2.6%. At December 31, 1999, if interest rates increased by 100 basis points, net
interest income would have decreased by $80.2 million, or 8.0% and if interest
rates had decreased by 100 basis points, net interest income would have
decreased by $81.1 million, or 8.1%. This change in sensitivity was primarily
related to a decrease in short-term borrowings, the addition of deposits from
SBNE and the investment portfolio deleveraging strategy.
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 5.92% 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
liabilities to variable rate liabilities. Sovereign utilizes interest rate swaps
that have a high degree of correlation to the related financial instrument.
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 increased significantly with the completion of the SBNE
acquisition in 2000 which added $12.3 billion of 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.
-38-
<PAGE>
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Items 1 through 5 not applicable or the responses are negative.
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
-39-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SOVEREIGN BANCORP, INC.
--------------------------------------
(Registrant)
Date November 14, 2000 /s/Dennis S. Marlo
--------------------------- --------------------------------------
Dennis S. Marlo
Chief Financial Officer
(Authorized Officer & Principal
Financial Officer)
Date November 14, 2000 /s/Mark R. McCollom
--------------------------- --------------------------------------
Mark R. McCollom
Chief Accounting Officer
