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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934, FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997, OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934, FOR THE TRANSITION PERIOD FROM N/A TO .
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COMMISSION FILE NUMBER 0-16533
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SOVEREIGN BANCORP, INC.
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(Exact name of Registrant as specified in its charter)
PENNSYLVANIA 23-2453088
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1130 BERKSHIRE BOULEVARD, WYOMISSING, PENNSYLVANIA 19610
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(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER: (610) 320-8400
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock (without par value)
Series B 6 1/4% Cumulative Convertible Preferred Stock (without par value)
(Title of class)
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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the shares of Common Stock of the Registrant
held by nonaffiliates of the Registrant was $2,200,293,862 at March 4, 1998. As
of March 4, 1998, the Registrant had 131,197,646 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's definitive Proxy Statement to be used in connection with
its 1998 Annual Meeting of Shareholders is incorporated herein by reference in
response to Part III hereof.
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FORWARD LOOKING STATEMENTS
Except for historical information, this report may be deemed to contain
"forward looking" statements. Sovereign Bancorp, Inc. ("Sovereign") desires to
avail itself of the Safe Harbor provisions of the Private Securities Litigation
Reform Act of 1995 (the "Act") and is including this cautionary statement for
the express purpose of availing itself of the protection afforded by the Act.
Examples of forward looking statements include, but are not limited to (a)
projections of or statements regarding future earnings, net interest income,
other income, earnings or loss per share, asset mix and quality, growth
prospects, capital structure and other financial terms, (b) statements of plans
and objectives of Sovereign or its management or Board of Directors, (c)
statements of future economic performance, and (d) statements of assumptions,
such as economic conditions in Sovereign's market areas, underlying other
statements and statements about Sovereign or its businesses. Such forward
looking statements can be identified by the use of forward looking terminology
such as "believes," "expects," "may," "intends," "will," "should,"
"anticipates," or the negative of any of the foregoing or other variations
thereon or comparable terminology, or by discussion of strategy.
No assurance can be given that the future results covered by the
forward-looking statements will be achieved. Such statements are subject to
risks, uncertainties, and other factors which could cause actual results to
differ materially from future results expressed or implied by such
forward-looking statements. Important factors that could impact Sovereign's
operating results include, but are not limited to, (i) the effects of changing
economic conditions in Sovereign's market areas and nationally, (ii) credit
risks of commercial, real estate, consumer and other lending activities, (iii)
significant changes in interest rates, (iv) changes in federal and state banking
laws and regulations which could impact Sovereign's operations, (v) funding
costs, and (vi) other external developments which could materially affect
Sovereign's business and operations.
PART I
ITEM 1. BUSINESS.
GENERAL
Sovereign is a Pennsylvania business corporation and is the holding company
for Sovereign Bank. Both Sovereign and Sovereign Bank are headquartered in
Wyomissing, Pennsylvania, a suburb of Reading, Pennsylvania.
Sovereign Bank was created in 1984 under the name Penn Savings Bank, F.S.B.
through the merger of two financial institutions with market areas primarily in
Berks and Lancaster counties, Pennsylvania. Sovereign Bank assumed its current
name on December 31, 1991. Sovereign was incorporated by Sovereign Bank in 1987.
From 1989 through 1996, Sovereign expanded its markets throughout eastern
Pennsylvania, central New Jersey and northern Delaware by completing 15
acquisitions with assets totaling approximately $4.5 billion. At December 31,
1996, Sovereign had 120 offices and $12.5 billion in assets.
On September 19, 1997, Sovereign purchased Fleet Financial Group Inc.'s
("Fleet") Automobile Finance Division ("Fleet Auto"). Fleet Auto consists of
approximately $2.0 billion of indirect auto loans, automotive floor plan loans
and loans to automotive lessors and has business relationships throughout New
Jersey, New York and several New England states.
On August 29, 1997, Sovereign acquired Bankers Corp. ("Bankers"), a $2.6
billion financial services holding company headquartered in Perth Amboy, New
Jersey. Bankers' sole banking subsidiary, Bankers Savings, operates 15 branch
offices located in Middlesex, Monmouth and Ocean counties, New Jersey. This
transaction was accounted for as a pooling-of-interests.
On February 18, 1997, Sovereign acquired First State Financial Services,
Inc. ("First State"), a $603 million savings institution headquartered in West
Caldwell, New Jersey with 14 branch offices located throughout central and
northern New Jersey. This transaction was accounted for as a pooling-
of-interests.
At December 31, 1997, Sovereign's consolidated assets, deposits and
shareholders' equity were approximately $14.3 billion, $7.9 billion and $778
million, respectively. Based on assets at December 31, 1997, Sovereign is the
largest thrift holding company and the third largest bank headquartered in
Pennsylvania.
Sovereign's primary business consists of attracting deposits from its
network of community banking offices, located throughout eastern Pennsylvania,
New Jersey and northern Delaware, and originating commercial, consumer and
residential mortgage loans in those communities. In addition, with its recent
acquisition of Fleet Auto, Sovereign also serves customers throughout New York
and several New England States.
Sovereign operates in a heavily regulated environment. Changes in laws and
regulations affecting it and its subsidiaries may have an impact on its
operations. See "Business -- Supervision and Regulation."
For additional information with respect to Sovereign's business activities,
see Part II, Item 7 "Management's Discussion and Analysis of Financial Condition
and Results of Operations" hereof.
SUBSIDIARIES
Sovereign has two wholly-owned subsidiaries: Sovereign Bank and Sovereign
Capital Trust I.
In 1995, Sovereign Bank reorganized its existing subsidiary structure.
Sovereign Bank now has the following wholly-owned subsidiaries: 201 Associates,
Inc., First Lancaster Financial Corp., and Sovereign REIT Holdings, Inc.
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201 Associates, Inc. is a Delaware corporation whose primary purpose is to
purchase and hold certain investment securities. First Lancaster Financial Corp.
is a Pennsylvania business corporation whose primary function is to act as a
holding company for The Sovereign Annuity Corp. and The Sovereign Agency, Inc.
The Sovereign Annuity Corp. is a New Jersey corporation whose primary purpose is
to market investment securities, mutual funds and insurance annuities. The
Sovereign Agency, Inc. is a New Jersey corporation whose primary purpose is to
market insurance products. Sovereign REIT Holdings, Inc. is a Delaware
corporation whose primary purpose is to conduct certain cash management
activities. Sovereign Capital Trust I has no subsidiaries. Sovereign Capital
Trust I is a special-purpose statutory trust, created in 1997 expressly for the
issuance of preferred capital securities, which solely holds subordinated
debentures of Sovereign.
Federal regulations generally permit federally-chartered savings
institutions to invest up to 2% of assets in the capital stock of, and make
secured and unsecured loans to, certain types of subsidiary service
corporations. At December 31, 1997, Sovereign Bank was authorized to have a
maximum investment of approximately $284.5 million in such subsidiaries,
pursuant to applicable federal regulations. As of such date, Sovereign Bank had
a total investment of $2.0 million in subsidiary service corporations, which
excludes 201 Associates, Inc., as it is considered to be an operating subsidiary
for purposes of this test.
EMPLOYEES
At December 31, 1997, Sovereign had 1,959 full-time and 334 part-time
employees. None of these employees is represented by a collective bargaining
agent, and Sovereign believes it enjoys good relations with its personnel.
COMPETITION
Sovereign experiences substantial competition in attracting and retaining
deposits and in lending funds. The primary factors in competing for deposits are
the ability to offer attractive rates and the convenience of office locations.
Direct competition for deposits comes primarily from other thrift institutions
and commercial banks. Competition for deposits also comes from money market
mutual funds, corporate and government securities, and credit unions. The
primary factors in the competition for loans are interest rates, loan
origination fees and the range of products and services offered. Competition for
origination of real estate loans normally comes from other thrift institutions,
commercial banks, mortgage bankers, mortgage brokers and insurance companies.
IMPACT OF YEAR 2000
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of Sovereign's
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
Based on a continuing assessment, Sovereign has preliminarily determined
that it, or third party vendors with which Sovereign contracts, will be required
to modify or replace portions of software and hardware so that computer systems
will function properly with respect to dates in the year 2000 and thereafter.
Sovereign presently believes that with modifications or replacements to existing
software and hardware and conversions to new software and hardware, the Year
2000 Issue will not pose significant operational problems for its computer
systems. However, if such modifications and conversions are not made, or are not
completed timely, the Year 2000 Issue could have a material impact on the
operations of Sovereign.
For additional information with respect to Sovereign's plans and intentions
regarding the impact of the Year 2000 Issue, see Part II, Item 7 "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Impact of Year 2000" hereof.
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ENVIRONMENTAL LAWS
Environmentally related hazards have become a source of high risk and
potentially unlimited liability for financial institutions relative to their
loans. Environmentally contaminated properties owned by an institution's
borrowers may result in a drastic reduction in the value of the collateral
securing the institution's loans to such borrowers, high environmental clean up
costs to the borrower affecting its ability to repay the loans, the
subordination of any lien in favor of the institution to a state or federal lien
securing clean up costs, and liability to the institution for clean up costs if
it forecloses on the contaminated property or becomes involved in the management
of the borrower. To minimize this risk, Sovereign Bank may require an
environmental examination of and report with respect to the property of any
borrower or prospective borrower if circumstances affecting the property
indicate a potential for contamination, taking into consideration the potential
loss to the institution in relation to the burdens to the borrower. Such
examination must be performed by an engineering firm experienced in
environmental risk studies and acceptable to the institution, and the costs of
such examinations and reports are the responsibility of the borrower. These
costs may be substantial and may deter a prospective borrower from entering into
a loan transaction with Sovereign Bank. Sovereign is not aware of any borrower
who is currently subject to any environmental investigation or clean up
proceeding which is likely to have a material adverse effect on the financial
condition or results of operations of Sovereign Bank.
SUPERVISION AND REGULATION
General. Sovereign is a "savings and loan holding company" registered with
the Office of Thrift Supervision ("OTS") under the Home Owners' Loan Act
("HOLA") and as such, Sovereign is subject to OTS regulation, examination,
supervision and reporting. The deposits of Sovereign Bank are insured by the
Federal Deposit Insurance Corporation ("FDIC"). The FDIC manages two funds: the
Savings Association Insurance Fund ("SAIF") and the Bank Insurance Fund ("BIF").
These funds are required to be separately maintained and not combined. The
majority of Sovereign Bank's deposits are subject to the FDIC's SAIF deposit
insurance assessment rate; however, certain deposits which Sovereign acquired
from other institutions are subject to the FDIC's BIF deposit insurance
assessment rate. See "Insurance of Deposit Accounts" below. Sovereign Bank is
required to file reports with the OTS describing its activities and financial
condition and is periodically examined to test compliance with various
regulatory requirements. Sovereign Bank is also subject to examination by the
FDIC. Such examinations are conducted for the purpose of protecting depositors
and the insurance fund and not for the purpose of protecting holders of equity
or debt securities of Sovereign or Sovereign Bank. Sovereign Bank is a member of
the Federal Home Loan Bank ("FHLB") of Pittsburgh, which is one of the twelve
regional banks comprising the FHLB system. Sovereign Bank is also subject to
regulation by the Board of Governors of the Federal Reserve System with respect
to reserves maintained against deposits and certain other matters. Except as
described herein, Sovereign's management is not aware of any current
recommendations by regulatory authorities that would have a material effect on
Sovereign's operations, capital resources or liquidity.
Holding Company Regulation. The HOLA prohibits a registered savings and
loan holding company from directly or indirectly acquiring control, including
through an acquisition by merger, consolidation or purchase of assets, of any
savings association (as defined in HOLA to include a federal savings bank) or
any other savings and loan holding company, without prior OTS approval.
Generally, a savings and loan holding company may not acquire more than 5% of
the voting shares of any savings association unless by merger, consolidation or
purchase of assets. Certain regulations of the OTS describe standards for
control under the HOLA. See "Control of Sovereign" below.
Federal law empowers the Director of the OTS to take substantive action
when the Director determines that there is reasonable cause to believe that the
continuation by a savings and loan holding company of any particular activity
constitutes a serious risk to the financial safety, soundness or stability of a
savings and loan holding company's subsidiary savings institution. The Director
of the OTS has oversight authority for all holding company affiliates, not just
the insured institution. Specifically, the Director of the OTS may, as
necessary, (i) limit the payment of dividends by the savings institution;
(ii) limit transactions between the savings institution, the holding company
and the
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subsidiaries or affiliates of either; (iii) limit any activities of the savings
institution that might create a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the savings institution. Any such
limits would be issued in the form of a directive having the legal efficacy of a
cease and desist order.
Control of Sovereign. Under the Savings and Loan Holding Company Act and
the related Change in Bank Control Act (the "Control Act"), individuals,
corporations or other entities acquiring Sovereign common stock may, alone or
"in concert" with other investors, be deemed to control Sovereign and thereby
Sovereign Bank. If deemed to control Sovereign, such person or group will be
required to obtain OTS approval to acquire Sovereign's common stock and will be
subject to certain ongoing reporting procedures and restrictions under federal
law and regulations. Under the regulations, ownership of 25% of the capital
stock of Sovereign will be deemed to constitute "control," and ownership of more
than 10% of the capital stock may also be deemed to constitute "control" if
certain other control factors are present. It is possible that even lower levels
of ownership of such securities could constitute "control" under the
regulations. As of December 31, 1997, no individual corporation or other entity
owned more than 10% of Sovereign's capital stock.
Regulatory Capital Requirements. OTS regulations require savings
associations to maintain a minimum tangible capital ratio of not less than 1.5%,
a minimum core capital, or "leverage" ratio of not less than 3% and a minimum
risk-based capital ratio (based upon credit risk) of not less than 8%. These
standards are the same as the capital standards that are applicable to other
insured depository institutions, such as banks. Federal banking agencies are
required to ensure that their risk-based capital guidelines take adequate
account of interest rate risk, concentration of credit risk and risks of non-
traditional activities. In August 1995, the federal banking agencies, including
the OTS, issued a rule modifying their then-existing risk-based capital
standards to provide for consideration of interest rate risk when assessing the
capital adequacy of an institution. This new rule implements the first step of a
two-step process by explicitly including a depository institution's exposure to
declines in the value of its capital due to changes in interest rates as one
factor that the banking agencies will consider in evaluating an institution's
capital adequacy. The new rule does not establish a measurement framework for
assessing an institution's interest rate risk exposure level. Examiners will use
data collected by the banking agencies to determine the adequacy of an
individual institution's capital in light of interest rate risk. Examiners will
also consider historical financial performance, earnings exposure to interest
rate movements and the adequacy of internal interest rate risk management, among
other things. This case-by-case approach for assessing an institution's capital
adequacy for interest rate risk is transitional. The second step of the federal
banking agencies' interest rate risk regulation will be to establish an explicit
minimum capital charge for interest rate risk, based on measured levels of
interest rate risk exposure. The banking agencies may implement this second step
at some future date.
The federal banking agencies, including the OTS, also adopted final rules
relating to concentration of credit risk and risks of non-traditional activities
effective on January 17, 1995. The agencies declined to adopt a quantitative
test for concentrations of credit risk and, instead, provided that such risk
would be considered in addition to other risks in assessing an institution's
overall capital adequacy. Institutions with higher concentration of credit risk
will be required to maintain greater levels of capital. Similarly, the federal
agencies incorporated the evaluation of the risks of non-traditional activities
into the overall assessment of capital adequacy. The agencies also indicated
that proposed rules regarding specific types of non-traditional activities will
be promulgated from time to time.
Under the Federal Deposit Insurance Act ("FDIA"), insured depository
institutions must be classified in one of five defined categories
(well-capitalized, adequately-capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized). Under OTS regulations, an
institution will be considered "well-capitalized" if it has (i) a total
risk-based capital ratio of 10% or greater, (ii) a Tier 1 risk-based capital
ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv) is not
subject to any order or written directive to meet and maintain a specific
capital level. An "adequately-capitalized" institution is one that has (i) a
total risk-based capital ratio of 8% or greater, (ii) a Tier 1 risk-based
capital ratio of 4% or greater, (iii) a leverage ratio of 4% or greater (or 3%
or greater in the case of a bank with the highest composite regulatory
examination rating) and (iv) does
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not meet the definition of a well-capitalized institution. An institution will
be considered (A) "undercapitalized" if it has (i) a total risk-based capital
ratio of less than 8% (ii) a Tier 1 risk-based capital ratio of less than 4% or
(iii) a leverage ratio of less than 4% (or 3% in the case of an institution with
the highest regulatory examination rating); (B) "significantly undercapitalized"
if the institution has (i) a total risk-based capital ratio of less than 6% (ii)
a Tier 1 risk-based capital ratio of less than 3% or (iii) a leverage ratio of
less than 3%; and (C) "critically undercapitalized" if the institution has a
ratio of tangible equity to total assets of equal to or less than 2%. The OTS
may, under certain circumstances, reclassify a "well-capitalized" institution as
"adequately-capitalized" or require an "adequately-capitalized" or
"undercapitalized" institution to comply with supervisory actions as if it were
in the next lower category. Such a reclassification could be made if the OTS
determines that the institution is in an unsafe or unsound condition (which
could include unsatisfactory examination ratings). A savings institution's
capital category is determined with respect to its most recent thrift financial
report filed with the OTS. In the event an institution's capital deteriorates to
the undercapitalized category or below, the FDIA and OTS regulations prescribe
an increasing amount of regulatory intervention, including the adoption by the
institution of a capital restoration plan, a guarantee of the plan by its parent
holding company and the placement of a hold on increases in assets, number of
branches and lines of business.
If capital has reached the significantly or critically undercapitalized
levels, further material restrictions can be imposed, including restrictions on
interest payable on accounts, dismissal of management and (in critically
undercapitalized situations) appointment of a receiver or conservator.
Critically undercapitalized institutions generally may not, beginning 60 days
after becoming critically undercapitalized, make any payment of principal or
interest on their subordinated debt. All but well-capitalized institutions are
prohibited from accepting brokered deposits without prior regulatory approval.
Pursuant to the FDIA and OTS regulations, savings associations which are not
categorized as well-capitalized or adequately-capitalized are restricted from
making capital distributions which include cash dividends, stock redemptions or
repurchases, cash-out mergers, interest payments on certain convertible debt and
other transactions charged to the capital account of a savings association. At
December 31, 1997, Sovereign Bank met the criteria to be classified as
"well-capitalized."
Standards for Safety and Soundness. The federal banking agencies adopted,
effective in August 1995, certain operational and managerial standards for
depository institutions, including internal audit system components, loan
documentation requirements, asset growth parameters, and compensation standards
for officers, directors and employees. The implementation or enforcement of
these guidelines has not had a material adverse effect on Sovereign's results of
operations.
Insurance of Deposit Accounts. The FDIC has implemented a risk-related
premium schedule for all insured depository institutions that results in the
assessment of premiums based on capital and supervisory measures. Under the
risk-related premium schedule, the FDIC assigns, on a semi-annual basis, each
institution to one of three capital groups (well-capitalized,
adequately-capitalized or undercapitalized) and further assigns such institution
to one of three subgroups within a capital group. The institution's subgroup
assignment is based upon the FDIC's judgment of the institution's strength in
light of supervisory evaluations, including examination reports, statistical
analyses and other information relevant to measuring the risk posed by the
institution. Only institutions with a total capital to risk-adjusted assets
ratio of 10% or greater, a Tier 1 capital to risk-adjusted assets ratio of 6% or
greater, and a Tier 1 leverage ratio of 5% or greater, are assigned to the
well-capitalized group. At December 31, 1997, Sovereign Bank was classified as
well-capitalized for purposes of calculating insurance assessments. Institutions
are prohibited from disclosing the risk classification of the subgroup to which
they have been assigned. For the year ended December 31, 1997, the FDIC
calculated deposit insurance assessments at the rate of $.00 for every $100 of
insured deposits for the members of the SAIF in the lowest risk-based premium
category and $.27 for every $100 of insured deposits for members of the SAIF in
the highest risk-based premium category. This compares to 1996 FDIC SAIF deposit
insurance assessment rates of $.23 and $.31, respectively, for every $100 of
insured deposits.
In August 1995, the FDIC adopted an amendment to the BIF risk-based
assessment schedule that lowers the deposit insurance assessment rate for most
(90% or more) commercial banks and other
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depository institutions with deposits insured by the BIF to $.04 per $100 of
insured deposits. On November 14, 1995, the FDIC further reduced the BIF
assessment rates to a range of $.00 per $100 of insured deposits (subject to a
minimum annual premium of $2,000 prior to 1997) for those institutions with the
least risk to $.27 for every $100 of insured deposits for institutions deemed to
have the highest risk, beginning January 1, 1996. At the same time, the FDIC
voted to retain the existing assessment rates for SAIF-insured institutions. The
reduced BIF assessment rates resulted in a substantial disparity in the deposit
insurance premiums paid by BIF and SAIF members and placed SAIF-insured savings
associations at a significant competitive disadvantage to BIF-insured
institutions.
On January 1, 1997, in accordance with the Deposit Insurance Funds Act of
1996 ("DIFA"), the Financing Corporation ("FICO") debt service assessment became
applicable to all insured institutions. The FICO assessment is paid in addition
to the FDIC deposit insurance assessment; however, it is not tied to the FDIC
risk classification.
On September 30, 1996, legislation was signed into law which effectively
ends the BIF/SAIF rate disparity by the year 2000, and significantly reduces the
disparity for years 1997 through 1999. As part of the new law, SAIF-insured
institutions were required to make a one-time payment of 65.7 basis points for
all SAIF-insured deposits held as of March 31, 1995. At Sovereign, this amounted
to an after-tax charge of $20.9 million during 1996.
Federal savings banks like Sovereign Bank are required by OTS regulations
to pay assessments to the OTS to fund the operations of the OTS. The general
assessment is paid on a quarterly basis and is computed based on total assets of
the institution, including subsidiaries.
TAXATION
Federal Taxation. Sovereign and its subsidiaries are subject to those
rules of federal income taxation generally applicable to corporations and report
their respective income and expenses on the accrual basis method of accounting.
Sovereign and its subsidiaries file a consolidated federal income tax return on
a calendar year basis. Each member of the consolidated group separately computes
its income and deductions. Intercompany distributions (including dividends) and
certain other items of income and loss derived from intercompany transactions
are eliminated upon consolidation of all the consolidated group members'
respective taxable income and losses.
In computing separate taxable income and loss, Sovereign Bank separately
computes additions to its bad debt reserves, pursuant to the special
preferential rules of Section 593 of the Internal Revenue Code of 1986, as
amended (the "Code"), applicable only to certain savings banks, cooperative
banks, and domestic building and loan associations (generically, sometimes
referred to as either a "thrift" or a "savings institution"). Under certain
circumstances, Sovereign Bank's separate bad debt reserve additions may be
subject to adjustments upon consolidation.
As a result of provisions of the Small Business Jobs Protection Act of 1996
(the "Jobs Protection Act"), which repealed the tax reserve method for bad debts
for thrift institutions and the circumstances requiring bad debt recapture for
large institutions, Sovereign must determine the tax deduction for bad debt
based on actual charge-offs.
The Jobs Protection Act retained the existing base year bad debt reserve
and requires recapture into taxable income in certain circumstances, such as in
the case of certain excess distributions or complete redemptions. If Sovereign
Bank distributes amounts to stockholders (i.e., to Sovereign) and the
distribution is treated as being from accumulated bad debt reserves, the
distribution will cause Sovereign Bank to have additional taxable income. A
distribution to stockholders is deemed to have been made from accumulated bad
debt reserves to the extent that (a) the bad debt reserves exceed the amount
that would have been accumulated on the basis of the experience method and (b)
the distribution is a "nondividend distribution." A distribution in respect of
stock is a "nondividend distribution" to the extent that, for federal income tax
purposes, (i) it is in redemption of shares, (ii) it is pursuant to a partial or
complete liquidation of the institution or (iii) the distribution, together with
all other such distributions during the taxable year, exceeds the distributing
savings institution's current and post-1951 accumulated earnings and profits.
The amount of additional taxable income resulting
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from a "nondividend distribution" is an amount that, when reduced by the tax
attributable to such distribution, is equal to the amount of the distribution.
None of the limited circumstances requiring recapture are anticipated by
Sovereign.
The Code imposes a corporate alternative minimum tax ("AMT"). The corporate
AMT only applies if such tax exceeds a corporation's regular tax liability. In
general, the AMT is calculated by multiplying the corporate AMT rate of 20% by
an amount equal to the excess of (i) the sum of (a) regular taxable income plus
(b) certain adjustments and tax preference items ("alternative minimum taxable
income" or "AMTI") over (ii) an exemption amount ($40,000 for a corporation, but
such amount is reduced by 25% of the excess of AMTI over $150,000 and is
completely eliminated when AMTI equals $310,000). The excess, if any, of the bad
debt deduction using the "percentage of taxable income" method over the bad debt
deduction calculated on the basis of actual experience method is treated as a
preference item for determining AMTI. Although there are other applicable
adjustment and preference items (e.g., the adjustment for depreciation) for
determining AMTI of a savings institution, this particular preference item is
significant in determining AMTI. If a savings institution is subject to AMT,
then all or a portion of the amount of such preference will effectively be
subject to a 20% surtax.
Sovereign's consolidated federal income tax return, as well as certain
prior year separate returns from predecessor companies for the tax years
beginning after 1993, are open under the statute of limitations.
State Taxation. Sovereign and its non-thrift Pennsylvania subsidiaries are
subject to the Pennsylvania Corporate Net Income Tax and Capital Stock Tax. The
Corporate Net Income Tax rate for 1995 and thereafter is 9.99% and is imposed on
a corporate taxpayer's unconsolidated taxable income for federal purposes with
certain adjustments. In general, the Capital Stock Tax is a property tax imposed
on a corporate taxpayer's capital stock value apportionable to the Commonwealth
of Pennsylvania, which is determined in accordance with a fixed formula based
upon average book income and net worth. In the case of a holding company, an
optional elective method permits the corporate taxpayer to be taxed on only 10%
of such capital stock value. The Capital Stock Tax rate is presently 1.275%.
Sovereign Bank is taxed under the Pennsylvania Mutual Thrift Institutions
Tax Act (the "Mutual Tax Act"). The Mutual Tax Act exempts Sovereign Bank from
all other corporate taxes imposed by the Commonwealth of Pennsylvania for
Pennsylvania purposes and from all local taxation imposed by political
subdivisions of Pennsylvania, except taxes on real estate and real estate
transfers. The Mutual Tax Act is a tax upon net income apportioned to
Pennsylvania, determined in accordance with generally accepted accounting
principles ("GAAP"), with certain modifications. The Mutual Tax Act, in
computing GAAP income, allows for the deduction of interest earned on
Pennsylvania governmental and federal securities, while disallowing a percentage
of a thrift's interest expense deduction in the proportion of the interest
income from those securities to the overall interest income of the institution.
Pursuant to the Mutual Tax Act, Sovereign Bank's tax rate is presently 11.5% of
such net income.
Sovereign Bank is also taxed under the New Jersey Savings Institution Tax.
The New Jersey Savings Institution Tax rate is 3% and is imposed on the portion
of the taxpayer's modified federal taxable income (with certain adjustments)
that is properly attributable to New Jersey. Effective September 29, 1995,
Sovereign Bank is subject to a Delaware Franchise Tax that is imposed on federal
savings banks not headquartered in Delaware. The Delaware Franchise Tax, which
is imposed on taxable income properly attributable to Delaware branches, varies
from a rate of 8.7% on taxable income up to $20 million to a rate of 2.7% on
taxable income over $30 million. Sovereign Bank is taxed in Maryland under the
Financial Institution Franchise Tax. The Maryland tax rate is 7% and is based on
the taxpayer's adjusted federal taxable income that is apportioned to Maryland.
Effective September 19, 1997, Sovereign Bank is subject to tax in the
following states: Massachusetts, New York, Connecticut, and Florida. Sovereign
Bank is taxed under the Massachusetts Bank Excise Tax, with a tax equal to
11.72% of adjusted federal taxable income attributable to Massachusetts.
Sovereign Bank is taxed under the New York Banking Corporation Franchise Tax
with a tax equal to 9% of adjusted federal taxable income attributable to New
York. Sovereign Bank is
7
subject to the Connecticut Corporation Business Tax. In Connecticut, the tax is
equal to the larger of 10.75% of modified federal taxable income attributable to
Connecticut or 4% of average capital attributable to Connecticut. In Florida,
Sovereign Bank is taxed under the Corporate Income/Franchise and Emergency
Excise Tax with a tax equal to 5.5% of adjusted federal taxable income
apportioned to Florida.
ITEM 2. PROPERTIES.
Sovereign Bank is the owner of a five-story office building in Wyomissing,
Berks County, Pennsylvania. The building is used as Sovereign's and Sovereign
Bank's executive offices and as Sovereign Bank's operations center.
Sovereign Bank has 150 branch offices, including 3 loan production and
personalized banking offices. Sovereign owns 80 of these offices and leases 70.
Branch office leases are generally long-term. Loan production and personalized
banking office leases generally have terms of two years or less.
ITEM 3. LEGAL PROCEEDINGS.
Sovereign is not involved in any pending legal proceedings other than
non-material legal proceedings occurring in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.
Certain information, including principal occupation during the past five
years, relating to the principal executive officers of Sovereign, as of March 4,
1998, is set forth below:
Richard E. Mohn -- Age 66. Mr. Mohn was elected the Chairman of the Board
of Sovereign on April 24, 1995. Mr. Mohn became Chairman of the Board of
Sovereign Bank in November 1989. He is Chairman of Cloister Spring Water
Company, Lancaster, Pennsylvania, a bottler and distributor of spring water.
Jay S. Sidhu -- Age 46. Mr. Sidhu has served as President and Chief
Executive Officer of Sovereign since November 21, 1989. Prior thereto, Mr. Sidhu
served as Treasurer and Chief Financial Officer of Sovereign. Mr. Sidhu is also
President and Chief Executive Officer of Sovereign Bank. Prior to becoming
President and Chief Executive Officer of Sovereign Bank on March 28, 1989, Mr.
Sidhu served as Vice Chairman and Chief Operating Officer of Sovereign Bank.
Lawrence M. Thompson, Jr. -- Age 45. Mr. Thompson serves as Chief
Administrative Officer and Secretary of Sovereign and Chief Operating Officer
and Secretary of Sovereign Bank. Mr. Thompson was hired as Sovereign Bank's
General Counsel and Secretary in 1984. He was promoted to Vice President in
1985. In April 1986, he became Sovereign Bank's Senior Vice President for legal
affairs and administration. In January 1990, he became Group Executive Officer
- -- Lending and in June 1995, he became Chief Administrative Officer of Sovereign
and Sovereign Bank. Mr. Thompson became Chief Operating Officer of Sovereign
Bank in November 1996.
Karl D. Gerhart -- Age 45. Mr. Gerhart was elected Chief Financial Officer
and Treasurer of Sovereign on February 20, 1990. Mr. Gerhart is also Group
Executive Officer, Treasurer and Chief Financial Officer of Sovereign Bank. Mr.
Gerhart joined Sovereign Bank in 1975 and in 1986 was promoted to Vice President
- -- Investments. In 1987, he became Sovereign Bank's Senior Vice President,
Treasurer and Chief Investment Officer, responsible for managing Sovereign
Bank's investment portfolio and interest rate risk.
8
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
Sovereign's common stock is traded in the over-the-counter market and is
quoted on the National Association of Securities Dealers Automated Quotation
System ("NASDAQ") National Market System under the symbol "SVRN." At March 4,
1998, the total number of holders of record of Sovereign's common stock was
10,998.
The high and low bid prices reported on the NASDAQ National Market System
for Sovereign's common stock for 1997, adjusted to reflect all stock dividends
and splits, including a 6-for-5 stock split declared on January 22, 1998, were
$18.000 and $9.125 and for 1996 were $9.438 and $6.438, respectively.
During 1997, as restated for First State and Bankers, Sovereign paid a cash
dividend of $.032 per share in the first quarter, $.032 per share in the second
quarter, $.030 per share in the third quarter and $.017 per share in the fourth
quarter. During 1996, Sovereign paid a cash dividend of $.029 per share in the
first quarter, $.029 per share in the second quarter, $.031 per share in the
third quarter and $.031 per share in the fourth quarter. During 1995, Sovereign
paid a cash dividend of $.026 per share in the first quarter, $.026 in the
second quarter, $.029 in the third quarter and $.025 in the fourth quarter.
These per share amounts have been adjusted to reflect all stock dividends and
stock splits declared through January 1998.
For certain limitations on the ability of Sovereign Bank to pay dividends
to Sovereign, see Part I, Item 1 "Business -- Supervision and Regulation --
Regulatory Capital Requirements" and Note 11 at Item 8 "Financial Statements and
Supplementary Data" hereof.
9
ITEM 6. SELECTED FINANCIAL DATA.
SELECTED FINANCIAL DATA(1)
BALANCE SHEET DATA
(IN THOUSANDS)
AT DECEMBER 31,
-----------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- ----------- ---------- ----------
Total assets............................ $14,336,283 $12,500,852 $10,616,931 $8,873,991 $6,975,798
Loans................................... 9,923,510 8,321,771 6,463,490 6,029,568 4,398,125
Allowance for possible loan losses...... 90,881 52,689 49,075 50,785 50,108
Investment and mortgage-backed
securities available-for-sale......... 1,029,524 528,887 904,732 107,481 --
Investment and mortgage-backed
securities held-to-maturity........... 2,871,815 3,195,094 2,644,467 2,333,829 2,192,008
Deposits................................ 7,889,921 7,235,395 7,237,723 5,959,860 4,990,952
Borrowings.............................. 5,491,555 4,476,284 2,621,006 2,310,091 1,441,732
Stockholders' equity.................... 778,247 701,425 655,264 513,587 454,426
SUMMARY STATEMENT OF OPERATIONS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
Total interest income.............................. $960,728 $818,594 $666,645 $495,678 $418,379
Total interest expense............................. 619,879 514,473 414,388 263,312 216,559
-------- -------- -------- -------- --------
Net interest income................................ 340,849 304,121 252,257 232,366 201,820
Provision for possible loan losses................. 37,199 15,366 8,150 9,962 13,130
-------- -------- -------- -------- --------
Net interest income after provision for possible
loan losses ..................................... 303,650 288,755 244,107 222,404 188,690
-------- -------- -------- -------- --------
Other income....................................... 38,480 46,304 32,936 20,387 23,266
Other expenses..................................... 182,856 187,731 155,279 131,000 117,269
One-time, merger-related charges................... 29,258 -- -- -- --
Non-recurring SAIF assessment...................... -- 33,753 -- -- --
-------- -------- -------- -------- --------
Income before income taxes and cumulative effect of
change in accounting principle................... 130,016 113,575 121,764 111,791 94,687
Income tax provision............................... 52,376 43,436 41,354 40,888 35,080
-------- -------- -------- -------- --------
Income before cumulative effect of change in
accounting principle............................. 77,640 70,139 80,410 70,903 59,607
Cumulative effect of change in accounting
principle........................................ -- -- -- -- 4,800
-------- -------- -------- -------- --------
Net income......................................... $ 77,640 $ 70,139 $ 80,410 $ 70,903 $ 64,407
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Net income applicable to common stock.............. $ 71,396 $ 63,889 $ 75,722 $ 70,903 $ 64,407
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
10
FINANCIAL RATIOS
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995 1994 1993
------ ----- ----- ----- -----
Performance Ratios:
Return on average equity(2)................................. 15.59% 13.36% 13.53% 14.61% 13.95%
Return on average total assets(2)........................... .85 .78 .84 .92 .93
Average equity to average total assets...................... 5.47 5.87 6.18 6.30 6.67
Net interest margin......................................... 2.68 2.76 2.76 3.17 3.31
Stockholders' equity to total assets........................ 5.43 5.61 6.17 5.79 6.51
General and administrative expenses to average total
assets.................................................... 1.22 1.47 1.44 1.56 1.66
Efficiency ratio............................................ 43.09 49.28 49.18 47.78 48.09
Asset Quality Ratios:
Non-performing assets to total assets....................... .63 .80 .99 1.14 1.62
Non-performing loans to total loans......................... .81 1.01 1.31 1.28 1.78
Allowance for possible loan losses to total loans........... .92 .63 .74 .84 1.13
Allowance for possible loan losses to non-performing
loans..................................................... 107.78 57.94 56.01 63.00 60.09
Capital Ratios:
Tangible capital to tangible assets......................... 4.60 4.83 5.05 5.16 6.16
Leverage (core) capital to tangible assets.................. 5.24 4.83 5.05 5.18 6.20
Leverage (core) capital to risk-adjusted assets............. 9.26 10.02 10.85 10.43 12.10
Risk-based capital to risk-adjusted assets.................. 12.15 13.58 15.14 13.97 16.49
Return on average risk-adjusted assets(2)................... 1.70 1.60 1.72 1.83 1.77
SHARE DATA (3)
AT DECEMBER 31,
----------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- ------
Common shares outstanding at end of period (in
thousands)............................................. 107,522 105,514 100,603 100,423 94,724
Preferred shares outstanding at end of period (in
thousands)............................................. 1,996 2,000 2,000 -- --
Basic earnings per share:(4)
Before cumulative effect of change in accounting
principle.......................................... $ .67 $ .61 $ .72 $ .66 $ .57
After cumulative effect of change in accounting
principle.......................................... .67 .61 .72 .66 .61
Diluted earnings per share:(4)
Before cumulative effect of change in accounting
principle.......................................... .63 .58 .69 .64 .55
After cumulative effect of change in accounting
principle.......................................... .63 .58 .69 .64 .59
Book value per share at end of period(5)................. 6.33 5.79 5.60 4.67 4.15
Common share price at end of period...................... 17-5/16 9-1/8 6-11/16 4-7/8 7-1/2
Dividends per common share(6)............................ .092 .122 .108 .103 .079
Dividend payout ratio(6)(7).............................. 14.60% 21.03% 15.65% 16.09% 13.39%
- ------------------
(1) All selected financial data has been restated to reflect all acquisitions
which have been accounted for under the pooling-of-interests method of
accounting.
(2) The 1997 results do not include the impact of one-time, merger-related
charges of $36.6 million (after-tax) resulting from Sovereign's acquisitions
during 1997. The 1996 results do not include a non-recurring SAIF assessment
of $20.9 million (after-tax) paid to the FDIC for the recapitalization of
the SAIF. The 1993 results do not include a $4.8 million cumulative effect
of change in accounting principle resulting from the adoption of Statement
of Financial Accounting Standard No. 109 in 1993.
(3) All per share data have been adjusted to reflect all stock dividends and
stock splits declared through January 1998.
(4) The 1997 results include the one-time, merger-related charges described in
Note 2 above. Excluding the one-time, merger-related charges, basic earnings
per share and diluted earnings per share for 1997 were $1.02 and $.93,
respectively. The 1996 results include the non-recurring SAIF assessment
described in Note 2 above. Excluding the non-recurring SAIF assessment,
basic earnings per share and diluted earnings per share for 1996 were $.81
and $.75, respectively.
(5) Book value is calculated using equity divided by diluted shares.
(6) The higher dividend rate in prior periods is the result of acquisitions
which were accounted for as a pooling-of-interests.
(7) The dividend payout ratio is calculated using dividends per common share
divided by diluted earnings per share.
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
General. Sovereign and subsidiaries reported net operating income of
$114.4 million for the year ended December 31, 1997. This represents an increase
of 26% over net operating income of $91.0 million reported for 1996. Operating
earnings per share was $.93 for 1997, which represents an increase of 24% over
1996 operating earnings per share of $.75. Return on average equity and return
on average assets were 15.59% and .85%, respectively, for 1997 compared to
13.36% and .78%, respectively, for 1996. Return on average risk-adjusted assets
was 1.70% for 1997 compared to 1.60% for 1996. The amounts presented for 1997
exclude one-time, merger charges of $36.6 million (after-tax) related to
Sovereign's acquisition of First State Financial Services, Inc. ("First State")
and Bankers Corp. ("Bankers") during 1997. Results for 1996 exclude a
non-recurring Savings Association Insurance Fund ("SAIF") assessment of $20.9
million (after-tax) paid to the Federal Deposit Insurance Corporation ("FDIC")
during 1996 for the recapitalization of the SAIF. All per share amounts
presented in Management's Discussion and Analysis of Financial Condition and
Results of Operations have been calculated based on average diluted shares
outstanding.
Reported net income for the year ended December 31, 1997, including the
impact of the one-time, merger-related charges, was $77.6 million or $.63 per
share.
Sovereign's financial results for 1997 include the following significant
events:
Fleet Auto. On September 19, 1997, Sovereign purchased Fleet Financial
Group Inc.'s ("Fleet") Automobile Finance Division ("Fleet Auto"). Fleet
Auto consists of approximately $2.0 billion of indirect auto loans, automotive
floor plan loans and loans to automotive lessors and has business relationships
throughout New Jersey, New York and several New England states.
Bankers. On August 29, 1997, Sovereign acquired Bankers, a $2.6 billion
financial services holding company headquartered in Perth Amboy, New Jersey.
Bankers' sole banking subsidiary, Bankers Savings, operates 15 branch offices
located in Middlesex, Monmouth and Ocean counties, New Jersey. This transaction
was accounted for as a pooling-of-interests.
First State. On February 18, 1997, Sovereign acquired First State, a $603
million savings institution headquartered in West Caldwell, New Jersey with 14
branch offices located throughout central and northern New Jersey. This
transaction was accounted for as a pooling-of-interests.
Accounting Changes. In June 1997, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS")
No. 131, "Disclosures about Segments of an Enterprise and Related Information."
SFAS No. 131 requires that public companies report certain information about
operating segments in complete sets of financial statements of the company and
in condensed financial statements of interim periods issued to shareholders. It
also requires that public companies report certain information about their
products and services, the geographic areas in which they operate, and their
major customers. SFAS No. 131 is effective for fiscal years beginning after
December 15, 1997. Subsequent to the effective date, all prior-period amounts
are required to be restated to conform to the provisions of SFAS No. 131.
Sovereign will adopt SFAS No. 131 in 1998 and if necessary, the consolidated
financial statements will be restated to conform to the provisions of this
statement.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." The overall objective of SFAS No. 130 is to provide prominent
disclosure of comprehensive income items. Comprehensive income is the change in
equity of a company during a given period from transactions and other events
from non-owner sources. SFAS No. 130 is effective for fiscal years beginning
after December 15, 1997. Subsequent to the effective date, all prior-period
amounts are required to be restated to conform to the provisions of SFAS No.
130. Sovereign will adopt SFAS No. 130 in 1998 and accordingly, the consolidated
financial statements will be restated to conform to the provisions of this
statement.
12
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share." This
statement supersedes APB Opinion No. 15, "Earnings per Share" and FASB Statement
No. 85, "Yield Test for Determining whether a Convertible Security Is a Common
Stock Equivalent." The overall objective of SFAS No. 128 is to simplify the
calculation of earnings per share and achieve comparability with the recently
issued International Accounting Standard No. 33, "Earnings Per Share." SFAS No.
128 is effective for all periods ending after December 15, 1997. Subsequent to
the effective date, all prior-period earnings per share amounts are required to
be restated to conform to the provisions of SFAS No. 128.
Under SFAS No. 128, primary earnings per share has been replaced with basic
earnings per share. Basic earnings per share is calculated by dividing income
available to common stockholders by the weighted average common shares
outstanding, excluding options, warrants, and convertible securities from the
calculation.
Under SFAS No. 128, fully diluted earnings per share has been renamed
diluted earnings per share. Income available to common stockholders is adjusted
for the assumed conversion of all potentially dilutive securities. In
calculating diluted earnings per share, the dilutive effect of options and
warrants continues to be calculated using the treasury stock method. However,
unlike the calculation of fully diluted earnings per share, the treasury stock
method is applied using the average market price for the period rather than the
higher of the average market price or the ending market price. The dilutive
effect of convertible debt or preferred stock continues to be calculated using
the if-converted method. Sovereign adopted SFAS No. 128 in December 1997 and
accordingly, the calculation of primary and fully diluted earnings per share for
current and prior periods has been restated to conform to the provisions of SFAS
No. 128.
Stock Dividends/Splits. Sovereign declared a 6-for-5 stock split on
January 22, 1998, a 20% stock split on January 16, 1997 and 5% stock dividends
on December 20, 1995 and on February 22, 1995. All per share information such as
earnings, book value, share price and dividends have been restated to reflect
all stock dividends and stock splits declared through January 1998. For a
detailed discussion of Sovereign's stock dividends and stock splits, see Note
1(c) at Item 8 "Financial Statements and Supplementary Data" hereof.
Impact of Year 2000. The Year 2000 Issue is the result of computer
programs being written using two digits rather than four to define the
applicable year. Any of Sovereign's computer programs that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities.
Based on a continuing assessment, Sovereign has preliminarily determined
that it, or third party vendors with which Sovereign contracts, will be required
to modify or replace portions of software and hardware so that computer systems
will function properly with respect to dates in the year 2000 and thereafter.
Sovereign presently believes that with modifications or replacements to existing
software and hardware and conversions to new software and hardware, the Year
2000 Issue will not pose significant operational problems for its computer
systems. However, if such modifications and conversions are not made, or are not
completed timely, the Year 2000 Issue could have a material impact on the
operations of Sovereign.
Sovereign is initiating an ongoing program of formal communications with
all of its significant suppliers and large customers to determine the extent to
which Sovereign's interface systems are vulnerable to those third parties'
failure to remediate their own Year 2000 Issues. However, there can be no
guarantee that the systems of other companies on which Sovereign's systems rely
will be timely converted and would not have an adverse effect on Sovereign's
systems or operations.
Sovereign will utilize both internal and external resources to reprogram,
or replace, and test the software and hardware for Year 2000 modifications.
Sovereign anticipates completing the Year 2000 project prior to any anticipated
impact on its operating systems. Sovereign estimates that the expenses
associated with the Year 2000 project for 1998 may cost in the $5 million to $10
million range, although this estimate is subject to change. The total cost of
the Year 2000 project is anticipated to be funded through operating cash flows
and expensed as incurred.
13
The costs of the project and the time table on which Sovereign believes it
will complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future events,
including the continued availability of certain resources, third party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved and actual results could differ materially from
those anticipated. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct all relevant computer codes, and
similar uncertainties.
Although Sovereign believes that the program outlined above should be
adequate to address the Year 2000 Issue, there can be no assurance to that
effect.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
Net Interest Income. Net interest income for 1997 was $340.8 million
compared to $304.1 million for 1996. This represents an increase of 12% and is
primarily due to an increase in average balances resulting from internal growth
and acquisitions, partially offset by a decline in Sovereign's full year net
interest margin.
Interest on interest-earning deposits was $4.3 million for 1997 compared to
$3.4 million for 1996. The average balance of interest-earning deposits was
$19.3 million with an average yield of 22.11% for 1997 compared to an average
balance of $16.3 million with an average yield of 20.89% for 1996. The high
yields in 1997 and 1996 were the result of a contractual arrangement whereby a
third-party vendor performed check processing and reconcilement functions for
Sovereign's disbursement accounts. Under the agreement, the vendor is required
to pay Sovereign interest on disbursed funds during the two to three day float
period, effectively producing interest income with no corresponding asset
balance. This agreement will continue to favorably impact the yield on
Sovereign's interest-earning deposits in 1998 and future years.
Interest on investment and mortgage-backed securities available-for-sale
was $47.1 million for 1997 compared to $36.4 million for 1996. The average
balance of investment and mortgage-backed securities available-for-sale was
$760.7 million with an average yield of 6.67% for 1997 compared to an average
balance of $552.3 million with an average yield of 6.89% for 1996.
Interest on investment and mortgage-backed securities held-to-maturity was
$241.4 million for 1997 compared to $213.6 million for 1996. The average balance
of investment and mortgage-backed securities held-to-maturity was $3.37 billion
with an average yield of 7.16% for 1997 compared to an average balance of $3.02
billion with an average yield of 7.08% for 1996.
Interest and fees on loans were $668.0 million for 1997 compared to $565.1
million for 1996. The average balance of loans was $8.75 billion with an average
yield of 7.65% for 1997 compared to an average balance of $7.52 billion with an
average yield of 7.52% for 1996. The increases in average balance and average
yield were primarily due to Sovereign's acquisition of Fleet Auto in 1997, which
added $2.0 billion of higher yielding commercial and consumer loans to
Sovereign's loan portfolio, and the full year effect of Sovereign's record level
of residential mortgage loan originations in 1996.
Interest on total deposits was $320.6 million for 1997 compared to $297.8
million for 1996. The average balance of total deposits was $7.54 billion with
an average cost of 4.25% for 1997 compared to an average balance of $7.12
billion with an average cost of 4.18% for 1996. The increase in the average
balance of deposits is primarily the result of Sovereign's relationship selling
campaign during 1997.
Interest on total borrowings was $299.3 million for 1997 compared to $216.7
million for 1996. The average balance of total borrowings was $4.98 billion with
an average cost of 6.01% for 1997 compared to an average balance of $3.66
billion with an average cost of 5.92% for 1996. The increase in the average
balance of borrowings was the result of the Fleet Auto acquisition and other
internal balance sheet growth being funded principally by borrowings.
14
Table 1 presents a summary of Sovereign's average balances, the yields
earned on average assets and the cost of average liabilities and stockholders'
equity for the years indicated (in thousands):
TABLE 1: SPREAD ANALYSIS
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------------
1997 1996 1995
------------------------------- ------------------------------- ------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
----------- -------- ----- ----------- -------- ----- ---------- -------- -----
Interest-earning assets:
Interest-earning deposits.... $ 19,256 $ 4,258 22.11% $ 16,301 $ 3,406 20.89% $ 25,663 $ 3,995 15.57%
Investment and
mortgage-backed securities
available-for-sale(1)...... 760,729 47,064 6.67 552,272 36,439 6.89 156,246 10,643 7.04
Investment and
mortgage-backed securities
held-to-maturity........... 3,374,270 241,437 7.16 3,018,301 213,607 7.08 2,722,215 187,414 6.89
Net loans(2)(3).............. 8,746,480 667,969 7.65 7,524,371 565,142 7.52 6,253,894 464,593 7.43
----------- -------- ----- ----------- -------- ----- ---------- -------- -----
Total interest-earning
assets..................... 12,900,735 960,728 7.49 11,111,245 818,594 7.39 9,158,018 666,645 7.29
Non-interest-earning
assets..................... 511,453 -- -- 497,938 -- -- 466,918 -- --
----------- -------- ----- ----------- -------- ----- ---------- -------- -----
Total assets................ $13,412,188 960,728 7.20 $11,609,183 818,594 7.07 $9,624,936 666,645 6.94
----------- -------- ----- ----------- -------- ----- ---------- -------- -----
----------- ----------- ----------
Interest-bearing liabilities:
Deposits:
Demand deposit and NOW
accounts.................. $ 865,479 7,436 .86 $ 738,254 7,721 1.05 $ 628,818 7,809 1.24
Savings accounts............ 1,717,605 49,708 2.89 1,740,095 47,802 2.75 1,611,017 45,147 2.80
Money market accounts....... 639,165 26,633 4.17 659,215 27,558 4.18 610,039 26,515 4.35
Certificates of deposit..... 4,319,980 236,790 5.48 3,978,977 214,725 5.40 4,127,411 221,283 5.36
----------- -------- ----- ----------- -------- ----- ---------- -------- -----
Total deposits.............. 7,542,229 320,567 4.25 7,116,541 297,806 4.18 6,977,285 300,754 4.31
Total borrowings............. 4,976,491 299,312 6.01 3,659,251 216,667 5.92 1,916,925 113,634 5.93
----------- -------- ----- ----------- -------- ----- ---------- -------- -----
Total interest-bearing
liabilities................ 12,518,720 619,879 4.95 10,775,792 514,473 4.77 8,894,210 414,388 4.66
Non-interest-bearing
liabilities................ 159,734 -- -- 150,389 -- -- 136,300 -- --
----------- -------- ----- ----------- -------- ----- ---------- -------- -----
Total liabilities........... 12,678,454 619,879 4.89 10,926,181 514,473 4.71 9,030,510 414,388 4.59
Stockholders' equity......... 733,734 -- -- 683,002 -- -- 594,426 -- --
----------- -------- ----- ----------- -------- ----- ---------- -------- -----
Total liabilities and
stockholders'
equity.................... $13,412,188 619,879 4.62 $11,609,183 514,473 4.43 $9,624,936 414,388 4.31
----------- -------- ----- ----------- -------- ----- ---------- -------- -----
----------- ----------- ----------
Interest rate spread(4)...... 2.58% 2.64% 2.63%
----- ----- -----
----- ----- -----
Net interest income/net
interest margin(5)......... $340,849 2.68% $304,121 2.76% $252,257 2.76%
-------- ----- -------- ----- -------- -----
-------- ----- -------- ----- -------- -----
Ratio of interest-earning
assets to interest-bearing
liabilities................ 1.03x 1.03x 1.03x
----- ----- -----
----- ----- -----
- ------------------
(1) The tax equivalent adjustments for the years ended December 31, 1997, 1996
and 1995 were $3.7 million, $1.6 million and $358,000, respectively, and are
based on an effective tax rate of 38% in 1997 and 1996 and 35% in 1995.
(2) Amortization of net fees of $2.3 million, $2.1 million and $3.2 million for
the years ended December 31, 1997, 1996 and 1995, respectively, are included
in interest income. Average loan balances include non-accrual loans and
loans held for sale.
(3) The tax equivalent adjustments for the years ended December 31, 1997, 1996
and 1995, were $966,000, $974,000 and $284,000, respectively, and are based
on an effective tax rate of 38% in 1997 and 1996 and 35% in 1995.
(4) Represents the difference between the yield on total assets and the cost of
total liabilities and stockholders' equity.
(5) Represents tax equivalent net interest income divided by average
interest-earning assets.
15
Table 2 presents, prior to any tax equivalent adjustments, the relative
contribution of changes in volumes and changes in rates to changes in net
interest income for the periods indicated. The change in interest income and
interest expense attributable to the combined impact of both volume and rate has
been allocated proportionately to the change due to volume and the change due to
rate (in thousands):
TABLE 2: VOLUME/RATE ANALYSIS
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
1997 VS. 1996 1996 VS. 1995
INCREASE/(DECREASE) INCREASE/(DECREASE)
----------------------------- -----------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------- -------- -------- ------- -------- --------
Interest-earning assets:
Interest-earning deposits................ $ 645 $ 207 $ 852 $(9,510) $ 8,921 $ (589)
Investment and mortgage-backed securities
available-for-sale..................... 12,727 (2,102) 10,625 26,119 (323) 25,796
Investment and mortgage-backed securities
held-to-maturity....................... 25,447 2,383 27,830 20,838 5,355 26,193
Net loans(1)............................. 93,188 9,639 102,827 95,370 5,179 100,549
-------- --------
Total interest-earning assets.............. 142,134 151,949
-------- --------
Interest-bearing liabilities:
Deposits................................. 18,035 4,726 22,761 6,382 (9,330) (2,948)
Borrowings............................... 79,174 3,471 82,645 103,164 (131) 103,033
-------- --------
Total interest-bearing liabilities......... 105,406 100,085
-------- --------
Net change in net interest income.......... $47,448 $(10,720) $ 36,728 $54,201 $ (2,337) $ 51,864
------- -------- -------- ------- -------- --------
------- -------- -------- ------- -------- --------
- ------------------
(1) Includes non-accrual loans and loans held for sale.
Provision for Possible Loan Losses. The provision for possible loan losses
was $37.2 million for 1997 compared to $15.4 million for 1996. In 1996,
Sovereign diversified its lending efforts and began to offer small business
loans and an expanded line of consumer products, such as auto loans and
credit cards. Sovereign's 1997 acquisition of Fleet Auto and Sovereign's planned
acquisition of ML Bancorp, Inc. ("ML Bancorp") in 1998 will further diversify
its loan portfolio composition. Management recognizes the increased risk
inherent in these loan products and as a result, Sovereign's 1997 loan loss
provision increased by 142% over 1996 levels. The increased loan loss provision
for 1997 included $24.9 million of additional reserves which Sovereign
determined would be necessary as a result of its conservative approach with
respect to an aggressive workout plan for certain assets acquired from Bankers
and First State. In addition, Sovereign established an initial loan loss reserve
of $22.0 million in connection with its acquisition of Fleet Auto during 1997.
As Sovereign continues to place emphasis on small business and consumer lending
in 1998 and future years, management will continually evaluate its loan
portfolio and record additional loan loss reserves as is necessary. For
additional information with respect to Sovereign's asset quality, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Credit Quality."
During 1997, Sovereign charged-off $22.6 million compared to $14.1 million
for 1996. This increased level of charge-offs for 1997 was partially off-set by
recoveries of $4.3 million, resulting in net charge-offs for 1997 of $18.3
million. This compares to recoveries of $1.6 million and net charge-offs of
$12.5 million for 1996. Sovereign's increased level of charge-offs for 1997 is
primarily the result of increased consumer and commercial loan charge-offs, the
majority of which are related to Sovereign's 1997 acquisition activity.
Historically, non-residential lending will typically result in higher charge-off
levels than other types of lending; however, recoveries and income potential
will also be greater. In Sovereign's experience, strategy that involves the
accelerated resolution of problem assets is more appropriate than a long-term
workout approach. In connection with this philosophy, additional reserves were
added during 1997 as described above.
16
Table 3 presents the activity in the allowance for possible loan losses for
the years indicated (in thousands):
TABLE 3: RECONCILIATION OF THE ALLOWANCE FOR POSSIBLE LOAN LOSSES
DECEMBER 31,
-----------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
Allowance, beginning of year............ $52,689 $49,075 $50,785 $50,108 $44,076
Charge-offs:
Residential........................... 8,548 10,172 8,938 9,090 5,903
Commercial real estate................ 1,339 1,946 1,435 4,302 980
Commercial............................ 1,764 252 321 579 200
Consumer (1).......................... 10,960 1,713 542 1,081 701
------- ------- ------- ------- -------
Total charge-offs.................. 22,611 14,083 11,236 15,052 7,784
------- ------- ------- ------- -------
Recoveries:
Residential........................... 1,013 1,254 691 399 515
Commercial real estate................ 1,082 75 125 439 45
Commercial............................ 226 15 28 78 --
Consumer (1).......................... 1,954 271 47 309 82
------- ------- ------- ------- -------
Total recoveries................... 4,275 1,615 891 1,225 642
------- ------- ------- ------- -------
Charge-offs, net of recoveries.......... 18,336 12,468 10,345 13,827 7,142
Provision for possible loan losses...... 37,199 15,366 8,150 9,962 13,130
Acquired reserves and other
additions (2)......................... 19,329 716 485 4,542 44
------- ------- ------- ------- -------
Allowance, end of year.................. $90,881 $52,689 $49,075 $50,785 $50,108
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Charge-offs, net of recoveries to
average total loans................... .208% .165% .164% .265% .177%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
- ------------------
(1) Includes indirect auto loans and home equity lines of credit.
(2) For 1997, acquired reserves and other additions represent $22.0 million of
loan loss reserves established as part of the Fleet Auto acquisition,
partially off-set by net charge-offs of $2.7 million related to First State
for the three-month period ended December 31, 1996 resulting from the
differing fiscal year of First State.
Table 4 summarizes the allocation of the allowance for possible loan losses
and the percentage of such allocation to each loan type for the years indicated
(in thousands):
TABLE 4: ALLOCATION OF THE ALLOWANCE FOR POSSIBLE LOAN LOSSES
AT DECEMBER 31,
-------------------------------------------------------------------------------------------------
BALANCE AT END OF
PERIOD ATTRIBUTABLE TO: 1997 1996 1995 1994 1993
- ----------------------------- ----------------- ----------------- ----------------- ----------------- -----------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Residential.................. $33,169 36.50% $22,723 43.13% $20,899 42.59% $21,004 41.36% $18,462 36.84%
Commercial real estate....... 11,074 12.19 6,449 12.24 2,140 4.36 2,018 3.97 3,215 6.42
Commercial................... 5,349 5.88 3,100 5.88 1,846 3.76 2,147 4.23 2,799 5.58
Consumer..................... 21,893 24.09 8,432 16.00 4,923 10.03 5,123 10.09 1,502 3.00
Unallocated.................. 19,396 21.34 11,985 22.75 19,267 39.26 20,493 40.35 24,130 48.16
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total.................... $90,881 100.00% $52,689 100.00% $49,075 100.00% $50,785 100.00% $50,108 100.00%
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
17
Other Income. Total other income was $38.5 million for 1997 compared to
$46.3 million for 1996. The decrease in other income is the result of a decrease
in other loan fees and service charges which is directly attributable to First
State's credit card portfolio as discussed below.
Other loan fees and service charges were $9.1 million for 1997 compared to
$19.1 million for 1996. This decrease was the result of fees earned in 1996 by
First State's credit card portfolio which was sold prior to Sovereign's
acquisition of First State in February 1997. Excluding First State's credit card
portfolio, other loan fees and service charges for 1996 were $6.4 million. Other
loan fees and service charges result primarily from Sovereign's loan servicing
portfolio. At December 31, 1997, Sovereign serviced $7.99 billion of its own
loans and $1.67 billion of loans for others. This compares to $6.50 billion of
its own loans and $1.41 billion of loans for others at December 31, 1996.
Deposit fees were $16.5 million for 1997 compared to $15.3 million for
1996. This increase was primarily the result of an increase in the number of
transaction accounts in 1997 compared to 1996.
Mortgage banking gains were $6.4 million for 1997 compared to $1.6 million
for 1996. This increase was primarily due to gains of $5.3 million resulting
from the sale of loans and mortgage servicing rights in 1997 totaling $231.9
million.
Gains on sales of loans and investment and mortgage-backed securities
available-for-sale were $599,000 for 1997 compared to $5.5 million for 1996.
This decrease was primarily attributable to gains of $4.2 million related to the
liquidation of $156.5 million of available-for-sale and equity securities in
1996. These gains were realized as part of Sovereign's ongoing management of
risk in its available-for-sale portfolio and taking advantage of favorable
market conditions. During the third quarter of 1997, in conjunction with the
Bankers acquisition, Sovereign liquidated $750.5 million of investments
including some held-to-maturity securities. This sale was completed in
accordance with the provisions of SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" to maintain Sovereigns pre-merger
interest rate risk position. The $10.3 million (pre-tax) loss on the sale of
these investments is included as part of the one-time, merger-related charges
taken during 1997.
Miscellaneous income was $5.8 million for 1997 compared to $4.9 million for
1996. This increase was primarily due to increased inter-change income resulting
from growth in the number of Sovereign's debit cards and credit cards issued and
in use over the last year.
General and Administrative Expenses. Total general and administrative
expenses were $163.3 million for 1997 compared to $170.5 million for 1996. The
ratio of general and administrative expenses to average assets was 1.22% for
1997 compared to 1.47% for 1996.
Sovereign's efficiency ratio (all general and administrative expenses as a
percentage of net interest income and recurring non-interest income) for 1997
was 43.09% compared to 49.28% for 1996. The decrease in total general and
administrative expenses and the resulting favorable decrease in Sovereign's
expense ratios was the result of efficiences realized from recent acquisitions
and an increase in average balances and net interest income without a
corresponding increase in operating expenses.
Other Operating Expenses. Total other operating expenses were $48.8
million for 1997 compared to $51.0 million for 1996. Results for 1997
include $7.0 million of Trust Preferred Securities expense which was not
incurred in 1996 and one-time, merger-related charges of $29.3 million related
to Sovereign's 1997 acquisitions. Expenses included as part of the one-time,
merger-related charges were human resources related costs, losses on the sale of
certain assets and other expenses, including investment banker fees and legal
expenses. Results for 1996 include a non-recurring SAIF assessment of $33.8
million paid to the FDIC for the recapitalization of the SAIF. Also included in
other operating expenses was amortization of goodwill and other intangible
assets of $11.7 million for 1997 compared to $12.7 million for 1996 and net real
estate owned ("REO") losses of $814,000 for 1997 compared to $4.5 million for
1996.
Income Tax Provision. The income tax provision was $52.4 million for 1997
compared to $43.4 million for 1996. The effective tax rate for 1997 was 40.3%
compared to 38.2% for 1996. The increased effective tax rate for 1997 was
primarily attributable to certain non-deductible expenses incurred in
conjunction with Sovereign's 1997 acquisitions.
18
FINANCIAL CONDITION
Loan Portfolio. Sovereign's loan portfolio at December 31, 1997 was $9.92
billion compared to $8.32 billion at December 31, 1996. This increase is
primarily the result of Sovereign's 1997 acquisition of Fleet Auto which added
approximately $2.0 billion of commercial and consumer loans to Sovereign's loan
portfolio. During 1997, Sovereign closed approximately $1.24 billion of first
mortgage loans including approximately $918.9 million of variable rate mortgage
loans. This compares to first mortgage loan closings of $2.31 billion including
approximately $1.87 billion of variable rate mortgage loans during 1996. This
decrease is the result of record level residential first mortgage loan closings
in 1996 and lower interest rates in 1997 versus 1996 which weakened consumer
demand for variable rate loans.
Over the past two years, Sovereign has increased its emphasis on commercial
and consumer loan originations. As a result, during 1997, Sovereign closed
$139.5 million of commercial loans and $845.0 million of consumer loans. These
results compare to $165.4 million of commercial loans and $769.1 million of
consumer loans closed during 1996.
Sovereign's primary residential loan products are variable rate mortgage
loans on owner-occupied residential real estate. As a result, at December 31,
1997, 72% of Sovereign's total loan portfolio was secured by residential real
estate and 61% of the total loan portfolio was comprised of variable rate loans.
However, as a result of Sovereign's use of interest rate swaps for interest rate
risk management, at December 31, 1997, $389.0 million of variable rate mortgage
loans have been effectively converted to fixed rate mortgage loans. In addition,
$208.8 million of intermediate variable rate mortgage loans (loans with a
five-year fixed rate period) have effectively been converted to variable rate
over the fixed rate period.
At December 31, 1997, Sovereign's total loan portfolio included $6.14
billion of first mortgage loans secured primarily by liens on owner-occupied
one-to-four family residential properties. With its increased focus on
non-residential lending and the Fleet Auto acquisition, at December 31, 1997,
Sovereign's total loan portfolio also included $836.5 million of commercial
loans and $2.89 billion of consumer loans, including $838.8 million of
outstanding home equity loans (excluding $680.9 million of additional unused
commitments for home equity lines of credit) secured primarily by second
mortgages on owner-occupied one-to-four family residential properties.
19
Table 5 presents the composition of Sovereign's loan portfolio by type of
loan and by fixed and variable rates at the dates indicated (in thousands):
TABLE 5: COMPOSITION OF LOAN PORTFOLIO
AT DECEMBER 31,
-----------------------------------------------------------------------------------------
1997 1996 1995 1994
-------------------- -------------------- -------------------- --------------------
BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT
---------- ------ ---------- ------ ---------- ------ ---------- ------
Residential real
estate loans....... $6,142,559 61.90% $6,848,639 82.30% $5,494,154 85.00% $5,124,778 85.00%
Residential
construction
loans.............. 53,378 .54 83,736 1.00 45,365 .70 53,164 .88
---------- ------ ---------- ------ ---------- ------ ---------- ------
Total Residential
Loans............ 6,195,937 62.44 6,932,375 83.30 5,539,519 85.70 5,177,942 85.88
---------- ------ ---------- ------ ---------- ------ ---------- ------
Multi-family loans... 90,100 .91 87,417 1.05 116,962 1.81 135,520 2.25
Commercial real
estate loans....... 310,472 3.13 175,896 2.11 152,627 2.36 135,294 2.24
Commercial loans..... 156,211 1.57 126,086 1.52 51,500 .80 37,600 .62
Automotive floor plan
loans.............. 279,757 2.82 -- -- -- -- -- --
---------- ------ ---------- ------ ---------- ------ ---------- ------
Total Commercial
Loans............ 836,540 8.43 389,399 4.68 321,089 4.97 308,414 5.11
---------- ------ ---------- ------ ---------- ------ ---------- ------
Auto loans........... 1,544,431 15.56 64,033 .77 3,842 .06 3,928 .07
Home equity loans.... 838,755 8.45 634,194 7.62 528,319 8.17 485,479 8.05
Loans to automotive
lessors............ 267,033 2.69 -- -- -- -- -- --
Student loans........ 176,096 1.78 204,797 2.46 14,232 .22 13,107 .22
Credit cards......... 54,887 .55 82,798 1.00 32,274 .50 10,338 .17
Other................ 9,831 .10 14,175 .17 24,215 .38 30,360 .50
---------- ------ ---------- ------ ---------- ------ ---------- ------
Total Consumer
Loans............ 2,891,033 29.13 999,997 12.02 602,882 9.33 543,212 9.01
---------- ------ ---------- ------ ---------- ------ ---------- ------
Total Loans........ $9,923,510 100.00% $8,321,771 100.00% $6,463,490 100.00% $6,029,568 100.00%
---------- ------ ---------- ------ ---------- ------ ---------- ------
---------- ------ ---------- ------ ---------- ------ ---------- ------
Total Loans with:(1)
Fixed rates........ $3,822,936 38.52% $1,547,309 18.59% $1,379,466 21.34% $1,333,581 22.12%
Variable rates..... 6,100,574 61.48 6,774,462 81.41 5,084,024 78.66 4,695,987 77.88
---------- ------ ---------- ------ ---------- ------ ---------- ------
Total Loans...... $9,923,510 100.00% $8,321,771 100.00% $6,463,490 100.00% $6,029,568 100.00%
---------- ------ ---------- ------ ---------- ------ ---------- ------
---------- ------ ---------- ------ ---------- ------ ---------- ------
1993
--------------------
BALANCE PERCENT
---------- ------
Residential real
estate loans....... $3,692,437 83.95%
Residential
construction
loans.............. 25,868 .59
---------- ------
Total Residential
Loans............ 3,718,305 84.54
---------- ------
Multi-family loans... 156,901 3.57
Commercial real
estate loans....... 97,070 2.21
Commercial loans..... 30,004 .68
Automotive floor plan
loans.............. -- --
---------- ------
Total Commercial
Loans............ 283,975 6.46
---------- ------
Automotive loans..... 2,313 .05
Home equity loans.... 346,276 7.87
Loans to automotive
lessors............ -- --
Student loans........ 9,081 .21
Credit cards......... 11,289 .26
Other................ 26,886 .61
---------- ------
Total Consumer
Loans............ 395,845 9.00
---------- ------
Total Loans........ $4,398,125 100.00%
---------- ------
---------- ------
Total Loans with:(1)
Fixed rates........ $1,125,809 25.60%
Variable rates..... 3,272,316 74.40
---------- ------
Total Loans...... $4,398,125 100.00%
---------- ------
---------- ------
- ------------------
(1) Loan totals do not reflect the impact of off-balance sheet interest rate
swaps used for interest rate risk management as discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Loan Portfolio."
20
Table 6 sets forth the maturity of Sovereign's residential construction,
commercial real estate and commercial loans as scheduled to mature contractually
at December 31, 1997 (in thousands):
TABLE 6: LOAN MATURITY SCHEDULE
AT DECEMBER 31, 1997, MATURING
----------------------------------------------------
IN ONE YEAR AFTER ONE YEAR AFTER
OR LESS --FIVE YEARS FIVE YEARS TOTAL
----------- -------------- ---------- --------
Residential construction loans (net of loans in
process of $34,695)(1)............................. $ 8,229 $ 882 $ 44,267 $ 53,378
Commercial real estate loans......................... 47,135 109,848 153,489 310,472
Commercial loans..................................... 72,515 45,677 38,019 156,211
-------- -------- -------- --------
Total.......................................... $127,879 $156,407 $235,775 $520,061
-------- -------- -------- --------
-------- -------- -------- --------
Loans with:
Fixed rates........................................ $ 54,054 $112,630 $109,978 $276,662
Variable rates..................................... 73,825 43,777 125,797 243,399
-------- -------- -------- --------
Total.......................................... $127,879 $156,407 $235,775 $520,061
-------- -------- -------- --------
-------- -------- -------- --------
- ------------------
(1) Loans classified as residential construction loans convert to residential
mortgage loans after a one-year period. The residential construction loans
are closed as either fifteen-year or thirty-year terms added to the one-year
construction loan period. Accordingly, the majority of these loan balances
are anticipated to mature beyond five years.
Credit Quality. Since Sovereign's primary loan products are residential
loans, Sovereign has instituted various controls specifically designed to
improve the credit quality of residential loans. For instance, Sovereign
utilizes underwriting standards which comply with those of the Federal Home Loan
Mortgage Corporation ("FHLMC") or the Federal National Mortgage Association
("FNMA"). Sovereign maintains an independent Loan Review Department which each
month reviews a statistical sampling of all new originations for sound
underwriting practices and reviews and rates all mortgage loan requests which
exceed certain specified guidelines. Results of these loan reviews are discussed
at quarterly Loan Review meetings. Criticized loans and deficiencies in those
loans are discussed. Guidelines are modified to prevent future deficiencies.
Sovereign also closely monitors delinquencies as a means of maintaining
high asset quality. Collection efforts begin as early as one day after a
consumer loan payment is missed. A predictive dialer is used to assist
collection efforts in the early stages of delinquency on the entire retail
portfolio. An attempt is made to contact all borrowers and to offer a variety of
loss mitigation alternatives. If these attempts fail, Sovereign will proceed to
gain control of any and all collateral in a timely manner in order to minimize
losses. While liquidation and recovery efforts continue, officers continue to
work with the borrowers, if appropriate, to recover all monies owed to
Sovereign. Legal counsel is retained when necessary. Sovereign monitors
delinquency trends at 30, 60, and 90 days past due. These trends are discussed
at the quarterly Loan Review and monthly Asset Review meetings. Minutes from
these meetings are submitted to the Boards of Directors of Sovereign Bank.
The acquisition of Fleet Auto added approximately $2.0 billion of indirect
auto loans, automotive floor plan loans and loans to automotive lessors to
Sovereign's loan portfolio. This transaction enhances Sovereign's transition to
becoming a Super Community Bank by increasing consumer and commercial loans to
about 38% of total loans. The commercial loan portfolio for Fleet Auto has
experienced no significant delinquency during the past twelve months.
Historically, this division has originated only prime quality loans; however, in
keeping with Sovereign's conservative approach to high asset quality, a reserve
of 1.00% will be maintained against this portfolio.
21
At December 31, 1997, Sovereign's non-performing assets were $89.6 million
compared to $100.1 million at December 31, 1996. Non-performing assets as a
percentage of total assets were .63% at December 31, 1997 compared to .80% at
December 31, 1996. This decrease is primarily attributable to the sale of $21.0
million of certain problem commercial loans and non-performing assets during the
first quarter of 1997 which were acquired from First State. At December 31,
1997, 76% of non-performing assets consisted of loans or REO related to real
estate. The remainder of Sovereign's non-performing assets consist principally
of consumer and commercial loans; most of which are attributable to Sovereign's
1997 acquisition activity. Non-performing assets at December 31, 1997, included
$8.9 million of REO which is carried at lower of cost or estimated fair value
less estimated costs to sell. Sovereign places all loans 90 days or more
delinquent (except auto loans and loans guaranteed by the government or secured
by deposit accounts) on non-performing status. Sovereign's auto loans continue
to accrue interest until they are 120 days delinquent, at which time they are
placed on non-accrual status.
Table 7 presents the composition of non-performing assets at the dates
indicated (in thousands):
TABLE 7: NON-PERFORMING ASSETS
AT DECEMBER 31,
----------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
Non-accrual loans:
Past due 90 days or more as to interest or
principal:
Real estate related............................ $ 58,577 $ 70,359 $ 69,476 $ 64,215 $ 68,229
Other.......................................... 21,284 12,080 8,466 5,905 5,565
Past due less than 90 days as to interest or
principal:
Real estate related............................ 555 639 3,884 2,980 1,056
Other.......................................... -- 160 739 -- --
-------- -------- -------- -------- --------
Total non-accrual loans............................ 80,416 83,238 82,565 73,100 74,850
Restructured loans................................. 327 1,561 3,772 4,264 4,244
-------- -------- -------- -------- --------
Total non-performing loans......................... 80,743 84,799 86,337 77,364 79,094
Real estate owned:
Real estate related.............................. 8,834 11,636 9,256 11,380 12,356
Other............................................ 44 3,660 9,878 12,526 21,589
-------- -------- -------- -------- --------
Total real estate owned............................ 8,878 15,296 19,134 23,906 33,945
-------- -------- -------- -------- --------
Total non-performing assets........................ $ 89,621 $100,095 $105,471 $101,270 $113,039
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Past due 90 days or more as to interest or
principal and accruing interest(1)............... $ 6,672 $ 15,883 $ 2,001 $ 2,129 $ 4,192
Non-performing assets as a percentage of total
assets........................................... .63% .80% .99% 1.14% 1.62%
Non-performing loans as a percentage of total
loans............................................ .81 1.01 1.31 1.28 1.78
Non-performing assets as a percentage of total
loans and real estate owned...................... .97 1.39 1.62 1.71 2.61
Allowance for possible loan losses as a percentage
of total non-performing assets................... 97.10 49.08 45.85 48.13 42.05
Allowance for possible loan losses as a percentage
of total non-performing loans.................... 107.78 57.94 56.01 63.00 60.09
- ------------------
(1) Non-performing assets past due 90 days or more as to interest or principal
and accruing interest at December 1997 and 1996 included $6.7 million and
$10.5 million, respectively, of student loans which are government-
guaranteed and Sovereign retains minimal risk of credit losses related to
these loans.
22
Potential problem loans (consisting of loans which management has serious
doubts as to the ability of such borrowers to comply with present repayment
terms, although not currently classified as non-performing loans) were comprised
of 34 loans which amounted to $6.5 million at December 31, 1997 and consisted
principally of commercial real estate loans.
At December 31, 1997, Sovereign serviced, with recourse, a total of $48.9
million of single-family residential loans. Substantially all of this recourse
servicing was acquired in a 1992 acquisition. These are seasoned loans and
historical loss experience has been minimal.
The adequacy of Sovereign's allowance for possible loan losses is
constantly evaluated. Management's evaluation of the adequacy of the allowance
to absorb potential future loan losses takes into consideration the risks
inherent in the loan portfolio, past loan loss experience, specific loans which
have loss potential, geographic and industry concentrations, delinquency trends,
economic conditions, the level of originations and other relevant factors. At
December 31, 1997, Sovereign's loan delinquencies (all loans greater than 30
days delinquent) as a percentage of total loans was 2.72% compared to 1.83% at
December 31, 1996. This increase is primarily attributable to loans acquired
from Fleet Auto, Sovereign's student loan portfolio, and the delinquencies
associated with these portfolios. Sovereign's loan delinquencies as a percentage
of total loans, excluding delinquencies related to the loans acquired from Fleet
Auto and Sovereign's student loan portfolio, was 1.81%, down slightly from 1996.
Sovereign's student loans are government-guaranteed and Sovereign retains
minimal risk of credit losses related to these loans.
These factors indicated to management that a higher provision for possible
loan losses was necessary to maintain the allowance for possible loan losses at
a level which management conservatively estimates is necessary to absorb
potential future losses in consideration of the factors noted above. As a
result, Sovereign's 1997 loan loss provision was $37.2 million compared to $15.4
million in 1996.
Investment and Mortgage-backed Securities. Sovereign's investment
portfolio is concentrated in mortgage-backed securities and collateralized
mortgage obligations issued by federal agencies or private label issues. The
private label issues have ratings of "AAA" by Standard and Poor's and Fitch at
the date of issuance. The classes are backed by single-family residential loans
which are primary residences geographically dispersed throughout the United
States. Sovereign purchases classes which are senior positions backed by
subordinate classes. The subordinate classes absorb the losses and must be
completely eliminated before any losses flow through the senior positions.
Sovereign's strategy is to purchase classes which have an average life of three
years or less. At December 31, 1997, Sovereign had no securities classified as
high risk as defined by the FFIEC Policy Statement on securities activities. The
effective duration of the total investment portfolio at December 31, 1997 was
1.3 years.
Investment and Mortgage-backed Securities Available-for-Sale. Securities
expected to be held for an indefinite period of time are classified as
available-for-sale and are carried at fair value, with unrealized gains and
losses reported as a separate component of stockholders' equity, net of
estimated income taxes. Decisions to purchase or sell these securities are based
on economic conditions including changes in interest rates, liquidity, and
asset/liability management strategies. For additional information with respect
to the amortized cost and estimated fair value of Sovereign's investment and
mortgage-backed securities available-for-sale, see Note 4 at Item 8 "Financial
Statements and Supplementary Data" hereof.
The maturities of mortgage-backed securities available-for-sale are based
upon contractually scheduled repayments. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or repay
obligations with or without call or prepayment penalties. Yields on tax-exempt
securities were computed on a tax equivalent basis using Sovereign's effective
tax rate of 38%.
23
Table 8 sets forth the amortized cost, expected maturities and yields of
Sovereign's investment and mortgage-backed securities available-for-sale at
December 31, 1997 (in thousands):
TABLE 8: INVESTMENT AND MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE
MATURITY SCHEDULE
AT DECEMBER 31, 1997, DUE
------------------------------------------------------------------------
NO
IN ONE YEAR ONE YEAR FIVE YEARS STATED MATURITY
OR LESS --FIVE YEARS --TEN YEARS OR RATE TOTAL
----------- ------------ ------------ --------------- ----------
Investment Securities:
Equity securities............... $ -- $ -- $ -- $590,040 $ 590,040
-- -- -- 4.80% 4.80%
Mortgage-backed Securities:
FHLMC........................... -- -- 89,975 -- 89,975
-- -- 6.29% -- 6.29%
FNMA............................ -- -- 52,914 -- 52,914
-- -- 5.41% -- 5.41%
GNMA............................ -- -- 60,702 -- 60,702
-- -- 5.66% -- 5.66%
Collateralized mortgage
obligations................... 29,603 144,407 44,103 -- 218,113
6.67% 6.53% 6.96% -- 6.64%
------- -------- -------- -------- ----------
Total investment and
mortgage-backed
securities
available-for-sale....... $29,603 $144,407 $247,694 $590,040 $1,011,744
------- -------- -------- -------- ----------
------- -------- -------- -------- ----------
6.67% 6.53% 6.07% 4.80% 5.41%
------- -------- -------- -------- ----------
------- -------- -------- -------- ----------
Investment and Mortgage-backed Securities Held-to-Maturity. Securities
that Sovereign has the intent and ability to hold to maturity are classified as
held-to-maturity and reported at amortized cost. This portfolio is primarily
comprised of U.S. Treasury and government agency securities; corporate debt
securities; mortgage-backed securities issued by FHLMC, FNMA, the Government
National Mortgage Association ("GNMA"), the RTC and private issuers; and
collateralized mortgage obligations. For additional information with respect to
the amortized cost and estimated fair value of Sovereign's investment and
mortgage-backed securities held-to-maturity, see Note 4 at Item 8 "Financial
Statements and Supplementary Data" hereof.
The maturities of the mortgage-backed securities held-to-maturity are based
upon contractually scheduled repayments. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or repay
obligations with or without call or prepayment penalties. Yields on tax-exempt
securities were computed on a tax equivalent basis using Sovereign's effective
tax rate of 38%.
24
Table 9 sets forth the expected maturity and yields of Sovereign's
investment and mortgage-backed securities held-to-maturity at December 31, 1997
(in thousands):
TABLE 9: INVESTMENT AND MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY
MATURITY SCHEDULE
AT DECEMBER 31, 1997, DUE
------------------------------------------------------------------
IN ONE YEAR ONE YEAR FIVE YEARS AFTER
OR LESS --FIVE YEARS --TEN YEARS TEN YEARS TOTAL
----------- ------------- ----------- --------- ----------
Investment Securities:
U.S. Treasury and government agency
securities......................... $ 1,749 $ 9,378 $ -- $ 1,000 $ 12,127
5.07% 6.21% -- 7.04% 6.11%
Corporate securities................. 50 1,000 -- -- 1,050
6.80% 8.20% -- -- 8.13%
Other securities..................... 217 50 2,940 66,575 69,782
3.32% 3.20% 6.65% 9.73% 9.58%
Mortgage-backed Securities:
FHLMC................................ 1,560 32,561 210,455 985 245,561
6.76% 8.07% 7.47% 8.51% 7.55%
FNMA................................. 9,887 21,023 61,913 23,655 116,478
7.35% 7.01% 7.42% 7.67% 7.39%
GNMA................................. -- 2,960 258,905 124,406 386,271
-- 7.52% 6.93% 6.94% 6.94%
RTC.................................. -- -- -- 411 411
-- -- -- 7.26% 7.26%
Private issues....................... -- 64,379 36,026 4,901 105,306
-- 7.04% 7.18% 7.21% 7.10%
Collateralized mortgage
obligations........................ 3,478 887,843 709,235 334,273 1,934,829
10.04% 7.25% 7.36% 7.24% 7.29%
------- ---------- ---------- -------- ----------
Total investment and
mortgage-backed securities
held-to-maturity................. $16,941 $1,019,194 $1,279,474 $556,206 $2,871,815
------- ---------- ---------- -------- ----------
------- ---------- ---------- -------- ----------
7.56% 7.25% 7.29% 7.49% 7.32%
------- ---------- ---------- -------- ----------
------- ---------- ---------- -------- ----------
25
Table 10 presents the securities of single issuers (other than obligations
of the United States and its political subdivisions, agencies and corporations)
having an aggregate book value in excess of 10% of Sovereign's shareholders'
equity which were held by Sovereign at December 31, 1997 (in thousands):
TABLE 10: INVESTMENT AND MORTGAGE-BACKED SECURITIES
AT DECEMBER 31, 1997
---------------------------
ISSUER CARRYING VALUE FAIR VALUE
------ -------------- ----------
G.E. Capital Mortgage Servicing, Inc........................ $282,891 $282,156
PHH Mortgage Servicing Corp................................. 346,773 348,045
Prudential Home Mortgage Securities, Inc.................... 140,338 140,528
Residential Funding Mortgage Securities, Inc................ 220,511 221,074
-------- --------
Total..................................................... $990,513 $991,803
-------- --------
-------- --------
Other Assets. Premises and equipment at December 31, 1997 was $67.2
million compared to $74.6 million at December 31, 1996. This decrease is
primarily attributable to depreciation and the 1997 disposition of First State's
corporate headquarters building and other fixed assets without a corresponding
increase in purchases.
Goodwill and intangible assets at December 31, 1997 were $115.9 million
compared to $116.9 million at December 31, 1996. This nominal decrease is due to
the planned amortization of these assets, offset by additional goodwill created
through the Fleet Auto acquisition in 1997.
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 December 31, 1997 were $7.89 billion compared to $7.24
billion at December 31, 1996.
Table 11 presents the composition of Sovereign's deposits at the dates
indicated (in thousands):
TABLE 11: DEPOSIT PORTFOLIO COMPOSITION
AT DECEMBER 31,
---------------------------------------------------------------------
1997 1996 1995
--------------------- --------------------- ---------------------
% OF % OF % OF
ACCOUNT TYPE BALANCE DEPOSITS BALANCE DEPOSITS BALANCE DEPOSITS
- ---------------------------------------- ---------- ------ ---------- ------ ---------- ------
Demand deposit and NOW accounts......... $ 952,504 12.07% $ 874,379 12.08% $ 746,232 10.31%
Savings accounts........................ 1,683,670 21.34 1,677,814 23.19 1,585,856 21.91
Money market accounts................... 698,405 8.85 661,987 9.15 774,165 10.70
Retail certificates of deposit.......... 4,073,578 51.63 3,795,733 52.46 3,889,066 53.73
---------- ------ ---------- ------ ---------- ------
Total retail deposits................. 7,408,157 93.89 7,009,913 96.88 6,995,319 96.65
Jumbo certificates of deposit........... 481,764 6.11 225,482 3.12 242,404 3.35
---------- ------ ---------- ------ ---------- ------
Total deposits........................ $7,889,921 100.00% $7,235,395 100.00% $7,237,723 100.00%
---------- ------ ---------- ------ ---------- ------
---------- ------ ---------- ------ ---------- ------
Borrowings. Sovereign utilizes borrowings as a source of funds for its
asset growth and its asset/liability management. Collateralized advances are
available from the Federal Home Loan Bank of Pittsburgh ("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 December 31, 1997 were $5.49 billion of which $4.63
billion were short-term compared to total borrowings of $4.48 billion of which
$3.38 billion were short-term at December 31, 1996.
26
Table 12 presents information regarding borrowings at the dates indicated
(in thousands):
TABLE 12: BORROWINGS
AT DECEMBER 31,
---------------------------------------------------------------------------------
1997 1996 1995
------------------------- ------------------------- -------------------------
WEIGHTED WEIGHTED WEIGHTED
BALANCE AVERAGE RATE BALANCE AVERAGE RATE BALANCE AVERAGE RATE
---------- ------------ ------- ------------ ------- ------------
Securities sold under
repurchase agreements.... $ 430,057 5.91% $ 603,090 5.65% $ 431,024 6.32%
FHLB advances.............. 4,873,347 5.94 3,694,446 5.85 2,002,656 5.76
Other borrowings........... 188,151 5.88 178,748 7.45 187,326 7.34
---------- ---- ---------- ---- ---------- ----
Total borrowings......... $5,491,555 5.94% $4,476,284 5.89% $2,621,006 5.97%
---------- ---- ---------- ---- ---------- ----
---------- ---- ---------- ---- ---------- ----
Through the use of interest rate swaps, $2.10 billion of the FHLB advances
at December 31, 1997 have been effectively converted from variable rate
obligations to fixed rate obligations.
At December 31, 1997, other borrowings included $28.5 million of
subordinated debentures which have, through the use of an interest rate swap,
been converted from a fixed rate obligation to a variable rate obligation.
In addition, $1.20 billion of borrowings have been protected from upward
repricing through the use of interest rate caps, floor and/or corridors.
Effective during the first quarter of 1998, $650.0 million of short-term,
variable rate borrowings will be converted to longer-term, fixed rate borrowings
through the use of forward swaps.
Stockholders' Equity. Total stockholders' equity at December 31, 1997 was
$778.2 million compared to $701.4 million at December 31, 1996. The increase in
stockholders' equity was primarily attributable to the retention of earnings of
$77.6 million in 1997.
27
LIQUIDITY AND CAPITAL RESOURCES
Sovereign Bank is 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 Bank
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
OTS to reflect economic conditions. Sovereign Bank's liquidity ratio for
December 1997 was 29.4%.
Sovereign's primary financing sources are deposits obtained in its own
market area and borrowings in the form of securities sold under repurchase
agreements and advances from the FHLB. While the majority of Sovereign's
certificate of deposit accounts are expected to mature within a one year period,
historically, the retention rate has been approximately 70%. If a significant
portion of maturing certificates would not renew at maturity, the impact on
Sovereign's operations and liquidity would be minimal due to cash flows produced
by Sovereign's investment portfolio which approximate $90 million per month. At
December 31, 1997, Sovereign had $3.21 billion in unpledged investment and
mortgage-backed securities which could be used to collateralize additional
borrowings. Sovereign Bank can also borrow from the FHLB, subject to required
collateralization. Other sources of funds include operating activities,
repayments of principal on investment and mortgage-backed securities, repayment
of principal on loans and other investing activities.
Cash and cash equivalents increased $68.2 million for 1997. Net cash
provided by operating activities was $67.2 million for 1997. Net cash used by
investing activities for 1997 was $1.75 billion consisting primarily of
purchases of mortgage-backed securities and loans, partially offset by proceeds
from repayments and maturities of investment and mortgage-backed securities
held-to-maturity. Net cash used for purchases of loans was $2.76 billion for
1997 compared to $1.40 billion for 1996. This increase is primarily attributable
to the acquisition of Fleet Auto and increased purchases of residential mortgage
loans through the secondary market. Net cash provided by financing activities
for 1997 was $1.75 billion which includes an increase in deposits of $655.7
million, an increase in short-term borrowings of $426.8 million and an increase
in proceeds from long-term borrowings of $584.2 million.
At December 31, 1997, Sovereign Bank was classified as well-capitalized and
was in compliance with all capital requirements. For a detailed discussion on
regulatory capital requirements, see Part I, Item 1 "Business -- Supervision and
Regulation -- Regulatory Capital Requirements" and Note 11 at Item 8 "Financial
Statements and Supplementary Data" hereof.
The following table sets forth the capital ratios of Sovereign Bancorp and
Sovereign Bank and the current regulatory requirements at December 31, 1997:
WELL
SOVEREIGN SOVEREIGN MINIMUM CAPITALIZED
BANCORP(1) BANK REQUIREMENT REQUIREMENT
---------- --------- ----------- -----------
Tangible capital to tangible
assets.......................... 4.60% 5.61% 1.50% None
Leverage (core) capital to
tangible
assets.......................... 5.24 5.55 3.00 5.00%
Leverage (core) capital to
risk-adjusted
assets.......................... 9.26 9.94 4.00 6.00
Risk-based capital to
risk-adjusted
assets.......................... 12.15 11.01 8.00 10.00
- ------------------
(1) OTS capital regulations do not apply to holding companies. These ratios are
computed as if those regulations did apply to Sovereign Bancorp.
28
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 these factors on the estimated level of
net interest income.
There are a number of industry standards used to measure an institution's
interest rate risk position. Most common among these is the one year gap which
is the ratio representing the difference between assets, liabilities and
off-balance sheet positions which will mature or reprice within one year
expressed as a percentage of total assets. Using management's estimates of asset
prepayments, core deposit decay and core deposit repricing in its computation,
Sovereign estimates that its cumulative one year gap position was a positive
5.80% at December 31, 1997.
Sovereign also utilizes income simulation modeling in measuring its
interest rate risk and managing its interest rate sensitivity. Income simulation
considers not only the impact of changing market interest rates on forecasted
net interest income, but also other factors such as yield curve relationships,
the volume and mix of assets and liabilities, customer preferences and general
market conditions.
Sovereign manages the one year interest rate gap within a range of +/-10%.
A positive gap position implies that the bank is asset sensitive which could
cause net interest income to decrease if interest rates fall. Conversely, a
negative gap position implies that the bank is liability sensitive which could
cause net interest income to decrease if interest rates rise. Sovereign manages
the impact to net interest income in a +200 basis point instantaneous parallel
rate shock environment to be within a 10% loss. At December 31, 1997, Sovereign
estimates that if interest rates rise by 200 basis points, net interest income
would increase by $17.2 million or 4.33%.
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.
Amortizing and non-amortizing interest rate swaps are generally used to
convert fixed rate assets and liabilities to variable rate assets and
liabilities and vice versa. Sovereign utilizes amortizing interest rate swaps to
convert discounted adjustable rate loans to fixed rates for a period of time.
The amortization of the notional amount of the interest rate swaps are tied to
the level of an index such as the One Year Treasury Constant Maturity, LIBOR, or
a prepayment rate of a pool of mortgage-backed securities. In order for interest
rate swaps to achieve the desired objective, Sovereign selects interest rate
swaps that will have a high degree of correlation to the related financial
instrument. Sovereign utilizes non-amortizing interest rate swaps to convert
fixed rate liabilities to floating, and floating rate liabilities to fixed, to
reduce Sovereign's overall cost of funds.
Interest rate caps are generally used to limit the exposure from the
repricing and maturity of liabilities and interest rate floors are generally
used to limit the exposure from the 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 against changing
interest rates while limiting the cost of that protection.
Due to competitive conditions, Sovereign originates fixed rate residential
mortgages. It sells the majority of these loans to FHLMC, FNMA and private
investors. The loans are exchanged for cash or marketable fixed rate
mortgage-backed securities which are generally sold. This helps insulate
Sovereign from the interest rate risk associated with these fixed rate assets.
Sovereign uses forward sales, cash sales and options on mortgage-backed
securities as a means of hedging loans in the mortgage pipeline which are
originated for sale.
29
Sovereign's primary funding source is deposits obtained in its own
marketplace. Deposit programs at Sovereign are priced to meet management's
asset/liability objectives, while taking into account the rates available on
investment opportunities and also considering the cost of alternative funding
sources. Borrowings are 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.
Table 13 presents the amounts of interest-earning assets and
interest-bearing liabilities that are assumed to mature or reprice during the
periods indicated at December 31, 1997, and their related average yields and
costs. Adjustable and floating rate loans and securities are included in the
period in which interest rates are next scheduled to adjust rather than the
period in which they mature (in thousands):
TABLE 13: GAP ANALYSIS
AT DECEMBER 31, 1997, REPRICING
-----------------------------------------------------------
0-3 4 MONTHS YEAR 2
MONTHS -1 YEAR & OVER TOTAL
----------- ----------- ----------- -----------
Interest-earning assets:
Investment and mortgage-backed securities(1)(2)........... $ 1,184,034 $ 1,368,356 $ 1,361,560 $ 3,913,950
6.60% 7.51% 7.38% 7.19%
Loans(3).................................................. 2,025,016 3,056,088 4,774,351 9,855,455
8.42% 7.86% 7.93% 8.01%
----------- ----------- ----------- -----------
Total interest-earning assets............................... 3,209,050 4,424,444 6,135,911 13,769,405
7.75% 7.75% 7.81% 7.78%
Non-interest-earning assets................................. -- -- 566,878 566,878
----------- ----------- ----------- -----------
Total assets................................................ $ 3,209,050 $ 4,424,444 $ 6,702,789 $14,336,283
7.75% 7.75% 7.15% 7.47%
----------- ----------- ----------- -----------
Interest-bearing liabilities:
Deposits(4)............................................... $ 2,312,824 $ 2,560,949 $ 3,016,148 $ 7,889,921
5.09% 5.37% 2.86% 4.33%
Borrowings................................................ 3,356,284 1,242,291 892,980 5,491,555
5.85% 6.08% 6.10% 5.94%
----------- ----------- ----------- -----------
Total interest-bearing liabilities.......................... 5,669,108 3,803,240 3,909,128 13,381,476
5.54% 5.60% 3.60% 4.99%
Non-interest-bearing liabilities............................ -- -- 176,560 176,560
Stockholders' equity........................................ -- -- 778,247 778,247
----------- ----------- ----------- -----------
Total liabilities and stockholders' equity.................. $ 5,669,108 $ 3,803,240 $ 4,863,935 $14,336,283
5.54% 5.60% 2.89% 4.66%
----------- ----------- ----------- -----------
Excess assets (liabilities) before effect of off-balance
sheet positions........................................... $(2,460,058) $ 621,204 $ 1,838,854
----------- ----------- -----------
To total assets........................................... (17.16)% 4.33% 12.83% 2.81%
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Cumulative excess assets (liabilities) before effect of
off-balance sheet positions............................... $(2,460,058) $(1,838,854) $ --
----------- ----------- -----------
----------- ----------- -----------
To total assets......................................... (17.16)% (12.83)%
Effect of off-balance sheet positions on assets and
liabilities............................................... $ 1,788,831 $ 881,763 $(2,670,594)
----------- ----------- -----------
Excess assets (liabilities) after effect of off-balance
sheet positions........................................... $ (671,227) $ 1,502,967 $ (831,740)
----------- ----------- -----------
----------- ----------- -----------
To total assets......................................... (4.68)% 10.48% (5.80)%
Cumulative excess assets (liabilities) after off-balance
sheet positions........................................... $ (671,227) $ 831,740 $ --
----------- ----------- -----------
----------- ----------- -----------
To total assets......................................... (4.68)% 5.80%
- ------------------
(1) Includes interest-earning deposits.
(2) Mortgage-backed securities include market rate prepayment and repayment
assumptions. Balances on these securities are presented net of deferred loan
fees.
(3) Loan balances include annual prepayment and repayment assumptions between 6%
and 45% initially with gradual slowing thereafter. Loan balances are
presented net of deferred loan fees and include loans held for sale and the
allowance for loan losses.
(4) Savings, NOW, money market and demand deposit accounts have been assumed to
decay at an annual rate of 8%.
30
Table 14 presents selected quarterly consolidated financial data (in
thousands, except per share data):
TABLE 14: SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA
THREE MONTHS ENDED
---------------------------------------------------------------------------------------
DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
1997 1997 1997 1997 1996 1996 1996 1996
-------- --------- -------- -------- -------- --------- -------- --------
Total interest income.......... $266,143 $244,371 $231,559 $218,655 $219,746 $213,979 $198,690 $186,179
Total interest expense......... 170,751 159,278 149,903 139,947 141,457 136,167 122,517 114,332
-------- -------- -------- -------- -------- -------- -------- --------
Net interest income............ 95,392 85,093 81,656 78,708 78,289 77,812 76,173 71,847
Provision for possible loan
losses....................... 6,000 19,199 2,150 9,850 5,200 5,800 2,666 1,700
-------- -------- -------- -------- -------- -------- -------- --------
Net interest income after
provision.................... 89,392 65,894 79,506 68,858 73,089 72,012 73,507 70,147
Other income................... 11,150 9,203 10,076 8,051 15,214 12,374 9,861 8,855
Other expenses................. 52,050 45,707 43,567 41,532 50,150 49,586 46,267 41,728
One-time, merger-related
charges(1)................... -- 21,303 -- 7,955 -- -- -- --
Non-recurring SAIF
assessment(2)................ -- -- -- -- 3,096 30,657 -- --
-------- -------- -------- -------- -------- -------- -------- --------
Income before income taxes..... 48,492 8,087 46,015 27,422 35,057 4,143 37,101 37,274
Income tax provision........... 18,427 5,547 17,300 11,102 13,793 1,902 13,860 13,881
-------- -------- -------- -------- -------- -------- -------- --------
Net income..................... $ 30,065 $ 2,540 $ 28,715 $ 16,320 $ 21,264 $ 2,241 $ 23,241 $ 23,393
-------- -------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- -------- --------
Net income before one-time,
merger-related charges and
non-recurring SAIF
assessment................... $ 30,065 $ 28,571 $ 28,715 $ 27,020 $ 23,018 $ 21,333 $ 23,241 $ 23,393
-------- -------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) applicable to
common stock................. $ 28,506 $ 979 $ 27,153 $ 14,758 $ 19,701 $ 679 $ 21,679 $ 21,830
-------- -------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- -------- --------
Basic earnings per
share(3)(4).................. $ .27 $ .00 $ .26 $ .14 $ .19 $ .00 $ .21 $ .21
Diluted earnings per
share(3)(4).................. .24 .02 .24 .13 .18 .02 .19 .19
Market prices(3)
High......................... 18 14 9/16 12 11/16 11 11/16 9 7/16 7 5/8 7 13/16 7 3/4
Low.......................... 14 5/16 12 1/4 9 1/2 9 1/8 7 9/16 6 11/16 6 15/16 6 7/16
Dividends per common
share(3)(5).................. .017 .011 .032 .032 .031 .031 .031 .029
- ------------------
(1) Reflects one-time, merger charges of $38.3 million ($25.9 million
after-tax) related to the acquisition of Bankers during the three-month
period ended September 30, 1997 of which $17.0 million (pre-tax) is
classified as provision for possible loan losses. Reflects one-time, merger
charges of $15.9 million ($10.7 million after-tax) related to the
acquisition of First State during the three-month period ended March 31,
1997 of which $7.9 million (pre-tax) is classified as provision for
possible loan losses.
(2) Reflects a non-recurring SAIF assessment of $20.9 million (after-tax) paid
to the FDIC for the recapitalization of the SAIF.
(3) All per share data have been adjusted to reflect all stock dividends and
stock splits declared through January 1998.
(4) Results for the three-month periods ended September 30, 1997 and March 31,
1997 include one-time, merger-related charges described in Note 1 above.
Excluding the one-time, merger-related charges, basic earnings per share for
the three-month periods ended September 30, 1997 and March 31, 1997 were
$.25 and $.24, respectively and diluted earnings per share for the same
periods were $.23 and $.22, respectively. Results for the three-month
periods ended December 31, 1996 and September 30, 1996 include the non-
recurring SAIF assessment described in Note 2 above. Excluding the
non-recurring SAIF assessment, basic earnings per share for the three-month
periods ended December 31, 1996 and September 30, 1996 were $.20 and $.19,
respectively and diluted earnings per share for the same periods were $.19
and $.18, respectively.
(5) The higher dividend rate in prior periods is the result of acquisitions
which were accounted for as a pooling-of-interests.
31
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
Net Income. Net operating income for the year ended December 31, 1996 was
$91.0 million. This represents an increase of 13% over net operating income of
$80.4 million reported for 1995. Operating earnings per share was $.75 for
1996, which represents an increase of 9% over 1995 operating earnings per share
of $.69. Return on average equity and return on average assets were 13.36% and
.78%, respectively, for 1996 compared to 13.53% and .84%, respectively, for
1995. Return on average risk-adjusted assets was 1.60% for 1996 compared to
1.72% for 1995. The amounts presented exclude a non-recurring SAIF assessment
of $20.9 million (after-tax) paid to the FDIC during 1996 for the
recapitalization of the SAIF.
Reported net income for the year ended December 31, 1996, including the
impact of the non-recurring SAIF assessment, was $70.1 million or $.58 per
share.
Net Interest Income. Net interest income for 1996 was $304.1 million
compared to $252.3 million for 1995. This represents an increase of 21% and is
primarily due to an increase in average balances resulting from internal growth.
Interest on interest-earning deposits was $3.4 million for 1996 compared to
$4.0 million for 1995. The average balance of interest-earning deposits was
$16.3 million with an average yield of 20.89% for 1996 compared to an average
balance of $25.7 million with an average yield of 15.57% for 1995. The high
yields in 1996 and 1995 were the result of a contractual arrangement whereby a
third-party vendor performed check processing and reconcilement functions for
Sovereign's disbursement accounts. Under the agreement, the vendor is required
to pay Sovereign interest on disbursed funds during the two to three day float
period, effectively producing interest income with no corresponding asset
balance. This agreement will continue to favorably impact the yield on
Sovereign's interest-bearing deposits in future years.
Interest on investment and mortgage-backed securities available-for-sale
was $36.4 million for 1996 compared to $10.6 million for 1995. The average
balance of investment and mortgage-backed securities available-for-sale was
$552.3 million with an average yield of 6.89% for 1996 compared to an average
balance of $156.2 million with an average yield of 7.04% for 1995. The increase
in average balance was the result of the reclassification of $773.0 million of
securities from held-to-maturity to available-for-sale in December 1995.
Interest on investment and mortgage-backed securities held-to-maturity was
$213.6 million for 1996 compared to $187.4 million for 1995. The average balance
of investment and mortgage-backed securities held-to-maturity was $3.02 billion
with an average yield of 7.08% for 1996 compared to an average balance of $2.72
billion with an average yield of 6.89% for 1995.
Interest and fees on loans were $565.1 million for 1996 compared to $464.6
million for 1995. The average balance of loans was $7.52 billion with an average
yield of 7.52% for 1996 compared to an average balance of $6.25 billion with an
average yield of 7.43% for 1995. The increases in average balance and interest
were primarily due to the origination of $2.31 billion of residential mortgage
loans of which $1.88 billion (principally discounted adjustable rate loans) were
retained in Sovereign's loan portfolio. The increase in average yield was the
result of the upward repricing of discounted adjustable rate loans which
Sovereign originated in 1995 and the greater emphasis placed on higher yielding
commercial and consumer loans in 1996 than in 1995.
Interest on total deposits was $297.8 million for 1996 compared to $300.8
million for 1995. The average balance of total deposits was $7.12 billion with
an average cost of 4.18% for 1996 compared to an average balance of $6.98
billion with an average cost of 4.31% for 1995. Despite a general rise in
interest rates, the average cost of deposits decreased due to increased average
balances of lower interest rate deposit products.
Interest on total borrowings was $216.7 million for 1996 compared to $113.6
million for 1995. The average balance of total borrowings was $3.66 billion with
an average cost of 5.92% for 1996 compared to an average balance of $1.92
billion with an average cost of 5.93% for 1995. The increase in average balance
was the result of balance sheet growth being funded principally by borrowings.
32
Provision for Possible Loan Losses. The provision for possible loan losses
was $15.4 million for 1996 compared to $8.2 million for 1995. This represents an
increase of 88% and was primarily the result of a strategic restructuring by
First State in 1996 in which substantially all of First State's non-performing
assets were liquidated, thereby necessitating the higher loan loss provision in
1996. Sovereign's 1996 loan loss provision also increased in response to its
non-residential lending efforts and the inherent risk associated with these
products. In addition, Sovereign acquired approximately $713,000 in loan loss
reserve as a result of its acquisition of West Jersey during 1996.
During 1996, Sovereign charged-off (net of recoveries) $12.5 million of
loans compared to $10.3 million during 1995. The increased level of charge-offs
is primarily due to growth of $1.9 billion, or 29% in Sovereign's loan portfolio
during 1996.
Other Income. Total other income was $46.3 million for 1996 compared to
$32.9 million for 1995.
Other loan fees and service charges were $19.1 million for 1996 compared to
$8.6 million for 1995. This increase was primarily attributable to substantially
higher fees earned in 1996 by First State's credit card portfolio compared to
1995. Excluding First State's credit card portfolio, other loan fees and service
charges for 1996 and 1995 were $6.4 million and $6.3 million, respectively.
Other loan fees and service charges result primarily from Sovereign's loan
servicing portfolio. At December 31, 1996, Sovereign serviced $6.50 billion of
its own loans and $1.41 billion of loans for others. This compares to $5.62
billion of its own loans and $1.18 billion of loans for others at December 31,
1995.
Deposit fees were $15.3 million for 1996 compared to $12.8 million for
1995. This increase was primarily the result of an increase in the number of
transaction accounts in 1996 compared to 1995.
Mortgage banking gains were $1.6 million for 1996 compared to $6.2 million
for 1995. This decrease was primarily due to a gain of $3.6 million from the
sale of $238.5 million of mortgage servicing rights in 1995.
Gains on sales of loans and investment and mortgage-backed securities
available-for-sale were $5.5 million for 1996 compared to losses of $1.3 million
for 1995. This increase was primarily attributable to gains of $4.2 million
related to the liquidation of $156.5 million of available-for-sale and equity
securities in 1996 and losses of $1.6 million resulting from the sale of
securities available-for-sale by Bankers in 1995.
Miscellaneous income was $4.9 million for 1996 compared to $6.8 million for
1995. This decrease was primarily due to a $2.6 million gain related to the sale
of $130.6 million of deposits sold in 1995.
General and Administrative Expenses. Total general and administrative
expenses were $170.5 million for 1996 compared to $138.8 million for 1995. The
ratio of general and administrative expenses to average assets was 1.47% for
1996 compared to 1.44% for 1995.
Sovereign's efficiency ratio (all general and administrative expenses as a
percentage of net interest income and recurring non-interest income) for 1996
was 49.28% compared to 49.18% for 1995. The slight increase in these expense
ratios was primarily the result of higher Outside Services expense in 1996
related to First State's credit card portfolio compared to 1995. Excluding First
State's credit card portfolio, total general and administrative expenses for
1996 increased by 14% over 1995 levels. This compares to a 21% increase in the
average balance sheet over the same period.
Other Operating Expenses. Total other operating expenses were $51.0
million for 1996 compared to $16.5 million for 1995. This increase is
primarily the result of a non-recurring SAIF assessment of $33.8 million paid to
the FDIC for the recapitalization of the SAIF in 1996. Also included in other
operating expenses was amortization of goodwill and other intangible assets of
$12.7 million for 1996 compared to $13.5 million for 1995 and net REO losses of
$4.5 million for 1996 compared to $2.9 million for 1995.
Income Tax Provision. The income tax provision was $43.4 million for 1996
compared to $41.4 million for 1995. The effective tax rate for 1996 was 38.2%
compared to 34.0% for 1995. The increased effective tax rate in 1996 was
primarily attributable to a lower than normal effective tax rate in 1995, which
was caused by the reversal of certain tax reserves which management determined
were no longer necessary.
33
MARKET AND DIVIDEND INFORMATION
Sovereign's common and preferred stock is traded and listed on the NASDAQ
National Market System under the symbol "SVRN" and "SVRNP," respectively.
Options on Sovereign common stock are traded on the Philadelphia Stock Exchange
(PHLX) under the symbol "SVRN" or "SQV." At December 31, 1997, the total number
of holders of record of Sovereign's common stock was 10,601.
Holders of Sovereign's common stock are entitled to receive dividends when,
as and if declared by Sovereign's Board of Directors, out of funds legally
available therefor. The timing and amount of any future dividends will depend on
earnings, capital requirements, federal and state laws, regulations and policies
and other factors including the amounts of dividends payable to Sovereign by its
subsidiaries. The current quarterly dividend, adjusted to reflect all stock
dividends and stock splits declared through January 1998, is $.020 per share.
Holders of Sovereign's preferred stock are entitled to receive, when and as
declared by the Board of Directors, out of assets of the Corporation legally
available for payment, cash dividends payable quarterly at the rate of 6 1/4%
per annum. Dividends on the preferred stock, calculated as a percentage of the
liquidation preference, are payable quarterly on February 15, May 15, August 15
and November 15 of each year.
34
REPORT OF MANAGEMENT
To Our Stockholders:
FINANCIAL STATEMENTS
Sovereign Bancorp, Inc. ("Sovereign") is responsible for the preparation,
integrity and fair presentation of its published financial statements. The
consolidated financial statements of Sovereign have been prepared in accordance
with generally accepted accounting principles and, as such, include some amounts
that are based on judgments and estimates of management.
INTERNAL CONTROLS OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining an effective
internal control structure over financial reporting presented in conformity with
generally accepted accounting principles. The system contains monitoring
mechanisms, and actions are taken to correct deficiencies identified.
There are inherent limitations in the effectiveness of any system of
internal control, including the possibility of human error and the circumvention
or overriding of controls. Accordingly, even an effective internal control
system can provide only reasonable assurance with respect to financial statement
preparation. Further, because of changes in conditions, the effectiveness of an
internal control system may vary over time.
Management assessed Sovereign's internal control structure over financial
reporting presented in conformity with generally accepted accounting principles
as of December 31, 1997. This assessment was based on criteria for effective
internal control over the preparation of its published annual financial
statements described in "Internal Control -- Integrated Framework" issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on this
assessment, management believes that Sovereign maintained an effective internal
control structure over financial reporting presented in conformity with
generally accepted accounting principles as of December 31, 1997.
COMPLIANCE WITH LAWS AND REGULATIONS
Management is also responsible for compliance with the federal and state
laws and regulations concerning dividend restrictions and federal laws and
regulations concerning loans to insiders designated by the Office of Thrift
Supervision as safety and soundness laws and regulations.
Management assessed compliance by Sovereign Bank with the designated laws
and regulations relating to safety and soundness. Based on this assessment,
management believes that Sovereign Bank complied, in all significant respects,
with the designated laws and regulations related to safety and soundness for the
year ended December 31, 1997.
/s/ Jay S. Sidhu /s/ Karl D. Gerhart /s/ Mark R. McCollom
- ----------------------- ----------------------- ------------------------
JAY S. SIDHU KARL D. GERHART MARK R. MCCOLLOM
PRESIDENT AND TREASURER AND CHIEF ACCOUNTING OFFICER
CHIEF EXECUTIVE OFFICER CHIEF FINANCIAL OFFICER
35
ITEM 7A. MANAGEMENT'S DISCUSSION OF MARKET RISK.
Incorporated herein by reference from Part II, Item 7 "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Asset and Liability Management" hereof.
36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Sovereign Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of Sovereign
Bancorp, Inc. as of December 31, 1997 and 1996, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1997. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits. We did not
audit the 1996 or 1995 combined financial statements of First State Financial
Services, Inc. and Bankers Corp., which statements reflect total assets
constituting 25% as of December 31, 1996, and combined net interest income
constituting 29% and 31% for the years ended December 31, 1996 and 1995,
respectively, of the related consolidated totals. Those statements were audited
by other auditors whose reports have been furnished to us, and our opinion,
insofar as it relates to data included for First State Financial Services, Inc.
and Bankers Corp., is based solely on the reports of other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the reports of other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Sovereign Bancorp, Inc. at December 31,
1997 and 1996, and the consolidated results of its operations and its cash flows
for each of the three years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles.
In 1997, the Company changed its method of accounting for transfers of
financial instruments and extinguishment of liabilities, as discussed in Note 1
to the consolidated financial statements. In 1995, the Company changed its
method of accounting for mortgage servicing rights, as discussed in Note 1 to
the consolidated financial statements.
/s/ Ernst & Young LLP
- ------------------------
March 2, 1998
Harrisburg, Pennsylvania
37
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
AT DECEMBER 31,
-------------------------
1997 1996
----------- -----------
ASSETS
Cash and amounts due from depository institutions........ $ 189,101 $ 127,253
Interest-earning deposits................................ 12,611 6,273
Loans held for sale (approximate fair value of $22,898
and $33,162 at December 31, 1997 and 1996,
respectively)......................................... 22,826 32,955
Investment and mortgage-backed securities
available-for-sale.................................... 1,029,524 528,887
Investment and mortgage-backed securities
held-to-maturity (approximate fair value of $2,898,609
and $3,176,660 at December 31, 1997 and 1996,
respectively)......................................... 2,871,815 3,195,094
Loans.................................................... 9,923,510 8,321,771
Allowance for possible loan losses....................... (90,881) (52,689)
Premises and equipment................................... 67,178 74,609
Real estate owned........................................ 8,878 15,296
Accrued interest receivable.............................. 87,112 72,029
Goodwill and other intangible assets..................... 115,907 116,935
Other assets............................................. 98,702 62,439
----------- -----------
TOTAL ASSETS....................................... $14,336,283 $12,500,852
----------- -----------
----------- -----------
LIABILITIES
Deposits................................................. $ 7,889,921 $ 7,235,395
Borrowings
Short-term............................................ 4,633,714 3,379,208
Long-term............................................. 857,841 1,097,076
Advance payments by borrowers for taxes and insurance.... 38,946 38,152
Other liabilities........................................ 40,142 49,596
----------- -----------
Total Liabilities.................................. 13,460,564 11,799,427
----------- -----------
Corporation-obligated mandatorily redeemable capital
securities of subsidiary trust holding solely
subordinated debentures of Sovereign Bancorp, Inc.
("Trust Preferred Securities")........................ 97,472 --
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock; no par value; $50 liquidation
preference; 7,500,000 shares authorized; 1,996,467
shares issued and outstanding at December 31, 1997 and
2,000,000 shares issued and outstanding at December
31, 1996.............................................. 96,276 96,446
Common stock; no par value; 200,000,000 shares
authorized; 112,146,144 shares issued at December 31,
1997 and 115,117,224 shares issued at December 31,
1996.................................................. 382,531 399,580
Unallocated common stock held by the Employee Stock
Ownership Plan at cost; 4,611,132 shares at December
31, 1997 and 5,076,857 shares at December 31, 1996.... (31,194) (33,316)
Treasury stock; at cost; 13,210 shares at December 31,
1997 and 4,526,630 shares at December 31, 1996........ (185) (27,651)
Unrecognized gain on investment and mortgage-backed
securities available-for-sale, net of tax............. 10,846 1,794
Retained earnings........................................ 319,973 264,572
----------- -----------
Total Stockholders' Equity............................ 778,247 701,425
----------- -----------
TOTAL LIABILITIES, MINORITY INTERESTS AND
STOCKHOLDERS' EQUITY............................ $14,336,283 $12,500,852
----------- -----------
----------- -----------
See accompanying notes to consolidated financial statements.
38
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
------------------------------
1997 1996 1995
-------- -------- --------
INTEREST INCOME:
Interest on interest-earning deposits............... $ 4,258 $ 3,406 $ 3,995
Interest and dividends on investment and
mortgage-backed securities....................... 288,501 250,046 198,057
Interest and fees on loans.......................... 667,969 565,142 464,593
-------- -------- --------
Total interest income...................... 960,728 818,594 666,645
-------- -------- --------
INTEREST EXPENSE:
Interest on deposits................................ 320,567 297,806 300,754
Interest on borrowings.............................. 299,312 216,667 113,634
-------- -------- --------
Total interest expense..................... 619,879 514,473 414,388
-------- -------- --------
NET INTEREST INCOME................................... 340,849 304,121 252,257
Provision for possible loan losses.................... 37,199 15,366 8,150
-------- -------- --------
Net interest income after provision for possible loan
losses.............................................. 303,650 288,755 244,107
-------- -------- --------
OTHER INCOME:
Other loan fees and service charges................. 9,115 19,054 8,573
Deposit fees........................................ 16,545 15,285 12,751
Mortgage banking gains.............................. 6,388 1,622 6,167
Gain/(loss) on sale of loans and investment and
mortgage-backed securities available-for-sale.... 599 5,482 (1,343)
Miscellaneous income................................ 5,833 4,861 6,788
-------- -------- --------
Total other income......................... 38,480 46,304 32,936
-------- -------- --------
GENERAL AND ADMINISTRATIVE EXPENSES:
Salaries and employee benefits...................... 72,371 68,955 57,364
Occupancy and equipment expenses.................... 30,819 27,350 24,063
Outside services.................................... 24,450 33,754 16,874
Deposit insurance premiums.......................... 3,688 11,302 13,966
Advertising......................................... 6,558 4,866 5,989
Other administrative expenses....................... 25,452 24,232 20,528
-------- -------- --------
Total general and administrative
expenses................................. 163,338 170,459 138,784
-------- -------- --------
OTHER OPERATING EXPENSES:
One-time, merger-related charges.................... 29,258 -- --
Non-recurring SAIF assessment....................... -- 33,753 --
Amortization of goodwill and other intangible
assets........................................... 11,715 12,744 13,549
Trust Preferred Securities expense.................. 6,989 -- --
Real estate owned losses, net....................... 814 4,528 2,946
-------- -------- --------
Total other operating expenses............. 48,776 51,025 16,495
-------- -------- --------
Income before income taxes............................ 130,016 113,575 121,764
Income tax provision.................................. 52,376 43,436 41,354
-------- -------- --------
NET INCOME............................................ $ 77,640 $ 70,139 $ 80,410
-------- -------- --------
-------- -------- --------
NET INCOME APPLICABLE TO COMMON STOCK................. $ 71,396 $ 63,889 $ 75,722
-------- -------- --------
-------- -------- --------
BASIC EARNINGS PER SHARE(1) $ .67 $ .61 $ .72
-------- -------- --------
-------- -------- --------
DILUTED EARNINGS PER SHARE(1) $ .63 $ .58 $ .69
-------- -------- --------
-------- -------- --------
DIVIDENDS PER COMMON SHARE(1)......................... $ .092 $ .122 $ .108
-------- -------- --------
-------- -------- --------
- ------------------
(1) All per share data have been adjusted to reflect all stock dividends and
stock splits declared through January 1998.
See accompanying notes to consolidated financial statements.
39
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
UNALLOCATED
COMMON
COMMON PREFERRED STOCK
SHARES SHARES COMMON PREFERRED RETAINED TREASURY HELD BY
OUTSTANDING OUTSTANDING STOCK STOCK EARNINGS STOCK ESOP
----------- ----------- -------- --------- -------- -------- -----------
BALANCE, DECEMBER 31, 1994......... 100,423 -- $347,037 $ -- $185,988 $(15,232) $ (1,134)
Net Income......................... -- -- -- -- 80,410 -- --
Exercise of stock options.......... 691 -- 537 -- -- 583 --
Cash in lieu of fractional
shares............................ -- -- (2) -- -- -- --
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan............... 301 -- 1,963 -- -- -- --
Stock dividends.................... 3,292 -- 20,571 -- (20,571) -- --
Dividends on common stock,
$.108 per share................... -- -- -- -- (11,413) -- --
Preferred stock offering........... -- 2,000 -- 96,446 -- -- --
Dividends paid on preferred stock,
$2.344 per share.................. -- -- -- -- (4,688) -- --
Treasury stock repurchase.......... (145) -- -- -- -- (956) --
Unrecognized gain on investment and
mortgage-backed securities
available-for-sale, net of tax.... -- -- -- -- -- -- --
Purchase of shares under Employee
Stock Ownership Plan.............. (4,509) -- -- -- -- -- (30,286)
Allocation of shares under Employee
Stock Ownership Plan.............. 520 -- -- -- -- -- 2,027
Other.............................. 30 -- 630 -- (545) -- --
------- ----- -------- ------- -------- -------- --------
BALANCE, DECEMBER 31, 1995......... 100,603 2,000 370,736 96,446 229,181 (15,605) (29,393)
------- ----- -------- ------- -------- -------- --------
Net Income......................... -- -- -- -- 70,139 -- --
Exercise of stock options.......... 823 -- 900 -- -- 912 --
Cash in lieu of fractional
shares............................ -- -- (2) -- (9) -- --
Sale of stock under Dividend
Reinvestment and Employee Stock
Purchase Plan..................... 241 -- 1,699 -- -- -- --
Stock dividends.................... 3,486 -- 24,509 -- (24,509) -- --
Stock dividends on unallocated
Employee Stock Ownership Plan
shares............................ (215) -- -- -- 1,506 -- (1,506)
Dividends on common stock,
$.122 per share................... -- -- -- -- (12,741) -- --
Dividends paid on preferred stock,
$3.125 per share.................. -- -- -- -- (6,250) -- --
Treasury stock repurchase.......... (1,675) -- -- -- -- (12,958) --
Unrecognized loss on investment and
mortgage-backed securities
available-for-sale, net of tax.... -- -- -- -- -- -- --
Purchase of shares under Employee
Stock Ownership Plan.............. (653) -- -- -- -- -- (4,559)
Allocation of shares under Employee
Stock Ownership Plan.............. 478 -- 643 -- -- -- 2,142
Issuance of stock for West
Jersey............................ 2,396 -- 1,030 -- 7,255 -- --
Other.............................. 30 -- 65 -- -- -- --
------- ----- -------- ------- -------- -------- --------
BALANCE, DECEMBER 31, 1996......... 105,514 2,000 399,580 96,446 264,572 (27,651) (33,316)
------- ----- -------- ------- -------- -------- --------
Net Income......................... -- -- -- -- 77,640 -- --
Exercise of stock options.......... 1,099 -- 2,716 -- -- 1,055 --
Cash in lieu of fractional
shares............................ (3) -- (28) -- -- -- --
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan............... 216 -- 2,544 -- -- -- --
Dividends on common stock,
$.092 per share................... -- -- -- -- (9,778) -- --
Dividends paid on preferred stock,
$3.128 per share.................. -- -- -- -- (6,244) -- --
Treasury stock repurchase.......... (40) -- -- -- -- (473) --
Treasury stock sale................ 36 -- -- -- -- 376 --
Retirement of treasury shares...... -- -- (26,508) -- -- 26,508 --
Unrecognized gain on investment and
mortgage-backed securities
available-for-sale, net of tax.... -- -- -- -- -- -- --
Conversion of preferred stock...... 25 (4) 170 (170) -- -- --
Allocation of shares under Employee
Stock Ownership Plan.............. 466 -- 2,836 -- -- -- 2,122
Adjustment for First State's
different fiscal year end......... 209 -- 1,010 -- (6,217) -- --
Other.............................. -- -- 211 -- -- -- --
------- ----- -------- ------- -------- -------- --------
BALANCE, DECEMBER 31, 1997......... 107,522 1,996 $382,531 $96,276 $319,973 $ (185) $(31,194)
------- ----- -------- ------- -------- -------- --------
------- ----- -------- ------- -------- -------- --------
UNRECOGNIZED
LOSS/GAIN ON
AVAILABLE- TOTAL
FOR-SALE STOCKHOLDERS'
PORTFOLIO EQUITY
------------ -------------
BALANCE, DECEMBER 31, 1994......... $(3,072) $513,587
Net Income......................... -- 80,410
Exercise of stock options.......... -- 1,120
Cash in lieu of fractional
shares............................ -- (2)
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan............... -- 1,963
Stock dividends.................... -- --
Dividends on common stock,
$.108 per share................... -- (11,413)
Preferred stock offering........... -- 96,446
Dividends paid on preferred stock,
$2.344 per share.................. -- (4,688)
Treasury stock repurchase.......... -- (956)
Unrecognized gain on investment and
mortgage-backed securities
available-for-sale, net of tax.... 6,971 6,971
Purchase of shares under Employee
Stock Ownership Plan.............. -- (30,286)
Allocation of shares under Employee
Stock Ownership Plan.............. -- 2,027
Other.............................. -- 85
------- --------
BALANCE, DECEMBER 31, 1995......... 3,899 655,264
------- --------
Net Income......................... -- 70,139
Exercise of stock options.......... -- 1,812
Cash in lieu of fractional
shares............................ -- (11)
Sale of stock under Dividend
Reinvestment and Employee Stock
Purchase Plan..................... -- 1,699
Stock dividends.................... -- --
Stock dividends on unallocated
Employee Stock Ownership Plan
shares............................ -- --
Dividends on common stock,
$.122 per share................... -- (12,741)
Dividends paid on preferred stock,
$3.125 per share.................. -- (6,250)
Treasury stock repurchase.......... -- (12,958)
Unrecognized loss on investment and
mortgage-backed securities
available-for-sale, net of tax.... (2,105) (2,105)
Purchase of shares under Employee
Stock Ownership Plan.............. -- (4,559)
Allocation of shares under Employee
Stock Ownership Plan.............. -- 2,785
Issuance of stock for West
Jersey............................ -- 8,285
Other.............................. -- 65
------- --------
BALANCE, DECEMBER 31, 1996......... 1,794 701,425
------- --------
Net Income......................... -- 77,640
Exercise of stock options.......... -- 3,771
Cash in lieu of fractional
shares............................ -- (28)
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan............... -- 2,544
Dividends on common stock,
$.092 per share................... -- (9,778)
Dividends paid on preferred stock,
$3.128 per share.................. -- (6,244)
Treasury stock repurchase.......... -- (473)
Treasury stock sale................ -- 376
Retirement of treasury shares...... -- --
Unrecognized gain on investment and
mortgage-backed securities
available-for-sale, net of tax.... 8,824 8,824
Conversion of preferred stock...... -- --
Allocation of shares under Employee
Stock Ownership Plan.............. -- 4,958
Adjustment for First State's
different fiscal year end......... 228 (4,979)
Other.............................. -- 211
------- --------
BALANCE, DECEMBER 31, 1997......... $10,846 $778,247
------- --------
------- --------
See accompanying notes to consolidated financial statements.
40
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................. $ 77,640 $ 70,139 $ 80,410
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for possible loan losses and deferred taxes..... 30,987 19,809 9,679
Depreciation.............................................. 7,682 8,319 7,281
Amortization.............................................. 19,310 9,660 6,071
Gain on sale of loans, investment and mortgage-backed
securities and real estate
owned................................................... (395) (4,718) (846)
Allocation of Employee Stock Ownership Plan............... 4,958 2,785 2,027
Net change in:
Loans held for sale..................................... 10,129 104,776 (66,200)
Accrued interest receivable............................. (15,083) (11,554) (15,059)
Prepaid expenses and other assets....................... (60,582) (26,233) 1,138
Other liabilities....................................... (7,473) (19,104) 14,883
----------- ----------- -----------
Net cash provided by operating activities................... 67,173 153,879 39,384
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of investment and mortgage-backed
securities available-for-sale and held-to-maturity........ 771,175 696,199 70,598
Proceeds from repayments and maturities of investment and
mortgage-backed securities:
Available-for-sale........................................ 141,072 113,394 --
Held-to-maturity.......................................... 937,183 641,537 438,707
Purchases of investment and mortgage-backed securities:
Available-for-sale........................................ (679,543) (424,038) (100,724)
Held-to-maturity.......................................... (1,331,213) (1,180,465) (1,484,748)
Proceeds from sales of loans................................ 23,570 69,324 17,178
Purchase of loans........................................... (2,760,386) (1,402,490) (489,826)
Net change in loans other than purchases and sales.......... 1,134,321 (470,793) (19,463)
Proceeds from sales of premises and equipment............... 10,112 2,970 10,729
Purchases of premises and equipment......................... (10,736) (6,579) (20,034)
Proceeds from sales of real estate owned.................... 17,907 19,053 17,097
Net cash received from business combinations................ -- 4,983 5,569
Other, net.................................................. (4,996) -- --
----------- ----------- -----------
Net cash used by investing activities....................... (1,751,534) (1,936,905) (1,554,917)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Assumption of deposits...................................... -- -- 818,913
Net increase (decrease) in deposits......................... 655,666 (88,689) 353,924
Net increase (decrease) in short-term borrowings............ 426,785 852,142 (597,821)
Proceeds from long-term borrowings.......................... 584,156 1,005,001 910,499
Repayments of long-term borrowings.......................... -- (2) (716)
Net increase (decrease) in advance payments by borrowers for
taxes and insurance....................................... 794 2,589 (2,771)
Proceeds from issuance of Trust Preferred Securities........ 97,574 -- --
Cash dividends paid to stockholders......................... (18,003) (18,820) (15,844)
Proceeds from issuance of common stock...................... 5,997 4,595 3,166
Proceeds from issuance of preferred stock................... -- -- 96,446
Advance to the Employee Stock Ownership Plan................ (325) (10,206) (30,286)
Purchase of Treasury Stock.................................. (97) (12,958) (956)
----------- ----------- -----------
Net cash provided by financing activities................... 1,752,547 1,733,652 1,534,554
----------- ----------- -----------
Net change in cash and cash equivalents..................... 68,186 (49,374) 19,021
Cash and cash equivalents at beginning of period............ 133,526 182,900 163,879
----------- ----------- -----------
Cash and cash equivalents at end of period.................. $ 201,712 $ 133,526 $ 182,900
----------- ----------- -----------
----------- ----------- -----------
RECONCILIATION OF CASH AND CASH EQUIVALENTS TO CONSOLIDATED
BALANCE SHEETS:
Cash and amounts due from depository institutions........... $ 189,101 $ 127,253 $ 165,376
Interest-earning deposits................................... 12,611 6,273 17,524
----------- ----------- -----------
Cash and cash equivalents at end of period.................. $ 201,712 $ 133,526 $ 182,900
----------- ----------- -----------
----------- ----------- -----------
SUPPLEMENTAL DISCLOSURES:
Income tax payments totaled $44.3 million in 1997, $52.1 million in 1996
and $34.8 million in 1995. Interest payments totaled $597.4 million in 1997,
$564.2 million in 1996 and $399.0 million in 1995. Noncash activity consisted of
mortgage loan securitization of $283.0 million in 1997, $372.1 million in 1996
and $200.9 million in 1995; reclassification of long-term borrowings to
short-term borrowings of $824.0 million in 1997, $931.7 million in 1996 and
$315.8 million in 1995; and reclassification of mortgage loans to real estate
owned of $20.8 million in 1997, $19.4 million in 1996 and $15.4 million in 1995.
See accompanying notes to consolidated financial statements.
41
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a description of the significant accounting policies of
Sovereign Bancorp, Inc. and subsidiaries ("Sovereign"). Such accounting policies
are in accordance with generally accepted accounting principles and have been
followed on a consistent basis, except as separately noted herein.
a. Principles of Consolidation -- The accompanying financial statements
include the accounts of the parent company, Sovereign Bancorp, Inc. and its
wholly-owned subsidiaries: Sovereign Bank and Sovereign Capital Trust I. All
material intercompany balances and transactions have been eliminated in
consolidation.
b. Use of Estimates -- The preparation of 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.
c. Per Share Information -- All per share data has been restated to reflect
the effect of the 6-for-5 stock split which was authorized on January 22, 1998,
with a record date of March 31, 1998, the 20% stock split which was authorized
on January 16, 1997, with a record date of March 3, 1997, the 5% stock dividends
which were authorized on December 20, 1995 and February 22, 1995, with record
dates of February 1, 1996 and March 31, 1995, respectively and all prior stock
dividends and stock splits.
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 128, "Earnings Per
Share." This statement supersedes APB Opinion No. 15, "Earnings per Share" and
FASB Statement No. 85, "Yield Test for Determining whether a Convertible
Security Is a Common Stock Equivalent." The overall objective of SFAS No. 128 is
to simplify the calculation of earnings per share and achieve comparability with
the recently issued International Accounting Standard No. 33, "Earnings Per
Share." SFAS No. 128 is effective for all periods ending after December 15,
1997. Subsequent to the effective date, all prior-period earnings per share
amounts are required to be restated to conform to the provisions of SFAS No.
128.
Under SFAS No. 128, primary earnings per share has been replaced with basic
earnings per share. Basic earnings per share is calculated by dividing income
available to common stockholders by the weighted average common shares
outstanding, excluding options, warrants, and convertible securities from the
calculation.
Under SFAS No. 128, fully diluted earnings per share has been renamed
diluted earnings per share. Income available to common stockholders is adjusted
for the assumed conversion of all potentially dilutive securities. In
calculating diluted earnings per share, the dilutive effect of options and
warrants continues to be calculated using the treasury stock method. However,
unlike the calculation of fully diluted earnings per share, the treasury stock
method is applied using the average market price for the period rather than the
higher of the average market price or the ending market price. The dilutive
effect of convertible debt or preferred stock continues to be calculated using
the if-converted method. Sovereign adopted SFAS No. 128 in December 1997 and
accordingly, the calculation of primary and fully diluted earnings per share for
current and prior periods has been restated to conform to the provisions of
SFAS No. 128.
42
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
The following table presents the computation of earnings per share based on
the provisions of SFAS No. 128 for the years indicated (in thousands, except per
share data):
BASIC EARNINGS PER SHARE: 1997 1996 1995
- ------------------------- -------- -------- --------
Net income attributable to common stock(1)............ $ 71,396 $ 63,889 $ 75,722
-------- -------- --------
Average basic shares outstanding at end of
period(3)........................................... 106,472 104,481 105,379
-------- -------- --------
-------- -------- --------
Basic earnings per share(2)(3)........................ $ .67 $ .61 $ .72
-------- -------- --------
-------- -------- --------
DILUTED EARNINGS PER SHARE: 1997 1996 1995
- --------------------------- -------- -------- --------
Net income(1)......................................... $ 77,640 $ 70,139 $ 80,410
-------- -------- --------
Average diluted shares outstanding at end of
period(3)........................................... 120,831 118,849 114,502
Dilutive effect of average stock options, net of
shares assumed to be repurchased under the treasury
stock method(3)..................................... 2,116 2,351 2,585
-------- -------- --------
Total average diluted shares outstanding at end of
period(3)........................................... 122,947 121,200 117,087
-------- -------- --------
-------- -------- --------
Diluted earnings per share(2)(3)...................... $ .63 $ .58 $ .69
-------- -------- --------
-------- -------- --------
- ------------------
(1) The 1997 results include the impact of one-time, merger-related charges of
$36.6 million (after-tax) resulting from Sovereign's acquisitions during
1997. The 1996 results include a non-recurring SAIF assessment of $20.9
million (after-tax) paid to the FDIC for the recapitalization of the SAIF.
(2) Excluding the one-time, merger-related charges described in Note 1 above,
basic earnings per share and diluted earnings per share for 1997 were $1.02
and $.93, respectively. Excluding the non-recurring SAIF assessment
described in Note 1 above, basic earnings per share and diluted earnings per
share for 1996 were $.81 and $.75, respectively.
(3) All per share data have been adjusted to reflect all stock dividends and
stock splits declared through January 1998.
d. Interest-earning Deposits -- Interest-earning deposits consist of
deposit accounts with the Federal Home Loan Bank of Pittsburgh ("FHLB") and
deposits with other financial institutions generally having maturities of three
months or less.
e. Investment and Mortgage-backed Securities -- Debt securities that the
company has the intent and ability to hold to maturity are classified as
held-to-maturity and reported at amortized cost. Securities expected to be held
for an indefinite period of time are classified as available-for-sale and are
carried at fair value with unrealized gains and losses reported as a separate
component of stockholders' equity, net of estimated income taxes. Securities
that are bought and held principally for the purpose of selling are classified
as trading and reported at fair value, with unrealized gains and losses included
in earnings. Sovereign has no securities held for trading. Gains or losses on
the sales of securities are recognized at trade date utilizing the specific
identification method.
f. Forward Commitments and Options -- Sovereign utilizes forward
commitments and/or options to hedge interest rate risk associated with loans
held for sale and/or commitments to fund loans. Gains and losses on these
transactions are included in the net gain or loss when the asset is sold.
g. Mortgage Banking Activity -- Loans held for sale consist of
residential mortgage loans and mortgage-backed securities originated or
purchased by Sovereign. They are recorded at the lower of cost or estimated fair
value on an aggregate basis. Gains and losses are included in the consolidated
43
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
statements of operations. The fair value calculation includes consideration of
all open positions, outstanding commitments and related fees paid. Excess
servicing fees are computed as the present value of the difference between the
estimated future net revenues and normal servicing net revenues as established
by the federally sponsored secondary market makers. Resultant premiums are
deferred and amortized over the estimated life of the related mortgages using
the constant yield method.
Effective July 1, 1995, Sovereign prospectively adopted SFAS No. 122,
"Accounting for Mortgage Servicing Rights." SFAS No. 122 requires that
management recognize as separate assets, rights to service mortgage loans for
others, however these servicing rights are acquired. Management should allocate
the total cost of mortgage loans, either purchased or originated, to the loans
and the mortgage servicing rights based on their relative fair value. SFAS No.
122 also requires that management assess its capitalized mortgage servicing
rights for impairment based on the fair value of those rights, and that this
impairment be recognized through a valuation allowance. The provisions of SFAS
No. 122 were adopted in their entirety by SFAS No. 125, which supercedes SFAS
No. 122.
During 1997, Sovereign adopted the requirements of SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities," for various transfers of receivables and other financial assets
that occurred during the year. In December 1996, the FASB issued SFAS No. 127,
"Deferral of the Effective Date of Certain Provisions of SFAS No. 125," which
defers the effective date for the provisions of SFAS No. 125 relating to
accounting for repurchase agreements, dollar rolls, securities lending and
similar transactions until January 1, 1998. As a result of the adoption of SFAS
No. 125 in 1997, as amended by SFAS No. 127, Sovereign continues to record
servicing assets as well as retained rights to future interest income from the
serviced assets that exceed the contractual servicing fee (interest-only strips)
as assets on the balance sheet at the time the receivables are sold. As a
result, the impact of adoption on net income in 1997 was immaterial.
The following table presents the activity of Sovereign's mortgage servicing
rights for the years indicated (in thousands):
1997 1996
------ ------
Balance, beginning of year.......................... $5,954 $1,894
Net servicing assets recognized during the year..... 3,643 4,257
Amortization........................................ (669) (197)
------ ------
Balance, end of year................................ $8,928 $5,954
------ ------
------ ------
For purposes of measuring impairment of capitalized mortgage servicing
rights and minimizing the impact of risk, Sovereign conservatively evaluates the
loans underlying these rights by stratifying them into certain homogeneous
categories which include, but are not limited to, residential real estate
30-year and 15-year fixed rate mortgage loans, adjustable rate mortgage loans
and balloon loans. Sovereign also takes into consideration any inherent risks,
which historically have been minimal on these loan types, as well as other
relevant factors associated with each portfolio. Prices are obtained in the
secondary market and are based upon current market prices of similarly traded
loans and/or comparable secondary market instruments.
h. Allowance for Possible Loan Losses -- An allowance for possible loan
losses is maintained at a level that management considers adequate to provide
for potential losses based upon an evaluation of known and inherent risks in the
loan portfolio. Management's evaluation 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. While
management uses the best information available to make such evaluations, future
adjustments to the allowance may be necessary if conditions differ substantially
from the assumptions used in making the evaluations.
44
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
i. Loans -- Interest on loans is credited to income as it is earned.
Interest income is not recognized on loans when the loan payment is 90 days or
more delinquent (except auto loans, government-guaranteed loans or loans
secured by deposit accounts) or sooner if management believes the loan has
become impaired. Sovereign defines impairment as the existence of one or a
combination of any of the following loan weaknesses:
o the primary source of repayment is gone or severely impaired and
Sovereign may have to rely on the secondary source
o loss does not seem likely, but sufficient problems have arisen to
cause Sovereign to go to abnormal lengths to protect its position in
order to maintain a high probability of repayment
o Obligors are unable to generate enough cash flow to reduce their
debts
o Deterioration in collateral value or inadequate inspection or
verification of value (if the collateral is expected to be a source
of repayment)
o Flaws in documentation leave Sovereign in a subordinated or
unsecured position when the collateral is needed for repayment of
the loan
When a loan is placed on non-accrual status, all accrued yet uncollected
interest is reversed from income. Payments received on non-accrual loans are
generally applied to the outstanding principal balance. A non-accrual loan is a
loan in which it is probable that scheduled payments of principal and interest
will not be paid when due according to the contractual terms of the loan
agreement. In order for a non-accrual loan to revert to accruing status, all
delinquent interest must be paid and Sovereign must approve a repayment plan.
Loans delinquent 180 days or more (120 days for auto loans) are
considered for charge-off unless it can be clearly demonstrated that repayment
will occur regardless of the delinquency status. Examples of this would include:
a loan which is secured by collateral and is in the process of collection; a
loan supported by a valid guarantee or insurance; or a loan supported by a valid
claim against a solvent estate. A decision to charge-off a loan does not
necessarily mean that the asset has no recovery or salvage value, but rather it
is not practical to defer writing off the balance, even though partial or full
recovery may be realized in the future.
SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," requires
that certain impaired loans be measured based on the present value of expected
future cash flows discounted at the loan's effective interest rate or the fair
value of the collateral if the loan is collateral dependent, as amended by SFAS
No. 118, "Accounting by Creditors for Impairment of a Loan -- Income Recognition
and Disclosures." For purposes of measuring impairment as set forth by the
provisions of SFAS No. 114 and SFAS No. 118, Sovereign defines impairment as all
non-accrual loans, except for large groups of smaller-balance, homogeneous loans
such as residential mortgage and consumer loans which are collectively evaluated
for impairment.
j. Loan Fees, Discounts and Premiums -- Loan origination fees and certain
direct loan origination costs are deferred and recognized as interest income in
the consolidated statement of operations over the contractual life of the loan
utilizing the level yield method, except in the case of certain discounted loans
in which a portion of the net deferred fee may be amortized over the discount
period. Discounts and premiums on loans purchased are amortized into income
utilizing methods which approximate the level yield method.
45
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
k. Premises and Equipment -- Premises and equipment are carried at cost,
less accumulated depreciation. Depreciation is calculated utilizing both
accelerated and straight-line methods. Estimated useful lives are as follows:
Office buildings.......................... 15 to 50 years
Leasehold improvements.................... 5 to 10 years
Furniture, fixtures and equipment......... 3 to 10 years
Automobiles............................... 3 years
Expenditures for maintenance and repairs are charged to expense as
incurred.
l. Real Estate Owned -- Real estate owned consists of properties acquired
by or in lieu of foreclosure. Real estate owned is stated at the lower of cost
or estimated fair value minus estimated costs to sell. Write-downs of real
estate owned which occur after the initial transfer from the loan portfolio are
recorded as other operating expenses. Costs of holding foreclosed property are
charged to expense in the current period, except for significant property
improvements which are capitalized to the extent that carrying value does not
exceed estimated fair value.
m. Income Taxes -- Deferred income taxes are provided on temporary
differences between amounts reported for financial statement and tax purposes in
accordance with SFAS No. 109, "Accounting for Income Taxes."
n. Interest Rate Exchange Agreements (Including Swaps, Caps, and Floors) --
Sovereign has entered into certain interest rate exchange agreements in
connection with its asset/liability management program which are designated as
hedges. Related fees are deferred and amortized on a straight line basis over
the life of the interest rate exchange agreement, which corresponds to the
estimated life of the asset or liability item being hedged. Net interest
payments/receipts are accrued as an adjustment of interest expense/income on the
hedged assets or liabilities. Gains or losses resulting from early termination
of interest rate exchange agreements are deferred and amortized over the
remaining term of the original exchange agreements. In the event the related
asset/liability is disposed of, such deferred gains or losses are recognized as
an adjustment to the respective gain or loss on disposition. Changes in the
value of interest rate exchange agreements are not recorded in the financial
statements because the interest rate exchange agreements are designated as
hedges.
o. General and Administrative Expenses -- General and administrative
expenses are classified on a functional basis, except for salaries and employee
benefits. Certain direct loan origination costs are deferred and are being
amortized as a yield adjustment through net interest income (see note 1-j).
p. Consolidated Statement of Cash Flows -- For purposes of reporting cash
flows, cash and cash equivalents include cash and amounts due from depository
institutions, interest-earning deposits and securities purchased under resale
agreements with an original maturity of three months or less.
q. Reclassifications -- 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.
r. Long-Lived Assets -- In March 1995, the FASB issued SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed of," which requires impairment losses to be recorded on long-lived
assets used in operations when indicators of impairment are present and the
undiscounted cash flows estimated to be generated by those assets are less than
the assets' carrying amount. SFAS No. 121 also addresses the accounting for
long-lived assets that are expected to be disposed of. Sovereign adopted SFAS
No. 121 in 1996 and the effect of adoption was not material.
46
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
s. Intangibles -- Core deposit intangibles are a measure of the value of
consumer demand and savings deposits acquired in business combinations accounted
for as purchases. Core deposit intangibles are being amortized on accelerated
bases pursuant to core deposit studies and in accordance with SFAS No. 72,
"Accounting for Certain Acquisitions of Banking or Thrift Institutions," over
the estimated lives of the existing deposit relationships acquired, but not
exceeding 15 years. Goodwill is the excess of the purchase price over the fair
value of net assets of companies acquired through business combinations
accounted for as purchases. Goodwill is being amortized using the straight line
method over various periods not exceeding 20 years. The carrying amount of the
goodwill is reviewed if facts and circumstances suggest that it may be impaired.
If this review indicates that goodwill will not be recoverable, as determined
based on the loss of economic value, the carrying amount of the goodwill is
reduced by the estimated loss of value. In addition, goodwill associated with
impaired long-lived assets is included in the impairment evaluation which
Sovereign assesses under the rules of SFAS No. 121.
t. Comprehensive Income -- In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income." The overall objective of SFAS No. 130 is to
provide prominent disclosure of comprehensive income items. Comprehensive income
is the change in equity of a company during a given period from transactions and
other events from non-owner sources. SFAS No. 130 is effective for fiscal years
beginning after December 15, 1997. Subsequent to the effective date, all
prior-period amounts are required to be restated to conform to the provisions of
SFAS No. 130. Sovereign will adopt SFAS No. 130 in 1998 and accordingly, the
consolidated financial statements will be restated to conform to the provisions
of this statement.
u. Segment Reporting -- In June 1997, the FASB issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS No.
131 requires that public companies report certain information about operating
segments in complete sets of financial statements of the company and in
condensed financial statements of interim periods issued to shareholders. It
also requires that public companies report certain information about their
products and services, the geographic areas in which they operate, and their
major customers. SFAS No. 131 is effective for fiscal years beginning after
December 15, 1997. Sovereign will adopt SFAS No. 131 in 1998.
(2) BUSINESS COMBINATIONS
On September 19, 1997, Sovereign purchased Fleet Financial Group Inc.'s
("Fleet") Automobile Finance Division ("Fleet Auto"). Fleet Auto consists of
approximately $2.0 billion of indirect auto loans, automotive floor plan loans
and loans to automotive lessors. Fleet Auto has business relationships with over
2,000 automotive dealerships and serves approximately 225,000 customers
throughout New Jersey, New York and several New England states. Sovereign
purchased Fleet Auto at a discount, which in part, reflected the need to
establish initial reserves for possible loan losses of approximately $22.0
million or 1.50% of the indirect auto loans acquired. The transaction added
$10.7 million of goodwill to Sovereign's balance sheet. Sovereign's consolidated
results of operations include Fleet Auto's results of operations from September
19, 1997 and thereafter.
On August 29, 1997, Sovereign acquired Bankers Corp. ("Bankers"), a $2.6
billion financial services holding company headquartered in Perth Amboy, New
Jersey. Bankers' sole banking subsidiary, Bankers Savings, operates 15 branch
offices located in Middlesex, Monmouth and Ocean counties, New Jersey. The
transaction added loans, deposits, and shareholders' equity to Sovereign of $1.5
billion, $1.7 billion, and $203.5 million, respectively. In accordance with the
merger agreement, Bankers shareholders received 1.854 (2.225 shares as adjusted
for all subsequent stock dividends and stock splits) shares of Sovereign common
stock in exchange for each share of Bankers common stock. Sovereign issued
approximately 23.0 million new shares (27.6 million new shares as adjusted for
all subsequent stock dividends and stock splits) of Sovereign common stock in
connection with the
47
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) BUSINESS COMBINATIONS -- (CONTINUED)
transaction, which was tax-free to Bankers and Bankers shareholders. This
transaction was accounted for as a pooling-of-interests and accordingly, the
consolidated financial statements have been restated to include the accounts of
Bankers for all periods presented.
On February 18, 1997, Sovereign acquired First State Financial Services,
Inc. ("First State"), a $603 million savings institution headquartered in West
Caldwell, New Jersey with 14 branch offices located throughout central and
northern New Jersey. In accordance with the merger agreement, First State
shareholders received 1.225 (1.76 shares as adjusted for all subsequent stock
dividends and stock splits) shares of Sovereign common stock in exchange for
each share of First State common stock. Sovereign issued approximately 4.9
million new shares (7.06 million new shares as adjusted for all subsequent stock
dividends and stock splits) of Sovereign common stock in connection with the
transaction, which was tax-free to First State and First State shareholders.
This transaction was accounted for as a pooling-of-interests and accordingly,
the consolidated financial statements have been restated to include the accounts
of First State for all periods presented.
Prior to the combination, First State's fiscal year end was September 30,
and accordingly, Sovereign's consolidated results of operations for the years
ended December 31, 1996 and 1995 include First State's results of operations for
the twelve-month periods ended September 30, 1996 and 1995, respectively.
Sovereign's consolidated results of operations for the year ended December 31,
1997 include First State's results of operations for the twelve month period
ended December 31, 1997. A net decrease to Sovereign's stockholders' equity of
$5.0 million has been made to reflect First State's activity for the three-month
period ended December 31, 1996. That activity consisted of proceeds from the
exercise of stock options of $1.0 million, net loss of $6.2 million and net
change in unrecognized loss on available-for-sale securities of $228,000.
The pre-merger results of operations for Sovereign and First State and
Bankers (which were acquired pursuant to transactions accounted for as a
pooling-of-interests) were as follows (in thousands):
SOVEREIGN(1) BANKERS COMBINED
------------ -------- --------
Six Months Ended June 30, 1997 (unaudited)
Interest income..................................... $360,816 $ 89,398 $450,214
Interest expense.................................... 234,302 55,548 289,850
Provision for possible loan losses.................. 9,700 2,300 12,000
Other income........................................ 16,905 1,222 18,127
Non-interest expense................................ 82,776 10,278 93,054
Income tax provision................................ 20,230 8,172 28,402
-------- -------- --------
Net income.......................................... $ 30,713 $ 14,322 $ 45,035
-------- -------- --------
-------- -------- --------
SOVEREIGN FIRST STATE(2) BANKERS COMBINED
--------- -------------- -------- --------
Year Ended December 31, 1996
Interest income........................... $616,250 $ 49,239 $153,105 $818,594
Interest expense.......................... 399,540 24,054 90,879 514,473
Provision for possible loan losses........ 2,516 8,900 3,950 15,366
Other income.............................. 26,683 17,480 2,141 46,304
Non-interest expense...................... 130,053 37,926 19,752 187,731
Non-recurring SAIF assessment............. 27,818 3,096 2,839 33,753
Income tax provision...................... 31,543 (1,608) 13,501 43,436
-------- -------- -------- --------
Net income................................ $ 51,463 $ (5,649) $ 24,325 $ 70,139
-------- -------- -------- --------
-------- -------- -------- --------
48
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) BUSINESS COMBINATIONS -- (CONTINUED)
SOVEREIGN FIRST STATE(2) BANKERS COMBINED
-------- -------- -------- --------
Year Ended December 31, 1995
Interest income........................... $493,031 $ 44,349 $129,265 $666,645
Interest expense.......................... 318,805 21,765 73,818 414,388
Provision for possible loan losses........ 1,000 1,650 5,500 8,150
Other income.............................. 25,829 6,368 739 32,936
Non-interest expense...................... 113,108 22,172 19,999 155,279
Income tax provision...................... 29,539 1,132 10,683 41,354
-------- -------- -------- --------
Net income................................ $ 56,408 $ 3,998 $ 20,004 $ 80,410
-------- -------- -------- --------
-------- -------- -------- --------
- ------------------
(1) Sovereign's results of operations include First State's results of
operations.
(2) Reflects First State's results of operations for the years ended September
30, 1996 and 1995, respectively.
On May 31, 1996, Sovereign acquired West Jersey Bancshares, Inc. ("West
Jersey") in a transaction accounted for as a pooling-of-interests; however, the
consolidated financial statements have not been restated due to immateriality.
Sovereign acquired approximately $100.0 million in assets consisting principally
of investment securities and loans and assumed approximately $73.0 million of
deposit liabilities. West Jersey shareholders received .8335 (1.2 shares as
adjusted for all subsequent stock dividends and stock splits) shares of
Sovereign common stock in exchange for each share of West Jersey common stock,
or $8.91 per share. Sovereign issued 1.7 million new shares (2.4 million shares
as adjusted for all subsequent stock dividends and stock splits) of Sovereign
common stock in connection with the transaction, which was tax-free to West
Jersey and West Jersey shareholders.
On November 17, 1995, Sovereign acquired two branch offices and related
deposits of Berkeley Federal Bank & Trust, FSB ("Berkeley"). Sovereign assumed
approximately $111.7 million of deposits for a premium of $5.5 million. Of this
premium, $604,000 was recorded as a core deposit intangible and $4.9 million was
recorded as goodwill. The balances of this core deposit intangible and goodwill
at December 31, 1997 were $334,000 and $4.4 million, respectively.
On November 15, 1995, Sovereign acquired Colonial State Bank in a
transaction accounted for as a purchase. Sovereign acquired $46.5 million of
assets consisting principally of loans and investment securities. Sovereign also
assumed approximately $42.0 million of deposit liabilities. Sovereign acquired
Colonial State Bank in exchange for $6.3 million in cash. This transaction added
goodwill of $3.3 million to Sovereign's balance sheet. The balance of the
goodwill at December 31, 1997 was $2.9 million. After receipt of regulatory
approvals and pursuant to the terms of the agreement entered into by Sovereign
and Colonial State Bank, upon acquisition, Colonial State Bank became a
wholly-owned, BIF-insured subsidiary of Sovereign and converted to a federal
savings bank under the name Colonial Bank for Savings, a Federal Savings Bank.
On April 1, 1996, Colonial Bank for Savings, FSB was renamed Sovereign Community
Bank. During 1997, Sovereign Community Bank was merged into Sovereign Bank.
On November 10, 1995, Sovereign completed the sale of its Pottsville,
Pennsylvania branch office with related deposits totaling $23.9 million to
Northwest Savings Bank ("Northwest") and the sale of its English Village branch
office in North Wales, Pennsylvania with related deposits of $12.4 million to
Union National Bank & Trust Company ("Union National"). As a result of these
transactions, Sovereign recognized a pre-tax gain of $1.1 million and reduced
goodwill by $568,000, respectively.
On April 21, 1995, Sovereign completed its sale of seven southern New
Jersey offices with related deposits totaling $106.7 million to Collective
Bancorp, Inc. ("Collective"). Six of these offices had previously been purchased
from Berkeley as part of a transaction which occurred on January 1, 1995. In
addition, Sovereign acquired $7.0 million of deposits from Collective's
Wilmington,
49
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) BUSINESS COMBINATIONS -- (CONTINUED)
Delaware branch office. As a result of this transaction, Sovereign recognized a
pre-tax gain of $1.5 million and reduced its existing core deposit intangible by
approximately $6.0 million.
On January 1, 1995, Sovereign acquired 23 branch offices located in New
Jersey and Delaware with $909.3 million of deposit liabilities from Berkeley. In
exchange for assuming the deposits of the Berkeley offices, Sovereign acquired
principally cash and fixed assets, net of a deposit premium of $66.6 million
which was recorded as $7.6 million of core deposit intangible and $59.0 million
of goodwill. The balances of this core deposit intangible and goodwill at
December 31, 1997 were $2.6 million and $46.5 million, respectively.
On December 19, 1997, Sovereign executed a Definitive Agreement to acquire
First Home Bancorp, Inc. ("First Home"), a $525 million bank holding company
headquartered in Pennsville, New Jersey. First Home's principal operating
subsidiary operates ten banking offices located in the Salem, Gloucester and
Camden counties, New Jersey and New Castle county, Delaware. The terms of the
Agreement call for Sovereign to exchange $31.25 in Sovereign common stock for
each outstanding share of First Home common stock or a total consideration of
approximately $86 million in Sovereign common stock. If Sovereign's average
stock price remains between $15.00 and $18.33 per share (collectively, the
"Collars") during a 15-day pricing period as set forth in the Agreement, the
price will remain fixed at $31.25. However, if during the pricing period,
Sovereign's average stock price drops to $15.00 per share or lower, First Home
shareholders would receive a fixed exchange ratio of 2.083 shares of Sovereign
common stock for each share of First Home common stock. Conversely, if
Sovereign's average stock price is $18.33 per share or higher, First Home
shareholders would receive a fixed exchange ratio of 1.704 shares of Sovereign
common stock for each share of First Home common stock. First Home has the right
to terminate the Agreement if Sovereign's average stock price during the 15-day
pricing period falls below $11.25. The transaction will be accounted for as a
pooling-of-interests. Sovereign anticipates recording a one-time, after-tax,
merger-related charge of $4 million to $5 million at the closing of the
transaction which is anticipated to be during the second quarter of 1998. All
per share information concerning this transaction has been restated to reflect
all subsequent stock dividends and stock splits declared through January 1998.
On December 15, 1997, Sovereign executed a Definitive Agreement to acquire
Carnegie Bancorp ("Carnegie"), a $424 million commercial bank holding company
headquartered in Princeton, New Jersey. Carnegie's principal operating
subsidiary operates seven banking offices throughout central New Jersey and one
community banking office in Pennsylvania. The terms of the Agreement call for
Sovereign to exchange $35.50 in Sovereign common stock for each outstanding
share of Carnegie common stock or a total consideration of approximately $106
million in Sovereign common stock. If Sovereign's average stock price remains
between $15.00 and $18.33 per share (collectively, the "Collars") during a
15-day pricing period as set forth in the Agreement, the price will remain fixed
at $35.50. However, if during the pricing period, Sovereign's average stock
price drops to $15.00 per share or lower, Carnegie's shareholders would receive
a fixed exchange ratio of 2.366 shares of Sovereign common stock for each share
of Carnegie common stock. Conversely, if Sovereign's average stock price is
$18.33 per share or higher, Carnegie shareholders would receive a fixed exchange
ratio of 1.937 shares of Sovereign common stock for each share of Carnegie
common stock. Carnegie has the right to terminate the Agreement if Sovereign's
average stock price during the 15-day pricing period falls below $12.06 and
Sovereign's decline in value is 15% greater than the percentage decline of a
group of similar financial institutions, subject to Sovereign's right to
increase the exchange ratio in order to result in a minimum price of $28.53 in
Sovereign common stock. The transaction will be accounted for as a
pooling-of-interests. Sovereign anticipates recording a one-time, after-tax,
merger-related charge of $7 million to $8 million at the closing of the
transaction which is anticipated to be during the second quarter of 1998. All
per share information concerning this transaction has been restated to reflect
all subsequent stock dividends and stock splits declared through January 1998.
50
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) BUSINESS COMBINATIONS -- (CONTINUED)
On September 18, 1997, Sovereign executed a Definitive Agreement to acquire
ML Bancorp, Inc. ("ML Bancorp"), a $2.3 billion bank holding company
headquartered in Villanova, Pennsylvania. ML Bancorp's principal operating
subsidiary, Main Line Bank, operates 29 branch offices located in the suburbs of
Philadelphia, Pennsylvania. This transaction subsequently closed on February 28,
1998. The transaction added loans, deposits and stockholders' equity to
Sovereign of $1.04 billion, $989.5 million and $173.1 million, respectively. In
accordance with the merger agreement, ML Bancorp shareholders received 1.62
(1.944 shares as adjusted for all subsequent stock dividends and stock splits)
shares of common stock in exchange for each share of ML Bancorp common stock.
Approximately 20.5 million new shares (24.6 million new shares as adjusted for
all subsequent stock dividends and stock splits) of Sovereign common stock were
issued in connection with the transaction. The transaction is tax-free to ML
Bancorp and ML Bancorp shareholders, and will be accounted for as a
pooling-of-interests.
The pro forma results of operations for Sovereign and ML Bancorp (which
subsequently closed on February 28, 1998) are as follows (in thousands):
SOVEREIGN ML BANCORP(1) COMBINED
--------- ------------- --------
Year Ended December 31, 1997
Net Interest income............................... $340,849 $47,940 $388,789
Net income........................................ 77,640 12,302 89,942
Basic earnings per share.......................... .67 1.14 .66
Diluted earnings per share........................ .63 1.08 .62
SOVEREIGN ML BANCORP(2) COMBINED
--------- ------------- --------
Year Ended December 31, 1996
Net Interest income............................... $304,121 $54,179 $358,300
Net income........................................ 70,139 13,810 83,949
Basic earnings per share.......................... .61 1.24 .62
Diluted earnings per share........................ .58 1.20 .58
SOVEREIGN ML BANCORP(2) COMBINED
--------- ------------- --------
Year Ended December 31, 1995
Net Interest income............................... $252,257 $43,762 $296,019
Net income........................................ 80,410 11,620 92,030
Basic earnings per share.......................... .72 .94 .67
Diluted earnings per share........................ .69 .92 .65
- ------------------
(1) Reflects ML Bancorp's results of operations for the nine-month period ended
December 31, 1997.
(2) Reflects ML Bancorp's results of operations for the years ended March 31,
1997 and 1996, respectively.
(3) RESTRICTIONS ON CASH AND AMOUNTS DUE FROM DEPOSITORY INSTITUTIONS
Sovereign Bank is required to maintain certain average reserve balances as
established by the Federal Reserve Board. The amounts of those reserve balances
for the reserve computation periods which included December 31, 1997 and 1996
were $76.6 million and $48.7 million, respectively.
51
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(4) INVESTMENT AND MORTGAGE-BACKED SECURITIES
The amortized cost and estimated fair value of investment and
mortgage-backed securities are as follows (in thousands):
AT DECEMBER 31,
---------------------------------------------------------------------------------
1997 1996
----------------------------------------------------- -------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED
COST APPRECIATION DEPRECIATION VALUE COST APPRECIATION
---------- ------------ ------------ ---------- ---------- ------------
Investment and Mortgage-
backed Securities
Available-for-Sale:
Investment Securities:
U.S. Treasury and
government agency
securities.............. $ -- $ -- $ -- $ -- $ 40,810 $ 43
Equity securities......... 590,040 17,024 19 607,045 286,482 3,525
Other securities.......... -- -- -- -- 7,720 --
Mortgage-backed Securities:
FHLMC..................... 89,975 7 57 89,925 25,288 --
FNMA...................... 52,914 5 162 52,757 -- --
GNMA...................... 60,702 414 -- 61,116 -- --
Collateralized mortgage
obligations............. 218,113 747 179 218,681 164,459 895
Other securities.......... -- -- -- -- 1,259 --
---------- ------- ------ ---------- ---------- -------
Total investment and
mortgage-backed securities
available-for-sale........ $1,011,744 $18,197 $ 417 $1,029,524 $ 526,018 $ 4,463
---------- ------- ------ ---------- ---------- -------
---------- ------- ------ ---------- ---------- -------
AT DECEMBER 31,
-------------------------
1996
-------------------------
UNREALIZED FAIR
DEPRECIATION VALUE
------------ ----------
Investment and Mortgage-
backed Securities
Available-for-Sale:
Investment Securities:
U.S. Treasury and
government agency
securities.............. $ 908 $ 39,945
Equity securities......... -- 290,007
Other securities.......... 248 7,472
Mortgage-backed Securities:
FHLMC..................... 287 25,001
FNMA...................... -- --
GNMA...................... -- --
Collateralized mortgage
obligations............. 129 165,225
Other securities.......... 22 1,237
------- ----------
Total investment and
mortgage-backed securities
available-for-sale........ $ 1,594 $ 528,887
------- ----------
------- ----------
AT DECEMBER 31,
---------------------------------------------------------------------------------
1997 1996
----------------------------------------------------- -------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED
COST APPRECIATION DEPRECIATION VALUE COST APPRECIATION
---------- ------------ ------------ ---------- ---------- ------------
Investment and Mortgage-
backed Securities Held-to-
Maturity:
Investment Securities:
U.S. Treasury and
government agency
securities.............. $ 12,127 $ 57 $ 14 $ 12,170 $ 13,926 $ 60
Corporate securities...... 1,050 24 -- 1,074 25,492 136
Other securities.......... 69,782 3,832 150 73,464 66,061 128
Mortgage-backed Securities:
FHLMC..................... 245,561 6,276 75 251,762 267,014 3,295
FNMA...................... 116,478 2,096 47 118,527 252,515 2,024
GNMA...................... 386,271 8,079 -- 394,350 350,826 5,098
RTC....................... 411 -- 1 410 -- --
Private issues............ 105,306 866 68 106,104 273,555 87
Collateralized mortgage
obligations............. 1,934,829 7,972 2,053 1,940,748 1,943,619 5,708
Other securities.......... -- -- -- -- 2,086 --
---------- ------- ------ ---------- ---------- -------
Total investment and
mortgage-backed securities
held-to-maturity.......... $2,871,815 $29,202 $2,408 $2,898,609 $3,195,094 $16,536
---------- ------- ------ ---------- ---------- -------
---------- ------- ------ ---------- ---------- -------
UNREALIZED FAIR
DEPRECIATION VALUE
------------ ----------
Investment and Mortgage-
backed Securities Held-to-
Maturity:
Investment Securities:
U.S. Treasury and
government agency
securities.............. $ 171 $ 13,815
Corporate securities...... 71 25,557
Other securities.......... 242 65,947
Mortgage-backed Securities:
FHLMC..................... 3,425 266,884
FNMA...................... 5,102 249,437
GNMA...................... 463 355,461
RTC....................... -- --
Private issues............ 9,546 264,096
Collateralized mortgage
obligations............. 15,914 1,933,413
Other securities.......... 36 2,050
------- ----------
Total investment and
mortgage-backed securities
held-to-maturity.......... $34,970 $3,176,660
------- ----------
------- ----------
52
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(4) INVESTMENT AND MORTGAGE-BACKED SECURITIES -- (CONTINUED)
The amortized cost and estimated fair value of investment and
mortgage-backed securities at December 31, 1997 by contractual maturity are
shown below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties (in thousands):
AMORTIZED
COST FAIR VALUE
---------- ----------
Investment and Mortgage-backed Securities
Available-for-Sale:
Due in one year or less................................... $ -- $ --
Due after one year through five years..................... -- --
Due after five years through ten years.................... 27,304 27,345
Due after ten years....................................... 394,400 395,134
No stated maturity........................................ 590,040 607,045
---------- ----------
Total investment and mortgage-backed securities
available-for-sale................................... $1,011,744 $1,029,524
---------- ----------
---------- ----------
AMORTIZED
COST FAIR VALUE
---------- ----------
Investment and Mortgage-backed Securities Held-to-Maturity:
Due in one year or less................................... $ 3,934 $ 3,928
Due after one year through five years..................... 33,516 33,776
Due after five years through ten years.................... 37,349 38,062
Due after ten years....................................... 2,797,016 2,822,843
---------- ----------
Total investment and mortgage-backed securities
held-to-maturity..................................... $2,871,815 $2,898,609
---------- ----------
---------- ----------
Proceeds from sales of investment and mortgage-backed securities and the
realized gross gains and losses from those sales are as follows (in thousands):
AVAILABLE-FOR-SALE HELD-TO-MATURITY
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
----------------------------- -----------------------------
1997 1996 1995 1997 1996 1995
-------- -------- ------- -------- -------- -------
Proceeds from sales........ $209,859 $696,199 $70,598 $561,316 $ -- $ --
-------- -------- ------- -------- -------- -------
-------- -------- ------- -------- -------- -------
Gross realized gains....... $ 1,387 $ 9,034 $ 358 $ 183 $ -- $ --
Gross realized losses...... 2,738 4,543 1,829 10,217 -- --
-------- -------- ------- -------- -------- -------
Net realized
(losses)/gains........... $ (1,351) $ 4,491 $(1,471) $(10,034) $ -- $ --
-------- -------- ------- -------- -------- -------
-------- -------- ------- -------- -------- -------
Proceeds from sales of investment and mortgage-backed securities
held-to-maturity for the year ended December 31, 1997 is a result of the
liquidation of certain held-to-maturity securities acquired from Bankers during
the third quarter of 1997. This sale was completed in accordance with the
provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" to maintain Sovereign's pre-merger interest rate risk
position, and the impact of this sale is included with the one-time, merger-
related charges for Bankers.
Investment and mortgage-backed securities with an estimated fair value of
$693.5 million and $763.5 million were pledged as collateral for borrowings,
interest rate agreements and public deposits at December 31, 1997 and 1996,
respectively.
53
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(5) LOANS
A summary of loans included in the consolidated balance sheets follows (in
thousands):
AT DECEMBER 31,
-----------------------
1997 1996
---------- ----------
Residential real estate loans............................... $6,142,559 $6,848,639
Residential construction loans (net of loans in process of
$34,695 and $45,088, respectively)........................ 53,378 83,736
---------- ----------
Total Residential Loans................................ 6,195,937 6,932,375
---------- ----------
Multi-family loans.......................................... 90,100 87,417
Commercial real estate loans................................ 310,472 175,896
Commercial loans............................................ 156,211 126,086
Automotive floor plan loans................................. 279,757 --
---------- ----------
Total Commercial Loans................................. 836,540 389,399
---------- ----------
Auto loans.................................................. 1,544,431 64,033
Home equity loans........................................... 838,755 634,194
Loans to automotive lessors................................. 267,033 --
Student loans............................................... 176,096 204,797
Credit cards................................................ 54,887 82,798
Other....................................................... 9,831 14,175
---------- ----------
Total Consumer Loans................................... 2,891,033 999,997
---------- ----------
Total Loans............................................ $9,923,510 $8,321,771
---------- ----------
Total Loans with:(1)
Fixed rate................................................ $3,822,936 $1,547,309
Variable rate............................................. 6,100,574 6,774,462
---------- ----------
Total Loans............................................ $9,923,510 $8,321,771
---------- ----------
---------- ----------
- ------------------
(1) Loan totals do not reflect the impact of off-balance sheet interest rate
swaps used for interest rate risk management as discussed below.
As a result of Sovereign's use of interest rate swaps for interest rate
risk management, at December 31, 1997, $389.0 million of variable rate mortgage
loans have been effectively converted to fixed rate mortgage loans. In addition,
$208.8 million of intermediate variable rate mortgage loans (loans with a
five-year fixed rate period) have effectively been converted to variable rate
over the fixed rate period.
The majority of all loans are located in Sovereign's marketplace (eastern
Pennsylvania, New Jersey, northern Delaware, New York and several New England
states). This is Sovereign's only significant geographic concentration.
The total amount of loans being serviced for the benefit of others was
$1.67 billion and $1.41 billion at December 31, 1997 and 1996, respectively. At
December 31, 1997 and 1996, Sovereign had recognized excess servicing assets,
which are accounted for as interest-only strips, of $1.0 million and $815,000
and mortgage servicing rights of $8.9 million and $6.0 million, respectively.
54
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(5) LOANS -- (CONTINUED)
The activity in the allowance for possible loan losses is as follows (in
thousands):
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------- ------- -------
Balance, beginning of period............................. $52,689 $49,075 $50,785
Acquired reserves and other additions.................... 19,329 716 485
Provision for possible loan losses....................... 37,199 15,366 8,150
Charge-offs.............................................. 22,611 14,083 11,236
Recoveries............................................... 4,275 1,615 891
------- ------- -------
Balance, end of period................................... $90,881 $52,689 $49,075
------- ------- -------
------- ------- -------
Sovereign encourages loan officers to follow specific procedures in the
early identification and collection of problem loans. If a loan becomes
seriously delinquent or the loan officer is not successful in the resolution of
the problem loan, the account is transferred to Sovereign's Asset Recovery Team.
At this time the account is analyzed for collateral values and the cash flows
available to repay the loan. If it is determined that there is a collateral
shortfall and insufficient cash flow to repay the debt, a reserve will be
established immediately based on this analysis. At any time during this process
and at the loan officer's discretion, the account may be placed on non-accrual
status. By following these procedures, losses are minimized on impaired loans.
55
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(5) LOANS -- (CONTINUED)
Impaired loans are summarized as follows (in thousands):
AT DECEMBER 31,
-----------------
1997 1996
------- -------
Impaired loans without a related reserve.................... $ 7,435 $15,120
Impaired loans with a related reserve....................... 10,389 10,468
------- -------
Total impaired loans................................... $17,824 $25,588
======= =======
Reserve for impaired loans.................................. $ 4,825 $ 7,649
------- -------
------- -------
The average balance of impaired loans for 1997, 1996 and 1995 was $20.9
million, $22.1 million and $22.0 million, respectively.
(6) PREMISES AND EQUIPMENT
A summary of premises and equipment, less accumulated depreciation and
amortization, follows (in thousands):
AT DECEMBER 31,
-------------------
1997 1996
-------- --------
Land...................................................... $ 12,657 $ 13,312
Office buildings.......................................... 49,346 57,346
Furniture, fixtures, and equipment........................ 60,690 65,865
Leasehold improvements.................................... 8,727 8,619
Automobiles............................................... 898 973
-------- --------
132,318 146,115
Less accumulated depreciation............................. (65,140) (71,506)
-------- --------
Total premises and equipment............................ $ 67,178 $ 74,609
-------- --------
-------- --------
Sovereign is committed under various non-cancelable operating leases
relating to branch facilities having initial or remaining terms in excess of one
year. The minimum annual rental commitments under these leases at December 31,
1997, are summarized as follows (in thousands):
1998............................................... $ 4,866
1999............................................... 4,129
2000............................................... 3,569
2001............................................... 3,166
2002............................................... 2,022
Thereafter......................................... 4,772
-------
$22,524
-------
-------
Total rental expense for all leases for the years ended December 31, 1997,
1996 and 1995 was $4.7 million, $3.8 million and $3.2 million, respectively.
56
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(7) ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows (in thousands):
AT DECEMBER 31,
-----------------
1997 1996
------- -------
Accrued interest receivable on:
Investment and mortgage-backed securities................. $25,825 $23,764
Loans..................................................... 61,287 48,265
------- -------
Total interest receivable.............................. $87,112 $72,029
------- -------
------- -------
Accrued interest receivable is stated net of an allowance for potentially
uncollected interest (for loans on non-accrual and for loans that have been
restructured). If these non-accruing and restructured loans had been current in
accordance with their original terms and had been outstanding throughout the
period, gross interest income for the years ended December 31, 1997 and 1996
would have increased by approximately $6.2 million and $7.3 million,
respectively. Interest income recorded on these loans for the years ended
December 31, 1997 and 1996 was $2.2 million and $2.2 million, respectively.
(8) DEPOSITS
Deposits are summarized as follows (in thousands):
AT DECEMBER 31,
------------------------------------------------------------------
1997 1996
------------------------------ ------------------------------
TYPE OF ACCOUNT BALANCE PERCENT RATE BALANCE PERCENT RATE
- --------------- ---------- ------- ---- ---------- ------- ----
Demand deposit accounts........... $ 356,854 4% --% $ 322,158 4% --%
NOW accounts...................... 595,650 8 1.28 552,221 8 1.51
Savings accounts.................. 1,683,670 21 2.95 1,677,814 23 2.86
Money market accounts............. 698,405 9 4.25 661,987 9 3.96
Retail certificates of deposit.... 4,073,578 52 5.57 3,795,733 53 5.33
Jumbo certificates of deposit..... 481,764 6 5.75 225,482 3 5.54
---------- --- ---- ---------- --- ----
Total deposits............... $7,889,921 100% 4.33% $7,235,395 100% 4.11%
---------- --- ---- ---------- --- ----
---------- --- ---- ---------- --- ----
Certificate accounts are frequently renewed at maturity rather than paid
out. The following table sets forth the maturity of Sovereign's certificates of
deposit as scheduled to mature contractually at December 31, 1997 (in
thousands):
WITHIN SIX SIX MOS. -- ONE -- THREE -- FIVE -- OVER
MOS. ONE YR. THREE YRS. FIVE YRS. TEN YRS. TEN YRS. TOTAL
---------- ----------- ---------- --------- ------------- -------- ----------
Certificate accounts by
rate:
2.001% -- 4.000%....... $ 41,016 $ 827 $ 222 $ 195 $ 19 $ 21 $ 42,300
4.001% -- 6.000%....... 2,248,262 1,343,369 531,590 22,602 7,812 290 4,153,925
6.001% -- 8.000%....... 86,806 93,138 113,576 17,131 31,576 3,000 345,227
8.001% -- 10.000%...... 2,590 1,242 5,185 488 948 318 10,771
Above 10.000%.......... 16 126 995 269 1,713 -- 3,119
---------- ---------- -------- ------- ------- ------ ----------
Total certificate
accounts............. $2,378,690 $1,438,702 $651,568 $40,685 $42,068 $3,629 $4,555,342
---------- ---------- -------- ------- ------- ------ ----------
---------- ---------- -------- ------- ------- ------ ----------
57
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(8) DEPOSITS -- (CONTINUED)
The following table sets forth the maturity of Sovereign's certificates of
deposit of $100,000 or more as scheduled to mature contractually at December 31,
1997 (in thousands):
AT DECEMBER 31,
1997
---------------
Three months or less........................... $266,562
Over three through six months.................. 259,771
Over six through twelve months................. 115,938
Over twelve months............................. 65,205
--------
Total..................................... $707,476
--------
--------
Interest expense on deposits is summarized as follows (in thousands):
AT DECEMBER 31,
------------------------------
1997 1996 1995
-------- -------- --------
Demand deposit and NOW accounts....................... $ 7,436 $ 7,721 $ 7,809
Savings accounts...................................... 49,708 47,802 45,147
Money market accounts................................. 26,633 27,558 26,515
Certificates of deposit............................... 236,790 214,725 221,283
-------- -------- --------
Total interest expense on deposits............... $320,567 $297,806 $300,754
-------- -------- --------
-------- -------- --------
(9) SHORT-TERM AND LONG-TERM BORROWINGS
Short-term Borrowings. Short-term borrowings included in the consolidated
balance sheets are as follows (in thousands):
AT DECEMBER 31,
-----------------------
1997 1996
---------- ----------
Securities sold under repurchase agreements................. $ 334,089 $ 603,090
Federal Home Loan Bank advances............................. 4,257,832 2,765,118
Federal funds purchased..................................... -- 11,000
Other borrowings............................................ 41,793 --
---------- ----------
Total borrowings....................................... $4,633,714 $3,379,208
---------- ----------
---------- ----------
Included in short-term borrowings are sales of securities under repurchase
agreements. Securities underlying these repurchase agreements consisted of
investment and mortgage-backed securities which had a book value of $314.9
million and $436.5 million and a market value of $317.0 million and $442.2
million at December 31, 1997 and 1996, respectively.
Effective January 1, 1998, Sovereign will adopt the provisions of SFAS No.
127, "Deferral of the Effective Date of Certain Provisions of SFAS No. 125." The
provisions of SFAS No. 127 defer the effective date for the provisions of SFAS
No. 125 relating to accounting for repurchase agreements, dollar rolls,
securities lending and similar transactions. Accordingly, qualifying repurchase
agreements are treated as financings and the obligations to repurchase
securities sold are reflected as a liability in the balance sheet. The dollar
amount of securities underlying the agreements remains in the asset accounts,
although the securities underlying the agreements are delivered to the brokers
who arranged the transactions. In certain instances, the broker may have sold,
loaned, or disposed of the securities to other parties in the normal course of
their operations, and have agreed to resell to Sovereign substantially similar
securities at the maturity of the agreements. The broker/dealers who participate
with Sovereign in these agreements are primary broker/dealers reporting to the
Federal Reserve Bank of New York.
58
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(9) SHORT-TERM AND LONG-TERM BORROWINGS -- (CONTINUED)
The following table summarizes information regarding short-term securities
sold under repurchase agreements (in thousands):
SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
DECEMBER 31,
--------------------------------------
1997 1996 1995
---------- -------- --------
Balance............................................ $ 334,089 $603,090 $431,024
Weighted average interest rate..................... 5.91% 5.65% 6.32%
Maximum amount outstanding at any month-end during
the period....................................... $1,029,947 $893,977 $719,822
Average amount outstanding during the period....... $ 792,214 $488,646 $538,091
Weighted average interest rate during the period... 5.82% 5.94% 6.01%
The following table summarizes information regarding short-term FHLB
advances (in thousands):
FEDERAL HOME LOAN BANK ADVANCES
DECEMBER 31,
------------------------------------------
1997 1996 1995
---------- ---------- ----------
Balance......................................... $4,257,832 $2,765,118 $1,146,661
Weighted average interest rate.................. 5.91% 5.79% 5.67%
Maximum amount outstanding at any month-end
during the period............................. $4,280,250 $3,323,966 $1,151,286
Average amount outstanding during the period.... $3,359,383 $2,009,989 $ 807,794
Weighted average interest rate during the
period........................................ 6.04% 5.88% 5.55%
FEDERAL FUNDS PURCHASED
The following table summarizes information regarding short-term federal
funds purchased (in thousands):
DECEMBER 31,
---------------------------------
1997 1996 1995
------- ------- -------
Balance................................................ $ -- $11,000 $18,500
Weighted average interest rate......................... --% 7.25% 6.00%
Maximum amount outstanding at any month-end during the
period............................................... $12,000 $31,000 $21,000
Average amount outstanding during the period........... $ 1,288 $ 8,116 $ 5,555
Weighted average interest rate during the period....... 5.68% 5.45% 5.86%
59
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(9) SHORT-TERM AND LONG-TERM BORROWINGS -- (CONTINUED)
Long-term Borrowings. Long-term securities sold under repurchase
agreements had a weighted average interest rate of 5.89% at December 31, 1997.
Long-term FHLB advances had weighted average interest rates of 6.15% and 6.04%
at December 31, 1997 and 1996, respectively. Long-term borrowings are as follows
(in thousands):
AT DECEMBER 31,
---------------------
1997 1996
-------- ----------
Securities sold under repurchase agreements, maturing March
1999 to April 1999........................................ $ 95,968 $ --
FHLB advances, maturing January 1999 to April 2012.......... 615,515 929,328
6.75% senior notes, due July 1, 2000........................ 49,655 49,517
6.75% subordinated debentures, due 2000..................... 27,831 49,585
8.50% subordinated debentures, due 2002..................... 19,629 19,550
8.00% subordinated debentures, due 2003..................... 49,243 49,096
-------- ----------
Total long-term borrowings............................. $857,841 $1,097,076
-------- ----------
-------- ----------
Included in long-term borrowings are sales of securities under repurchase
agreements. Securities underlying these repurchase agreements consisted of
investment and mortgage-backed securities which had a book value of $89.6
million and a market value of $90.2 million at December 31, 1997. The 6.75%
notes are non-amortizing and are not redeemable prior to maturity. The 6.75%
debentures are non-amortizing and are not redeemable prior to maturity. The
6.75% debentures have, through the use of an interest rate swap, been
effectively converted from a fixed rate obligation to a variable rate obligation
tied to the 3-month LIBOR plus 140.5 basis points. The 8.50% debentures are non-
amortizing and are redeemable at the option of Sovereign in whole or in part at
any time on or after September 15, 1999. The 8.00% debentures are non-amortizing
and are not redeemable prior to maturity.
(10) TRUST PREFERRED SECURITIES
During March 1997, Sovereign issued $100 million of preferred capital
securities ("Trust Preferred") through Sovereign Capital Trust I ("Trust"), a
special-purpose statutory trust created expressly for the issuance of these
securities. Distributions on the Trust Preferred will be payable at an annual
rate of 9% of the stated liquidation amount of $1,000 per capital security,
payable semi-annually. After issuance costs, proceeds of $97.6 million were
invested in Junior Subordinated Debentures of Sovereign, at terms identical to
the Trust Preferred offering. Cash distributions on the Trust Preferred are made
to the extent interest on the debentures is received by the Trust. In the event
of certain changes or amendments to regulatory requirements or federal tax
rules, the Trust Preferred securities are redeemable in whole. Otherwise, the
Trust Preferred securities are generally redeemable in whole or in part on or
after April 1, 2007, at a declining redemption price ranging from 103.875% to
100% of the liquidation amount. On or after April 1, 2017, the Trust Preferred
securities may be redeemed at 100% of the liquidation amount.
The Trust Preferred offering is classified as and is similar to a minority
interest and is presented as "Corporation-obligated mandatorily redeemable
capital securities of subsidiary trust holding solely subordinated debentures of
Sovereign Bancorp, Inc." The Trust Preferred offering qualifies for Tier I
capital treatment for Sovereign and the loan payments from Sovereign to the
Trust are fully tax deductible.
60
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(11) STOCKHOLDERS' EQUITY
The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA")
requires institutions regulated by the OTS to have minimum regulatory tangible
capital equal to 1.5% of total tangible assets, 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%. Sovereign Bank was in compliance with all of these
capital requirements as of December 31, 1997. The following schedule summarizes
the actual capital balances of Sovereign Bank at December 31, 1997 (in
thousands):
TANGIBLE LEVERAGE LEVERAGE RISK-BASED
CAPITAL TO CAPITAL TO CAPITAL TO CAPITAL TO
TANGIBLE TANGIBLE RISK-ADJUSTED RISK-ADJUSTED
ASSETS ASSETS ASSETS ASSETS
---------- ---------- ------------- -------------
SOVEREIGN BANK:
- ---------------
Regulatory capital........................ $795,395 $795,395 $795,395 $881,285
Minimum capital requirement............... 212,775 425,550 320,173 640,346
-------- -------- -------- --------
Excess.................................. $582,620 $369,845 $475,222 $240,939
-------- -------- -------- --------
-------- -------- -------- --------
Capital ratio............................. 5.61% 5.55% 9.94% 11.01%
OTS capital regulations do not apply to holding companies. The following
schedule summarizes actual capital balances of Sovereign Bancorp at December 31,
1997 as if those regulations did apply to Sovereign Bancorp (in thousands):
TANGIBLE LEVERAGE LEVERAGE RISK-BASED
CAPITAL TO CAPITAL TO CAPITAL TO CAPITAL TO
TANGIBLE TANGIBLE RISK-ADJUSTED RISK-ADJUSTED
ASSETS ASSETS ASSETS ASSETS
---------- ---------- ------------- -------------
SOVEREIGN BANCORP:
- ------------------
Regulatory capital........................ $650,601 $748,073 $748,073 $981,963
Minimum capital requirement............... 212,184 424,369 323,170 646,340
-------- -------- -------- --------
Excess.................................. $438,417 $323,704 $424,903 $335,623
-------- -------- -------- --------
-------- -------- -------- --------
Capital ratio............................. 4.60% 5.24% 9.26% 12.15%
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA")
established five 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. At December 31, 1997, 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.
As a result of provisions of the Small Business Jobs Protection Act of 1996
(the "Jobs Protection Act"), which repealed the tax reserve method for bad debts
for thrift institutions and the circumstances requiring bad debt recapture for
large institutions, Sovereign must determine the tax deduction for bad debt
based on actual charge-offs. The Jobs Protection Act retained the existing base
year bad debt reserve and requires recapture into taxable income in certain
circumstances such as in the case of certain excess distributions or complete
redemptions. None of the limited circumstances requiring recapture are
anticipated by Sovereign. Retained earnings at December 31, 1997 included $48.9
61
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(11) STOCKHOLDERS' EQUITY -- (CONTINUED)
million in bad debt reserves, for which no deferred taxes have been provided due
to the indefinite nature of the recapture provisions.
Sovereign maintains a Dividend Reinvestment and Stock Purchase Plan which
permits holders of record of Sovereign common stock to purchase additional
shares of common stock directly from Sovereign via reinvestment of cash
dividends and optional cash purchases. At December 31, 1997, purchases of common
stock with reinvested dividends are made at a 5% discount from the current
market price as defined and optional cash purchases are limited to a maximum of
$5,000 per quarter.
Sovereign maintains a Stockholder Rights Plan (the "Rights Plan"). The
Rights Plan is designed to protect stockholders from attempts to acquire control
of Sovereign at an inadequate price. Under the Rights Plan, Sovereign
distributed a dividend of one right to purchase a unit of preferred stock on
each outstanding share of Sovereign's common stock. The rights are not currently
exercisable or transferable and no separate certificates evidencing such rights
will be distributed, unless certain events occur. The rights attach to shares of
common stock outstanding on October 2, 1989 and will expire on September 27,
2004 as stated in the amendment to the Rights Plan dated September 27, 1995. The
rights will entitle the holders to purchase either Sovereign's common stock or
the common stock of the potential acquirer at a substantially reduced price.
On May 17, 1995, Sovereign completed the sale of 2.0 million shares of
Convertible Preferred Stock, raising $96.4 million in capital. The 6 1/4%
non-voting, Cumulative Convertible Preferred Stock is convertible at the option
of the holder at any time, unless previously redeemed, at a conversion rate
(adjusted to reflect all stock dividends and stock splits declared through
January 1998) of 7.184 shares of common stock for each share of preferred stock;
equivalent to a conversion price of $6.960 per share of common stock. The
preferred stock may not be redeemed prior to May 15, 1998. Thereafter, the
preferred stock is redeemable at the option of Sovereign, in whole or in part,
at $52.188 per share during the twelve months beginning May 15, 1998, and
thereafter at prices declining ratably to par on and after May 15, 2005.
(12) STOCK OPTION PLANS
Sovereign grants stock options for a fixed number of shares to key officers
and directors with an exercise price equal to the fair value of the shares at
the date of grant. Sovereign accounts for stock option grants in accordance with
APB Opinion No. 25, "Accounting for Stock Issued to Employees," and accordingly,
recognizes no compensation expense for the stock option grants. There are 13.0
million shares of common stock reserved for issuance under the plans. These
shares, along with the per share data in the following summary of option
transactions, have been adjusted to reflect all stock dividends and stock splits
declared through January 1998.
1986 PLAN 1987 PLAN 1989 PLAN 1990 PLAN 1993 PLAN 1996 PLAN
OPTION PRICE $.96-$6.94 $3.12 $1.53-$5.38 $1.30 $3.78-$9.78 $6.94-$16.77 TOTAL
------------ ---------- --------- ----------- --------- ----------- ------------ ----------
Options outstanding December 31,
1995............................. 1,221,010 380,936 842,184 327,833 1,122,012 -- 3,893,975
--------- -------- --------- -------- ---------- -------- ----------
Granted.......................... 86,184 -- 161,924 -- 161,967 11,520 421,595
Exercised........................ (137,105) (44,541) (323,498) (246,169) (73,144) -- (824,457)
Forfeited........................ (1,512) -- -- -- (64,851) -- (66,363)
Options outstanding December 31,
1996............................. 1,168,577 336,395 680,610 81,664 1,145,984 11,520 3,424,750
--------- -------- --------- -------- ---------- -------- ----------
Granted.......................... -- -- -- -- 35,597 690,360 725,957
Exercised........................ (149,597) (336,395) (399,229) -- (389,051) -- (1,274,272)
Forfeited........................ -- -- -- -- (11,132) (2,880) (14,012)
Options outstanding December 31,
1997............................. 1,018,980 -- 281,381 81,664 781,398 699,000 2,862,423
--------- -------- --------- -------- ---------- -------- ----------
--------- -------- --------- -------- ---------- -------- ----------
Options exercisable December 31,
1997............................. 1,018,980 -- 281,381 81,664 114,990 10,080 1,507,095
--------- -------- --------- -------- ---------- -------- ----------
--------- -------- --------- -------- ---------- -------- ----------
62
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(12) STOCK OPTION PLANS -- (CONTINUED)
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," which provides companies with a choice either to expense the fair
value of employee stock options over the vesting period (recognition method) or
to continue the previous practice but disclose the pro forma effects on net
income and earnings per share had the fair value method been used (disclosure
only method). Companies electing the disclosure only method will be required to
include the pro forma effects of all awards granted in fiscal years beginning
after December 15, 1994. Sovereign adopted the disclosure only method during
1996.
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123 and has been determined as if Sovereign had accounted
for its employee stock options under the fair value method of that statement.
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following assumptions:
1986 PLAN 1993 PLAN 1996 PLAN
--------- ------------------------------------------- -----------------------------
Grant date year................. 1996 1995 1996 1997 1996 1997
Options granted................. 86,184 137,416 24,551 35,597 11,520 690,360
Options forfeited............... 1,512 4,057 -- -- 1,440 1,440
Expected volatility............. .254 .254 .254 .254 .254 .254
Expected life in years.......... 6.00 4.00 5.00 - 6.00 5.00 6.00 6.00
Stock price on date of grant.... $6.53 $7.51 $6.66 - $7.50 $9.78 $6.94 $9.38 - $16.78
Exercise price.................. $6.53 $7.51 $6.66 - $7.50 $9.78 $6.94 $9.38 - $16.78
Expected dividend yield......... .22% .21% .21% .21% .21% .21%
Risk-free interest rate......... 6.30% 5.70% 5.23% - 6.42% 6.20% 6.86% 5.76% - 6.66%
Vesting period in years......... 1 1 0 - 1 0 1 1
The Black-Scholes option valuation model was developed for use in
estimating the fair market value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions, including the expected stock
price volatility. Because Sovereign's employee stock options have
characteristics significantly different from those traded options and because
changes in the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide reliable single measure of fair value of its employee stock options.
The pro forma reduction to after-tax net income for 1997, 1996 and 1995 was
$1.1 million, $287,000 and $53,000, respectively. The pro forma reduction to
diluted earnings per share for 1997 was $.009, for 1996 was $.002 and for 1995
was $.000.
(13) EMPLOYEE BENEFIT PLANS
Sovereign sponsors a non-contributory defined benefit pension plan which
covers substantially all employees who have attained the age of 21 and completed
one year of service. Benefits under the plan are based upon years of service and
the employees' average compensation computed based upon the five consecutive
plan years of highest pay during the ten years preceding retirement or
termination.
It is Sovereign's policy to fund the minimum contribution as determined by
an actuarial valuation. The net periodic pension costs for this plan are
comprised of the following components (in thousands):
63
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(13) EMPLOYEE BENEFIT PLANS -- (CONTINUED)
YEAR ENDED DECEMBER 31,
------------------------
1997 1996 1995
------ ------ ------
Service cost benefits earned during the period...... $1,403 $1,484 $1,364
Interest cost on projected benefit obligation....... 1,624 2,178 2,039
Actual return on plan assets........................ (6,651) (4,537) (6,067)
Amortization of unrecognized net assets and other
deferred amounts, net............................. 4,267 1,487 3,665
Curtailment loss.................................... -- 542 --
------ ------ ------
Net periodic pension expense...................... $ 643 $1,154 $1,001
------ ------ ------
------ ------ ------
The following table sets forth the pension plan's funded status at December
31, 1997 and 1996 (in thousands):
YEAR ENDED
DECEMBER 31,
-----------------
1997 1996
------- -------
Fair value of plan assets................................. $31,937 $37,237
------- -------
------- -------
Projected benefit obligation:
Vested benefits......................................... $22,263 $28,127
Non-vested benefits..................................... 689 1,026
Effect of projected future salary increases............. 3,061 3,656
------- -------
Projected benefit obligation......................... $26,013 $32,809
------- -------
------- -------
Plan assets in excess of (less than) the projected benefit
obligation.............................................. $ 5,924 $ 4,429
Unrecognized net (asset) existing at transition date...... (123) (443)
Unrecognized net loss..................................... (2,638) (1,087)
Unrecognized prior service cost........................... (92) (137)
------- -------
Net pension asset included in balance sheet............. $ 3,071 $ 2,762
------- -------
------- -------
In determining the projected benefit obligation, the assumed discount rates
at December 31, 1997, 1996 and 1995 were 6.75%, 7.16% and 7.32%, respectively.
The weighted average rate of salary increase was 4.50% for 1997, 5.15% for 1996
and 5.25% for 1995. The expected long-term rate of return on assets used in
determining net periodic pension expense was 9.00% for 1997, 8.78% for 1996 and
8.79% for 1995.
The pension plan's assets consist primarily of common stock, fixed income
securities such as corporate bonds and U.S. Treasury securities and units of
certain common trust funds.
Sovereign also maintains a 401(k) savings plan. Substantially all employees
of Sovereign are eligible to participate in the 401(k) savings plan following
their completion of one year of service and attaining age 21. Sovereign's
contributions to this plan were $490,000, $211,000 and $191,000 during 1997,
1996 and 1995, respectively. Pursuant to this plan, employees can contribute up
to 10% of their compensation to the plan. Sovereign contributes 50% of the
employee contribution up to 6% of compensation in the form of Sovereign common
stock.
Additionally, Sovereign maintains an Employee Stock Ownership Plan
("ESOP"). Substantially all employees of Sovereign are eligible to participate
in the ESOP following their completion of one year of service and attaining age
21. The ESOP is a deferred contribution plan which provides retirement benefits
for participants and beneficiaries by purchasing Sovereign common stock in the
open market. The amount of annual contributions to the ESOP by Sovereign is
determined by the
64
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(13) EMPLOYEE BENEFIT PLANS -- (CONTINUED)
Board of Directors based upon the financial performance of Sovereign each year.
Sovereign recognized as expense $4.7 million, $2.7 million and $1.9 million to
the ESOP during 1997, 1996 and 1995, respectively.
On November 21, 1994, Sovereign's Board of Directors authorized an
amendment to Sovereign's ESOP to add a leverage feature to purchase up to 6.7
million shares of Sovereign's outstanding common stock in the open market or in
negotiated transactions. The ESOP is funded through direct loans from Sovereign
totaling $40.0 million in 1997. The proceeds from these loans were used to
purchase outstanding shares of Sovereign's common stock. As the debt on these
loans is repaid, shares of Sovereign common stock are released and become
eligible for allocation to employee accounts. In addition, dividends are paid on
all shares of Sovereign common stock, including unallocated shares held by the
ESOP. Dividends on the unallocated shares are allocated on a pro-rata basis when
purchased shares are released. Compensation expense is recognized based on the
fair value of the shares committed to be released to employees and the shares
then become outstanding for earnings per share computations. Sovereign has
committed to make contributions sufficient to provide for the ESOP debt
requirements. At December 31, 1997, the ESOP held 5.9 million shares of which
1.3 million shares were allocated to employee accounts. The unallocated ESOP
shares are presented as a reduction of stockholders' equity in the consolidated
financial statements. At December 31, 1997, the fair value of the unallocated
shares held by the ESOP was $79.7 million.
Sovereign's Compensation Committee administers the ESOP. Under the ESOP,
the trustees are directed to vote all allocated shares held in the ESOP in
accordance with the instructions of the participants to whom the shares have
been allocated. In addition, the trustees shall vote in their sole discretion
any shares in the unallocated suspense account.
In 1992, Sovereign implemented the Employee Stock Purchase Plan which
permits eligible employees to purchase Sovereign common stock directly from
Sovereign. Purchases of common stock are limited to 15% of a participant's
compensation. During 1997, 1996 and 1995, participants purchased Sovereign
common stock at a price equal to 92.5% of the fair value of Sovereign common
stock on the offering date. Compensation expense for this plan for the year
ended December 31, 1997, 1996 and 1995 was $46,000, $41,000 and $31,000,
respectively.
65
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(14) INCOME TAXES
The provision for income taxes in the consolidated statement of operations
is comprised of the following components (in thousands):
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------- ------- -------
Current:
Federal................................................ $56,247 $35,549 $35,762
State.................................................. 2,341 3,444 4,063
------- ------- -------
58,588 38,993 39,825
Deferred................................................. (6,212) 4,443 1,529
------- ------- -------
Total income tax expense............................... $52,376 $43,436 $41,354
------- ------- -------
------- ------- -------
The following is a reconciliation of the actual tax provisions with taxes
computed at the federal statutory rate of 35% for 1997, 1996 and 1995:
YEAR ENDED DECEMBER 31,
------------------------
1997 1996 1995
---- ---- ----
Federal income tax at statutory rate........................ 35.0% 35.0% 35.0%
Increase (decrease) in taxes resulting from:
Tax-exempt interest....................................... (2.3) (1.3) (.3)
State income taxes, net of federal tax benefit............ 1.2 2.0 2.0
Amortization of intangible assets and other purchase
accounting adjustments................................. 1.3 1.5 1.8
Non-deductible, merger-related costs...................... 2.7 .2 .1
Other..................................................... 2.4 .8 (4.6)
---- ---- ----
40.3% 38.2% 34.0%
---- ---- ----
---- ---- ----
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are presented
below (in thousands):
YEAR ENDED DECEMBER 31,
------------------------------
1997 1996 1995
-------- -------- --------
Deferred tax assets:
Allowance for possible loan losses................... $ 28,441 $ 18,106 $ 18,794
Merger related liabilities........................... 1,104 1,006 785
Purchase accounting adjustments...................... 926 2,329 3,538
Unrealized loss on available-for-sale portfolio...... 89 89 30
Net operating loss carryforwards..................... 417 417 --
Other................................................ 4,016 4,502 2,209
-------- -------- --------
Total deferred tax assets............................ $ 34,993 $ 26,449 $ 25,356
-------- -------- --------
Deferred tax liabilities:
Purchase accounting adjustments...................... $ 6,231 $ 7,188 $ 8,559
Deferred loan fees................................... 5,543 5,574 2,994
Unrealized gain on available-for-sale portfolio...... 7,093 1,815 2,708
Other................................................ 14,029 11,545 8,202
-------- -------- --------
Total deferred tax liabilities....................... $ 32,896 $ 26,122 $ 22,463
-------- -------- --------
Net deferred tax asset............................... $ 2,097 $ 327 $ 2,893
-------- -------- --------
-------- -------- --------
66
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(14) INCOME TAXES -- (CONTINUED)
Sovereign has determined that it is not required to establish any valuation
reserve for deferred tax assets since it is more likely than not that deferred
tax assets will be principally realized through carry back to taxable income in
prior years. Sovereign's conclusion that it is "more likely than not" that the
deferred tax assets will be realized is based on a history of growth in earnings
and the prospects for continued growth including an analysis of potential
uncertainties that may affect future operating results. Sovereign will continue
to review the criteria related to the recognition of deferred tax assets on a
quarterly basis.
(15) COMMITMENTS AND CONTINGENCIES
Financial Instruments
Sovereign is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers
and to manage its own exposure to fluctuations in interest rates. These
financial instruments include commitments to extend credit, standby letters of
credit, loans sold with recourse, forward contracts and interest rate swaps,
caps and floors. These financial instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the consolidated balance sheet. The contract or notional amounts of these
financial instruments reflect the extent of involvement Sovereign has in
particular classes of financial instruments.
Sovereign's exposure to credit loss in the event of non-performance by the
other party to the financial instrument for commitments to extend credit,
standby letters of credit and loans sold with recourse is represented by the
contractual amount of those instruments. Sovereign uses the same credit policies
in making commitments and conditional obligations as it does for on-balance
sheet instruments. For interest rate swaps, caps and floors and forward
contracts, the contract or notional amounts do not represent exposure to credit
loss. Sovereign controls the credit risk of its interest rate swaps, caps and
floors and forward contracts through credit approvals, limits and monitoring
procedures. Unless noted otherwise, Sovereign does not require and is not
required to pledge collateral or other security to support financial instruments
with credit risk.
The following schedule summarizes Sovereign's off-balance sheet financial
instruments (in thousands):
CONTRACT OR NOTIONAL AMOUNT
AT DECEMBER 31,
----------------------------
1997 1996
----------- -----------
Financial instruments whose contract amounts represent
credit risk:
Commitments to extend credit.............................. $ 912,252 $ 615,835
Standby letters of credit................................. 8,483 4,541
Loans sold with recourse.................................. 48,899 60,113
Financial instruments whose notional or contract amounts
exceed the amount of credit risk:
Forward contracts......................................... 51,872 32,500
Interest rate swaps....................................... 3,589,376 2,517,013
Interest rate caps/floors................................. 1,200,000 500,000
67
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(15) COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. Sovereign evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained upon
extension of credit is based on management's credit evaluation of the
counterparty. Collateral held usually consists of real estate but may include
securities, accounts receivable, inventory and property, plant and equipment.
Standby letters of credit are conditional commitments issued by Sovereign
to guarantee the performance of a customer to a third party. The guarantees are
primarily issued to support public and private borrowing arrangements. Most
guarantees expire in 1998, one guarantee expires in April 1999, one guarantee
expires in September 2000 and one guarantee for $1.4 million expires in January
2011. The credit risk involved in issuing letters of credit is essentially the
same as that involved in extending loan facilities to customers. Sovereign holds
various collateral to support the commitments.
Loans sold with recourse primarily represent residential loans.
The forward contracts used by Sovereign in its mortgage banking activities
are contracts for delayed delivery of securities in which Sovereign agrees to
make delivery of a specified instrument, at a specified future date, at a
specified price or yield. Risks arise from the possible inability of
counterparties to meet the terms of their contracts and from movements in
securities' values and interest rates.
Interest rate swaps, caps and floors enable Sovereign to transfer, modify
or reduce its interest rate risk and are used as part of asset and liability
management. Sovereign may become a principal in the exchange of interest
payments with another party and therefore, is exposed to loss should one of the
other parties default. Sovereign minimizes this risk by performing credit
reviews on counterparties.
Notional principal amounts often are used to express the volume of these
transactions, but the amounts potentially subject to credit risk are much
smaller.
Litigation
At December 31, 1997, Sovereign was party to a number of lawsuits. While
any litigation has an element of uncertainty, management, after reviewing these
actions with legal counsel, is of the opinion that the liability, if any,
resulting from these actions will not have a material effect on the financial
condition or results of operations of Sovereign.
68
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents disclosures about the fair value of financial
instruments as defined by SFAS No. 107, "Fair Value of Financial Instruments."
These fair values are presented based upon subjective estimates of relevant
market conditions at a specific point in time and information about each
financial instrument. In cases where quoted market prices are not available,
fair values are based on estimates using present value or other valuation
techniques. These techniques involve uncertainties resulting in variability in
estimates affected by changes in assumptions and risks of the financial
instruments at a certain point in time. Therefore, the derived fair value
estimates presented below cannot be substantiated by comparison to independent
markets. In addition, the fair values do not reflect any premium or discount
that could result from offering for sale at one time an entity's entire holdings
of a particular financial instrument nor does it reflect potential taxes and the
expenses that would be incurred in an actual sale or settlement. Accordingly,
the aggregate fair value amounts presented do not represent the underlying value
of Sovereign (in thousands):
AT DECEMBER 31,
-------------------------------------------------
1997 1996
----------------------- -----------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
---------- ---------- ---------- ----------
Financial Assets:
Cash and amounts due from depository
institutions...................... $ 189,101 $ 189,101 $ 127,253 $ 127,253
Interest-earning deposits............ 12,611 12,611 6,273 6,273
Loans held for sale.................. 22,826 22,898 32,955 33,162
Investment and mortgage-backed
securities available-for-sale..... 1,029,524 1,029,524 528,887 528,887
Investment and mortgage-backed
securities held-to-maturity....... 2,871,815 2,898,609 3,195,094 3,176,660
Loans, net........................... 9,832,629 9,877,750 8,269,082 8,277,033
Interest-only strips................. 1,031 5,287 815 4,187
Mortgage servicing rights............ 8,928 11,160 5,954 7,428
Cash surrender value of life
insurance......................... -- -- 11,978 11,978
Financial Liabilities:
Deposits............................. 7,889,921 7,890,682 7,235,395 7,233,585
Borrowings(1)........................ 5,501,982 5,510,538 4,490,431 4,494,576
Unrecognized Financial Instruments:(2)
Commitments to extend credit......... 2,266 2,272 1,315 1,239
Standby letters of credit............ 1 5 7 12
Loans sold with recourse............. 244 98 301 120
Interest rate swaps, caps and
floors............................ 9,963 (12,858) 9,283 3,755
- ------------------
(1) Borrowings are shown without unamortized cap premiums, as cap premiums are
reflected separately below in "Interest rate swaps, caps and floors."
(2) The amounts shown under "carrying value" represent accruals or deferred
income (cost) arising from those unrecognized financial instruments.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments:
Cash and amounts due from depository institutions and interest-earning
deposits. For these short-term instruments, the carrying amount is a reasonable
estimate of fair value.
Loans held for sale. Fair values are estimated using quoted rates based
upon secondary market sources for securities backed by similar loans. Fair value
estimates include consideration of all open positions (including forward
contracts), outstanding commitments and related fees paid.
69
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS -- (CONTINUED)
Investment and mortgage-backed securities available-for-sale. The fair
value of investment and mortgage-backed securities available-for-sale are based
on quoted market prices as of the balance sheet date. In accordance with SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities,"
changes in fair value are reflected in the carrying value of the asset and are
shown as a separate component of stockholders' equity.
Investment and mortgage-backed securities held-to-maturity. The carrying
amounts for short-term investment and mortgage-backed securities
held-to-maturity approximate fair value because of the short maturity of these
instruments and they do not present unanticipated credit concerns. The fair
value of long-term investments and mortgage-backed securities held-to-maturity
is estimated based upon bid quotations received from securities dealers and an
independent pricing servicing bureau.
Loans. Fair value is estimated by discounting cash flows using estimated
market discount rates at which similar loans would be made to borrowers and
reflect similar credit ratings and interest rate risk for the same remaining
maturities.
Mortgage servicing rights. The fair value of mortgage servicing rights,
including excess servicing rights which are accounted for as interest-only
strips, is estimated using quoted rates based upon secondary market sources. The
estimated fair value approximates the amount for which the servicing could
currently be sold.
Cash surrender value of life insurance. The carrying value of the cash
surrender value of life insurance, which was acquired in the First State
transaction, is a reasonable estimate of fair value.
Deposits. The fair value of deposits with no stated maturity, such as
non-interest bearing demand deposits, NOW accounts, savings accounts and certain
money market accounts, is equal to the amount payable on demand as of the
balance sheet date. The fair value of fixed-maturity certificates of deposit is
estimated by discounting cash flows using currently offered rates for deposits
of similar remaining maturities.
Borrowings. Fair value is estimated by discounting cash flows using rates
currently available to Sovereign for other borrowings with similar terms and
remaining maturities.
Commitments to extend credit. The fair value of commitments to extend
credit is estimated using the fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
present creditworthiness of the counterparties. For fixed rate loan commitments,
fair value also considers the difference between current levels of interest
rates and the committed rates.
Standby letters of credit. The fair value of letters of credit is based on
fees currently charged for similar agreements or on the estimated cost to
terminate them or otherwise settle the obligations with the counterparties.
Loans sold with recourse. The fair value of loans sold with recourse is
estimated based upon the cost to terminate Sovereign's obligations under the
recourse provisions.
Interest rate swaps, caps and floors. The fair value of interest rate
swaps, caps and floors which represent the estimated amount Sovereign would
receive or pay to terminate the contracts or agreements, taking into account
current interest rates and when appropriate, the current creditworthiness of the
counterparties are obtained from dealer quotes.
70
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(17) INTEREST RATE EXCHANGE AGREEMENTS
Amortizing and non-amortizing interest rate swaps are generally used to
convert fixed rate assets and liabilities to variable rate assets and
liabilities and vice versa. Interest rate caps are generally used to limit the
exposure from the repricing and maturity of liabilities. Interest rate floors
are generally used to limit the exposure from repricing and maturity of assets.
Interest rate caps and floors are also used to limit the exposure created by
other interest rate swaps. In certain cases, interest rate caps and floors are
simultaneously bought and sold to create a range of protection 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 (in thousands):
AT DECEMBER 31, 1997 AT DECEMBER 31, 1996
------------------------------------------- -------------------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
NOTIONAL BOOK ESTIMATED MATURITY NOTIONAL BOOK ESTIMATED MATURITY
AMOUNT VALUE FAIR VALUE IN YEARS AMOUNT VALUE FAIR VALUE IN YEARS
---------- ------ ---------- -------- ---------- ------ ---------- --------
Amortizing interest rate
swaps:
Pay variable-receive
fixed(1)............ $ 602,116 $ -- $ 1,436 2.8 $ 713,448 $ -- $(10,459) 3.6
Pay fixed-receive
variable(2)......... 208,761 -- (9) 1.3 398,565 -- (464) 2.3
Non-amortizing interest
rate swaps:
Pay variable-receive
fixed(3)............ 28,499 -- (561) 2.7 50,000 -- (1,738) 3.7
Pay fixed-receive
variable(4)......... 2,750,000 -- (9,290) 2.3 1,355,000 -- 9,152 2.2
Interest rate
caps/floors(5)........ 1,200,000 9,963 (4,434) 4.0 500,000 9,283 7,264 4.5
---------- ------ -------- ---------- ------ --------
$4,789,376 $9,963 $(12,858) $3,017,013 $9,283 $ 3,755
---------- ------ -------- ---------- ------ --------
---------- ------ -------- ---------- ------ --------
- ------------------
(1) The weighted average pay rate was 5.58% and 5.50% and the weighted average
receive rate was 5.97% and 5.93% at December 31, 1997 and 1996,
respectively.
(2) The weighted average pay rate was 6.87% and 6.76% and the weighted average
receive rate was 6.80% and 6.18% at December 31, 1997 and 1996,
respectively.
(3) The weighted average pay rate was 7.28% and 6.91% and the weighted average
receive rate was 6.75% and 6.75% at December 31, 1997 and 1996,
respectively.
(4) The weighted average pay rate was 5.89% and 5.28% and the weighted average
receive rate was 4.47% and 5.53% at December 31, 1997 and 1996,
respectively.
(5) The weighted average strike price range was 5.25%-7.50% at December 31, 1997
and the weighted average contract rate was 6.00% at December 31, 1996.
71
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(17) INTEREST RATE EXCHANGE AGREEMENTS -- (CONTINUED)
The following table summarizes by notional amounts the activity of
Sovereign's interest rate exchange agreements (in thousands):
AMORTIZING NON-AMORTIZING
INTEREST INTEREST INTEREST
RATE SWAPS RATE SWAPS RATE CAPS TOTAL
---------- -------------- ---------- ----------
Balance, December 31, 1994............ $1,085,645 $ 250,000 $ 450,000 $1,785,645
---------- ---------- ---------- ----------
Additions........................... 300,000 280,000 996,000 1,576,000
Maturities/Amortization............. 326,795 200,000 -- 526,795
Terminations........................ 177,720 -- -- 177,720
---------- ---------- ---------- ----------
Balance, December 31, 1995............ 881,130 330,000 1,446,000 2,657,130
---------- ---------- ---------- ----------
Additions........................... 300,000 1,125,000 500,000 1,925,000
Maturities/Amortization............. 69,117 -- 450,000 519,117
Terminations........................ -- 50,000 996,000 1,046,000
---------- ---------- ---------- ----------
Balance, December 31, 1996............ 1,112,013 1,405,000 500,000 3,017,013
---------- ---------- ---------- ----------
Additions........................... -- 4,125,000 700,000 4,825,000
Maturities/Amortization............. 151,136 151,501 -- 302,637
Terminations........................ 150,000 2,600,000 -- 2,750,000
---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1997............ $ 810,877 $2,778,499 $1,200,000 $4,789,376
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
At December 31, 1997, Sovereign's balance sheet included a net deferred
loss of $956,000 related to interest rate exchange agreements terminated in June
1996 and September 1997 which were originally accounted for as hedges. This net
deferred loss will amortize into interest expense in 1998.
Net interest income resulting from interest rate exchange agreements
included $4.8 million of income and $4.8 million of expense for 1997, $5.1
million of income and $7.4 million of expense for 1996 and $1.7 million of
income and $3.6 million of expense for 1995.
72
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(18) PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Sovereign Bancorp, Inc. is as follows
(in thousands):
BALANCE SHEETS
---------------------
AT DECEMBER 31,
---------------------
1997 1996
---------- --------
Assets
Interest-earning deposits............................ $ 1,628 $ 120
Investment securities................................ 103,173 15,514
Investment in subsidiaries........................... 917,172 841,452
Other assets......................................... 4,829 18,975
---------- --------
Total Assets........................................... $1,026,802 $876,061
---------- --------
---------- --------
Liabilities
Long-term borrowings................................. $ 146,358 $167,748
Other liabilities.................................... 4,725 6,888
---------- --------
Total liabilities...................................... 151,083 174,636
---------- --------
Trust Preferred Securities............................. 97,472 --
---------- --------
Stockholders' Equity................................... 778,247 701,425
---------- --------
Total Liabilities, Minority Interests and Stockholders'
Equity............................................... $1,026,802 $876,061
---------- --------
---------- --------
STATEMENTS OF OPERATIONS
---------------------------
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------- ------- -------
Interest income.................................. $ 8,763 $ 2,790 $ 4,460
Other income..................................... 473 18,003 8,991
------- ------- -------
Total income..................................... 9,236 20,793 13,451
------- ------- -------
Interest expense................................. 13,089 13,117 11,758
Other expense.................................... 8,663 5,567 4,892
Trust Preferred Securities expense............... 6,989 -- --
------- ------- -------
Total expense.................................... 28,741 18,684 16,650
------- ------- -------
Income before taxes, dividends and undistributed
earnings of subsidiaries....................... (19,505) 2,109 (3,199)
Income taxes..................................... (6,523) (5,431) (4,565)
------- ------- -------
Income before earnings of subsidiaries........... (12,982) 7,540 1,366
Distributed earnings from subsidiaries........... -- -- 20,544
Undistributed earnings of subsidiaries........... 90,622 62,599 58,500
------- ------- -------
Net Income....................................... $77,640 $70,139 $80,410
------- ------- -------
------- ------- -------
73
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(18) PARENT COMPANY FINANCIAL INFORMATION -- (CONTINUED)
STATEMENTS OF CASH FLOWS
---------------------------
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------- ------- -------
Cash Flows from Operating Activities:
Net income..................................... $77,640 $70,139 $80,410
Adjustments to reconcile net income to net cash
provided by operating activities:
Dividends received from subsidiaries(1)..... -- 1,600 18,944
Earnings from subsidiaries.................. (90,622) (62,599) (79,044)
Allocation of Employee Stock Ownership Plan
shares................................... 4,958 2,785 2,027
Change in other assets...................... 14,146 29,992 (45,038)
Change in other liabilities................. (284) 1,298 2,476
------- ------- -------
Net cash provided (used) by operating
activities..................................... 5,838 43,215 (20,225)
------- ------- -------
Cash Flows from Investing Activities:
Investment in subsidiaries..................... 14,902 (10,282) (88,168)
Maturity and repayments of investment
securities.................................. 1,781 1,259 1,221
Net change in investment securities(1)......... (80,098) (6,561) (1,551)
Other, net..................................... (4,996) 3,968 7,100
------- ------- -------
Net cash used by investing activities............ (68,411) (11,616) (81,398)
------- ------- -------
Cash Flows from Financing Activities:
Net change in short-term borrowings............ -- (714) (714)
Net change in long-term borrowings............. (21,390) 477 (376)
Proceeds from issuance of Trust Preferred
Securities.................................. 97,574 -- --
Cash dividends paid to stockholders............ (18,003) (18,820) (15,844)
Net cash received from debt offering........... -- -- 49,379
Proceeds from issuance of common stock......... 5,997 4,595 3,166
Proceeds from issuance of preferred stock...... -- -- 96,446
Purchase of Employee Stock Ownership Plan
shares...................................... -- (4,559) (30,286)
Purchase of treasury stock..................... (97) (12,958) (956)
------- ------- -------
Net cash provided (used) by financing
activities..................................... 64,081 (31,979) 100,815
------- ------- -------
Increase (decrease) in cash and cash
equivalents.................................... 1,508 (380) (808)
Cash and cash equivalents at beginning of
period......................................... 120 500 1,308
------- ------- -------
Cash and cash equivalents at end of period....... $ 1,628 $ 120 $ 500
------- ------- -------
------- ------- -------
- ------------------
(1) The 1996 results reflect the dissolution and subsequent merger of Sovereign
Investment Corporation into Sovereign Bancorp during 1996.
74
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information relating to executive officers of Sovereign is included
under Item 4A in Part I hereof. The information required by this item relating
to directors of Sovereign is incorporated herein by reference to (i) that
portion of the section captioned "Election of Directors" located in the
definitive Proxy Statement to be used in connection with Sovereign's 1998 Annual
Meeting of Shareholders (the "Proxy Statement"). The information required by
this item relating to compliance with Section 16(a) of the Securities Exchange
Act of 1934 is incorporated herein by reference to the section captioned
"Additional Information Regarding Directors and Officers" in the Proxy
Statement.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated herein by reference
to (i) the sections captioned "Compensation Paid to Directors" through
"Indemnification" in the Proxy Statement and (ii) the section captioned
"Performance Graph" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is incorporated herein by reference
to (i) the section captioned "Principal Shareholders" in the Proxy Statement and
(ii) that portion of the section captioned "Election of Directors" in the Proxy
Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated herein by reference
to the sections captioned "Indebtedness of Management" in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(A) 1. FINANCIAL STATEMENTS.
Consolidated financial statements are omitted because the required
information is either not applicable, not required or is shown in the respective
financial statements in the notes thereto.
2. FINANCIAL STATEMENT SCHEDULES.
Financial statement schedules are omitted because the required information
is either not applicable, not required or is shown in the respective financial
statements or in the notes thereto.
3. EXHIBITS.
(3.1) Articles of Incorporation, as amended and restated, of Sovereign
Bancorp, Inc. (Incorporated by reference to Exhibit 3.1 to
Sovereign's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995.)
(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 the
fiscal year ended December 31, 1993.)
(4.1) Sovereign Bancorp, Inc. has certain long-term debt outstanding.
None of the instruments evidencing such debt authorizes an amount
of securities in excess of 10% of the total assets of Sovereign
Bancorp, Inc. and its subsidiaries on a consolidated basis;
therefore, copies of such instruments are not included as exhibits
to this Annual Report on Form 10-K. Sovereign Bancorp, Inc. agrees
to furnish copies of such instruments to the Commission on request.
75
(10.1) Sovereign Bancorp, Inc. Stock Option Plan. (Incorporated by
reference to Exhibit 10.1 to Sovereign's Annual Report on Form 10-K
for the fiscal year ended December 31, 1994.)
(10.2) Sovereign Bancorp, Inc. Employee Stock Purchase Plan. (Incorporated
by reference to Exhibit 4.1 to Sovereign's Registration Statement
No. 33-44108 on Form S-8.)
(10.3) Agreement dated as of March 1, 1997, between Sovereign Bancorp,
Inc., Sovereign Bank, and Jay S. Sidhu. (Incorporated by
reference to Exhibit 10.1 to Sovereign's Quarterly Report on Form
10-Q for the quarter ended March 31, 1997.)
(10.4) Agreement dated as of September 25, 1997, between Sovereign Bank
and Karl D. Gerhart.
(10.5) Agreement dated as of September 25, 1997, between Sovereign Bank
and Lawrence M. Thompson, Jr.
(10.6) Penn Savings Bank Senior Officer Incentive Plan. (Incorporated by
reference to Exhibit 10.6 to Sovereign's Annual Report on Form 10-K
for the year ended December 31, 1994.)
(10.11) Rights Agreement dated September 19, 1989, between Sovereign
Bancorp, Inc. and Harris Trust Company of New York. (Incorporated
by reference to Exhibit 4.3 to Sovereign's Registration Statement
No. 33-89586 on Form S-8).
(10.12) Sovereign Bancorp, Inc. Non-Employee Director Incentive
Compensation Plan. (Incorporated by reference to Exhibit 10.12 to
Sovereign's Registration Statement No. 33-43195 on Form S-1).
(10.14) 1993 Sovereign Bancorp, Inc. Stock Option Plan. (Incorporated by
reference to Exhibit 10.23 to Sovereign's Annual Report on Form
10-K for the year ended December 31, 1992).
(10.15) Indemnification Agreement dated December 21, 1993, between
Sovereign Bank and Jay S. Sidhu. (Incorporated by reference to
Exhibit 10.25 to Sovereign's Annual Report on Form 10-K for the
fiscal year ended December 31, 1993.)
(10.16) Employment Agreement dated as of August 8, 1988, between Charter
Federal Savings Bank and Patrick J. Petrone. (Incorporated by
reference to Exhibit 10.23 to Sovereign's Annual Report on Form
10-K for the fiscal year ended December 31, 1994.)
(10.17) Amendment to Employment Agreement between Patrick J. Petrone and
Charter Federal Savings Bank, dated October 17, 1994. (Incorporated
by reference to Exhibit 10.24 to Sovereign's Annual Report on Form
10-K for the fiscal year ended December 31, 1994.)
76
(10.18) Amendment to Rights Agreement, dated as of September 27, 1995,
between Sovereign Bancorp, Inc. and Chemical Bank, as successor to
Harris Trust Company of New York, as Rights Agent. (Incorporated by
reference to Exhibit 2.2 of Amendment No. 1 of Sovereign's
Registration Statement on Form 8-A.)
(11.1) Computation of Per Share Earnings.
(21) Subsidiaries of the Registrant
(23.1) Consent of Ernst & Young LLP, Independent Auditors.
(23.2) Consent of KPMG Peat Marwick LLP, Independent Auditors.
(23.3) Consent of KPMG Peat Marwick LLP, Independent Auditors.
(27) Financial Data Schedule
(99.1) Report of KPMG Peat Marwick LLP, Independent Auditors.
(99.2) Report of KPMG Peat Marwick LLP, Independent Auditors.
(B) REPORTS ON FORM 8-K.
1. Report on Form 8-K, dated February 3, 1997 (date of earliest event --
January 20, 1997), contained a press release announcing Sovereign Bancorp Inc.'s
earnings for the year ended December 31, 1996 and a press release announcing an
amendment to the timing of the 6 for 5 stock split on Sovereign Bancorp Inc.
common stock which was declared on January 16, 1997.
2. Report on Form 8-K, dated February 6, 1997 (date of earliest event --
February 6, 1997), contained a press release announcing the execution of an
Agreement and Plan of Merger for Sovereign Bancorp Inc. to acquire Bankers Corp.
3. Report on Form 8-K, dated February 13, 1997 (date of earliest event --
February 5, 1997), described the Agreement and Plan of Merger dated February 5,
1997 pursuant to which Sovereign Bancorp Inc. will acquire Bankers Corp.
4. Report on Form 8-K, dated March 17, 1997 (date of earliest event -- March
17, 1997), contained pro forma financial information showing the effects of the
merger of First State Financial Services, Inc. with and into Sovereign Bancorp,
Inc. which was effective as of February 18, 1997, and the pending acquisition of
Bankers Corp.
5. Report on Form 8-K, dated June 17, 1997 (date of earliest event -- June
17, 1997), contained Sovereign Bancorp Inc.'s 1996 financial statements restated
to include the merger of First State Financial Services, Inc. with and into
Sovereign Bancorp, Inc.
6. Report on Form 8-K, dated September 12, 1997 (date of earliest event --
August 29, 1997), summarized the completion of Sovereign Bancorp Inc.'s
acquisition of Bankers Corp.
7. Report on Form 8-K, dated September 22, 1997 (date of earliest event --
September 18, 1997), contained a press release announcing the execution of an
Agreement and Plan of Merger for Sovereign Bancorp Inc. to acquire ML Bancorp.
8. Report on Form 8-K/A, dated November 10, 1997 (date of earliest event --
August 29, 1997), contained Bankers Corp.'s 1996 Form 10-K and pro forma
financial information showing the effects of the merger of Bankers Corp. with
and into Sovereign Bancorp, Inc., which was effective as of August 29, 1997.
9. Report on Form 8-K, dated December 9, 1997 (date of earliest event --
December 8, 1997), contained Sovereign Bancorp Inc.'s 1996 financial statements
restated to include the merger of Bankers Corp. with and into Sovereign
Bancorp, Inc.
77
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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)
February 19, 1998 By /s/ JAY S. SIDHU
--------------------------------
Jay S. Sidhu, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities and on
the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
Director
- -------------------------
Fred D. Hafer
/S/ RICHARD E. MOHN Chairman of Board and Director February 19, 1998
- -------------------------
Richard E. Mohn
/S/ RHODA S. OBERHOLTZER Director February 19, 1998
- -------------------------
Rhoda S. Oberholtzer
/S/ PATRICK J. PETRONE Director February 19, 1998
- -------------------------
Patrick J. Petrone
/S/ DANIEL K. ROTHERMEL Director February 19, 1998
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Daniel K. Rothermel
/S/ JAY S. SIDHU Director, President and Chief February 19, 1998
- ------------------------- Executive Officer
Jay S. Sidhu (Principal Executive Officer)
Director
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Cameron C. Troilo
/S/ G. ARTHUR WEAVER Director February 19, 1998
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G. Arthur Weaver
/S/ KARL D. GERHART Chief Financial Officer February 19, 1998
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Karl D. Gerhart
/S/ MARK R.McCOLLOM Chief Accounting Officer February 19, 1998
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Mark R.McCollom