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UNITED STATES
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, 2000, 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 ____________ .
Commission File Number 0-16533
SOVEREIGN BANCORP, INC.
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2453088
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
2000 Market Street, Philadelphia, Pennsylvania 19103
(Address of Principal Executive Offices) (Zip Code)
(215) 557-4630
Registrant's Telephone Number
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)
(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 [_]
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 $2,189,266,460 at March 1, 2001. As
of March 1, 2001, the Registrant had 246,677,911 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's definitive Proxy Statement to be used in connection with
its 2001 Annual Meeting of Shareholders is incorporated herein by reference in
response to Part III hereof.
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FORWARD-LOOKING STATEMENTS
Sovereign Bancorp, Inc. ("Sovereign" or "the Company") may from time to
time make "forward-looking statements," including statements contained in
Sovereign's filings with the Securities and Exchange Commission (including this
Annual Report on Form 10-K and the Exhibits hereto), in its reports to
shareholders (including its 2000 Annual Report) and in other communications by
Sovereign, which are made in good faith by Sovereign, pursuant to the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include statements with respect to
Sovereign's vision, mission, strategies, goals, beliefs, plans, objectives,
expectations, anticipations, estimates, intentions, financial condition, results
of operations, future performance and business of Sovereign, including:(i)
statements relating to Sovereign's expectations and goals with respect to (a)
growth in cash earnings, operating earnings, net income, shareholder value and
internal tangible equity generation; (b) growth in earnings per share; (c)
return on equity; (d) return on assets; (e)efficiency ratio; (f)tier 1 leverage
ratio; (g) annualized net charge-offs and other asset quality measures; (h) fee
income as a percentage of total revenue; (i) tangible equity to assets; (j) book
value and tangible book value per share; (k) loan and deposit portfolio
compositions, employee retention, deposit retention, asset quality, reserve
adequacy; and (ii)statements preceded by, followed by or that include the words
"may," "could," "should," "pro forma," "looking forward," "would," "believe,"
"expect," "anticipate," "estimate," "intend," "plan," "strive," "hopefully,"
"try," or similar expressions. Although we believe that the expectations
reflected in our forward-looking statements are reasonable, these
forward-looking statements involve risks and uncertainties which are subject to
change based on various important factors (some of which, in whole or in part,
are beyond Sovereign's control). The following factors, among others, could
cause Sovereign's financial performance to differ materially from the goals,
plans, objectives, intentions and expectations, forecasts and projections (and
underlying assumptions) expressed in such forward-looking statements:(1)the
strength of the United States economy in general and the strength of the
regional and local economies in which Sovereign conducts operations, (2) the
effects of, and changes in, trade, monetary and fiscal policies and laws,
including interest rate policies of the Board of Governors of the Federal
Reserve System; (3) inflation, interest rate, market and monetary fluctuations;
(4) the ability of Sovereign and Sovereign Bank to successfully integrate the
assets, liabilities, customers, systems and management we acquire into our
operations; (5) the timely development of competitive new products and services
by Sovereign Bank and the acceptance of such products and services by customers;
(6) the willingness of customers to substitute competitors' products and
services and vice versa; (7) the success of Sovereign and Sovereign Bank in
meeting the post-closing regulatory requirements with respect to the FleetBoston
acquisition, and the ability to pay installments on a timely basis related to
the non-solicitation agreement in connection with the acquisition; (8) the
impact of changes in financial services' laws and regulations and the
application of such laws and regulations (including laws concerning taxes,
capital, liquidity, proper accounting treatment, securities and insurance) and
the impact of changes in generally accepted accounting principles; (9)
technological changes; (10) changes in consumer spending and savings habits;
(11) unanticipated regulatory or judicial proceedings; (12) changes in asset
quality; and (13) the success of Sovereign at managing the risks involved in the
foregoing.
Operating earnings, cash earnings, and core revenue, as defined, and the
related ratios using these measures are not a substitute for other financial
measures determined in accordance with generally accepted accounting principles
("GAAP"). Because all companies do not calculate these non-GAAPmeasures in the
same fashion, these measures as presented may not be comparable to other
similarly titled measures of other companies.
Sovereign cautions that the foregoing list of important factors is not
exclusive, and neither such list nor any such forward-looking statement takes
into account the impact that any future acquisition may have on Sovereign and
any such forward-looking statement. Sovereign does not undertake to update any
forward-looking statement, whether written or oral, that may be made from time
to time by or on behalf of Sovereign.
[THIS PAGE INTENTIONALLY LEFT BLANK]
PART I
Item 1. Business.
General
Sovereign Bancorp, Inc. ("Sovereign" or "the Company") is the holding
company for Sovereign Bank ("Sovereign Bank"). Sovereign Bank is among the 30
largest financial insitutions in the United States with over 550 offices
covering a geographic region stretching from north of Boston to south of
Philadelphia. Sovereign is a Pennsylvania business corporation and is
headquartered in Philadelphia, Pennsylvania. Sovereign Bank is 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. Since then, Sovereign
has completed 25 acquisitions with assets totaling approximately $25.7 billion
through December 31, 2000. Sovereign's business consists primarily of attracting
deposits from our network of community banking offices, and originating small
business and middle market commercial and asset-based loans, consumer and
residential mortgage loans and home equity lines of credit in eastern
Pennsylvania, New Jersey, Delaware and New England. As of December 31, 2000,
Sovereign had consolidated assets of $33.5 billion, deposits of $24.5 billion
and stockholders' equity of $1.9 billion.
During 2000, Sovereign acquired $12.3 billion of deposits, $8.0 billion of
loans, and over 280 community banking offices from FleetBoston Financial (the
"SBNE acquisition"). Sovereign successfully completed the SBNE acquisition in
three phases on March 24, June 16, and July 21, 2000. The acquisition, which
became the Sovereign Bank New England Division of Sovereign Bank ("SBNE"),
amounted to the largest branch acquisition in banking history. This transaction
was accounted for as a purchase.
On June 30, 1999, Sovereign acquired Peoples Bancorp, Inc. ("Peoples"), a
$1.4 billion bank holding company headquartered in Lawrenceville, New Jersey
whose principal operating subsidiary operated 14 community banking offices in
Mercer, Burlington and Ocean counties, New Jersey. This transaction was
accounted for as a purchase.
On June 15, 1999, Sovereign acquired The Network Companies ("Network"), a
$50 million privately held specialty leasing company headquartered in Commack,
New York. Network provided financing for the purchase or lease of equipment and
specialty vehicles plus other specialty products for businesses throughout the
United States. This acquisition was accounted for as a purchase.
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 five wholly-owned subsidiaries: Sovereign Bank, Sovereign
Delaware Investment Corporation, is Sovereign Capital Trust I, Sovereign Capital
Trust II, and ML Capital Trust I. Sovereign Delaware Investment Corporation, is
a Delaware corporation whose primary purpose is to purchase and hold certain
investment securities. Sovereign Capital Trust I and Sovereign Capital Trust II
are special-purpose statutory trusts, created expressly for the issuance of
preferred capital securities, which solely holds subordinated debentures of
Sovereign. ML Capital Trust I is a special-purpose statutory trust created
expressly for the issuance of preferred capital securities.
Employees
At December 31, 2000, Sovereign had 6,554 full-time and 1,207 part-time
employees. None of these employees are 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
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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 loans normally comes from other thrift institutions, commercial
banks, mortgage bankers, mortgage brokers and insurance companies.
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
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 could 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
2
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, 2000, 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 2%, 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 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 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. Associations whose exposure
to interest-rate risk is deemed to be above normal will be required to deduct a
portion of such exposure in calculating their risk-based capital. The OTS may
establish, on a case-by-case basis, individual minimum capital requirements for
a savings association that vary from the minimum requirements that otherwise
would apply under the OTS capital regulations. The OTS has not yet established
such individual minimum capital requirements. 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 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.
3
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, 2000, Sovereign Bank met the criteria to be classified as
"well-capitalized."
The OTS Order (the "OTS Order") issued in connection with the SBNE
acquisition requires Sovereign Bank to be "well capitalized" and also to meet
certain other capital ratio requirements and other conditions. Sovereign's
various agreements with its lenders also require it to cause Sovereign Bank to
be "well capitalized" at all times and in compliance with all regulatory
requirements. To be "well capitalized," Sovereign Bank must maintain a Tier 1
leverage ratio of at least 5%, a Tier 1 risk-based capital ratio of at least 6%
and total risk based capital of at least 10%. As of December 31, 2000, Sovereign
Bank was classified as well capitalized and in compliance with the conditions
and capital requirements discussed above. Management expects that Sovereign Bank
will continue to be classified as well capitalized and in compliance with such
capital requirements and conditions. Although OTS capital regulations do not
apply to savings and loan holding companies, the OTS Order requires Sovereign to
maintain certain Tier 1 capital and related liquidity levels. Sovereign is
presently in compliance with these requirements and expects to remain in
compliance.
Standards for Safety and Soundness. The federal banking agencies adopted
certain operational and managerial standards for depository institutions,
including internal audit system components, loan documentation requirements,
asset growth parameters, information technology and data security practices, 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 Accounts and Regulation by the FDIC. Sovereign Bank is a
member of the Savings Association Insurance Fund, which is administered by the
FDIC. Deposits are insured up to the applicable limits by the FDIC and such
insurance is backed by the full faith and credit of the United States
government. As insurer, the FDIC imposes deposit insurance premiums and is
authorized to conduct examinations of, and to require reporting by, FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious risk
to the Savings Association Insurance Fund or Bank Insurance Fund. The FDIC also
has the authority to initiate enforcement actions against savings institutions,
after giving the Office of Thrift Supervision an opportunity to take such
action, and may terminate an institution's deposit insurance if it determines
that the institution has engaged in unsafe or unsound practices or is in an
unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, institutions classified as
well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1
or core capital to risk-weighted assets ("Tier 1 risk-based capital") of at
least 6% and a risk-based capital ratio of at least 10%) and considered healthy
pay the lowest premium while institutions that are less than adequately
capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a
total risk-based capital ratio of less than 8%) and considered of substantial
supervisory concern pay the highest premium. Risk classification of all insured
institutions is made by the FDIC for each semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semi-annual
basis, if it determines that the reserve ratio of the Savings Association
Insurance Fund will be less than the designated reserve ratio of 1.25% of
Savings Association Insurance Fund insured deposits. In setting these increased
assessments, the FDIC must seek to restore the reserve ratio to that designated
reserve level, or such higher reserve ratio as established by the FDIC. The FDIC
may also impose special assessments on Savings Association Insurance Fund
members to repay amounts borrowed from the United States Treasury or for any
other reason deemed necessary by the FDIC.
The current premium schedule for Savings Association Insurance Fund insured
institutions ranges from 0 to 27 basis points per $100 of deposits. Sovereign
Bank is in the category of institutions that pay no deposit insurance premiums.
However, all insured institutions are required to pay a Financing Corporation
assessment, in order to fund the interest on bonds issued to resolve thrift
failures in the 1980s. The current rate for all insured institutions is 1.96
basis points for each $100 in domestic deposits. These assessments, which may be
revised based upon the level of Bank Insurance Fund and Savings Association
Insurance Fund deposits, will continue until the bonds mature in the year 2017.
4
Federal Restrictions on Transactions with Affiliates. All banks and savings
institutions are subject to affiliate and insider transaction rules applicable
to member banks of the Federal Reserve System set forth in Sections 23A, 23B,
22(g) and 22(h) of the Federal Reserve Act, as well as such additional
limitations as the institutions' primary federal regulator may adopt. These
provisions prohibit or limit a savings institution from extending credit to, or
entering into certain transactions with, affiliates, principal stockholders,
directors and executive officers of the savings institution and its affiliates.
For these purposes, the term "affiliate" generally includes a holding company
such as Sovereign and any company under common control with the savings
institution. In addition, the federal law governing unitary savings and loan
holding companies prohibits Sovereign Bank from making any loan to any affiliate
whose activity is not permitted for a subsidiary of a bank holding company. This
law also prohibits Sovereign Bank from making any equity investment in any
affiliate that is not its subsidiary.
Restrictions on Subsidiary Savings Institution Capital Distributions.
Sovereign's principal sources of funds are cash dividends paid to it by
Sovereign Bank, investment income and borrowings. OTS regulations limit the
ability of savings associations such as Sovereign Bank to pay dividends and make
other capital distributions. Associations that are subsidiaries of a savings and
loan holding company must file a notice with the OTS at least 30 days before the
proposed declaration of a dividend or approval of the proposed capital
distribution by its board of directors. In addition, a savings association must
obtain prior approval from the OTS if it fails to meet certain regulatory
conditions, or if, after giving effect to the proposed distribution, the
association's capital distributions in a calendar year would exceed its
year-to-date net income plus retained net income for the preceding two years or
the association would not be at least adequately capitalized or if the
distribution would violate a statute, regulation, regulatory agreement or a
regulatory condition to which the association is subject.
Qualified Thrift Lender. All savings institutions are required to meet a
qualified thrift lender test to avoid certain restrictions on their operations.
This test requires a savings institution to have at least 65% of its portfolio
assets, as defined by regulation, in qualified thrift investments. As an
alternative, the savings institution may maintain 60% of its assets in those
assets specified in Section 7701(a)(19) of the Internal Revenue Code. Under
either test, such assets primarily consist of residential housing related loans
and investments. Sovereign Bank is currently in compliance with the qualified
thrift lender regulations.
Any savings institution that fails to meet the qualified thrift lender test
must convert to a national bank charter, unless it requalifies as a qualified
thrift lender and thereafter remains a qualified thrift lender. If an
institution does not requalify and converts to a national bank charter, it must
remain SAIF insured until the FDIC permits it to transfer to the BIF. If such an
institution has not yet requalified or converted to a national bank, its new
investments and activities are limited to those permissible for both a savings
institution and a national bank, and it is limited to national bank branching
rights in its home state. In addition, the institution is immediately ineligible
to receive any new FHLB borrowings and is subject to national bank limits for
payment of dividends. If such an institution has not requalified or converted to
a national bank within three years after the failure, it must divest itself of
all investments and cease all activities not permissible for a national bank. In
addition, it must repay promptly any outstanding FHLB borrowings, which may
result in prepayment penalties. If any institution that fails the qualified
thrift lender test is controlled by a holding company, then within one year
after the failure, the holding company must register as a bank holding company
and become subject to all restrictions on bank holding companies.
Other Loan Limitations. Federal law limits the amount of non-residential
mortgage loans a savings institution, such as Sovereign Bank, may make. Separate
from the qualified thrift lender test, the law limits a savings institution to a
maximum of 10% of its assets in large commercial loans, with another 10% of
assets permissible in "small business loans." Commercial loans secured by real
estate, however, are in addition to the above amounts, and can be made in an
amount up to four times an institution's capital. An institution can also have
commercial leases in addition to the above, up to 10% of its assets. Commercial
paper, corporate bonds, and consumer loans taken together cannot exceed 35% of
an institution's assets. For this purpose, however, residential mortgage loans
and credit card loans are not considered consumer loans, and are both unlimited
in amount. The foregoing limitations are established by statute, and cannot be
waived by the OTS.
Federal Reserve Regulation. Under Federal Reserve Board regulations,
Sovereign Bank is required to maintain a reserve against its transaction
accounts (primarily interest-bearing and noninterest-bearing checking accounts).
Because reserves must generally be maintained in cash or in noninterest-bearing
accounts, the effect of the reserve requirements is to increase an institution's
cost of funds. These regulations generally require that Sovereign Bank maintain
reserves against net transaction accounts in the amount of 3% on amounts of
$44.3 million or less, plus 10% on amounts in excess of $44.3 million.
Institutions may designate and exempt $5.0 million of certain reservable
liabilities from these reserve requirements. These amounts and percentages are
subject to adjustment by the Federal Reserve Board. A savings bank, like other
depository institutions maintaining reservable accounts, may borrow from the
Federal Reserve Bank discount window, but the Federal Reserve Board's
regulations require the savings bank to exhaust other reasonable alternative
sources before borrowing from the Federal Reserve Bank.
Numerous other regulations promulgated by the Federal Reserve Board affect
the business operations of Sovereign Bank. These include regulations relating to
equal credit opportunity, electronic fund transfers, collection of checks, truth
in lending, truth in savings and availability of funds.
5
Federal Home Loan Bank System. The FHLB System was created in 1932 and
consists of twelve regional FHLBs. The FHLBs are federally chartered but
privately owned institutions created by Congress. The Federal Housing Finance
board ("Finance Board") is an agency of the federal government and is generally
responsible for regulating the FHLB System. Each FHLB is owned by its member
institutions. The primary purpose of the FHLBs is to provide funding to their
members for making housing loans as well as for affordable housing and community
development lending. FHLBs are generally able to make advances to their member
institutions at interest rates that are lower than could otherwise be obtained
by such institutions.
Under current rules, a FHLB member is generally required to purchase FHLB
stock in an amount equal to at least 5% of the aggregate outstanding advances
made by the FHLB to the member. Generally, an institution is eligible to be a
member of the FHLB for the district where the member's principal place of
business is located. Sovereign Bank is a member of the Pittsburgh FHLB.
Community Reinvestment Act. The Community Reinvestment Act ("CRA") requires
financial institutions regulated by the federal financial supervisory agencies
to ascertain and help meet the credit needs of their delineated communities,
including low- to moderate-income neighborhoods within those communities, while
maintaining safe and sound banking practices. A bank's performance under the CRA
is important in determining whether the bank may obtain approval for, or utilize
streamlined procedures in, certain applications for acquisitions or to engage in
new activities. Sovereign Bank's lending activities are in compliance with
applicable CRA requirements.
New Legislation. Landmark legislation in the financial services area was
signed into law by the President on November 12, 1999. The Gramm-Leach-Bliley
Act dramatically changes certain banking laws that have been in effect since the
early part of the 20th century. The most radical changes are that the separation
between banking and the securities businesses mandated by the Glass-Steagall Act
has now been removed, and the provisions of any state law that prohibits
affiliation between banking and insurance entities have been preempted.
Accordingly, the new legislation now permits firms engaged in underwriting and
dealing in securities, and insurance companies, to own banking entities, and
permits bank holding companies (and in some cases, banks) to own securities
firms and insurance companies. As Sovereign is a savings and loan holding
company, many of the provisions of the new legislation do not apply to it. The
new law does change the status of Sovereign, however, in that Sovereign can no
longer become part of a non-financial group of companies, as it could under
prior law. Sovereign is still permitted to acquire non-financial companies,
however.
The new legislation also makes a number of additions and revisions to
numerous federal laws that affect the business of banking. For example, there is
now a federal law on privacy with respect to customer information held by banks.
The federal banking regulators have adopted rules regarding privacy for customer
information. Banks must establish a disclosure policy for non-public customer
information, disclose the policy to their customers, and give their customers
the opportunity to object to non-public information being disclosed to a third
party. The new law also requires any CRA agreement entered into between a bank
and a community group to be disclosed, with both the bank and the group
receiving any grants from the bank detailing the amount of funding provided and
what it was used for. The new law also requires a bank's policy on fees for
transactions at ATM machines by non-customers to be conspicuously posted on the
ATM. A number of other provisions affecting other general regulatory
requirements for banking institutions were also adopted.
The OTS and other banking regulators proposed revisions to their capital
rules concerning the treatment of residual interests in asset securitizations
and other transfers of financial assets. Generally, the proposed rule would
require that risk-based capital be held in an amount equal to the amount of
residual interests retained on an institution's balance sheet and would limit
the amount of residual interests that may be included in Tier 1 capital.
The OTS has proposed a regulation which would require certain savings and
loan holding companies to notify the OTS before engaging in or committing to
engage in a limited set of debt transactions, transactions that reduce capital,
some asset acquisitions, and other transactions. In addition, while the
regulation does not propose capital requirements applicable to all savings and
loan holding companies, the OTS is considering whether to adopt a rule setting
forth the circumstances in which it would review, on a case-by-case basis, the
capital adequacy of a savings and loan holding company and, when necessary,
require additional capital.
In January 2001, the four federal banking agencies jointly issued expanded
examination and supervision guidance relating to subprime lending activities. In
the guidance, "subprime" lending generally refers to programs that target
borrowers with weakened credit histories or lower repayment capacity. The
guidance principally applies to institutions with subprime lending programs with
an aggregate credit exposure equal to or greater than 25 percent of an
institution's Tier 1 capital. Such institutions would be subject to more
stringent risk management standards and, in many cases, additional capital
requirements. As a starting point, the guidance generally expects that such an
institution would hold capital against subprime portfolios in an amount that is
one and one-half to three times greater than the amount appropriate for similar
types of non-subprime assets. The guidance is primarily directed at insured
depository institutions.
6
In December 2000, the Federal Reserve Board published proposed regulations
which would implement the Home Ownership and Equity Protection Act ("HOEPA").
HOEPA, which was enacted in 1994, imposes additional disclosure requirements and
certain substantive limitations on certain mortgage loans with rates or fees
above specified levels. The proposed regulations would lower the rate levels
that trigger the application of HOEPA and would include additional fees in the
calculation of the fee amount that triggers HOEPA. The loans Sovereign Bank
currently makes are generally below the rate and fee levels that trigger HOEPA.
However, if the changes to the rate levels and the calculation of fee amounts in
the proposed regulation are adopted, more of the loans Sovereign Bank acquires
from other Lenders could be subject to HOEPA.
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 Bank's executive
offices and operations center.
Sovereign Bank has 556 branch and loan production offices. Sovereign owns
105 of these offices and leases 451. Sovereign Bank also leases several other
facilities throughout its market area to support its various administrative
functions.
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
27, 2001, is set forth below:
Richard E. Mohn--Age 69. Mr. Mohn was elected the Chairman of the Board of
Sovereign in May 1995. Mr. Mohn became Chairman of the Board of Sovereign
Bank in November 1989. He is the retired Chairman of Cloister Spring Water
Company, Lancaster, Pennsylvania, a bottler and distributor of spring
water.
Jay S. Sidhu--Age 49. Mr. Sidhu has served as President and Chief Executive
Officer of Sovereign since November 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 48. Mr. Thompson serves as Chief
Administrative Officer and Secretary of Sovereign. Also, Mr. Thompson was
appointed President and Chief Operating Officer of Sovereign Bank's
Consumer Banking Division in November 2000. 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.
Dennis S. Marlo--Age 58. Mr. Marlo was appointed Chief Financial Officer
and Treasurer of Sovereign in May 1998. Mr. Marlo joined Sovereign in
February 1998 as the President of the Pennsylvania Division of Sovereign
Bank. Prior thereto, Mr. Marlo served as President and Chief Executive
Officer of ML Bancorp, a predecessor company of Sovereign.
John P. Hamill--Age 60. Mr. Hamill was named Chairman and Chief Executive
Officer of SBNE in January 2000. Prior thereto, Mr. Hamill served as
President of Fleet National Bank--Massachusetts for eight years and
President of Shawmut Corporation.
Joseph P. Campanelli--Age 44. Mr. Campanelli was named President and Chief
Operating Officer of Sovereign Bank's Commercial and Business Banking
Division in November 2000 and was appointed President and Chief Operating
Officer of SBNE in January 2000. Mr. Campanelli joined Sovereign as
Executive Vice President in September 1997 through Sovereign's acquisition
of the Fleet Automotive Finance Division and assumed the role of Managing
Director of Sovereign's Automotive Finance Division and the Asset Based
Lending Group.
7
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 27,
2001, the total number of holders of Sovereign's common stock was 17,431.
The high and low bid prices reported on the NASDAQ National Market system
for Sovereign's common stock for 2000, adjusted to reflect all stock dividends
and splits, were $9.844 and $6.375 and for 1999 were $26.250 and $7.000,
respectively.
During each quarter of 2000 and 1999, Sovereign paid a cash dividend of
$.025 per share. During 1998, Sovereign paid a cash dividend of $.020 per share
in the first quarter, $.023 per share in the second quarter, $.020 per share in
the third quarter and $.021 per share in the fourth quarter. These per share
amounts have been adjusted to reflect all stock dividends and stock splits.
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 14 at Item 8 "Financial
Statements and Supplementary Data" hereof.
8
Item 6. Selected Financial Data.
SELECTED FINANCIAL DATA(1)
AT OR FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
(Dollars in thousands, except per share data)
Balance Sheet Data
Total assets ............................... $ 33,457,797 $ 26,607,112 $ 21,913,873 $ 17,655,455 $ 15,298,690
Loans ...................................... 21,912,245 14,288,465 11,582,770 11,634,800 9,733,834
Allowance for loan losses .................. (256,356) (132,986) (133,802) (116,823) (73,847)
Investment securities ...................... 7,293,852 10,392,263 8,502,082 5,372,713 5,012,118
Deposits and other customer accounts ....... 24,498,917 12,012,675 12,460,022 9,536,903 8,660,684
Borrowings and long term debt .............. 6,240,308 12,370,109 7,764,933 6,842,034 5,599,109
Stockholders' equity ....................... 1,948,884 1,821,495 1,204,068 1,047,795 889,751
Summary Statement of Operations
Total interest income ...................... 2,269,735 1,607,329 1,355,371 1,178,777 1,016,826
Total interest expense ..................... 1,414,924 992,673 861,759 746,695 629,860
------------ ------------ ------------ ------------ ------------
Net interest income ........................ 854,811 614,656 493,612 432,082 386,966
Provision for loan losses .................. 56,500 30,000 27,961 41,125 22,685
------------ ------------ ------------ ------------ ------------
Net interest income after provision
for loan losses ........................ 798,311 584,656 465,651 390,957 364,281
Other income ............................... 108,561 130,342 105,181 48,688 63,379
Other expenses ............................. 1,013,104 446,384 359,626 269,783 289,773
------------ ------------ ------------ ------------ ------------
Income/(loss) before income taxes
and extraordinary item ................. (106,232) 268,614 211,206 169,862 137,887
Income tax provision ....................... (65,215) 89,315 74,751 67,324 47,509
------------ ------------ ------------ ------------ ------------
Income/(loss) before extraordinary item .... (41,017) 179,299 136,455 102,538 90,378
Gain on sale of FHLB advances (net of tax
of $5,225) ............................ 10,775 -- -- -- --
------------ ------------ ------------ ------------ ------------
Net income/(loss)(2) ....................... $ (30,242) $ 179,299 $ 136,455 $ 102,538 $ 90,378
============ ============ ============ ============ ============
Share Data(3)
Common shares outstanding at end of period
(in thousands) ......................... 226,501 225,470 159,727 141,218 134,000
Preferred shares outstanding at end of period
(in thousands) ......................... -- -- -- 1,996 2,000
Basic earnings/(loss) per share(2) ......... $ (.13) $ 1.02 $ .88 $ .70 $ .63
Diluted earnings/(loss) per share(2) ....... $ (.13) $ 1.01 $ .85 $ .66 $ .59
Book value per share at end of period(4) ... $ 8.60 $ 8.08 $ 7.54 $ 7.42 $ 6.64
Common share price at end of period ........ $ 8 1/8 $ 72 9/64 $ 14 1/4 $ 17 5/16 $ 9 1/8
Dividends declared per common share ........ $ .10 $ .10 $ .08 $ .15 $ .18
Selected Financial Ratios
Dividend payout ratio(5)(6) ................ -- 9.9% 9.4% 12.1% 15.3%
Return on average assets(6) ................ -- .75% .70% .63% .63%
Return on average equity(6) ................ -- 13.20% 12.42% 10.92% 10.34%
Average equity to average assets ........... 5.83% 5.67% 5.60% 5.75% 6.14%
(1) All financial highlights have been restated to reflect all acquisitions
which have been accounted for under the pooling-of-interests method of
accounting.
(2) The results for the years ended 2000, 1999, 1998 and 1997 include merger
related and other integration charges of $270 million, $23 million, $34
million, and $37 million, after tax, respectively.
(3) All per share data have been adjusted to reflect all stock dividends and
stock splits.
(4) Book value is calculated using equity divided by common shares outstanding
at end of period.
(5) The higher dividend rate in prior periods is the result of acquisitions
which were accounted for as a pooling-of-interests.
(6) These ratios are not meaningful due to the net loss recognized for the
year ended December 31, 2000.
9
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
General. Sovereign Bancorp, Inc., ("Sovereign" or "the Company"), with
assets of $33.5 billion at December 31, 2000, was the 30th largest banking
company in the United States, with over 550 offices covering a geographic region
stretching from north of Boston to south of Philadelphia. The growth of
Sovereign in 2000 was mainly due to the acquisition of $12.3 billion of
deposits, $8.0 billion of loans, and over 280 community banking offices from
FleetBoston Financial (the "SBNE acquisition"). Sovereign successfully completed
the SBNE acquisition in three phases on March 24, June 16, and July 21, 2000.
The acquisition, which became the Sovereign Bank New England Division of
Sovereign Bank (SBNE), amounted to the largest branch acquisition in banking
history as detailed below. (For more details on the SBNE acquisition, and other
acquisitions, see Note 2- Business Combinations in the "Notes to Consolidated
Financial Statements")
- --------------------------------------------------------------------------------
SUMMARY OF COMPLETED SBNE ACQUISITION
(Dollars in billions)
DATE DIVESTED UNITS DEPOSITS LOANS BRANCHES
- ---- -------------- -------- ----- --------
March 24, 2000 ........ Rhode Island, Connecticut (BankBoston) $ 4.2 $ 2.5 90
June 16, 2000 ......... Eastern Mass (Fleet) 3.8 3.5 86
July 21, 2000 ......... Central Mass, New Hampshire (Fleet) 4.3 2.0 105
----- ----- ---
$12.3 $ 8.0 281
- --------------------------------------------------------------------------------
As a result of the SBNE acquisition, 2000 was a year of repositioning
Sovereign for the future--more than doubling our deposit base, changing the mix
of loans to be more similar to that of a commercial bank, adding experienced
banking professionals to senior management and over 3,000 staff to the
organization. Sovereign successfully integrated over 280 community banking
branches, accounting and computer systems and achieved net retention equal to
99.8% of the $12.3 billion deposits acquired in the SBNE acquisition at December
31, 2000.
Sovereign's financial results for 2000 reflect the SBNE acquisition from
the dates noted above. Additionally, the results reflect merger-related and
integration charges related to all of Sovereign's recent acquisitions,
restructuring charges, and non-solicitation expenses (for more information
related to these expenses see the Reconciliation of Net Income to Operating
Earnings on page 9).
All per share amounts presented in Management's Discussion and Analysis of
Financial Condition and Results of Operations have been adjusted to reflect all
stock dividends and stock splits.
Summary of Operations. Sovereign reported cash earnings for 2000 of $309
million, or $1.48 per share, up from $231 million and $1.34 per share in 1999.
This represents an increase in cash earnings of 33% and a 10% increase in cash
earnings per share. Cash earnings are operating earnings excluding amortization
of intangible assets and ESOP-related expense. Operating earnings for 2000 were
$240 million, an increase of 19% from 1999 operating earnings of $202 million.
Operating earnings per share for 2000 was $1.15, as compared to operating
earnings per share of $1.18 in 1999 (for more information related to operating
and cash earnings, see the Reconciliation of Net Income to Operating Earnings on
page 14). Net loss for 2000 was $30 million or $.13 per share. Net income for
1999 was $179 million or $1.01 per share. This represents a decrease in net
income of $209 million, which is due to increased merger-related and other
unusual charges recorded in 2000, primarily directly or indirectly related to
the SBNE acquisition, and certain securities transactions. On an operating
basis, return on average equity and return on average assets were 14.24% and
.77%, respectively, for 2000 compared to 15.51% and .85%, respectively, for
1999.
Sovereign analyzes its performance on a net income basis determined in
accordance with generally accepted accounting principles, as well as on an
operating and a cash operating basis before special charges referred to in this
analysis as "operating earnings" and "cash earnings". Operating and cash
earnings and related discussions are presented as supplementary information in
this analysis to enhance the readers' understanding of, and highlight trends in,
its core financial results excluding the nonrecurring effects of discreet
business acquisitions and other transactions. The Company has included these
additional disclosures of operations before special charges because this
information is both relevant and useful in understanding performance of the
Company. Operating and cash earnings should not be viewed as a substitute for
net income and earnings per share as determined in accordance with generally
accepted accounting principles. Merger-related charges and other items excluded
from net income used to derive operating and cash earnings and the effect of
certain non-recurring tax benefits included in operating earnings may be
significant and may not be comparable to other companies. Special charges were
$270.1 million after-tax for the year ended December 31, 2000 and $23.0 million
after-tax for the year ended 1999.
10
Restructuring Charges. In November 2000, the Company announced the results
of a restructuring initiative called "Shaping Sovereign's Future" (SSF). In
addition to realigning the Office of the Chief Executive Officer and the Company
around customer segments, Sovereign analyzed front and back office operations
and computer operating platforms and eliminated approximately 500 positions. In
total, Sovereign recorded $18.5 million in restructuring costs, which was
comprised of $14 million of severance and outplacement costs, and a $4.5 million
write-off of a redundant computer-operating platform.
Operating earnings include certain tax benefits related to the sale of
minority interests and exclude special charges related to restructuring and
merger-related costs as more fully described in the footnotes below. The net
impact of the tax benefits and special charges for the year ended December 31,
2000 were $243.8 million after-tax.
A reconciliation of net income to operating earnings is presented below:
- --------------------------------------------------------------------------------
RECONCILIATION OF NET INCOME TO OPERATING EARNINGS
(Dollars in thousands, except per share data - all amounts are after-tax)
YEAR ENDED DECEMBER 31,
--------------------------------------------
TOTAL PER SHARE
---------------------- ------------------
2000 1999 2000 1999
--------- --------- ------- -------
Net income/(loss) as reported ................................................ $ (30,242) $ 179,299 $ (0.13) $ 1.01
Net negative carry on escrowed bond proceeds(1) .............................. 18,589 3,123 0.08 0.02
Merger-related and integration costs related to recent acquisitions(2) ....... 97,063 20,576 0.43 0.12
Expense on convertible trust preferred securities ("PIERS")(1) ............... 6,502 2,125 0.03 0.01
Loss on securities due to restructuring of the balance sheet(3) .............. 66,956 -- 0.29 --
Restructuring(4) ............................................................. 12,025 -- 0.05 --
Non-solicitation expense(5) .................................................. 78,039 -- 0.35 --
Assumed income from reinvestment of net proceeds of
common equity and PIERS(1) .............................................. (9,051) (2,827) (0.04) (0.02)
Impact of additional shares outstanding for 2000 common and
PIERS securities offerings(6) ........................................... -- -- 0.09 0.04
--------- --------- ------- -------
Operating earnings(6)(7) ..................................................... $ 239,881 $ 202,296 $ 1.15 $ 1.18
========= ========= ======= =======
Cash earnings(6)(7) .......................................................... $ 308,564 $ 231,467 $ 1.48 $ 1.34
========= ========= ======= =======
(1) In connection with the SBNE acquisition, Sovereign raised $1.8 billion of
debt and equity capital in November and December 1999 of which $1.3 billion
of debt proceeds were in escrow with limited ability to reinvest the
proceeds until the acquisition was completed on July 21, 2000.
Consequently, the excess of negative carry and trust preferred expense over
interest expense reduction realized on the raised capital resulted in a net
reduction in pretax income of $24.7 million ($16.0 million after-tax) and
$3.7 million ($2.4 million after-tax) comprised of the following components
for the years ended December 31, 2000 and 1999: a) a reduction of net
interest income of $28.6 million ($18.6 million after-tax) and $4.7 million
($3.1 million after-tax); b) expense of $10.0 million ($6.5 million
after-tax) and $3.1 million ($2.1 million after-tax) associated with PIERS
issued in November 1999; c) an assumed $13.9 million ($9.1 million
after-tax) and $4.4 million ($2.8 million after-tax) of interest expense
reduction from the assumed paydown of other borrowings with the proceeds of
the Trust Preferred Securities and common stock offerings.
(2) Merger-related and integration charges related to recent acquisitions
include direct costs associated with the SBNE acquisition, including
investment banking and debt commitment fees, indirect costs incurred to
integrate recent acquisitionsinto Sovereign's back-office systems, costs of
training, relocation and associated travel, and management's estimate of
the carrying costs of certain facilities and personnel acquired in the
first closing on March 24, 2000 that were not fully operational until July
21, 2000, the date of the final closing. Also included in merger-related
and integration costs are expenses paid related to a structured real-estate
transaction involving certain real estate related to SBNE.
(3) In June and September 2000, Sovereign sold $2.1 billion of investment
securities as part of a balance sheet deleveraging strategy and incurred a
$103 million loss ($67.0 million after-tax). Sovereign used the proceeds
from such sales primarily to repay short-term borrowings.
(4) As more fully discussed in "Restructuring Charges", Sovereign recorded
$18.5 million ($12.0 million after-tax) primarily related to severance and
outplacement related expenses.
(5) As more fully discussed in Note 2 to the Financial Statements, Sovereign is
required to pay to FleetBoston, subject to FleetBoston's compliance with a
non-solicitation agreement, $333 million over a 19 month period. Sovereign
is expensing such payments ratably from the completion of the acquisition
to the completion of the payment period.
(6) Operating earnings per share and cash earnings per share are calculated
using a weighted average number of shares which include for the years ended
December 31, 2000 and 1999, a pro rata portion of the shares issued in
November, 1999 in proportion to deposits acquired on March 24, 2000, June
16, 2000, and July 21, 2000 over total estimated SBNE deposits acquired in
each phase of the SBNE acquisition.
(7) Operating earnings and cash earnings represent alternative measures of
performance and do not represent earnings available to stockholders.
11
Results of Operations for the Years Ended December 31, 2000 and 1999
Net Interest Income. Net interest income for 2000 was $855 million compared
to $615 million for 1999, or an increase of 39%. The increase in net interest
income in 2000 was due primarily to the increases in interest-earning assets
from the SBNE acquisition and internal asset growth, offset slightly by the
deleveraging of the balance sheet in the second and third quarters of 2000. The
SBNE acquisition added $8.0 billion to average loans and $6.9 billion to average
deposits (replacing higher cost FHLB borrowings) in 2000. Net interest margin -
operating basis (net interest income adjusted to eliminate the negative impact
from escrowed financing proceeds related to the SBNE acquisition, divided by
average interest-earning assets) was 3.19% for 2000 compared to 2.88% for 1999.
Interest on interest-earning deposits was $22.2 million for 2000 compared
to $4.7 million for 1999. The average balance of interest-earning deposits was
$138 million with an average yield of 16.08% for 2000 compared to an average
balance of $15.2 million with an average yield of 31.12% for 1999. The increase
in average interest-earning deposits was due to $200 million placed on deposit
with FleetBoston in March 2000 until the acquisition was completed in July 2000.
The high yields were the result of an outsourced accounts payable process
whereby a third-party vendor performs check processing and reconcilement
functions for Sovereign's disbursement accounts and pays Sovereign interest on
disbursed funds during the two-to-three day float period, effectively producing
interest income with no corresponding asset balance. The decrease in rates was
due primarily to the lower relative interest rate earned on the $200 million
deposit mentioned above as compared to the implied rate earned on the accounts
payable process.
Interest on investment securities available-for-sale was $487 million for
2000 compared to $544 million for 1999. The decrease in interest income was due
to the decrease in average investment securities available for sale from $8.1
billion in 1999 to $6.8 billion in 2000, which resulted from the sale of
approximately $2.1 billion in investment securities in June and September.
Interest on investment securities held-to-maturity was $132 million for
2000 compared to $99.8 million for 1999. The average balance of investment
securities held-to-maturity was $2.0 billion with an average yield of 6.80% for
2000 compared to an average balance of $1.4 billion with an average yield of
6.94% for 1999. The increase in the average balance was primarily due to the
creation of a $1.3 billion escrow fund in the fourth quarter 1999, which was
used to fund the SBNE transaction. The escrow funds were invested in commercial
paper which matured in conjunction with the escrow break on the final closing of
the acquisition on July 21, 2000.
Interest and fees on loans were $1.6 billion for 2000 compared to $959
million for 1999. The average balance of net loans was $19.4 billion with an
average yield of 8.40% for 2000 compared to an average balance of $12.4 billion
with an average yield of 7.77% for 1999. The increase in average loan volume was
primarily the result of the SBNE acquisition and internal loan growth. The
acquisition added $8.0 billion to average loans. The increase in the rate was
due to a higher mix of higher yielding commercial and consumer loans, and rate
increases reflected in the adjustable rate loans.
Interest on total deposits was $735 million for 2000 compared to $441
million for 1999. The average balance of total deposits was $19.2 billion with
an average cost of 3.83% for 2000 compared to an average balance of $12.2
billion with an average cost of 3.61% for 1999. The increase in the average
balance was due primarily to the acquisition of deposits in the SBNE
acquisition, which added over $6.9 billion to average deposits during 2000. The
increase in rates in 2000 mainly reflects the increase in time deposit and money
market account rates due to market conditions.
Interest on borrowings and long-term debt was $680 million for 2000
compared to $552 million for 1999. The average balance of total borrowings was
$10.3 billion with an average cost of 6.54% for 2000 compared to an average
balance of $10.1 billion with an average cost of 5.46% for 1999. Although the
average balance was consistent between 2000 and 1999, borrowings and debt
decreased approximately $6 billion on an absolute basis.
Average non-interest earning assets were $3.6 billion for 2000, as compared
to $2.0 billion for 1999, an increase of $1.6 billion. The increase was due
primarily to additions of non-earning assets during 2000 including $1.1 billion
in goodwill from the SBNE acquisition, an additional investment in bank owned
life insurance (BOLI) of $200 million, and the addition of the precious metals
business and equipment of $171 million, also related to the SBNE acquisition.
12
Table 1 presents a summary on a tax equivalent basis 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: NET INTEREST MARGIN
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------------------------
2000 1999 1998
------------------------------ ----------------------------- ------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ---- ------- -------- ---- ------- -------- ----
Interest-earning assets:
Interest-earning deposits ... $ 137,826 $ 22,158 16.08% $ 15,170 $ 4,721 31.12% $ 56,389 $ 7,397 13.12%
Investment securities(1):
available-for-sale ..... 6,840,799 496,922 7.26 8,079,731 553,167 6.85 4,336,872 292,531 6.75
held-to-maturity ....... 1,950,093 132,537 6.80 1,440,894 99,949 6.94 2,530,143 182,594 7.22
Net loans(1)(2) ............. 19,411,854 1,631,240 8.40 12,379,295 961,635 7.77 11,105,400 882,229 7.94
----------- ---------- ----- ----------- ---------- ----- ----------- ---------- -----
Total interest-earning
assets ................. 28,340,572 2,282,857 8.06 21,915,090 1,619,472 7.39% 18,028,804 1,364,751 7.57
Non-interest-earning
assets ................. 3,607,109 -- -- 2,027,003 -- -- 1,589,937 -- --
----------- ---------- ----- ----------- ---------- ----- ----------- ---------- -----
Total assets ........... $31,947,681 $2,282,857 7.15% $23,942,093 $1,619,472 6.76% $19,618,741 $1,364,751 6.96%
=========== ========== ==== =========== ========== ==== =========== ========== ====
Interest-bearing liabilities:
Deposits:
Demand deposit and
NOW accounts ......... $ 5,468,164 $ 81,842 1.50% $ 2,835,152 $ 34,622 1.22% $ 1,774,514 $ 19,920 1.12%
Savings accounts ....... 2,741,867 67,880 2.48 2,246,127 58,333 2.60 2,126,149 62,694 2.95
Money market accounts .. 3,059,568 132,131 4.32 1,288,581 50,246 3.90 1,173,889 45,055 3.84
Certificates of deposit 7,935,943 453,234 5.71 5,836,785 297,625 5.10 5,688,568 316,164 5.56
----------- ---------- ----- ----------- ---------- ----- ----------- ---------- -----
Total deposits ......... 19,205,542 735,087 3.83 12,206,645 440,826 3.61 10,763,120 443,833 4.12
Total borrowings ............ 10,338,648 679,837 6.58 10,101,973 551,847 5.46 7,342,402 417,926 5.69
----------- ---------- ----- ----------- ---------- ----- ----------- ---------- -----
Total interest-bearing
liabilities ............ 29,544,190 1,414,924 4.79 22,308,618 992,673 4.45 18,105,522 861,759 4.76
Non-interest-bearing
liabilities ............ 541,035 -- -- 274,858 -- -- 414,719 -- --
----------- ---------- ----- ----------- ---------- ----- ----------- ---------- -----
Total liabilities ...... 30,085,225 1,414,924 4.70 22,583,476 992,673 4.40 18,520,241 861,759 4.65
Stockholders' equity ........ 1,862,456 -- -- 1,358,617 -- -- 1,098,500 -- --
----------- ---------- ----- ----------- ---------- ----- ----------- ---------- -----
Total liabilities and
stockholders' equity ... $31,947,681 $1,414,924 4.43 $23,942,093 $ 992,673 4.15 $19,618,741 $ 861,759 4.39
=========== ========== ==== =========== ========== ==== =========== ========== ====
Net interest spread(3) ...... 2.72% 2.61% 2.57%
===== ===== =====
Taxable equivalent interest
income/net interest
margin(4) .............. 867,933 3.06% 626,799 2.86% 502,992 2.79%
===== ===== =====
Tax equivalent
basis adjustment ....... (13,122) (12,143) (9,380)
---------- ---------- ----------
Net interest income .... $ 854,811 $ 614,656 $ 493,612
========== ========== ==========
Net interest margin-
operating basis(5) .... 3.19% 2.88% 2.79%
===== ===== =====
Ratio of interest-earning
assets to interest-
bearing liabilities .... .96 x .98 x 1.00 x
===== ===== =====
(1) Tax equivalent adjustments to interest on investment securities available
for sale for the years ended December 31, 2000, 1999 and 1998 were $9.5 million,
$9.5 million and $8.1 million, respectively. Tax equivalent adjustments to
interest loans for the years ended December 31, 2000, 1999 and 1998, were $3.6
million, $2.5 million and $1.1 million, respectively. Tax equivalent interest
income is based upon an effective tax rate of 35%.
(2) Amortization of net fees of $14.4 million, $10.4 million and $2.6 million
for the years ended December 31, 2000, 1999 and 1998, respectively, are included
in interest income. Average loan balances include non-accrual loans and loans
held for sale.
(3) Represents the difference between the yield on total assets and the cost of
total liabilities and stockholders' equity.
(4) Represents taxable equivalent net interest income divided by average
interest-earning assets. Excluding the taxable equivalent adjustment, net
interest income divided by average interest-earning assets was 3.02%, 2.80%, and
2.74% for the years ended December 31, 2000, 1999, and 1998, respectively.
(5) Represents net interest margin adjusted to eliminate the negative impact
from escrowed financing proceeds relating to the acquisition of SBNE. Sovereign
was required to raise $1.8 billion of debt and equity capital by December 15,
1999. Substantially all of the proceeds were required to be escrowed with
limited ability to reinvest between closing of the financings and the assumption
of the FleetBoston branches. The funds were released from escrow on the final
closing of the acquisition on July 21, 2000.
13
Table 2 presents, on a tax equivalent basis, the relative contribution of
changes in volumes and changes in rates to changes in net interest income for
the periods indicated (in thousands):
- --------------------------------------------------------------------------------
TABLE 2: VOLUME/RATE ANALYSIS
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------
2000 VS. 1999 1999 VS. 1998
INCREASE/(DECREASE) INCREASE/(DECREASE)
------------------------------------- -------------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
--------- --------- --------- --------- --------- ---------
Interest-earning assets:
Interest-earning deposits ................. $ 38,171 $ (20,734) $ 17,437 $ (5,407) $ 2,731 $ (2,676)
Investment securities
available-for-sale ...................... (84,822) 28,577 (56,245) 252,464 8,172 260,636
Investment securities
held-to-maturity ........................ 35,321 (2,733) 32,588 (78,608) (4,037) (82,645)
Net loans(1) .............................. 546,296 123,309 669,605 101,200 (21,794) 79,406
--------- ---------
Total interest-earning assets .................. 663,385 254,721
--------- ---------
Interest-bearing liabilities:
Deposits .................................. 252,755 41,506 294,261 59,526 (62,533) (3,007)
Borrowings ................................ 12,929 115,061 127,990 157,073 (23,152) 133,921
--------- ---------
Total interest-bearing liabilities ............. 422,251 130,914
--------- ---------
Net change in net interest income .............. $ 269,282 $ (28,148) $ 241,134 $ 53,050 $ 70,757 $ 123,807
========= ========= ========= ========= ========= =========
(1) Includes non-accrual loans and loans held for sale.
- --------------------------------------------------------------------------------
Provision for Loan Losses. The provision for loan loss is based upon credit
loss experience and an estimation of losses arising in the current loan
portfolio. The provision for loan losses for 2000 was $56.5 million compared to
$30.0 million for 1999. The higher provisioning was required because of an
increase in net charge-offs during the year, and management's desire to raise
the overall level of the allowance, from .93% at 1999 to 1.17% in 2000, given
increased levels of non-performing and potential problem loans, and current
economic conditions.
As Sovereign continues to place emphasis on commercial and consumer
lending, management will regularly evaluate the risk inherent in its loan
portfolio and increase its loan loss provision as is necessary. Historically,
Sovereign's additions to its loan loss allowance (through income statement
charges and acquisition accounting) have been sufficient to absorb the
incremental credit risk in its loan portfolio. During 2000, Sovereign
established an initial allowance of $134.7 million in connection with the SBNE
acquisition. This initial allowance for SBNE, together with the provision of
$56.5 million exceeded net charge-offs, and thereby increased the loan loss
allowance by $123.4 million over 1999 levels.
Sovereign's net charge-offs for 2000 were $67.8 million and consisted of
charge-offs of $92.9 million and recoveries of $25.1 million. This compares to
1999 net charge-offs of $35.6 million consisting of charge-offs of $55.0 million
and recoveries of $19.4 million. Sovereign's increased level of commercial
charge-offs in 2000 was related primarily to deterioration in a segment of the
portfolio concentrated in cash flow, or enterprise lending in syndicated
multi-bank credits that were originated by other banks and participated in by
Sovereign, as well as direct loans made to Sovereign customers.
The ratio of net loan charge-offs to average loans, including loans held
for sale, was .35% for 2000, compared to .29% for 1999 and .30% for 1998.
Commercial loan net charge-offs as a percentage of average commercial loans were
.50% for 2000, compared to .11% for 1999 and .14% for 1998. Excluding
charge-offs related to large corporate credits, commercial loan net charge-offs
were .26% for 2000. Consumer loan net charge-offs as a percentage of average
consumer loans were .49% for 2000, compared to .49% for 1999 and .80% for 1998.
Residential real estate mortgage loan net charge-offs as a percentage of average
residential mortgage loans, including loans held for sale, were .09% for 2000,
.23% for 1999, and .08% for 1998. The increased level of residential mortgage
loan net charge-offs in 1999 was the result of $7.0 million net charge-offs
incurred as part of a bulk sale of non-performing residential loans.
14
Table 3 presents the activity in the allowance for loan losses for the years
indicated (in thousands):
- --------------------------------------------------------------------------------
TABLE 3: RECONCILIATION OF THE ALLOWANCE FOR LOAN LOSSES
DECEMBER 31,
-------------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- -------
Allowance, beginning of year ............ $132,986 $133,802 $116,823 $ 73,847 $67,515
Charge-offs:
Residential(1) ..................... 8,293 14,038 6,223 8,869 11,016
Commercial ......................... 41,071 4,659 3,220 3,687 5,846
Consumer ........................... 43,528 36,326 36,887 11,628 2,079
-------- -------- -------- -------- -------
Total charge-offs .............. 92,892 55,023 46,330 24,184 18,941
-------- -------- -------- -------- -------
Recoveries:
Residential ........................ 1,433 1,629 1,134 1,040 1,376
Commercial ......................... 8,729 1,429 839 2,264 133
Consumer ........................... 14,894 16,350 10,715 2,079 363
-------- -------- -------- -------- -------
Total recoveries ............... 25,056 19,408 12,688 5,383 1,872
-------- -------- -------- -------- -------
Charge-offs, net of recoveries .......... 67,836 35,615 33,642 18,801 17,069
Provision for loan losses ............... 56,500 30,000 27,961 41,125 22,685
Acquired allowance and other additions(2) 134,706 4,799 22,660 20,652 716
-------- -------- -------- -------- -------
Allowance, end of year .................. $256,356 $132,986 $133,802 $116,823 $73,847
======== ======== ======== ======== =======
Charge-offs, net of recoveries,
to average total loans ............. .346% .285% .300% .184% .193%
======== ======== ======== ======== =======
(1) The 1999 residential charge-offs include $7.0 million of charge-offs
incurred as part of accelerated dispositions of non-performing residential
loans sold during the second and fourth quarters of 1999.
(2) For 2000, amount represents initial allowance established in connection
with SBNE acquisition. For 1999, amount represents Sovereign's June 1999
acquisition of Peoples Bancorp, Inc. For 1998, amount includes $20.5
million of loan loss allowance established in connection with the
CoreStates branch acquisition. For 1997, amount includes $22.0 million of
loan loss allowance 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 end of First State.
- --------------------------------------------------------------------------------
Sovereign's policy for charging off loans varies with respect to the
category of loans and specific circumstances surrounding each loan under
consideration. Consumer loans and residential real estate mortgage loans are
generally charged off when deemed to be uncollectible or 180 days past due,
whichever comes first. Charge-offs of commercial loans are made on the basis of
management's ongoing evaluation of non-performing loans.
Other Income. Total other income was $109 million for 2000 compared to $130
million for 1999. Several factors contributed to the decrease in other income as
discussed below.
Deposit fees were $91.3 million for 2000 compared to $49.2 million for
1999. This increase was primarily due to a favorable shift into core and
corporate deposit products over the last year and the impact of the
SBNE acquisition.
Mortgage banking revenues were $25.2 million for 2000 compared to $29.9
million for 1999. At December 31, 2000, Sovereign serviced $4.2 billion of
residential loans for others as compared to $5.7 billion at December 31, 1999.
Sovereign sold mortgage servicing rights related to $2.5 billion of loans during
2000.
Loan fees and service charges were $16.9 million for 2000 compared to $8.9
million for 1999. This increase was due primarily to the SBNE acquisition which
added $8 billion in loans.
Net losses on sales of loans and investment securities were $121 million
for 2000, compared to a net gain of $4.3 million for 1999, which included net
investment security gains/(losses) of $(120.9) million and $3.7 million, and net
gains/(losses) on sales of loans of $.2 million and $.6 million in 2000 and
1999, respectively. This decrease was due primarily to the balance sheet
deleveraging transactions. During the second and third quarters of 2000,
Sovereign sold $2.1 billion of available-for-sale mortgage-backed securities,
resulting in losses of $103 million. The net impact of the sales on equity was
minimal as these losses were previously reflected as unrealized losses included
as a reduction of stockholders' equity in accordance with SFAS115.
During 2000, Sovereign created a Capital Markets Group. The group was built
in three phases. The first phase provided risk management services for corporate
clients including foreign exchange, investments and derivatives. The first phase
also included securitization expertise for Sovereign's balance sheet assets. The
second phase added merger andacquisitions expertise to assist clients. The third
phase, in process at December 31, 2000, includes the formation of a broker
dealer. The Capital Markets Group generated revenue of $11.1 million in 2000.
Income from bank-owned life insurance ("BOLI") was $33.3 million for 2000
compared to $22.8 million for 1999. This increase was primarily due to an
additional investment in BOLI of $200 million which was made during the year.
15
General and Administrative Expenses. Total general and administrative
expenses were $731 million for 2000 compared to $393 million in 1999. Included
in 2000 total general and administrative expenses were $149 million of
merger-related, integration and other charges related to recent acquisitions.
These special charges include charges directly attributable to the acquired
SBNEbranches, indirect costs incurred to integrate recent acquisitions into
Sovereign's back office systems, costs that management considered redundant due
to separating the SBNE acquisition from a single closing into three separate
closings, and expenses related to the structured real estate transaction that
involved properties utilized by SBNE. Included in 1999 general and
administrative expenses were $30.8 million of merger and integration charges.
Excluding the special charges, general and administrative expenses were $582.2
million and $362.1 million, for 2000 and 1999 respectively, or an increase of
61%. This increase was due primarily to the SBNE acquisition which increased
compensation and benefits expense for the approximately 3,700 staff and
management personnel which were added, increased occupancy and equipment
expenses for the additional 281 community banking offices acquired, and
increased other administrative expenses resulting from the acquisition. These
expenses were reflected in 2000 results from each of the respective three
closing dates. See Note2 - Business Combinations for more details on the SBNE
acquisition. Sovereign's efficiency ratio (all operating general and
administrative expenses as a percentage of net interest income and recurring
non-interest income) for 2000 was 54.3% compared to 48.6% for 1999.
Other Operating Expenses. Total other operating expenses were $282 million
for 2000 compared to $53.5 million for 1999. Other operating expenses included
amortization of goodwill and other intangible assets of $98.9 million for 2000
compared to $38.0 million for 1999 and trust preferred securities expense of
$44.3 million for 2000 compared to $15.4 million for 1999. The increase in
amortization expense is due to the SBNE acquisition which added $1.1 billion to
Sovereign's intangible assets. Trust preferred securities expense increased due
to the issuance of additional securities in November 1999.
Income Tax Provision. The income tax benefit was $65.2 million for 2000
compared to a provision of $89.3 million for 1999. The effective tax rate for
2000 was 66.5% compared to 33.2% for 1999. The effective tax rate for year 2000
is not meaningful due to the high proportion of permanent tax differences,
including certain one-time tax benefits included in operating earnings, in
relation to the recorded pretax loss. For additional information with respect to
Sovereign's income taxes, see Note 18 in the "Notes to Consolidated Financial
Statements" hereof.
Extraordinary Item. During the first quarter of 2000, Sovereign sold
FHLB advances which resulted in a pretax gain of $16.0 million ($10.8 million
after-tax) and is treated as an early extinguishment of debt under generally
accepted accounting principles.
Financial Condition
Loan Portfolio. Sovereign's loan portfolio at December 31, 2000 was $21.9
billion compared to $14.3 billion at December 31, 1999. The increase in net
loans was due to the SBNE acquisition which added $8.0 billion in loans and
strong originations in Sovereign's existing franchise offset by the
securitization of commercial and consumer loans and the conversion of
residential loans to mortgage-backed securities.
As a result of the SBNE acquisition and a continued focus on
non-residential lending in its existing franchise portfolio, Sovereign's loan
portfolio included $7.8 billion of commercial loans and $6.1 billion of consumer
loans. This compares to $4.1 billion of commercial loans and $4.5 billion of
consumer loans, at December 31, 1999.
In addition to the $3.1 billion of commercial loans acquired in the SBNE
acquisition, there were $2.3 billion of commercial loans originated during 2000,
compared to $3.2 billion of commercial loans originated during 1999. This
decrease was due to a high level of originations in 1999 in the Specialty
Lending Group including the syndicated cash flow loan participations and other
portfolios. Cash flow lending was curtailed in 2000 due to credit risk
considerations.
In addition to the $1.7 billion of consumer loans acquired in the SBNE
acquisition, Sovereign originated $2.1 billion of consumer loans during 2000
compared to $2.3 billion of consumer loans for 1999.
At December 31, 2000, Sovereign's total loan portfolio included $8.0
billion of first mortgage loans secured primarily by liens on owner-occupied
one-to-four-family residential properties compared to $5.7 billion at December
31, 1999. Total production of first mortgage loans was $2.3 billion in 2000 of
which $.7 billion were sold in the secondary market. This compares to first
mortgage loan closings of $2.9 billion and $1.6 billion of loans sold for 1999.
In addition, Sovereign acquired and retained $3.2 billion of residential
mortgages from FleetBoston, excluding $1.1 billion of residential mortgages
which were not relationship assets and were subsequently sold as part of
Sovereign's asset liability management strategy to reduce interest rate risk.
During 2000, Sovereign securitized commercial automotive floor plan loans
of $579 million and consumer home equity loans of $369 million. See Note 22
Asset Securitizations in the Notes to Consolidated Financial Statements for more
details. Sovereign also converted $1.2 billion of residential mortgages to FHLMC
mortgage backed securities which are included in Sovereign's investment
securities held-to-maturity portfolio at December 31, 2000.
16
Federal law limits the amount of non-residential mortgage loans a savings
institution, such as Sovereign Bank, may make. The law limits a savings
institution to a maximum of 10% of its assets in large commercial loans, with
another 10% of assets permissible in "small business loans." Commercial loans
secured by real estate, however, are in addition to the above amounts, and can
be made in an amount up to four times an institution's capital. An institution
can also have commercial leases in addition to the above, up to 10% of its
assets. Commercial loans and small business loans, as defined, totaled $2.9
billion and $1.3 billion, respectively, as compared to the 10% of assets
limitation of $3.3 billion at December 31, 2000.
Table 4 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 4: COMPOSITION OF LOAN PORTFOLIO
AT DECEMBER 31,
-------------------------------------------------------------------------------------------
2000 1999 1998 1997
------------------- --------------------- -------------------- --------------------
BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT
----------- ------- ----------- ------ ----------- ------ ----------- ------
Residential real estate loans .... $ 7,927,442 36.2% $ 5,685,220 39.8% $ 5,410,467 46.7% $ 6,944,949 59.7%
Residential construction loans ... 51,415 0.2 59,264 .4 62,536 .5 137,367 1.2
----------- ------ ----------- ------ ----------- ------ ----------- ------
Total Residential Loans ..... 7,978,857 36.4 5,744,484 40.2 5,473,003 47.2 7,082,316 60.9
----------- ------ ----------- ------ ----------- ------ ----------- ------
Commercial real estate loans ..... 2,793,616 12.7 1,516,953 10.6 887,938 7.7 664,943 5.6
Commercial loans ................. 4,397,009 20.1 1,690,744 11.8 717,440 6.2 356,517 3.1
Automotive floor plan loans ...... 513,641 2.4 730,623 5.1 578,147 5.0 279,757 2.4
Multi-family loans ............... 127,141 0.6 137,019 1.0 115,195 1.0 115,570 1.0
----------- ------ ----------- ------ ----------- ------ ----------- ------
Total Commercial Loans ...... 7,831,407 35.8 4,075,339 28.5 2,298,720 19.9 1,416,787 12.1
----------- ------ ----------- ------ ----------- ------ ----------- ------
Home equity loans ................ 3,256,598 14.9 1,957,945 13.7 1,750,883 15.1 1,050,304 9.0
Auto loans ....................... 2,309,025 10.5 1,936,980 13.6 1,510,676 13.0 1,553,318 13.4
Loans to automotive lessors ...... 317,281 1.4 288,636 2.0 252,856 2.2 267,033 2.3
Student loans .................... 26,283 0.1 249,279 1.7 256,744 2.2 190,440 1.6
Credit cards ..................... -- -- -- -- -- -- 54,887 .5
Other ............................ 192,794 0.9 35,802 .3 39,888 .4 19,715 .2
----------- ------ ----------- ------ ----------- ------ ----------- ------
Total Consumer Loans ............ 6,101,981 27.8 4,468,642 31.3 3,811,047 32.9 3,135,697 27.0
----------- ------ ----------- ------ ----------- ------ ----------- ------
Total Loans ................. $21,912,245 100.0% $14,288,465 100.0% $11,582,770 100.0% $11,634,800 100.0%
=========== ====== =========== ====== =========== ====== =========== ======
Total Loans with:
Fixed rates ................. $14,165,535 64.6% $ 8,769,876 61.4% $ 6,095,088 52.6% $ 4,859,629 41.8%
Variable rates .............. 7,746,710 35.4 5,518,589 38.6 5,487,682 47.4 6,775,171 58.2
----------- ------ ----------- ------ ----------- ------ ----------- ------
Total Loans ................. $21,912,245 100.0% $14,288,465 100.0% $11,582,770 100.0% $11,634,800 100.0%
=========== ====== =========== ====== =========== ====== =========== ======
AT DECEMBER 31,
--------------------
1996
--------------------
BALANCE PERCENT
---------- -------
Residential real estate loans .... $7,520,159 77.3%
Residential construction loans ... 136,436 1.3
---------- ------
Total Residential Loans ..... 7,656,595 78.6
---------- ------
Commercial real estate loans ..... 511,071 5.3
Commercial loans ................. 262,840 2.7
Automotive floor plan loans ...... -- --
Multi-family loans ............... 109,774 1.1
---------- ------
Total Commercial Loans ...... 883,685 9.1
---------- ------
Home equity loans ................ 800,559 8.1
Auto loans ....................... 73,393 .8
Loans to automotive lessors ...... -- --
Student loans .................... 211,358 2.2
Credit cards ..................... 82,798 .9
Other ............................ 25,446 .3
---------- ------
Total Consumer Loans ............ 1,193,554 12.3
---------- ------
Total Loans ................. $9,733,834 100.0%
========== ======
Total Loans with:
Fixed rates ................. $2,318,695 23.8
Variable rates .............. 7,415,139 76.2
---------- ------
Total Loans ................. $9,733,834 100.0%
========== ======
- --------------------------------------------------------------------------------
Table 5 presents the contractual maturity of Sovereign's commercial loans
at December 31, 2000 (in thousands):
TABLE 5: LOAN MATURITY SCHEDULE
AT DECEMBER 31, 2000, MATURING
----------------------------------------------------------
IN ONE YEAR ONE TO AFTER
OR LESS FIVE YEARS FIVE YEARS TOTAL
---------- ---------- ---------- ----------
Commercial real estate loans $ 128,641 $1,408,945 $1,256,030 $2,793,616
Commercial loans ........... 1,774,557 1,772,561 849,891 4,397,009
Automotive floor plans loans 233,115 193,196 87,330 513,641
Multi-family loans ......... 132 21,560 105,449 127,141
---------- ---------- ---------- ----------
Total ................. $2,136,445 $3,396,262 $2,298,700 $7,831,407
========== ========== ========== ==========
Loans with:
Fixed rates ........... $ 87,718 $1,937,439 $1,361,862 $3,387,019
Variable rates ........ 2,048,727 1,458,823 936,838 4,444,388
---------- ---------- ---------- ----------
Total ...................... $2,136,445 $3,396,262 $2,298,700 $7,831,407
========== ========== ========== ==========
17
Credit Risk Management. Extending credit exposes Sovereign to credit risk,
which is the risk that the principal balance of a loan and any related interest
will not be collected due to the inability of the borrower to repay the loan.
Sovereign manages credit risk in the loan portfolio through adherence to
consistent standards, guidelines and limitations established by the Board of
Directors. Written loan policies establish underwriting standards, lending
limits and other standards or limits as deemed necessary and prudent. Various
approval levels, based on the amount of the loan and whether the loan is secured
or unsecured, have also been established. Loan approval authority ranges from
the individual loan officer to the Board of Directors' Loan Committee. In
addition to being subjected to the judgement of experienced loan officers and
their managers, loans over a certain dollar size also require the co-approval of
credit officers independent of the loan officer to ensure consistency and
quality in accordance with Sovereign's credit standards.
The Loan Review Group conducts ongoing, independent reviews of the lending
process to ensure adherence to established policies and procedures, monitors
compliance with applicable laws and regulations, provides objective measurement
of the risk inherent in the loan portfolio, and ensures that proper
documentation exists. The results of these periodic reviews are reported to the
Asset Review Committee, and to the Board of Directors of both Sovereign and
Sovereign Bank. In response to Sovereign's increased emphasis on commercial and
consumer lending, Sovereign has added to its loan review group by hiring loan
review officers with significant commercial and consumer experience. Sovereign
also maintains a watch list for certain loans identified as requiring a higher
level of monitoring by management because of one or more factors, such as
economic conditions, industry trends, nature of collateral, collateral margin,
payment history, or other factors. Commercial loan credit quality is strong but
due to questions on the strength of the economy, is under a high level of
scrutiny by both line management and the independent Loan Review Group.
The following discussion summarizes the underwriting policies and
procedures for the major categories within the loan portfolio and addresses
Sovereign's strategies for managing the related credit risk.
Commercial Loans. Credit risk associated with commercial loans is primarily
influenced by prevailing and expected economic conditions and the level of
underwriting risk Sovereign is willing to assume. To manage credit risk when
extending commercial credit, Sovereign focuses on both assessing the borrower's
capacity and willingness to repay and on obtaining sufficient collateral.
Commercial and industrial loans are generally secured by the borrower's assets
and by personal guarantees. Commercial real estate loans are originated
primarily within the Pennsylvania, New Jersey, and New England market areas and
are secured by developed real estate at conservative loan-to-values and often by
a guarantee of the borrower. Management closely monitors the composition and
quality of the total commercial loan portfolio to ensure that significant credit
concentrations by borrower or industry do not exist.
Consumer Loans. Credit risk in the direct consumer loan portfolio is
controlled by strict adherence to conservative underwriting standards that
consider debt-to-income levels and the creditworthiness of the borrower and, if
secured, collateral values. In the home equity loan portfolio, combined
loan-to-value ratios are generally limited to 80% or credit insurance is
purchased to limit exposure. Other credit considerations may warrant higher
combined loan-to-value ratios for approved loans. The portion of the consumer
portfolio which is secured by real estate, vehicles, deposit accounts or
government guarantees comprises 96.8% of the entire portfolio.
Residential Loans. Sovereign originates fixed rate and adjustable rate
residential mortgage loans which are secured by the underlying 1-4 family
residential property. At December 31, 2000 and 1999, residential loans accounted
for 37% and 40%, respectively, of the total loan portfolio. This decrease was
the outcome of Sovereign's increased emphasis on commercial and consumer
lending. Credit risk exposure in this area of lending is minimized by the
evaluation of the creditworthiness of the borrower, including debt-to-equity
ratios, credit scores, and adherence to underwriting policies that emphasize
conservative loan-to-value ratios of generally no more than 80%. Residential
mortgage loans granted in excess of the 80% loan-to-value ratio criterion are
generally insured by private mortgage insurance, unless otherwise guaranteed or
insured by the Federal, state or local government. Sovereign also utilizes
underwriting standards which comply with those of the Federal Home Loan Mortgage
Corporation ("FHLMC") or the Federal National Mortgage Association ("FNMA").
Credit risk is further reduced since a portion of Sovereign's fixed rate
mortgage loan production is sold to investors in the secondary market without
recourse.
Collections. Sovereign closely monitors delinquencies as another means of
maintaining high asset quality. Collection efforts begin within 15 days after a
loan payment is missed by attempting 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. Sovereign monitors delinquency trends at 30, 60, and 90 days past
due. These trends are discussed at the monthly Asset Review Committee meetings.
Minutes from these meetings are submitted to the Board of Directors of Sovereign
Bank.
Non-performing Assets. At December 31, 2000, Sovereign's non-performing
assets were $187 million compared to $84 million at December 31, 1999.
Non-performing assets as a percentage of total assets was .56% at December 31,
2000
18
compared to .32% at December 31, 1999. This increase was caused by each segment
of the portfolio, but notably in residential and commercial portfolios.
Commercial non-performing loans are higher due to deterioration in a segment of
the portfolio concentrated in cash flow, or enterprise lending in syndicated,
multi-bank credits that were originated by other banks and participated in by
Sovereign, as well as direct loans made to Sovereign customers.
At December 31, 2000, 46% of non-performing assets consisted of loans
related to real estate or OREO. Another 7% of non-performing assets consist of
indirect auto loans and other repossessed assets. Indirect auto loans delinquent
in excess of 120 days carry an allowance allocation of 100%. Repossessed autos
carry an allowance allocation of 50%. Sovereign places all loans 90 days or more
delinquent (except auto loans and loans guaranteed by the government or secured
by deposit accounts) on non-performing status. Sovereign's auto loans continue
to accrue interest until they are 120 days delinquent, at which time they are
placed on non-accrual status and a 100% allowance allocation is assigned.
Effective January 1, 2001, Sovereign will extend the auto loans accrual policy
to other consumer loans.
Table 6 presents the composition of non-performing assets at the dates
indicated (in thousands):
- --------------------------------------------------------------------------------
TABLE 6: NON-PERFORMING ASSETS
AT DECEMBER 31,
-----------------------------------------------------
2000 1999 1998 1997 1996
-------- ------- -------- -------- --------
Non-accrual loans:
Residential .................................... $ 60,322 $32,374 $ 60,582 $ 65,930 $ 78,463
Commercial real estate ......................... 12,403 4,110 6,108 2,785 8,136
Commercial ..................................... 64,485 12,668 7,305 942 3,332
Consumer ....................................... 38,239 26,259 25,964 25,720 9,254
-------- ------- -------- -------- --------
Total non-accrual loans ............................. 175,449 75,411 99,959 95,377 99,185
Restructured loans .................................. 3,755 3,755 141 327 1,561
-------- ------- -------- -------- --------
Total non-performing loans .......................... 179,204 79,166 100,100 95,704 100,746
Other real estate owned and other
repossessed assets:
Residential real estate owned .................. 4,425 2,344 12,147 11,299 13,669
Commercial real estate owned ................... -- 1,223 665 710 4,380
Other repossessed assets ....................... 3,758 1,762 2,772 -- --
-------- ------- -------- -------- --------
Total other real estate owned and
other repossessed assets ....................... 8,183 5,329 15,584 12,009 18,049
-------- ------- -------- -------- --------
Total non-performing assets ......................... $187,387 $84,495 $115,684 $107,713 $118,795
======== ======= ======== ======== ========
Past due 90 days or more as to interest or principal
and accruing interest .......................... $ 16,733 $10,238 $ 9,975 $ 7,053 $ 16,722
Non-performing assets as a percentage of total assets .56% .32% .53% .61% .78%
Non-performing loans as a percentage of total loans . .82 .55 .86 .82 1.05
Non-performing assets as a percentage of total loans
and other real estate owned .................... .85 .59 1.00 .92 1.22
Allowance for loan losses as a percentage of total
non-performing assets .......................... 136.8 157.4 115.7 108.5 62.2
Allowance for loan losses as a percentage of total
non-performing loans ........................... 143.1 168.0 133.7 122.1 73.3
-------- ------- -------- -------- --------
- --------------------------------------------------------------------------------
Gross interest income for the years ended December 31, 2000, 1999 and 1998
would have increased by approximately $7.0 million, $5.0 million and $9.5
million, respectively, had Sovereign's period-end non-accruing and restructured
loans been current in accordance with their original terms and outstanding
throughout the period. Interest income recorded on these loans for the years
ended December 31, 2000, 1999, and 1998 was $3.8 million, $2.1 million and $3.3
million, respectively.
Potential Problem Loans. Potential problem loans (consisting of loans for
which management has doubts as to the ability of such borrowers to comply with
present repayment terms, although not currently classified as non-performing
loans) amounted to approximately $97 million and $13 million at December 31,
2000 and 1999.
Allowance for Loan Loss. The adequacy of Sovereign's allowance for loan
losses is regularly evaluated. Management's evaluation of the adequacy of the
allowance to absorb potential loan losses takes into consideration the risks
inherent in the loan portfolio, past loan loss experience, specific loans which
have loss potential, geographic and industry concentrations, delinquency trends,
economic conditions, the level of originations and other relevant factors.
Management also considers loan quality, changes in the size and character of the
loan portfolio, amount of non-performing loans, delinquency trends, economic
conditions, industry trends and consultation with regulatory authorities when
determining the allowance. The Company's last regulatory examination was as of
September 30, 2000.
19
At December 31, 2000, Sovereign's loan delinquencies (all performing loans
greater than 30 days delinquent) as a percentage of total loans was 2.29%
compared to 1.94% at December 31, 1999. This increase was evident in each
segment of the portfolio. Overall, management believes that delinquencies,
charge-offs, and non-performing statistics have evidenced deterioration because
of certain specific factors and not weakness throughout the entire portfolio.
Nonetheless, the allowance has been increased from .93% to 1.17% of total loans
reflecting these trends and the shift in portfolio composition throughout the
year, and credit risk management processes continue to identify deterioration as
soon as possible. At December 31, 1999, Sovereign's loan portfolio was 40%
residential, 31% consumer and 29% commercial. At December 31, 2000, Sovereign's
loan portfolio was 36% residential, 28% consumer and 36% commercial. Along with
higher yields, management believes this shift in loan composition brings higher
inherent risk.
Sovereign maintains an allowance for loan losses sufficient to absorb
inherent losses in the loan portfolio. As discussed in Credit Management,
Sovereign believes the current allowance to be at a level adequate to cover such
inherent losses. At December 31, 2000, the Company's total allowance was $256
million. The Company's total allowance at year-end equated to approximately 4.0
times the average charge-offs for the last three years and 5.6 times the average
net charge-offs for the same three-year period. Because historical charge-offs
are not necessarily indicative of future charge-off levels, the Company also
gives consideration to other risk indicators when determining the appropriate
allowance level.
Sovereign applies similar methods of determining the loan loss allowance
for purchased loan portfolios as it does in establishing allowances for
originated loans. Sovereign established $135 million of allowance for loan
losses for the loans acquired in the SBNE acquisition. In establishing this
allowance, Sovereign utilized its methodology, adjusted for increased
uncertainty regarding the quality of the acquired loans. Sovereign performed
specific reviews of large non-homogeneous loans, and established specific
allowances accordingly. For homogenous loans, Sovereign established the loan
loss allowance based on limited available performance history, industry
statistics and similar experiences with other acquired portfolios.
The allowance for loan losses consists of two elements: (i) an allocated
allowance, which for non-homogeneous loans is comprised of allowances
established on specific classified loans, and class allowances for both
homogeneous and non-homogeneous loans based on historical loss experience and
current trends, and (ii) unallocated allowances based on both general economic
conditions and other risk factors in the Company's individual markets and
portfolios, and to account for a level of imprecision in management's estimation
process.
The allowance recorded for consumer and residential portfolios is based on
an analysis of product mix, credit scoring and risk composition of the
portfolio, fraud loss and bankruptcy experiences, economic conditions and
historical and expected delinquency and charge-off statistics for each
homogeneous category or group of loans. Based on this information and analysis,
an allowance is established approximating a rolling twelve-month estimate of
net-charge-offs.
The allowance recorded for commercial loans is based on an analysis of the
individual credits and relationships and is separated into two parts, the
specific allowance and the class allowance.
The specific allowance element of the commercial loan allowance is based on
a regular analysis of criticized commercial loans where internal credit ratings
are below a predetermined classification. This analysis is performed by the
Managed Asset Division, where loans with recognized deficiencies are
administered, and periodically reviewed by the Loan Review Department. The
specific allowance established for these criticized loans is based on a careful
analysis of related collateral value, cash flow considerations and, if
applicable, guarantor capacity.
The class allowance element of the commercial loan allowance is determined
by an internal loan grading process in conjunction with associated allowance
factors. These class allowance factors are updated annually and are based
primarily on actual historical loss experience, consultation with regulatory
authorities, and peer groups loss experience. While this analysis is conducted
annually, the Company has the ability to revise the class allowance factors
whenever necessary in order to address improving or deteriorating credit quality
trends or specific risks associated with a given loan pool classification.
Regardless of the extent of the Company analysis of customer performance,
portfolio evaluations, trends or risk management processes established, certain
inherent but undetected losses are probable within the loan portfolio. This is
due to several factors including inherent delays in obtaining information
regarding a customer's financial condition or changes in their unique business
conditions; the judgmental nature of individual loan evaluations, collateral
assessments and the interpretation of economic trends; volatility of economic or
customer conditions and the sensitivity of assumptions utilized to establish
allocated allowances for homogeneous groups of loans among other factors. The
Company maintains an unallocated allowance to recognize the existence of these
exposures. These other risk factors are continuously reviewed and revised by
management where conditions indicate that the estimates initially applied are
different from actual results.
A comprehensive analysis of the allowance for loan losses is performed by
the Company on a quarterly basis. In addition, a review of allowance levels
based on nationally published statistics is conducted on an annual basis. The
Company has an Asset Review Committee, which has the responsibility of affirming
allowance methodology and assessing the general and specific
20
allowance factors in relation to estimated and actual net charge-off trends.
This Committee is also responsible for assessing the appropriateness of the
allowance for loan losses for each loan pool classification at Sovereign.
Although the Company determines the amount of each element of the allowance
separately and this process is an important credit management tool, the entire
allowance for credit losses is available for the entire loan portfolio. The
actual amount of losses incurred can vary significantly from the estimated
amounts. The Company's methodology includes several factors intended to minimize
the differences between estimated and actual losses. These factors allow the
Company to adjust its estimate of losses based on the most recent information
available.
During 2000, management analysis of historical losses of the residential
and consumer portfolios enabled the Company to reduce reserves for these
portfolios to a level that is more comparable to the portfolio's performance
history, as discussed below.
Table 7 summarizes Sovereign's allocation of the allowance for loan losses
for allocated and unallocated allowances by loan type, and the percentage of
each loan type of total portfolio loans (in thousands):
- --------------------------------------------------------------------------------
TABLE 7: ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
AT DECEMBER 31,
------------------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
----------------- ------------------ ------------------ ------------------ ----------------
% OF % OF % OF % OF % OF
LOANS TO LOANS TO LOANS TO LOANS TO LOANS TO
TOTAL TOTAL TOTAL TOTAL TOTAL
AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
------ -------- ------ -------- ------ -------- ------ -------- ------ --------
Allocated allowances:
Commercial loans ...... $149,828 36% $ 58,784 29% $ 38,354 20% $ 30,793 12% $21,091 9%
Residential real estate
mortgage loans ...... 34,629 36 19,535 40 22,427 47 36,351 61 25,835 79
Consumer loans ........ 48,053 28 43,455 31 48,083 33 24,300 27 10,274 12
Unallocated allowances ..... 23,846 n/a 11,212 n/a 24,938 n/a 25,379 n/a 16,647 n/a
-------- --- -------- --- -------- --- -------- --- ------- ---
Total allowance
for loan losses ....... $256,356 100% $132,986 100% $133,802 100% $116,823 100% $73,847 100%
======== === ======== === ======== === ======== === ======= ===
Residential Portfolio. The allowance for the residential mortgage portfolio
increased from $19.5 million at December 31, 1999 to $34.6 million at December
31, 2000. The increase was due primarily to reserves established in connection
with the SBNE acquisition of $15.6 million offset somewhat by a reduction of
$14.3 million of reserves allocated to the originated portion of the portfolio
due to a change in estimate. The increase between years represents an increase
in absolute levels, from .34% at December 31, 1999, to .41% at December 31,
2000, reflecting some increased levels of delinquencies and non-performing
assets. Delinquencies, stated on a consistent basis to reflect the FFIEC
classification guidelines implemented in 2000, increased slightly from 3.22% at
December 31, 1999 to 3.78% at December 31, 2000.
Consumer Portfolio. The allowance for the consumer loan portfolio increased
from $43.5 million at December 31, 1999 to $48.1 million at December 31, 2000
due to reserves established in connection with the SBNE acquisition of $18.6
million offset by a change in estimate of $16.8 million related to management's
analysis of portfolio performance over the past several years. Specifically,
since its acquisition of the portfolio from FleetBoston Financial in 1997, the
Company enhanced its underwriting and credit monitoring processes related to its
indirect auto portfolio and purchased indirect auto portfolio, which has
resulted in a decrease in historical net charge-offs in the auto portfolio from
1.23% for 1998 to .53% for 2000.
Commercial Portfolio. The allowance for loan losses for the commercial
portfolio increased $91 million to $149.8 million at December 31, 2000. This
increase is due to reserves established in connection with the SBNE acquisition
of $80 million and management's evaluation of general economic conditions and
trends in the performance of this portfolio which resulted in an increased
allocation of $31.1 million due to deterioration of certain asset based and cash
flow loans in the Specialty Lending Group. The allowance allocated to the
commercial portfolio was increased by $7.6 million due to rating changes in the
Company's general commercial credits. Although Sovereign experienced
deterioration in credit quality in selected portfolios, seasoning and improved
performance enabled the Company to release $6.7 million and $12.6 million,
respectively, from its small business portfolio and commercial real estate
portfolio. Total commercial non-accrual loans as a percentage of total
commercial loans increased from .41% at December 31, 1999 to .98% at December
31, 2000 primarily in the aforementioned Specialty Lending Group, and resulted
in the allowance allocated to commercial loans as a percentage of total
commercial loans increasing from 1.44% at December 31, 1999 to 1.91% at December
31, 2000. In addition to the increase in non-accruals noted above, this increase
was due to management's belief that economic conditions are showing signs of
slowing from periods of earlier robust growth and markets are mixed.
21
Unallocated Allowance. The unallocated allowance increased $12.6 million to
$23.8 million at December 31, 2000. The increase in the unallocated allowance is
related to management's evaluation of current economic conditions, loan
portfolio trends, and recently acquired portfolios. The increase raises the
unallocated allowance as a percentage of the total allowance for loan losses
from 8.4% at December 31, 1999 to 9.3% at December 31, 2000. This is a result of
increased uncertainty with respect to current economic conditions, along with
the shift in the Company's loan composition, which brings higher inherent risk.
Investment 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 four years or less. The effective
duration of the total investment portfolio at December 31, 2000 was 3.6 years.
Investment 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 securities available-for-sale, see Note 4 in the
"Notes to Consolidated Financial Statements" hereof. The actual maturities of
mortgage-backed securities available-for-sale will differ from contractual
maturities because borrowers may have the right to prepay obligations without
prepayment penalties. During 2000, Sovereign sold $2.1 billion of investment
securities available for sale and incurred a $103 million loss as part of a
balance sheet deleveraging strategy.
Investment 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"), and private issuers; and collateralized mortgage
obligations. For additional information with respect to the amortized cost and
estimated fair value of Sovereign's investment securities held-to-maturity, see
Note 4 in the "Notes to Consolidated Financial Statements" hereof.
The actual maturities of the mortgage-backed securities held-to-maturity
will differ from contractual maturities because borrowers may have the right to
call or repay obligations with or without call or prepayment penalties.
In the third and fourth quarters of 2000, $1.2 billion of owned mortgage
loans were securitized. Sovereign retained the resulting securities and
classified them as held-to-maturity.
22
Table 8 presents the book value of investment securities by obligation and
Table 9 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 stockholders' equity
which were held by Sovereign at December 31, 2000 (dollars in thousands):
- --------------------------------------------------------------------------------
TABLE 8: INVESTMENT SECURITIES BY OBLIGOR
AT DECEMBER 31,
--------------------------
2000 1999
---------- ----------
Investment securities available-for-sale:
U.S. Treasury and government
agency securities .................. $1,417,553 $ 964,016
State and municipal securities ..... 6,815 32,179
Other securities ................... 3,891,216 7,034,017
---------- ----------
Total investment securities
available-for-sale ................. $5,315,584 $8,030,212
========== ==========
Investment securities held-to-maturity:
U.S. Treasury and government
agency securities .................. $1,568,908 $ 504,673
State and municipal securities ..... 739 3,275
Other securities ................... 408,621 1,854,103
---------- ----------
Total investment securities
held-to-maturity ................... $1,978,268 $2,362,051
========== ==========
TABLE 9: INVESTMENT SECURITIES OF SINGLE ISSUERS
AT DECEMBER 31, 2000
----------------------------
AMORTIZED COST FAIR VALUE
-------------- ----------
Cendant Mortgage ...................... $ 402,939 $ 396,348
Countrywide Home Loans, Inc. .......... 253,919 249,104
First Nationwide Trust ................ 263,202 250,915
Norwest Asset Securities Corporation .. 272,596 262,823
PNC Mortgage Securities Corporation ... 420,346 418,592
Residential Asset Securitization Trust 305,521 301,034
Residential Funding Corporation ....... 424,247 425,998
Structured Asset Securities Corporation 386,216 378,054
---------- ----------
Total ............................ $2,728,986 $2,682,868
========== ==========
- --------------------------------------------------------------------------------
Table 10 presents the book value, expected maturities and yields of
Sovereign's investment securities available-for-sale at December 31, 2000 (in
thousands):
- --------------------------------------------------------------------------------
TABLE 10: INVESTMENT AND MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE
AT DECEMBER 31, 2000, DUE
-------------------------------------------------------------------------
AFTER 10
IN ONE YEAR ONE YEAR/ FIVE YEARS/ YEARS/
OR LESS FIVE YEARS TEN YEARS NO MATURITY TOTAL
------------- ---------- ------------- ------------- ----------
Investment Securities:
U.S. Treasury and government agency securities $ 80,831 $ 11,109 $ -- $ -- $ 91,940
6.42% 6.18% -- -- 6.39%
Corporate securities ......................... -- 604 180,693 124,512 305,809
-- 8.60% 8.84% 9.00% 8.91%
Asset-backed securities ...................... 96,084 264,600 119,469 31,443 511,596
6.82% 6.83% 6.70% 6.40% 6.77%
Equities ..................................... -- -- -- 51,660 51,660
-- -- -- -- --
FHLB stock ................................... -- -- -- 225,797 225,797
-- -- -- 7.25% 7.25%
Agency preferred stock ....................... -- -- -- 425,877 425,877
-- -- -- 7.94% 7.94%
Municipal securities ......................... 355 364 1,122 4,974 6,815
5.81% 5.84% 6.02% 6.00% 5.98%
Mortgage-backed Securities:
U.S. government agency passthroughs .......... 88,284 281,417 163,137 141,101 673,939
7.11% 7.08% 6.99% 6.86% 7.02%
Non-agency passthroughs ...................... 438,876 1,122,386 418,209 534,097 2,513,568
6.65% 6.66% 6.67% 7.26% 6.78%
Collateralized mortgage obligations ............... 50,360 278,287 155,402 24,534 508,583
7.30% 7.30% 7.36% 6.80% 7.29%
------------- ---------- ------------- ------------- ----------
Total investment and mortgage-backed
securities available-for-sale ................ $ 754,790 $1,958,767 $ 1,038,032 $ 1,563,995 $5,315,584
------------- ---------- ------------- ------------- ----------
Weighted average yield ............................ 6.75% 6.83% 7.20% 7.28% 7.02%
============= ========== ============= ============= ==========
23
Table 11 presents the book value, expected maturity and yields of
Sovereign's investment securities held-to-maturity at December 31, 2000 (in
thousands):
- --------------------------------------------------------------------------------
TABLE 11: INVESTMENT AND MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY
AT DECEMBER 31, 2000, 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 .... $ 4,704 $ 1,525 $ 153 $ -- $ 6,382
6.89% 7.19% 7.20% -- 6.97%
Corporate securities .............................. -- 2,525 33,259 -- 35,784
-- 10.21% 10.27% -- 10.27%
Municipal securities .............................. 406 333 -- -- 739
5.01% 5.83% -- -- 5.38%
Mortgage-backed Securities:
U.S. government agency passthroughs ............... 258,512 732,721 343,538 227,755 1,562,526
7.29% 7.17% 6.85% 6.26% 6.99%
Non-agency passthroughs ........................... 9,539 23,029 5,690 860 39,118
7.42% 7.69% 7.96% 7.93% 7.67%
Collateralized mortgage obligations .................... 80,947 222,672 17,176 12,924 333,719
6.23% 6.57% 7.18% 7.41% 6.55%
----------- -------- -------- --------- ----------
Total investment and mortgage-backed
securities held-to-maturity ....................... $ 354,108 $982,805 $399,816 $ 241,539 $1,978,268
=========== ======== ======== ========= ==========
Weighted average yield(1) .............................. 7.04% 7.06% 7.16% 6.32% 6.99%
=========== ======== ======== ========= ==========
(1) Weighted average yield calculated using amortized cost
- --------------------------------------------------------------------------------
Other Assets. Premises and equipment increased from 1999 due to the
acquisition of various assets in the SBNE franchise aggregating $68 million and
the growth of the existing franchise. Accrued interest receivable increased $66
million due to the increase in the loan portfolio and the increased yield on
such loans. BOLI increased due to an additional investment of $200 million
during the year. Other assets at December 31, 2000 was $951.2 million compared
to $530.2 million at December 31, 1999. The increase primarily relates to $180
million of precious metals inventory, and other assets, acquired in the SBNE
transaction.
Goodwill and other intangible assets increased $1.0 billion to $1.5 billion
which represented 4.3% of total assets and 74.7% of stockholders' equity at
December 31, 2000. This increase was primarily due to additional goodwill of
$726 million and core deposit intangible of $429 million related to the Fleet
acquisition offset by goodwill and intangible asset amortization of $99 million.
The goodwill arose from the purchase of $12.3 billion of deposits at a premium
of 12% (9% net of adjustments) and purchase accounting adjustments related
primary to marking the loans to market value and establishing an initial loan
loss allowance.
Deposits. Deposits are attracted from within Sovereign's primary market
area through the offering of various deposit instruments including demand and
NOW accounts, money market accounts, savings accounts, certificates of deposit
and retirement savings plans. Total deposits at December 31, 2000 were $24.5
billion compared to $12.0 billion at December 31, 1999. The increase in deposits
is attributable to $12.3 billion of deposits acquired in the SBNE acquisition,
of which net retention was 99.8%, and growth in our existing deposit base of
approximately $800 million, offset by $315 million of deposits divested in the
sale of 20 branches in northern Pennsylvania.
Table 12 presents the composition of Sovereign's average deposits and yield
rates for the periods indicated (in thousands):
- --------------------------------------------------------------------------------
TABLE 12: AVERAGE DEPOSITS AND YIELD RATES
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------
2000 1999 1998
---------------------- ----------------------- ----------------------
AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
----------- ------- ----------- -------- ----------- ------
Demand deposit and NOW accounts $ 5,468,164 1.50% $ 2,835,152 1.22% $ 1,774,514 1.12%
Savings accounts .............. 2,741,867 2.48% 2,246,127 2.60% 2,126,149 2.95%
Money market accounts ......... 3,059,568 4.32% 1,288,581 3.90% 1,173,889 3.84%
Retail certificates of deposit 7,073,743 5.65% 4,945,452 5.05% 4,903,742 5.56%
----------- ----------- -----------
Total retail deposits .... 18,343,342 3.72% 11,315,312 3.47% 9,978,294 4.01%
Jumbo certificates of deposit . 862,200 6.27% 891,333 5.36% 784,826 5.59%
----------- ----------- -----------
Total deposits ........... $19,205,542 3.83% $12,206,645 3.61% $10,763,120 4.12%
=========== =========== ===========
- --------------------------------------------------------------------------------
24
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 investment securities.
Total borrowings at December 31, 2000 were $1.3 billion, compared to total
borrowings of $6.2 billion at December 31, 1999.
Through the use of interest rate swaps, $400 million of the FHLB advances
at December 31, 2000 have been effectively converted from variable rate
obligations to fixed rate obligations. An additional $500 million of borrowings
have been protected from upward repricing through the use of interest rate caps.
Table 13 presents information regarding Sovereign's borrowings and the
related weighted average rate at the dates indicated (in thousands):
- --------------------------------------------------------------------------------
TABLE 13: BORROWINGS
AT DECEMBER 31,
-----------------------------------------------
2000 1999
-------------------- --------------------
BALANCE RATE BALANCE RATE
---------- ---- ---------- ----
Federal funds purchased ............................ $ 130,000 5.23% $ -- --
Securities sold under repurchase agreements ........ 230,900 6.58% 102,944 5.85%
Federal Home Loan Bank advances .................... 970,000 6.62% 6,054,995 5.67%
---------- ---- ---------- ----
Total borrowings ................................... $1,330,900 6.48% $6,157,939 5.67%
========== ==== ========== ====
- --------------------------------------------------------------------------------
Table 14 summarizes information regarding short-term securities sold under
repurchase agreements and short-term FHLB advances (in thousands):
- --------------------------------------------------------------------------------
TABLE 14: DETAILS OF BORROWINGS
DECEMBER 31,
--------------------------
2000 1999
----------- -----------
Short-term securities sold under repurchase agreement:
Balance ................................................... $ 230,900 $ 102,944
Weighted average interest rate ............................ 6.58% 5.85%
Maximum amount outstanding at any month-end during the year $1,426,828 $2,461,914
Average amount outstanding during the year ................ $ 811,601 $1,145,454
Weighted average interest rate during the year ............ 6.57% 5.46%
Short-term FHLB advances:
Balance ................................................... $ 970,000 $6,054,995
Weighted average interest rate ............................ 6.62% 5.67%
Maximum amount outstanding at any month-end during the year $8,753,000 $6,054,995
Average amount outstanding during the year ................ $4,267,647 $3,442,512
Weighted average interest rate during the year ............ 6.59% 5.57%
- --------------------------------------------------------------------------------
Long-Term Debt. Total long-term debt at December 31, 2000 was $4.9 billion
compared to $6.2 billion at December 31, 1999. The decrease in long-term debt
was due to the maturity of the 6.75% subordinated notes, the early repayment of
a portion of the senior credit facility, the sale of FHLB advances which
resulted in an extraordinary gain, and the maturity of long-term FHLB advances.
On March 1, 2001, Sovereign refinanced the $500 million senior secured
credit facility with a variable rate $400 million senior secured credit facility
consisting of a $350 million revolving line and a $50 million term note. On
February 20, 2001, Sovereign issued $175 million of senior unsecured notes at
8.625% which will mature on March 15, 2004. The proceeds of this issuance, along
with the proceeds of $150 million from the 20 million shares of common stock
issued on February 9, 2001, were used to repay $240 million of 6.625% senior
notes which matured on March 15, 2001 and for additional liquidity.
Bank Regulatory Capital
Federal law requires institutions regulated by the Office of Thrift
Supervision to have a minimum leverage capital ratio equal to 3% of tangible
assets and 4% of risk-adjusted assets, and a risk-based capital ratio equal to
8%. Federal law also requires OTS regulated institutions to have a minimum
tangible capital equal to 2% of total tangible assets.
25
The OTS Order, as amended, applicable to the approval of the SBNE
acquisition (the "OTS Order") requires Sovereign Bank to be "Well Capitalized"
and also to meet certain additional requirements and other conditions. Various
agreements with our lenders also require Sovereign Bank to be "Well Capitalized"
at all times and in compliance with all regulatory requirements. To be "well
capitalized", a thrift institution must maintain a Tier 1 Leverage ratio of at
least 5%, a Tier 1 risk-based capital ratio of 6% and total risk-based capital
of 10%. Management believes, as of December 31, 2000 and 1999, that Sovereign
Bank met all capital adequacy requirements to which they are subject in order to
be "Well Capitalized". Management expects that Sovereign Bank will continue to
be classified as well-capitalized and in compliance with such capital
requirements and conditions. Although OTS capital regulations do not apply to
savings and loan holding companies, the OTS Order requires us to maintain
certain Tier 1 capital levels. We are presently in compliance with this
requirement and expect to remain as such. For a detailed discussion on
regulatory capital requirements, see Note 15 in the "Notes to Consolidated
Financial Statements" hereof.
Table 15 presents the capital ratios of Sovereign Bank and the current
regulatory requirements at December 31, 2000.
- --------------------------------------------------------------------------------
TABLE 15: REGULATORY CAPITAL
WELL
SOVEREIGN MINIMUM CAPITALIZED
BANK REQUIREMENT REQUIREMENT
--------- ----------- -----------
Tangible capital to tangible assets ... 6.92% 2.00% None
Tier 1 leverage ratio ................. 6.92 3.00 5.00%
Tier 1 risk-based capital ratio ....... 9.20 4.00 6.00
Total risk-based capital ratio ........ 10.31 8.00 10.00
- --------------------------------------------------------------------------------
Liquidity and Capital Resources
Liquidity represents the ability of Sovereign to obtain cost effective
funding to meet the needs of customers, as well as Sovereign's financial
obligations. Sovereign's primary sources of liquidity include retail deposit
gathering, Federal Home Loan Bank (FHLB) borrowings, reverse repurchase
agreements and wholesale deposit purchases. Other sources of liquidity include
federal funds purchased, asset securitizations, liquid investment portfolio
securities and debt issuances.
Sovereign is required under applicable federal regulations to maintain
specified levels of liquid investments in cash and other qualifying investments.
Current regulations require Sovereign Bank to maintain liquid assets of not less
than 4% of its net withdrawable accounts plus short-term borrowings. As of
December 2000, the Bank's liquidity ratio was 48.38%.
Factors which impact the liquidity position of Sovereign include loan
origination volumes, loan prepayment rates, maturity structure of existing
loans, core deposit growth levels, CD maturity structure and retention,
Sovereign's credit ratings, investment portfolio cash flows, maturity structure
of wholesale funding, etc. These risks are monitored and centrally managed. This
process includes reviewing all available wholesale liquidity sources. As of
December 31, 2000, Sovereign had $5.4 billion in available overnight liquidity
in the form of unused federal funds purchased lines, unused FHLB borrowing
capacity and unencumbered investment portfolio securities. Sovereign also
forecasts future liquidity needs and develops strategies to ensure that adequate
liquidity is available at all times.
During 2000, the Company completed the following transactions to provide
either additional capital and/or increased liquidity:
Securitizations: In December 2000, the Company securitized and sold
approximately $369 million of home equity loans. In October 2000, Sovereign
securitized and sold $579 million of automotive floor plan commercial loans.
Branch Sale: In the fourth quarter 2000, Sovereign sold certain
non-strategic branches with deposits of $315 million.
The securitizations and branch sales resulted in a net gain of $9 million,
recorded as other income in the Financial Statements.
REIT Preferred Stock: In August 2000, the Company raised $140 million from
issuance of preferred stock of a subsidiary, Sovereign REIT.
Structured Real Estate Transaction: In the second quarter, 2000, Sovereign
executed a structured real estate transaction that involved the sale and
subsequent leaseback of its own real estate and entered into a long-term lease
arrangement for certain real estate used in the SBNE franchise. The total
transaction was valued at $308 million. Total expenses related to the
transaction were approximately $17 million pretax and were recorded as
merger-related charges.
26
During 1999, the Company raised $1.8 billion of debt and equity to finance
its acquisition of Sovereign Bank New England. Components of these financings
were as follows:
Common Stock: 43.8 million shares of common stock were issued on November
15, 1999 resulting in net proceeds to Sovereign of $331.5 million.
Piers Units: 5.75 million units of Trust Preferred Income Equity Redeemable
Securities (PIERS) were issued on November 15, 1999, resulting in net proceeds
to Sovereign of $278.3 million, $91.5 million of which has been allocated to the
value of the warrants and is treated as original issue discount. The original
issue discount is accreted into Trust Preferred Securities expense over the life
of the unit resulting in an effective yield of 11.74%. Each PIERS unit consists
of:
A preferred security issued by Sovereign Capital Trust II (the Trust),
having a stated liquidation amount of $50, representing an undivided
beneficial ownership interest in the Trust, which assets consist
solely of debentures issued by Sovereign. Distributions are payable
quarterly beginning February 15, 2000 at an annual rate of 7.5% of the
stated liquidation value; and
A warrant to purchase, subject to antidilution adjustments, 5.3355
shares of Sovereign common stock at any time prior to November 20,
2029.
Senior Notes: $200 million of 10.25% notes due May 15, 2004, and $500
million of 10.50% notes due November 15, 2006, on November 15, 1999 resulting in
net proceeds to Sovereign of $681.3 million. The senior notes are unsecured
senior obligations of Sovereign and rank equally with all existing and future
senior indebtedness.
Senior Secured Credit Facility: $500 million floating rate senior secured
credit facility resulting in net proceeds to Sovereign of $485.5 million on
December 16, 1999. The senior secured credit facility is secured primarily by
the stock of Sovereign Bank, which is wholly owned by Sovereign Bancorp. The
senior facility will mature on the date six months prior to the maturity date of
the 10.25% senior notes, but in no event later than June 30, 2003. The
facility's original amortization schedule was as follows: 2000-5%, $25 million;
2001-15%, $75 million; 2002-40%, $200 million; and 2003-40%, $200 million with
mandatory prepayments occurring if Sovereign's cash flow exceeds predetermined
levels. During year 2000, Sovereign made its required $25 million payment on the
Senior Credit Facility, and made additional payments of $125 million. These
prepayments were made voluntarily, and not due to Sovereign's cash flow
exceeding the predefined levels proscribed. On March 1, 2001, Sovereign repaid
this senior credit facility with the proceeds from another debt issuance as
described below.
2001 Activities: Subsequent to December 31, 2000, Sovereign entered into
the following transactions:
Common Stock: On February 9, 2001, Sovereign issued $150 million of common
equity consisting of 20 million shares sold at $7.50 per common stock share. The
proceeds of the issuance were used to repay a portion of the $240 million of
6.625% senior notes which matured on March 15, 2001.
Senior Notes: On February 20, 2001, Sovereign issued $175 million of senior
unsecured notes at 8.625% which will mature on March 15, 2004. The proceeds of
this issuance were used to repay the remaining portion of the $240 million of
6.625% senior notes which matured on March 15, 2001 and for additional
liquidity.
Senior Secured Credit Facility: On March 1, 2001, Sovereign refinanced the
$500 million senior secured credit facility described above (outstanding balance
at December 31, 2000 of $350 million) with a variable principal rate $400
million senior secured credit facility consisting of a $350 million revolving
line of credit and a $50 million term note. For the first two years, the
interest rates on both the line of credit and term loan is calculated using one
of five methods at the option of Sovereign as: (1) 1 month Eurodollar rate plus
250 bp, (2) 3 month Eurodollar rate plus 250 bp, (3) 6 month Eurodollar rate
plus 250 bp, (4) 12 month Eurodollar rate plus 250 bp, (5) the greater of the
prime rate, plus 75 bp, or Fed Funds rate plus 125 bp. The interest rates for
years 3-6 are structured based upon a rate table beginning with the Eurodollar
rate plus 275 bp or the greater of the prime rate plus 100 bp or the federal
funds rate plus 150 bp, and are decreased based upon each level of Sovereign's
senior unsecured long-term debt credit rating exceeding certain levels. The
revolving line matures $100 million in 2005, $200 million in 2006, and $50
million in 2007, and the term note matures in 2005.
Cash and cash equivalents increased $566 million for 2000. Net cash used by
operating activities was $189 million for 2000. Net cash provided by investing
activities for 2000 was $6.5 billion primarily due to the maturity of $1.3
billion securities held in escrow to finance the SBNE acquisition, and the sale
of $2.1 billion of investment securities as a part of the strategy to deleverage
the balance sheet, and the cash received from the SBNE acquisition. Net cash
used by financing activities for 2000 was $5.8 billion which was primarily
attributable to repayment of short-term borrowings.
Sovereign's debt agreements impose customary limitations on dividends,
other payments and transactions. These limits are not expected to affect
dividend payments at current levels, and reasonably anticipated increases.
27
Asset and Liability Management
Interest rate risk arises primarily through Sovereign's traditional
business activities of extending loans and accepting deposits. Many factors,
including economic and financial conditions, movements in market interest rates
and consumer preferences, affect the spread between interest earned on assets
and interest paid on liabilities. In managing its interest rate risk, the bank
seeks to minimize the variability of net interest income across various likely
scenarios while at the same time maximizing its net interest income and net
interest margin. To achieve these objectives, the bank works closely with each
business line in the company and guides new business flows. The bank also uses
various other tools to manage interest rate risk including wholesale funding
maturity targeting, investment portfolio purchase strategies, asset
securitization/sale, and financial derivatives.
Interest rate risk is managed centrally by the Asset and Liability
Committee. Management reviews various forms of analysis to monitor interest rate
risk including net interest income sensitivity, market value sensitivity,
repricing frequency of assets versus liabilities and scenario analysis. Numerous
assumptions are made to produce these analyses including assumptions on new
business volumes, loan and investment prepayment rates, deposit flows, interest
rate curves, economic conditions, competitor pricing, etc.
Sovereign reviews nine instantaneous rate shock scenarios to assess the
sensitivity of Net Interest Income due to changes in interest rates including
parallel shocks, curve steepening scenarios and curve flattening scenarios. At
December 31, 2000, if interest rates moved in parallel 200 basis points up or
down, or if the yield curve steepened or flattened by 200 basis points,
Sovereign estimates the loss to Net Interest Income to remain under 2.4%.
This has improved significantly from December 31, 1999 when the sensitivity
in the worst scenario exceeded 10%. This improvement is due to the following
factors: addition of $12 billion of deposits from the SBNE acquisition,
wholesale funding paydown of over $5 billion, investment deleveraging of over $2
billion, increase in the core deposit mix and the increase in the mix of shorter
duration consumer and commercial loans. Net interest income sensitivity is used
to gauge the short-term interest rate risk of the bank.
Sovereign also monitors the relative repricing sensitivities of its assets
versus its liabilities. As of December 31, 2000, the one year cumulative gap was
1% versus (19)% one year earlier. This improvement is due to the same factors
listed above. A neutral gap position indicates that the bank's margin will be
stable across various interest rate scenarios.
Finally, Sovereign monitors the market value sensitivity of its assets
versus the market value sensitivity of its liabilities. The analysis calculates
the market value of assets, subtracts the market value of liabilities and adds
any off-balance sheet items to come up with its Net Portfolio Value (NPV). This
NPV is then calculated in numerous interest rate scenarios. Imbalances in this
analysis indicate that the bank has sensitivity to changes in interest rates. At
December 31, 2000, Sovereign has a very balanced profile, in correlation to the
Gap Analysis and Net Interest Income simulation results discussed above. When
measuring Net Portfolio Value (NPV), Sovereign monitors closely two specific
interest rate environments as measured by standard industry practice, an
instantaneous rate shock of up and down 200 basis points. If rates move up or
down in parallel by 200 basis points, Sovereign's NPV remains remarkably
constant with a loss of less than 1.55% in the worst scenario of rates falling
200 basis points. The worst case scenario is used as a benchmark by regulators
and Sovereign to measure and monitor the interest rate risk sensitivity of an
institution. NPV is used as a gauge of long term interest rate risk.
Because the assumptions used are inherently uncertain, the model cannot
precisely predict the effect of higher or lower interest rates on net interest
income. Actual results will differ from simulated results due to the timing,
magnitude and frequency of interest rate changes, the difference between actual
experience and the assumed volume and characteristics of new business and
behavior of existing positions, and changes in market conditions and management
strategies, among other factors.
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.
Interest rate swaps are generally used to convert fixed rate assets and
liabilities to variable rate assets and liabilities and vice versa. Sovereign
utilizes interest rate swaps that have a high degree of correlation to the
related financial instrument. At December 31, 2000, Sovereign's principal
off-balance sheet transactions were to convert liabilities from fixed rate to
floating rate to reduce the 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.
28
As part of its mortgage banking strategy, Sovereign originates fixed rate
residential mortgages. It sells the majority of these loans to FHLMC, FNMA, and
private investors. The loans are exchanged for cash or marketable fixed rate
mortgage-backed securities which are generally sold. This helps insulate
Sovereign from the interest rate risk associated with these fixed rate assets.
Sovereign uses forward sales, cash sales and options on mortgage-backed
securities as a means of hedging loans in the mortgage pipeline which are
originated for sale.
To accommodate customer needs, Sovereign enters into customer-related
financial derivative transactions primarily consisting of interest rate swaps,
caps, and floors. Risk exposure from customer positions is managed through
transactions with other dealers.
Table 16 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, 2000 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 16: GAP ANALYSIS
AT DECEMBER 31, 2000 REPRICING
----------------------------------------------------------------------
YEAR ONE YEAR TWO YEAR THREE YEAR FOUR
-------- -------- ---------- ---------
Interest earning assets:
Investment securities(1)(2) .............. $ 2,831,369 $1,163,271 $ 626,477 $ 406,746
6.92% 7.14% 7.23% 7.26%
Loans(3) ................................. 11,346,502 3,163,161 1,930,388 1,193,130
9.02% 8.65% 8.51% 8.28%
----------- ---------- ----------- -----------
Total interest earning assets ............... 14,177,871 4,326,432 2,556,865 1,599,876
8.60% 8.24% 8.20% 8.02%
Non-interest earning assets .............. -- -- -- --
----------- ---------- ----------- -----------
Total assets ................................ $14,177,871 $4,326,432 $ 2,556,865 $ 1,599,876
8.60% 8.24% 8.20% 8.02%
----------- ---------- ----------- -----------
Interest bearing liabilities:
Deposits(4) ................................. $11,457,089 $2,812,408 $ 1,831,613 $ 1,675,735
5.46% 4.02% 2.62% 2.55%
Borrowings .................................. 2,484,393 169,979 49,995 3,035,941
6.55% 6.15% 8.00% 5.92%
----------- ---------- ----------- -----------
Total interest bearing liabilities .......... 13,941,482 2,982,387 1,881,608 4,711,676
5.65% 4.14% 2.76% 4.72%
Non-interest bearing liabilities ............ -- -- -- --
Stockholders' equity ........................ -- -- -- --
----------- ---------- ----------- -----------
Total liabilities and stockholders' equity .. $13,941,482 $2,982,387 $ 1,881,608 $ 4,711,676
5.65% 4.14% 2.76% 4.72%
Excess assets (liabilities) before effect of
off-balance sheet positions .............. $ 236,389 $1,344,045 $ 675,257 $(3,111,800)
----------- ---------- ----------- -----------
To total assets .......................... 0.71% 4.02% 2.02% (9.30)%
=========== ========== =========== ===========
Cumulative excess assets (liabilities) before
effect of off-balance sheet positions .... $ 236,389 $1,580,434 $ 2,255,691 $ (856,109)
=========== ========== =========== ===========
To total assets .......................... 0.71% 4.72% 6.74% (2.74)%
Effect of off-balance sheet positions on
assets and liabilities ................... $ 47,551 $ 92,449 $ (200,000) $ --
----------- ---------- ----------- -----------
Excess assets (liabilities) after effect of
off-balance sheet positions .............. $ 283,940 $1,436,494 $ 475,257 $(3,111,800)
=========== ========== =========== ===========
To total assets .......................... 0.85% 4.29% 1.42% (9.30)%
Cumulative excess assets (liabilities) after
off-balance sheet positions .............. $ 283,940 $1,720,434 $ 2,195,691 $ (916,109)
=========== ========== =========== ===========
To total assets .......................... 0.85% 5.14% 6.56% (2.74)%
AT DECEMBER 31, 2000 REPRICING
-----------------------------------------------------
YEAR FIVE THEREAFTER TOTAL
--------- ---------- -----
Interest earning assets:
Investment securities(1)(2) .............. $ 199,847 $2,066,142 $ 7,293,852
7.24% 6.88% 7.00%
Loans(3) ................................. 945,031 3,334,033 21,912,245
7.87% 7.71% 8.63%
------------- ---------- -----------
Total interest earning assets ............... 1,144,878 5,400,175 29,206,097
7.76% 7.39% 8.23%
Non-interest earning assets .............. -- 4,251,700 4,251,700
------------- ---------- -----------
Total assets ................................ $ 1,144,878 $9,651,875 $33,457,797
7.76% 4.14% 7.18%
------------- ---------- -----------
Interest bearing liabilities:
Deposits(4) ................................. $ 1,588,205 $5,133,867 $24,498,917
2.40% 1.54% 3.86%
Borrowings .................................. -- 500,000 6,240,308
-- 10.50% 6.56%
------------- ---------- -----------
Total interest bearing liabilities .......... 1,588,205 5,633,867 30,739,225
2.40% 2.34% 4.41%
Non-interest bearing liabilities ............ -- 769,688 769,688
Stockholders' equity ........................ -- 1,948,884 1,948,884
------------- ---------- -----------
Total liabilities and stockholders' equity .. $ 1,588,205 $8,352,439 $33,457,797
2.40% 1.58% 4.05%
Excess assets (liabilities) before effect of
off-balance sheet positions .............. $ (443,327) $1,299,436
------------- ----------
To total assets .......................... (1.33)% 3.88%
============= ==========
Cumulative excess assets (liabilities) before
effect of off-balance sheet positions .... $ (1,299,436) $ --
============= ==========
To total assets .......................... (3.88)% --
Effect of off-balance sheet positions on
assets and liabilities ................... $ -- $ 60,000
------------- ----------
Excess assets (liabilities) after effect of
off-balance sheet positions .............. $ (443,327) $1,359,436
============= ==========
To total assets .......................... (1.33)% 4.06%
Cumulative excess assets (liabilities) after
off-balance sheet positions .............. $ (1,359,436) $ --
============= ==========
To total assets .......................... (4.06)% --
(1) Include interest-earning deposits.
(2) Investment securities include market rate payment and repayment
assumptions.
(3) Loan balances include annual prepayment and repayment assumptions between
12% and 40%. Loan balances are presented net of deferred loan fees and
include loans held for sale.
(4) Saving, NOW, money market and demand deposit accounts have been assumed to
decay at an annual rate of 14.6%.
- --------------------------------------------------------------------------------
29
Table 17 presents selected quarterly consolidated financial data (in
thousands, except per share data):
- --------------------------------------------------------------------------------
TABLE 17: SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA
THREE MONTHS ENDED
-------------------------------------------------------------------------------------------------
DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
2000 2000 2000 2000 1999 1999 1999 1999
--------- --------- --------- --------- --------- --------- -------- --------
Total interest income .......... $ 605,507 $ 634,754 $ 557,593 $ 471,881 $ 445,902 $ 415,954 $377,444 $368,028
Total interest expense ......... 351,171 380,345 370,779 312,629 280,315 254,086 230,036 228,236
--------- --------- --------- --------- --------- --------- -------- --------
Net interest income ............ 254,336 254,409 186,814 159,252 165,587 161,868 147,408 139,792
Provision for loan losses ...... 28,500 10,000 10,000 8,000 7,500 7,500 7,500 7,500
--------- --------- --------- --------- --------- --------- -------- --------
Net interest income after
provision ................. 225,836 244,409 176,814 151,252 158,087 154,368 139,908 132,292
--------- --------- --------- --------- --------- --------- -------- --------
Gain/(loss) on sale of loans and
investment securities ..... 5,026 (45,052) (58,216) (22,872) (2,196) (299) 3,362 3,408
Other income ................... 79,438 59,614 46,494 44,130 31,993 35,250 29,928 28,896
Other expenses ................. 327,214 315,745 237,810 132,335 148,722 103,843 98,445 95,369
--------- --------- --------- --------- --------- --------- -------- --------
Income/(loss)before income taxes (16,914) (56,774) (72,718) 40,175 39,162 85,476 74,753 69,227
Income tax provision ........... (13,590) (40,859) (24,016) 13,250 9,939 29,488 25,974 23,914
--------- --------- --------- --------- --------- --------- -------- --------
Income/(loss) before
extraordinary item ........ (3,324) (15,915) (48,702) 26,925 29,223 55,988 48,779 45,313
Extraordinary item ............. -- -- -- 10,775 -- -- -- --
--------- --------- --------- --------- --------- --------- -------- --------
Net income/(loss) .............. $ (3,324) $ (15,915) $ (48,702) $ 37,700 $ 29,223 $ 55,988 $ 48,779 $ 45,313
========= ========= ========= ========= ========= ========= ======== ========
Operating earnings ............. $ 55,632 $ 74,121 $ 57,298 $ 52,831 $ 52,220 $ 55,988 $ 48,779 $ 45,313
========= ========= ========= ========= ========= ========= ======== ========
Net income/(loss) applicable
to common stock ........... $ (3,324) $ (15,915) $ (48,702) $ 37,700 $ 29,223 $ 55,988 $ 48,779 $ 45,313
--------- --------- --------- --------- --------- --------- -------- --------
Earnings/(loss) per share:
Basic
Income/(loss) before
extraordinary item ........ $ (0.01) $ (0.07) $ (0.22) $ 0.12 $ 0.14 $ 0.31 $ 0.31 $ 0.28
Extraordinary item ........ -- -- -- 0.05 -- -- -- --
--------- --------- --------- --------- --------- --------- -------- --------
Net income/(loss) ......... $ (0.01) $ (0.07) $ (0.22) $ 0.17 $ 0.14 $ 0.31 $ 0.31 $ 0.28
========= ========= ========= ========= ========= ========= ======== ========
Diluted
Income/(loss) before
extraordinary item ........ $ (0.01) $ (0.07) $ (0.22) $ 0.12 $ 0.14 $ 0.31 $ 0.30 $ 0.28
Extraordinary item ........ -- -- -- 0.05 -- -- -- --
--------- --------- --------- --------- --------- --------- -------- --------
Net income/(loss) ......... $ (0.01) $ (0.07) $ (0.22) $ 0.17 $ 0.14 $ 0.31 $ 0.30 $ 0.28
--------- --------- --------- --------- --------- --------- -------- --------
Operating(1)
Income/(loss) before
extraordinary item ........ $ 0.25 $ 0.33 $ 0.29 $ 0.29 $ 0.29 $ 0.31 $ 0.31 $ 0.28
Extraordinary item ........ -- -- -- 0.05 -- -- -- --
--------- --------- --------- --------- --------- --------- -------- --------
Net income/(loss) .............. $ 0.25 $ 0.33 $ 0.29 $ 0.34 $ 0.29 $ 0.31 $ 0.31 $ 0.28
========= ========= ========= ========= ========= ========= ======== ========
Market prices
High ...................... $9 8/17 $ 9 7/8 $ 8 $7 29/32 $9 23/64 $12 7/8 $ 17 1/2 $14 9/16
Low ....................... 6 39/50 7 1/32 6 7/16 6 11/16 7 3/16 9 3/32 11 5/8 11 15/16
Dividends declared per common
share ..................... 0.025 0.025 0.025 0.025 0.025 0.025 0.025 0.020
(1) Operating earnings exclude special charges of $59.0 million, $90.0 million,
$106.0 million and $15.1 million for the three-month periods ended December
31, September 30, June 30 and March 31, 2000, respectively and $23.0
million for the three-month period ended December 31, 1999. See
"Reconciliation of Net Income to Operating Earnings" of
Management's Discussion and Analysis.
- --------------------------------------------------------------------------------
Pending Accounting Pronouncements
In June 1999, The Financial Accounting Standards Board ("FASB") issued SFAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133", which delays the
effective date of SFAS No. 133. Accordingly SFAS No. 133, shall be effective for
all fiscal years beginning after June 15, 2000. SFAS No. 133 requires the
recognition of all derivatives on the balance sheet at fair value. Derivatives
that are not hedges must be adjusted to fair value as a component of income. If
the derivative is a hedge, depending on the nature of the hedge, changes in the
fair value of derivatives will either be off-set against the change in fair
value of the hedged assets, liabilities, or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is recognized in
earnings. The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings.
30
The fair value of Sovereign's derivative instruments is currently not on
the balance sheet. On January 1, 2001, Sovereign adopted SFAS No. 133, and at
that time, designated anew the derivative instruments used for risk management
into hedging relationships in accordance with the requirements of the new
standard. Derivative instruments used to hedge changes in the fair value of
assets and liabilities due to changes in interest rates or other factors were
designated in fair value hedge relationships. Derivative instruments used to
hedge the variability of forcasted cash flows attributable to a specific risk,
generally interest rate risk, were designated in cash flow hedge relationships.
Also on January 1, 2001, after-tax transition amounts associated with
establishing the fair values of the derivative instruments and hedged items on
the balance sheet of $1.1 million and $7.1 million were recorded as an increase
of net income and a reduction in other comprehensive income, respectively. The
transition adjustments will be presented as cumulative effect adjustments as
described in Accounting Principles Board Opinion No. 20, Accounting Changes, in
the 2001 Consolidated Financial Statements. The transition amounts were
determined based on the interpretive guidance issued by the Financial Accounting
Standards Board to date. The FASB continues to issue interpretive guidance which
could require changes in Sovereign's application of the standard and adjustments
to the transition amounts.
SFAS No. 133, as applied to Sovereign's risk management strategies, may
increase or decrease reported net income and stockholders' equity prospectively,
depending on future levels of interest rates and other variables affecting the
fair values of derivative instruments and hedged items, but will have no effect
on cash flows or economic risk.
Results of Operations for the Years Ended December 31, 1999 and 1998
Net Interest Income. Net interest income for 1999 was $615 million compared
to $494 million for 1998. This growth represents an increase of 24% and was
primarily due to internal commercial and consumer loan growth, recent
acquisitions, an increase in average balances in investment securities available
for sale and growth in core deposits. Net interest margin - operating basis (net
interest income adjusted to eliminate the negative impact from escrowed
financing proceeds relating to the pending acquisition of Sovereign Bank New
England, divided by average interest-earning assets - see Reconciliation of Net
Income to Operating Earnings) was 2.88% for 1999 compared to 2.79% for 1998.
Interest on interest-earning deposits was $4.7 million for 1999 compared to
$7.4 million for 1998. The average balance of interest-earning deposits was
$15.2 million with an average yield of 31.12% for 1999 compared to an average
balance of $56.4 million with an average yield of 13.12% for 1998. The high
yields on interest-earning deposits 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 future years.
Interest on investment securities available-for-sale was $544 million for
1999 compared to $284 million for 1998. The average balance of investment
securities available-for-sale was $8.1 billion with an average yield of 6.85%
for 1999 compared to an average balance of $4.3 billion with an average yield of
6.75% for 1998. The increase in the average balance of investment securities
available-for-sale was due to Sovereign's realignment of its investment
portfolio, and an active decision by management to increase balance sheet
flexibility by placing more investments into available-for-sale.
Interest on investment securities held-to-maturity was $99.8 million for
1999 compared to $182 million for 1998. The average balance of investment
securities held-to-maturity was $1.4 billion with an average yield of 6.94% for
1999 compared to an average balance of $2.5 billion with an average yield of
7.22% for 1998. The decrease in the yield at year end, and the majority of the
year-end balance, is associated with the escrowed proceeds from the November
offerings related to the Fleet Boston acquisition.
Interest and fees on loans were $959 million for 1999 compared to $881
million for 1998. The average balance of net loans was $12.4 billion with an
average yield of 7.77% for 1999 compared to an average balance of $11.1 billion
with an average yield of 7.94% for 1998. The increase in average loan volume was
primarily the result of Sovereign's significant progress during the year in
increasing its emphasis in commercial and consumer lending. The increase in
volume was offset slightly by an overall decrease in rates.
Interest on total deposits was $441 million for 1999 compared to $444
million for 1998. The average balance of total deposits was $12.2 billion with
an average cost of 3.61% for 1999 compared to an average balance of $10.8
billion with an average cost of 4.12% for 1998. The increase in the average
balance and the decrease in the average cost of deposits was primarily the
result of Sovereign's emphasis on attracting lower-cost core deposits from small
and medium size corporations, governmental units and consumers, and the
CoreStates branch acquisition in September 1998.
Interest on total borrowings was $552 million for 1999 compared to $418
million for 1998. The average balance of total borrowings was $10.1 billion with
an average cost of 5.46% for 1999 compared to an average balance of $7.3 billion
with an average cost of 5.69% for 1998. The increase in the average balance was
the result of both balance sheet growth and funding requirements needed in
anticipation of the pending acquisition of assets and liabilities from Fleet
Boston. The decrease in the average cost of borrowings was due to a higher
proportion of short-term borrowings in the current year versus prior year, and a
slight overall decrease in interest rates.
31
Provision for Loan Losses. The provision for loan losses was $30.0 million
for 1999 compared to $28.0 million for 1998. Sovereign's net charge-offs for
1999 were $35.6 million and consisted of charge-offs of $55.0 million and
recoveries of $19.4 million. This compares to 1998 net charge-offs of $33.6
million consisting of charge-offs of $46.3 million and recoveries of $12.7
million. The ratio of net loan charge-offs to average loans, including loans
held for sale, was .29% for 1999 as compared to .30% for 1998. Commercial loan
net charge-offs as a percentage of average commercial loans were .11% for 1999
as compared to .14% for 1998. Consumer loan net charge-offs as a percentage of
average consumer loans were .49% for 1999, compared to .80% for 1998.
Residential real estate mortgage loan net charge-offs as a percentage of average
residential mortgage loans, including loans held for sale, were .23% for 1999,
and .08% for 1998. The increase was due to a $7.0 million accelerated
disposition of non-performing residential loan in 1999. Sovereign's increased
level of consumer and commercial loan charge-offs in 1999 and 1998 was primarily
related to Sovereign's acquisition activity during 1999 and 1998. Although
commercial and consumer lending will typically result in higher net charge-off
levels than residential lending, historically, it has also resulted in higher
income potential.
Other Income. Total other income was $130 million for 1999 compared to $105
million for 1998. Several factors contributed to the increase in other income as
discussed below.
Deposit fees were $49.2 million for 1999 compared to $31.1 million for
1998. This increase was primarily due to an increase in the number of
Sovereign's transaction accounts and active fee collection efforts due in part
to customer relationships acquired in the CoreStates and Peoples' acquisitions.
Mortgage banking revenues were $29.9 million for 1999 compared to $28.2
million for 1998. At December 31, 1999, Sovereign serviced $10.2 billion of its
own loans and $5.7 billion of loans for others. This compares to $9.2 billion of
its own loans and $6.7 billion of loans for others at December 31, 1998.
Loan fees and service charges were $8.9 million for 1999 compared to $7.1
million for 1998. Loan fees and service charges relate primarily to Sovereign's
non-residential loan portfolios, and the growth period to period is the result
of growth in the commercial and consumer loan portfolios due to internal growth
and acquisitions.
Net gains on sales of loans and investment securities were $4.3 million for
1999 compared to $19.8 million for 1998, which included net investment security
gains of $3.7 million and $15.8 million, and net gains on sales of loans of $0.6
million and $4.0 million in 1999 and 1998, respectively. This decrease was in
part due to a net gain of $2.8 million resulting from the sale of Sovereign's
credit card portfolio during the second quarter of 1998, and gains on sales of
investment securities available-for-sale during 1998.
Income from bank-owned life insurance ("BOLI") was $22.8 million for 1999
compared to $12.6 million for 1998. This increase was primarily due to an
additional investment in BOLI, which was made during the first quarter of 1999.
General and Administrative Expenses. Total general and administrative
expenses were $393 million for 1999 compared to $327 million. Included in 1998
total general and administrative expenses were $49.9 million of merger-related
charges. The increase in general and administrative expenses for 1999 was
primarily due to Sovereign's overall franchise growth (including the full year
impact of the CoreStates branch acquisition completed September 4, 1998, and
inclusion of the Peoples acquisition from June 30, 1999), $30.8 million of
merger, integration and other charges related to Sovereign's recent and pending
acquisitions, and start-up costs related to the formation of Sovereign's Capital
Markets Group and 1stwebbankdirect.com during the fourth quarter of 1999. The
remaining increase in expenses are related to Sovereign's Year 2000 and other
technology initiatives, and expansion in its corporate banking business line
during the year. Sovereign's efficiency ratio (all operating general and
administrative expenses as a percentage of net interest income and recurring
non-interest income) for 1999 was 48.6% compared to 46.6% for 1998.
Other Operating Expenses. Total other operating expenses were $53.5 million
for 1999 compared to $32.3 million for 1998. Other operating expenses included
amortization of goodwill and other intangible assets of $38.0 million for 1999
compared to $20.6 million for 1998, Trust Preferred Securities expense of $15.4
million for 1999 compared to $12.5 million for 1998, and other net real estate
owned ("OREO") losses of $95,000 for 1999 compared to net OREO gains of $804,000
for 1998. This increase in amortization expense for goodwill and other
intangible assets is due to Sovereign's September 1998 CoreStates branch
acquisition. Trust Preferred Securities expense increased due to the issuance of
additional securities in November.
Income Tax Provision. The income tax provision was $89.3 million for 1999
compared to $74.8 million for 1998. The effective tax rate for 1999 was 33.2%
compared to 35.4% for 1998. The effective tax rate for 1999 includes the effect
of Sovereign's increased investment in BOLI during the first quarter of 1999.
For additional information with respect to Sovereign's income taxes, see Note 18
in the "Notes to Consolidated Financial Statements" hereof.
Item 7a. Quantitative and Qualitative Disclosures about Market Risk.
Incorporated by reference from Part II, Item 7 "Management's Discussion and
Analysis of Financial Conditions and Results of Operations -- Asset and
Liability Management" hereof.
32
Item 8. Financial Statements and Supplementary Data.
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 as of
December 31, 2000, and the year then ended. 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 Control over Financial Reporting
Management is responsible for establishing and maintaining effective
internal control over financial reporting. The system contains monitoring
mechanisms and actions are taken to correct deficiencies identified.
There are inherent limitations in the effectiveness of any internal
control, including the possibility of human error and the circumvention or
overriding of controls. Accordingly, even effective internal control can provide
only reasonable assurance with respect to financial statement preparation.
Further, because of changes in conditions, the effectiveness of internal control
may vary over time.
Management assessed Sovereign's internal control over financial reporting
as of December 31, 2000. This assessment was based on criteria for effective
internal control over financial reporting 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 effective internal control over financial
reporting as of December 31, 2000.
/s/ JAY S. SIDHU /s/ DENNIS S. MARLO /s/ MARK R. MCCOLLOM
-------------------- -------------------- ------------------------
Jay S. Sidhu Dennis S. Marlo Mark R. McCollom
President and Chief Treasurer and Chief Chief Accounting Officer
Executive Officer Financial Officer
33
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, 2000 and 1999, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 2000. These financial statements
are the responsibility of the management of Sovereign. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Sovereign
Bancorp, Inc. at December 31, 2000 and 1999, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States.
/s/ Ernst & Young LLP
Philadelphia, Pennsylvania
February 5, 2001,
except for Note 26, as to which
the date is March 1, 2001
34
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data) YEAR ENDED DECEMBER 31,
----------------------------
2000 1999
------------ ------------
Assets
Cash and amounts due from depository institutions ............................................. $ 945,196 $ 373,996
Interest-earning deposits ..................................................................... 14,447 19,238
Investment securities available-for-sale ...................................................... 5,315,584 8,030,212
Investment securities held-to-maturity (fair value approximates $1,971,896 and $2,367,025) .... 1,978,268 2,362,051
Loans (including loans held for sale of $59,993 and $61,925) .................................. 21,912,245 14,288,465
Allowance for loan losses ..................................................................... (256,356) (132,986)
Premises and equipment ........................................................................ 290,134 119,201
Other real estate owned (including other repossessed assets of $3,758 and $1,762) ............. 8,183 5,329
Accrued interest receivable ................................................................... 230,514 164,720
Goodwill and other intangible assets .......................................................... 1,455,331 434,078
Bank owned life insurance ..................................................................... 612,580 412,580
Other assets .................................................................................. 951,671 530,228
------------ ------------
Total Assets .............................................................................. $ 33,457,797 $ 26,607,112
============ ============
Liabilities
Deposits and other customer accounts .......................................................... $ 24,498,917 $ 12,012,675
Borrowings .................................................................................... 1,330,900 6,157,939
Long-term debt:
Repurchase agreements and FHLB advances ................................................... 3,544,984 4,618,489
Senior secured credit facility ............................................................ 350,792 500,000
Senior notes and subordinated debentures .................................................. 1,013,632 1,093,681
Advance payments by borrowers for taxes and insurance ......................................... 24,009 28,222
Other liabilities ............................................................................. 287,464 58,265
------------ ------------
Total Liabilities ......................................................................... 31,050,698 24,469,271
------------ ------------
Mandatorily redeemable capital securities ("Trust Preferred Securities") ...................... 319,959 316,346
Minority interest-preferred securities of subsidiary .......................................... 138,256 --
Stockholders' Equity
Preferred stock; no par value; $50 liquidation preference; 7,500,000 shares authorized;
0 shares issued and outstanding ........................................................... -- --
Common stock; no par value; 400,000,000 shares authorized; issued 231,465,030 and 230,647,896 . 1,259,374 1,254,037
Warrants ...................................................................................... 91,500 91,500
Unallocated common stock held by the Employee Stock Ownership Plan (4,565,924 shares and
4,856,254 shares at cost) ................................................................. (33,230) (36,295)
Treasury stock (397,756 shares and 383,875 shares at cost) .................................... (3,789) (3,595)
Accumulated other comprehensive loss .......................................................... (38,521) (210,932)
Retained earnings ............................................................................. 673,550 726,780
------------ ------------
Total Stockholders' Equity ................................................................ 1,948,884 1,821,495
------------ ------------
Total Liabilities and Stockholders' Equity ................................................ $ 33,457,797 $ 26,607,112
============ ============
See accompanying notes to consolidated financial statements.
35
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data) YEAR ENDED DECEMBER 31,
---------------------------------------------
2000 1999 1998
----------- ---------- -----------
Interest Income:
Interest on interest-earning deposits ..................................... $ 22,158 $ 4,721 $ 7,397
Interest and dividends on investment securities:
available-for-sale .................................................... 487,448 543,631 284,392
held-to-maturity ...................................................... 132,442 99,813 182,499
Interest and fees on loans ................................................ 1,627,687 959,164 881,083
----------- ---------- -----------
Total interest income ................................................. 2,269,735 1,607,329 1,355,371
----------- ---------- -----------
Interest Expense:
Interest on deposits ...................................................... 735,087 440,826 443,833
Interest on borrowings and long-term debt ................................. 679,837 551,847 417,926
----------- ---------- -----------
Total interest expense ................................................ 1,414,924 992,673 861,759
----------- ---------- -----------
Net interest income ............................................................ 854,811 614,656 493,612
Provision for loan losses ...................................................... 56,500 30,000 27,961
----------- ---------- -----------
Net interest income after provision for loan losses ............................ 798,311 584,656 465,651
----------- ---------- -----------
Other Income:
Deposit fees .............................................................. 91,304 49,177 31,078
Mortgage banking fees ..................................................... 25,207 29,926 28,209
Loan fees and service charges ............................................. 16,854 8,856 7,075
Gain/(loss) on sale of loans and investment securities .................... (121,114) 4,275 19,844
Capital markets revenue ................................................... 11,090 -- --
Bank owned life insurance ................................................. 33,269 22,813 12,572
Miscellaneous income ...................................................... 51,951 15,295 6,403
----------- ---------- -----------
Total other income .................................................... 108,561 130,342 105,181
----------- ---------- -----------
General and Administrative Expenses:
Compensation and benefits ................................................. 270,799 154,880 146,614
Occupancy and equipment ................................................... 158,629 67,564 70,272
Outside services .......................................................... 166,188 93,340 52,830
Other administrative ...................................................... 135,875 77,145 57,577
----------- ---------- -----------
Total general and administrative expenses ............................. 731,491 392,929 327,293
----------- ---------- -----------
Other Operating Expenses:
Amortization of goodwill and other intangibles ............................ 98,940 37,967 20,609
Trust Preferred Securities and other minority interest expense ............ 44,293 15,393 12,528
Other real estate owned (gains)/losses, net ............................... (180) 95 (804)
Restructuring ............................................................. 18,500 -- --
Non-solicitation expense .................................................. 120,060 -- --
----------- ---------- -----------
Total other operating expenses ........................................ 281,613 53,455 32,333
----------- ---------- -----------
Income/(loss) before income taxes .............................................. (106,232) 268,614 211,206
Income tax provision/(benefit) ................................................. (65,215) 89,315 74,751
----------- ---------- -----------
INCOME/(LOSS) BEFORE EXTRAORDINARY ITEM ........................................ (41,017) 179,299 136,455
Gain on the sale of FHLB advances (net of tax of $5,225) ....................... 10,775 -- --
----------- ---------- -----------
NET INCOME/(LOSS) .............................................................. $ (30,242) $ 179,299 $ 136,455
=========== ========== ===========
NET INCOME/(LOSS) APPLICABLE TO COMMON STOCK ................................... $ (30,242) $ 179,299 $ 134,959
=========== ========== ===========
Earnings/(loss) per share:
Basic
Income/(loss) before extraordinary item ................................... $ (0.18) $ 1.02 $ 0.88
Extraordinary item ........................................................ 0.05 -- --
----------- ---------- -----------
Net income/(loss) ......................................................... $ (0.13) $ 1.02 $ 0.88
=========== ========== ===========
Diluted
Income/(loss) before extraordinary item ................................... $ (0.18) $ 1.01 $ 0.85
Extraordinary item ........................................................ 0.05 -- --
----------- ---------- -----------
Net income/(loss) ......................................................... $ (0.13) $ 1.01 $ 0.85
=========== ========== ===========
Dividends Declared Per Common Share ............................................ $ .100 $ .100 $ .080
=========== ========== ===========
See accompanying notes to consolidated financial statements.
36
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
COMMON PREFERRED
SHARES SHARES COMMON PREFERRED
OUTSTANDING OUTSTANDING STOCK WARRANTS STOCK
----------- ----------- ------ -------- ---------
Balance, December 31, 1997 .................................. 141,218 1,996 $ 523,327 $ -- $ 96,276
Comprehensive income:
Net income ........................................... -- -- -- -- --
Change in unrecognized income on investment
securities available-for-sale, net of tax ............ -- -- -- -- --
Total comprehensive income ..................................
Exercise of stock options ................................... 2,296 -- 15,910 -- --
Cash in lieu of fractional shares ........................... -- -- (68) -- --
Sale of stock under Dividend Reinvestment and Employee
Stock Purchase Plan .................................. 296 -- 4,609 -- --
Dividends paid on common stock .............................. -- -- -- -- --
Dividends paid on preferred stock ........................... -- -- -- -- --
Treasury stock repurchased .................................. (86) -- -- -- --
Treasury stock sold ......................................... 18 -- -- -- --
Conversion of preferred stock ............................... 14,342 (1,996) 96,270 -- (96,270)
Redemption of preferred stock ............................... -- -- -- -- (6)
Allocation of shares under Employee Stock Ownership Plan .... 1,581 -- 11,760 -- --
Adjustment for ML Bancorp's different fiscal year end ....... -- -- -- -- --
-------- ------ ----------- ------- --------
Balance, December 31, 1998 .................................. 159,665 -- 651,808 -- --
-------- ------ ----------- ------- --------
Comprehensive income:
Net income ........................................... -- -- -- -- --
Change in unrecognized loss on investment securities
available-for-sale, net of tax ....................... -- -- -- -- --
Total comprehensive loss ....................................
Issuance of common stock .................................... 43,810 -- 331,478 -- --
Issuance of warrants ........................................ -- -- -- 91,500 --
Exercise of stock options ................................... 721 -- 6,919 -- --
Cash in lieu of fractional shares ........................... -- -- (6) -- --
Sale of stock under Dividend Reinvestment and Employee
Stock Purchase Plan .................................. 408 -- 4,412 -- --
Dividends paid on common stock .............................. -- -- -- -- --
Treasury stock repurchased .................................. (3,351) -- -- -- --
Treasury stock sold ......................................... 26 -- -- -- --
Allocation of shares under Employee Stock Ownership Plan .... 270 -- 1,255 -- --
Acquisition of Network Companies ............................ 235 -- 3,000 -- --
Acquisition of People's Bancorp, Inc ........................ 23,624 -- 255,171 -- --
-------- ------ ----------- ------- --------
Balance, December 31, 1999 .................................. 225,408 -- 1,254,037 91,500 --
-------- ------ ----------- ------- --------
Comprehensive income:
Net loss ............................................. -- -- -- -- --
Change in unrecognized loss on investment securities
available-for-sale, net of tax ....................... -- -- -- -- --
Total comprehensive income ..................................
Exercise of stock options ................................... 196 -- 678 -- --
Cash in lieu of fractional shares ........................... -- -- (3) -- --
Sale of stock under Dividend Reinvestment and Employee
Stock Purchase Plan .................................. 621 -- 4,569 -- --
Dividends paid on common stock .............................. -- -- -- -- --
Treasury stock repurchased .................................. (62) -- -- -- --
Treasury stock sold ......................................... 48 -- -- -- --
Allocation of shares under Employee Stock Ownership Plan, net 290 -- 93 -- --
-------- ------ ----------- ------- --------
Balance, December 31, 2000 .................................. 226,501 -- $ 1,259,374 $91,500 $ --
======== ====== =========== ======= ========
(in thousands) ACCUMULATED
UNALLOCATED OTHER TOTAL
RETAINED TREASURY STOCK HELD COMPREHENSIVE STOCKHOLDERS'
EARNINGS STOCK BY ESOP INCOME EQUITY
-------- ----- ------- ------ ------
Balance, December 31, 1997 .................................. $ 446,644 $ (185) $(37,211) $ 18,944 $ 1,047,795
Comprehensive income:
Net income ........................................... 136,455 -- -- -- 136,455
Change in unrecognized income on investment
securities available-for-sale, net of tax ............ -- -- -- (824) (824)
-----------
Total comprehensive income .................................. 135,631
Exercise of stock options ................................... -- -- -- -- 15,910
Cash in lieu of fractional shares ........................... -- -- -- -- (68)
Sale of stock under Dividend Reinvestment and Employee
Stock Purchase Plan .................................. -- -- -- -- 4,609
Dividends paid on common stock .............................. (12,790) -- -- -- (12,790)
Dividends paid on preferred stock ........................... (1,496) -- -- -- (1,496)
Treasury stock repurchased .................................. -- (1,258) -- -- (1,258)
Treasury stock sold ......................................... -- 357 -- -- 357
Conversion of preferred stock ............................... -- -- -- -- --
Redemption of preferred stock ............................... -- -- -- -- (6)
Allocation of shares under Employee Stock Ownership Plan .... -- -- 7,852 -- 19,612
Adjustment for ML Bancorp's different fiscal year end ....... (4,228) -- -- -- (4,228)
--------- -------- -------- --------- -----------
Balance, December 31, 1998 .................................. 564,585 (1,086) (29,359) 18,120 1,204,068
--------- -------- -------- --------- -----------
Comprehensive income:
Net income ........................................... 179,299 -- -- -- 179,299
Change in unrecognized loss on investment securities
available-for-sale, net of tax ....................... -- -- -- (229,052) (229,052)
-----------
Total comprehensive loss .................................... (49,753)
Issuance of common stock .................................... -- -- -- -- 331,478
Issuance of warrants ........................................ -- -- -- -- 91,500
Exercise of stock options ................................... -- -- -- -- 6,919
Cash in lieu of fractional shares ........................... -- -- -- -- (6)
Sale of stock under Dividend Reinvestment and Employee
Stock Purchase Plan .................................. -- -- -- -- 4,412
Dividends paid on common stock .............................. (17,104) -- -- -- (17,104)
Treasury stock repurchased .................................. -- (47,152) -- -- (47,152)
Treasury stock sold ......................................... -- 285 -- -- 285
Allocation of shares under Employee Stock Ownership Plan .... -- -- 1,834 -- 3,089
Acquisition of Network Companies ............................ -- -- -- -- 3,000
Acquisition of People's Bancorp, Inc ........................ -- 44,358 (8,770) -- 290,759
--------- -------- -------- --------- -----------
Balance, December 31, 1999 .................................. 726,780 (3,595) (36,295) (210,932) 1,821,495
--------- -------- -------- --------- -----------
Comprehensive income:
Net loss ............................................. (30,242) -- -- -- (30,242)
Change in unrecognized loss on investment securities
available-for-sale, net of tax ....................... -- -- -- 172,411 172,411
-----------
Total comprehensive income .................................. 142,169
Exercise of stock options ................................... -- -- -- -- 678
Cash in lieu of fractional shares ........................... (79) -- -- -- (82)
Sale of stock under Dividend Reinvestment and Employee
Stock Purchase Plan .................................. -- -- -- -- 4,569
Dividends paid on common stock .............................. (22,420) -- -- -- (22,420)
Treasury stock repurchased .................................. -- (473) -- -- (473)
Treasury stock sold ......................................... -- 279 -- -- 279
Allocation of shares under Employee Stock Ownership Plan, net (489) -- 3,065 -- 2,669
--------- -------- -------- --------- -----------
Balance, December 31, 2000 .................................. $ 673,550 $ (3,789) $(33,230) $ (38,521) $ 1,948,884
========= ======== ======== ========= ===========
See accompanying notes to consolidated financial statements.
37 & 38
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) YEAR ENDED DECEMBER 31,
-----------------------------------------
2000 1999 1998
----------- ----------- -----------
Cash Flows From Operating Activities:
Net income/(loss) ............................................... $ (30,242) $ 179,299 $ 136,455
Adjustments to reconcile net income/(loss) to net
cash provided by operating activities:
Provision for loan losses ................................... 56,500 30,000 27,961
Deferred taxes .............................................. (50,930) 18,852 (18,681)
Depreciation and amortization ............................... 128,587 18,802 13,434
Amortization/accretion of investment
securities and loan discounts ............................ (34,747) 58,830 18,204
(Gain) loss on sale of loans, investment
securities and real estate owned ......................... 117,897 (4,484) (20,076)
(Gain) loss on sale of fixed assets ......................... (165) -- --
(Gain) loss on sale of FHLB advances ........................ (16,000) -- --
Allocation of Employee Stock Ownership Plan ................. 3,065 3,089 19,612
Net change in:
Loans held for sale ......................................... 8,811 235,005 13,748
Accrued interest receivable ................................. (11,829) (9,262) (39,560)
Prepaid expenses and other costs ............................ (656,202) (273,033) (467,329)
Other liabilities ........................................... 296,326 (280,706) 301,217
----------- ----------- -----------
Net cash (used) by operating activities .............................. (188,929) (23,608) (15,015)
----------- ----------- -----------
Cash Flows From Investing Activities:
Proceeds from sales of investment securities .................... 8,248,463 5,553,469 2,157,904
Proceeds from repayments and maturities of investment securities:
Available-for-sale .......................................... 836,465 1,644,019 1,109,075
Held-to-maturity ............................................ 4,255,897 793,031 2,062,628
Purchases of investment securities:
Available-for-sale .......................................... (6,157,701) (8,024,026) (7,996,541)
Held-to-maturity ............................................ (2,704,498) (1,312,372) (471,326)
Proceeds from sales of loans .................................... 2,385,619 1,188,173 1,422,279
Purchase of loans ............................................... (2,572,063) (2,022,695) (1,966,864)
Net change in loans other than purchases and sales .............. 463,389 (1,561,471) 464,382
Proceeds from sales of premises and equipment ................... 46,490 5,757 18,437
Purchases of premises and equipment ............................. (178,106) (39,844) (32,872)
Proceeds from sales of real estate owned ........................ 3,624 17,081 19,069
Net cash received from/(paid for) business combinations ......... 1,916,345 112,998 (302,808)
Other, net ...................................................... -- -- (4,228)
----------- ----------- -----------
Net cash provided (used) by investing activities ..................... 6,543,924 (3,645,880) (3,520,865)
----------- ----------- -----------
Cash Flows From Financing Activities:
Assumption of deposits .......................................... -- -- 2,231,149
Net increase/(decrease) in deposits and other customer accounts . 210,550 (1,117,500) 576,982
Net increase/(decrease) in short-term borrowings ................ (5,449,523) 2,023,868 (2,135,369)
Proceeds from long-term borrowings .............................. 813,068 2,500,894 3,169,839
Repayments of long-term borrowings .............................. (569,982) (455,959) --
Sale of FHLB advances ........................................... (911,037) -- --
Net increase/(decrease) in advance payments by borrowers
for taxes and insurance ..................................... (4,213) 568 (14,192)
Proceeds from the issuance of preferred stock by subsidiary ..... 140,396 -- --
Proceeds from issuance of Trust Preferred Securities ............ -- 187,231 --
Cash dividends paid to stockholders ............................. (22,988) (17,104) (14,286)
Redemption of preferred stock ................................... -- -- (6)
Proceeds from issuance of common stock .......................... 5,337 342,803 20,451
Proceeds from issuance of warrants .............................. -- 91,500 --
Advance to the Employee Stock Ownership Plan .................... -- (436) --
(Purchase)/issuance of treasury stock ........................... (194) (46,867) (901)
----------- ----------- -----------
Net cash provided (used) by financing activities ..................... (5,788,586) 3,508,998 3,833,667
----------- ----------- -----------
Net change in cash and cash equivalents .............................. 566,409 (160,490) 297,787
Cash and cash equivalents at beginning of period ..................... 393,234 553,724 255,937
----------- ----------- -----------
Cash and cash equivalents at end of period ........................... $ 959,643 $ 393,234 $ 553,724
=========== =========== ===========
Supplemental Disclosures: Income tax payments totaled $6.2 million in 2000,
$101 million in 1999, and $77.4 million in 1998. Interest payments totaled $1.4
billion in 2000, $963 million in 1999, and $848 million in 1998. Noncash
activity consisted of acquisitions which included $9.1 billion of loans and
assumption of $12.3 billion of deposits in 2000, $551 million of loans and
assumption of $515 million in deposits in 1999, and $.7 billion of loans and
assumption of $2.2 billion of deposits in 1998. Other noncash activity consisted
of mortgage loan securitization of $1.2 billion in 2000, $1.0 billion in 1999,
and $1.2 billion in 1998; reclassification of long-term borrowings to short-term
borrowings of $950 million in 2000, $536 million in 1999, and $613 million in
1998; and reclassification of mortgage loans to real estate owned of $6.2
million in 2000, $11.7 million in 1999, and $18.8 million in 1998.
See accompanying notes to consolidated financial statements.
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Sovereign Bancorp, Inc. and subsidiaries ("Sovereign") is a Pennsylvania
business corporation and is the holding company of Sovereign Bank. Sovereign is
headquartered in Philadelphia, Pennsylvania and Sovereign Bank is headquartered
in Wyomissing, Pennsylvania. Sovereign's primary business consists of attracting
deposits from its network of community banking offices, located throughout
eastern Pennsylvania, New Jersey, New Hampshire, Massachusetts, Connecticut,
Rhode Island, and northern Delaware, and originating commercial, consumer and
residential mortgage loans in those communities. Sovereign also serves customers
throughout New York.
The following is a description of the significant accounting policies of
Sovereign. Such accounting policies are in accordance with accounting principles
generally accepted in the United States and have been followed on a consistent
basis.
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, Sovereign Delaware Investment
Corporation, Sovereign Capital Trust I, Sovereign Capital Trust II, and ML
Capital Trust I. All material intercompany balances and transactions have been
eliminated in consolidation.
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.
Basic earnings per share is calculated by dividing income available to
common stockholders by the weighted average common shares outstanding, excluding
options, warrants, and convertible securities from the calculation. In
calculating diluted earnings per share, the dilutive effect of options and
warrants is calculated using the treasury stock method using the average market
price of the period. The dilutive effect of preferred stock is calculated using
the if-converted method. See Note 23 for computation of earnings per share.
d. Interest-earning Deposits - Interest-earning deposits consist of deposit
accounts with other financial institutions generally having maturities of three
months or less.
e. Investment Securities - Investment 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 component of comprehensive
income within stockholders' equity, net of estimated income taxes. 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 options to hedge interest rate risk associated with loans held for sale.
Gains and losses on these transactions are included in the net gain or loss when
the asset is sold.
g. Loans Held for Sale - Loans held for sale are recorded at the lower of
cost or estimated fair value on an aggregate basis. Gains and losses are
included in the consolidated statements of operations.
h. Mortgage Banking Activity - Sovereign recognizes, as separate assets,
the rights to service mortgage loans, whether those rights are acquired through
loan purchase or loan origination activities. The initial recognition of
originated mortgage servicing assets is predicated upon an allocation of the
total cost of the related loans between the loans and the loan servicing rights
based on their relative estimated fair values. Purchased mortgage servicing
assets are recorded at cost. 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.
Mortgage servicing rights are amortized against loan servicing fee income
on an accelerated basis in proportion to, and over the period of, estimated net
future loan servicing fee income, which periods initially do not exceed eight
years. 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. See Note 6 for details of mortgage banking activity.
40
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)
i. Allowance for Loan Losses - An allowance for loan losses is maintained
at a level that management considers adequate to provide for 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 losses, 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.
The allowance for loan losses consists of two elements: (i) an allocated
allowance, which is comprised of allowances established on specific loans, and
class allowances based on historical loan loss experience and current trends,
and (ii) unallocated allowances based on both general economic conditions and
other risk factors in the Company's individual markets and portfolios, and to
account for a level of imprecision in management's estimation process.
The specific allowance element is based on a regular analysis of criticized
commercial loans where internal credit ratings are below a predetermined
classification. This analysis is performed at the relationship manager level,
and periodically reviewed by the loan review department. The specific allowance
established for these criticized loans is based on a careful analysis of related
collateral value, cash flow considerations and, if applicable, guarantor
capacity.
The class allowance element is determined by an internal loan grading
process in conjunction with associated allowance factors. These class allowance
factors are updated at least annually and are based primarily on actual
historical loss experience projected loss experience based on current
conditions, consultation with regulatory authorities, and peer group loss
experience. While this analysis is conducted at least annually, the Company has
the ability to revise the class allowance factors whenever necessary in order to
address improving or deteriorating credit quality trends or specific risks
associated with a given loan pool classification.
Regardless of the extent of the Company analysis of customer performance,
portfolio evaluations, trends or risk management processes established, certain
inherent, but undetected losses are probable within the loan portfolio. This is
due to several factors including inherent delays in obtaining information
regarding a customer's financial condition or changes in their unique business
conditions; the judgmental nature of individual loan evaluations, collateral
assessments and the interpretation of economic trends; and the sensitivity of
assumptions utilized to establish allocated allowances for homogeneous groups of
loans among other factors. The Company maintains an unallocated allowance to
recognize the existence of these exposures.
These other risk factors are continuously reviewed and revised by
management where conditions indicate that the estimates initially applied are
different from actual results.
A comprehensive analysis of the allowance for loan losses is performed by
the Company on a quarterly basis. In addition, a review of allowance levels
based on nationally published statistics is conducted on an annual basis. The
Company also has an asset review committee, which has the responsibility of
affirming allowance methodology and assessing the general and specific allowance
factors in relation to estimated and actual net charge-off trends. This
committee is also responsible for assessing the appropriateness of the allowance
for loan losses for each loan pool classification at Sovereign.
j. Loans - Loans are reported net of unearned income. Interest on loans is
credited to income as it is earned. Loan origination fees and certain direct
loan origination costs are deferred and recognized as adjustments to 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. 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.
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. 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. 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 charged-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.
For purposes of measuring impairment as set forth by the provisions of SFAS
No. 114 "Accounting by Creditors for Impairment of a Loan" and SFAS No. 118
"Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosure", Sovereign defines impaired loans as non-accrual, non-homogeneous
loans and certain other loans which are still accruing, which management has
specifically identified as being impaired.
41
NOTE 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 the
straight-line method. Estimated useful lives are as follows:
Office buildings ................................... 10 to 30 years
Leasehold improvements ............................. Remaining lease term*
Furniture, fixtures and equipment .................. 3 to 10 years
Automobiles ........................................ 5 years
Expenditures for maintenance and repairs are charged to expense as incurred.
*Including option periods, if applicable.
l. Other Real Estate Owned - Other real estate owned ("OREO") consists of
properties acquired by or in lieu of foreclosure. OREO is stated at the lower of
cost or estimated fair value minus estimated costs to sell. Write-downs of OREO
which occur after the initial transfer from the loan portfolio and costs of
holding the property are recorded as other operating expenses, 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.
n. Derivative Instruments and Hedging Activity - Sovereign has entered into
certain interest rate exchange agreements in connection with its asset/liability
management program which are designated as hedges. Derivatives used as hedges
must be effective at reducing the risk associated with the exposure being hedged
and must be designated as a hedge at the inception of the derivative contract.
To ensure effectiveness, Sovereign performs an analysis to ensure that changes
in fair value or cash flow of the derivative correlates to the equivalent
changes in the asset or liability being hedged. 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 and are reflected in other income. 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. Sovereign enters into interest rate swap contracts to provide for the
needs of its customers. Contracts held or issued for customers are valued at
fair market value with gains or losses included in capital markets revenue.
o. Foreign Exchange - The company enters into forward exchange contracts to
provide for the needs of its customers. Forward exchange contracts are valued at
current exchange rates. All gains or losses on forward exchange contracts are
included in capital markets revenue.
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. Goodwill and Other Intangibles - Core deposit intangibles are a measure
of the value of checking and savings deposits acquired in business combinations
accounted for as purchases. Core deposit intangibles are generally amortized
using an accelerated method over the estimated lives of the existing deposit
relationships acquired, but not exceeding 10 years. Goodwill is the excess of
the purchase price over the fair value of net tangible and identifiable
intangible assets of companies acquired through business combinations accounted
for as purchases. In finalizing a purchase allocation, the Company considers all
the facts that come to its attention during the allocation period, not to exceed
12 months, and, if necessary, will adjust the purchase price allocation
accordingly based on such facts.
Goodwill is amortized using the straight line method over various periods
not exceeding 25 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, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of."
42
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)
s. Segment Reporting - SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" requires that public companies report
certain information about operating segments. 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. Sovereign is
a large regional bank which offers a wide array of products and services to its
customers. Pursuant to its banking strategy, emphasis is placed on building
relationships with its customers, as opposed to building specific lines of
business. As a result, at December 31, 2000 and 1999 Sovereign is not organized
around discernable lines of business and prefers to work as an integrated unit
to customize solutions for its customers, with business line emphasis and
product offerings changing over time as needs and demands change. Thus, all
necessary requirements of SFAS No. 131 have been met by Sovereign as of December
31, 2000.
t. Asset Securitizations - When the Company sells home equity loans,
automobile and recreational vehicle loans, and residential mortgage loans, it
may retain interest only strips, one or more subordinated tranches, servicing
rights, and in some cases a cash reserve account, all of which are retained
interests in the securitized receivables. Gain or loss on sale of the
receivables depends in part on the previous carrying amount of the financial
assets involved in the transfer, allocated between the assets sold and the
retained interests based on their relative fair value at the date of the
transfer. The Company generally estimates fair value based on the present value
of expected future cash flows estimated using management's best estimates of the
key assumptions-credit losses, pre-payment speeds, forward yield curves, and
discount rates commensurate with the risks involved.
u. Pending Accounting Pronouncements - In June 1999, The Financial
Accounting Standards Board ("FASB") issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities-Deferral of the Effective Date of
FASB Statement No. 133", which delays the effective date of SFAS No. 133.
Accordingly, SFAS No. 133, shall be effective for all fiscal years beginning
after June 15, 2000. SFAS No. 133 requires the recognition of all derivatives on
the balance sheet at fair value. Derivatives that are not hedges must be
adjusted to fair value as a component of income. If the derivative is a hedge,
depending on the nature of the hedge, changes in the fair value of derivatives
will either be off-set against the change in fair value of the hedged assets,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings.
The fair value of Sovereign's derivative instruments is currently not on
the balance sheet. On January 1, 2001, Sovereign adopted SFAS No. 133, and at
that time, designated anew the derivative instruments used for risk management
into hedging relationships in accordance with the requirements of the new
standard. Derivative instuments used to hedge changes in the fair value of
assets and liabilities due to changes in interest rates or other factors were
designated in fair value hedge relationships. Derivative instruments used to
hedge the variability of forecasted cash flows attributable to a specific risk,
generally interest rate risk, were designated in cash flow hedge relationships.
Also on January 1, 2001, after-tax transition amounts associated with
establishing the fair values of the derivative instruments and hedged items on
the balance sheet of $1.1 million and $7.1 million were recorded as an increase
of net income and a reduction in other comprehensive income, respectively. The
transition adjustments will be presented as cumulative effect adjustments as
described in Accounting Principles Board Opinion No. 20, Accounting Changes, in
the 2001 Consolidated Financial Statements. The transition amounts were
determined based on the interpretive guidance issued by the Financial Accounting
Standards Board to date. The FASB continues to issue interpretive guidance which
could require changes in Sovereign's application of the standard and adjustments
to the transition amounts.
SFAS No. 133, as applied to Sovereign's risk management strategies, may
increase or decrease reported net income and stockholders' equity prospectively,
depending on future levels of interest rates and other variables affecting the
fair values of derivative instruments and hedged items, but will have no effect
on cash flows or economic risk.
NOTE 2 - BUSINESS COMBINATIONS
On September 3, 1999 and amended February 28, 2000, Sovereign entered into
a purchase and assumption agreement with FleetBoston Financial to acquire branch
banking offices located in Connecticut, Massachusetts, New Hampshire and Rhode
Island, and related deposit liabilities, loans and other assets associated with
the business of those branches. In total, Sovereign purchased 281 community
banking offices (exclusive of 4 locations which were resold to a third party) as
detailed in the chart below. The acquisition, which resulted in the creation of
Sovereign Bank New England ("SBNE") included the former Fleet Bank community
banking franchise in eastern Massachusetts; the entire former BankBoston
community banking franchise in Rhode Island; and select community banking
offices of Fleet Bank in Southern New Hampshire and BankBoston in Connecticut.
In addition, Sovereign acquired a substantial portion of the middle market and
small business-lending group from Fleet Bank in Massachusetts and New Hampshire,
and from BankBoston in Rhode Island and Connecticut. The acquisition included
the purchase of fully functioning business units, with the necessary management,
relationship officers, support staff and other infrastructure for the acquired
loans and deposits to be fully serviced.
43
NOTE 2 - BUSINESS COMBINATIONS - (Continued)
During 2000, Sovereign completed each of the three phases of the purchase
and assumption agreement of SBNE. Sovereign's results include the operations of
these acquired SBNE branches, assets and liabilities from their respective
acquisition dates, and thereafter. Total deposits transferred through the
acquisition were $12.3 billion. Additionally, loan balances transferred to
Sovereign approximated $8.0 billion, which included $3.1 billion of commercial
loans and leases, $1.7 billion of consumer loans and $3.2 billion of residential
mortgages, inclusive of $1.1 billion of residential mortgage loans which were
not relationship assets which were subsequently sold as part of Sovereign's
asset-liability management strategy to reduce interest-rate risk. Other assets
acquired included $85 million of currency, $68 million of premises and
equipment, $180 million of precious metals inventory and $213 million of prepaid
and other miscellaneous assets. Cash received, net of the premium paid, was $85
million.
- --------------------------------------------------------------------------------
Summary of Completed SBNE Acquisition (dollars in billions):
Date Completed Divested Units Deposits Loans Branches
- -------------- -------------------- -------- -------- --------
March 24, 2000 RI, CT (BankBoston) $ 4.2 $ 2.5 90
June 16, 2000 Eastern MA (Fleet) 3.8 3.5 86
July 21, 2000 Central MA, NH (Fleet) 4.3 2.0 105
-------- -------- ---
$ 12.3 $ 8.0 281
- --------------------------------------------------------------------------------
Total potential consideration for the SBNE acquisition is 12% of acquired
deposits less agreed upon reductions. Included in the 12% premium, Sovereign
will pay up to $333 million in periodic installments between January 2001 and
October 2001 if FleetBoston complies with its non-solicitation obligations under
the agreement and certain other conditions are met. These payments are recorded
as expense ratably from the completion of the acquisition on July 21, 2000
through the completion of the payments.
As of the final closing on July 21, 2000, Sovereign paid a net premium of
$848 million, recorded a fair value reduction on acquired loans of $79 million
and established an initial allowance for loan losses of $135 million, $17
million of which was recorded in the fourth quarter 2000. These items result in
total intangibles of $1.1 billion including goodwill of $685 million and core
deposit intangible of $428 million to be amortized over 25 years and 10 years,
respectively. Additionally, Sovereign expensed $120 million during 2000 as part
of its non-solicitation agreement with FleetBoston.
In November, 2000, the Company announced the results of a restructuring
initiative in which management analyzed front and back office operations and
computer operating platforms which were duplicated as a result of the
acquisition and eliminated approximately 500 positions. In total, Sovereign
recorded $18.5 million in restructuring costs, which was comprised of $14
million of severance and outplacement costs, and $4.5 million write-off of a
redundant computer-operating platform. As of December 31, 2000, $13.0 million of
liability remained.
On June 30, 1999, Sovereign acquired Peoples Bancorp, Inc. ("Peoples"), a
$1.4 billion bank holding company headquartered in Lawrenceville, New Jersey
whose principal operating subsidiary operated 14 community banking offices in
Mercer, Burlington and Ocean counties, New Jersey. The transaction added
investments, loans and deposits to Sovereign of approximately $922 million, $503
million and $515 million, respectively. Sovereign issued approximately 23.6
million shares or .80 shares of Sovereign common stock for each outstanding
share of Peoples common stock in connection with the transaction, which was
accounted for as a purchase. Sovereign recorded total intangibles of $39.5
million, of which $9.8 million was allocated to a core deposit intangible and
$29.7 million was allocated to goodwill. The goodwill and core deposit
intangible are being amortized over 25 years and 10 years, respectively.
Sovereign's results of operations include the operations of Peoples from June,
30 1999 and thereafter.
On June 15, 1999, Sovereign acquired The Network Companies ("Network"), a
privately held specialty leasing company headquartered in Commack, New York.
Network provides financing for the purchase or lease of equipment and specialty
vehicles plus other specialty products for businesses throughout the United
States, with transactions ranging from $15,000 to $250,000. The purchase price
of $6 million consisted of $4 million of stock and $2 million of cash.
Sovereign's results of operations include the operations of Network from June
15, 1999 and thereafter.
On September 4, 1998, Sovereign acquired 93 former CoreStates Financial
Corp. ("CoreStates") branch offices from First Union Corporation ("First
Union"). The former CoreStates offices, located throughout Pennsylvania and New
Jersey, added approximately $2.2 billion of commercial bank deposits and $725
million of commercial and consumer loans to Sovereign's balance sheet. This
transaction was accounted for as a purchase. Sovereign paid a premium of $325
million for the CoreStates branches which was allocated to core deposit
intangible and goodwill. Additionally, Sovereign established an initial loan
loss reserve of $20.5 million. The goodwill and core deposit intangible are
being amortized over 25 years and 10 years, respectively. In October and
November of 2000, Sovereign sold 20 of these branches, representing $315 million
of deposits.
44
NOTE 2 - BUSINESS COMBINATIONS - (Continued)
On July 31, 1998, Sovereign acquired Carnegie Bancorp ("Carnegie"), a $414
million commercial bank holding company headquartered in Princeton, New Jersey
which operated seven branch offices throughout central New Jersey and one in
Pennsylvania, and First Home Bancorp Inc. ("First Home"), a $510 million savings
bank holding company headquartered in Pennsville, New Jersey. First Home had one
principal operating subsidiary which operated ten branch offices in Salem,
Gloucester and Camden counties, New Jersey and New Castle County, Delaware.
As a result of the Carnegie and First Home transactions, Sovereign issued
approximately 10.9 million new shares of common stock during the third quarter
of 1998. These transactions were accounted for as pooling of interests.
On February 28, 1998, Sovereign acquired ML Bancorp, Inc. ("ML Bancorp"), a
$2.4 billion bank holding company headquartered in Villanova, Pennsylvania. ML
Bancorp's principal operating subsidiary, Main Line Bank, operated 29 branch
offices located in the suburbs of Philadelphia, Pennsylvania. Approximately 20.5
million adjusted new shares of Sovereign common stock were issued in connection
with the transaction. This transaction was accounted for as a
pooling-of-interests.
Prior to the combination, ML Bancorp's fiscal year end was March 31, and
accordingly, Sovereign's consolidated results of operations for the twelve-month
period ended December 31, 1998 include ML Bancorp's results of operations for
the two-month period ended February 28, 1998, Sovereign's consolidated results
of operations for the twelve-month period ended December 31, 1997 include ML
Bancorp's results of operations for the eleven-month period ended February 28,
1998 and a net decrease to Sovereign's stockholders' equity of $5.0 million has
been made to reflect ML Bancorp's activity for the two-month period ended
February 28, 1998. That activity consisted of net income of $4.2 million and net
unrealized gains on investment securities available-for-sale of $792,000.
The pre-merger results of operations for Sovereign, ML Bancorp, Carnegie
and First Home (which were acquired pursuant to transactions accounted for as a
pooling-of-interests) were as follows (in thousands):
- --------------------------------------------------------------------------------
SOVEREIGN ML BANCORP(1) CARNEGIE(2) FIRST HOME(2) COMBINED
--------- ------------- ----------- ------------- --------
Year Ended December 31, 1998
Interest income ......... $1,284,933 $27,935 $ 19,517 $22,986 $1,355,371
Interest expense ........ 821,529 16,295 9,848 14,087 861,759
Provision for loan losses 27,467 -- 260 234 27,961
Other income ............ 100,962 3,441 427 808 105,638
Non-interest expense .... 332,710 8,534 10,180 8,659 360,083
Income tax provision .... 71,539 2,319 390 503 74,751
---------- ------- -------- ------- ----------
Net Income .............. $ 132,650 $ 4,228 $ (734) $ 311 $ 136,455
========== ======= ======== ======= ==========
(1) Reflects ML Bancorp's results of operations for the two-month period ended
February 28, 1998.
(2) Reflects Carnegie and First Home results of operations for the seven-month
period ended July 31, 1998.
- --------------------------------------------------------------------------------
During 1998, Sovereign recorded pre-tax merger-related charges of $49.9
million, ($33.5 million after-tax) or $.21 per share, primarily related to costs
incurred in connection with its acquisitions of ML Bancorp, Inc., Carnegie
Bancorp and First Home Bancorp, Inc. The components of the merger-related
charges were as follows (in thousands):
- --------------------------------------------------------------------------------
REQUIRING CASH
--------------------
CASH OUTFLOW
PROVISION OUTFLOW TO DATE
------- ------- -------
Severance and employee-related costs $22,257 $22,257 $22,257
Merger transaction costs ........... 5,307 5,307 5,307
Writedowns of assets ............... 13,350 -- --
Office closing costs ............... 3,085 1,274 1,274
Miscellaneous ...................... 5,933 5,933 5,933
------- ------- -------
Total .............................. $49,932 $34,771 $34,771
======= ======= =======
- --------------------------------------------------------------------------------
Severance and employee-related costs relate primarily to severance costs
and related taxes for employees of the three companies who were displaced as a
result of merger, as well as the termination and distribution of ML Bancorp's
ESOP and restricted stock plans in connection with the merger. Writedowns of
assets include obsolescence of data processing equipment at all three companies
as well as writedowns of servicing-related assets at ML Bancorp. The entire
provision of $49.9 million was used in 1998.
45
NOTE 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, 2000 and 1999
were $243 million and $72 million, respectively.
NOTE 4 - INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities are as
follows (in thousands):
AT DECEMBER 31,
---------------------------------------------------------------------------------------------------
2000 1999
----------------------------------------------- -------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED AMORTIZED UNREALIZED UNREALIZED
COST APPRECIATION DEPRECIATION FAIR VALUE COST APPRECIATION DEPRECIATION FAIR VALUE
---------- ------------ ------------ ---------- --------- ------------ ------------ ----------
Investment Securities
Available-for-Sale:
Investment Securities:
U.S. Treasury and
government agency
securities ............. $ 92,341 $ 55 $ 455 $ 91,941 $ 77,229 $ 2 $ 1,210 $ 76,021
Corporate securities/Trust
preferred .............. 300,206 11,333 5,727 305,812 243,915 650 14,231 230,334
Asset-backed securities .. 523,466 248 12,118 511,596 685,274 -- 21,149 664,125
Equities ................. 25,196 126 3,427 21,895 32,142 31 11,420 20,753
FHLB stock ............... 225,797 -- -- 225,797 524,397 -- -- 524,397
Agency preferred stock ... 425,888 267 2,472 423,683 425,888 4,135 395 429,628
Municipal securities ..... 36,549 2,693 473 38,769 32,813 745 1,379 32,179
Mortgage-backed Securities:
Passthroughs:
U.S. government
agencies ............. 676,593 3,025 5,679 673,939 478,462 909 21,004 458,367
Non-agencies ........... 2,553,289 556 40,275 2,513,570 2,688,315 -- 132,333 2,555,982
Collateralized mortgage
obligations .......... 515,852 535 7,805 508,582 3,166,472 2,564 130,610 3,038,426
---------- ------- ------- ---------- ---------- ------ -------- ----------
Total investment securities
available-for-sale ....... $5,375,177 $18,838 $78,431 $5,315,584 $8,354,907 $9,036 $333,731 $8,030,212
========== ======= ======= ========== ========== ====== ======== ==========
AT DECEMBER 31,
---------------------------------------------------------------------------------------------------
2000 1999
----------------------------------------------- -------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED AMORTIZED UNREALIZED UNREALIZED
COST APPRECIATION DEPRECIATION FAIR VALUE COST APPRECIATION DEPRECIATION FAIR VALUE
---------- ------------ ------------ ---------- --------- ------------ ------------ ----------
Investment Securities
Held-to-Maturity:
Investment Securities:
U.S. Treasury and
government
agency securities ..... $ 6,382 $ -- $ 138 $ 6,244 $ 4,807 $ -- $ 109 $ 4,698
Corporate securities .... 35,785 2,282 6 38,061 1,326,827 9,852 165 1,336,514
Municipal securities .... 739 135 6 868 3,275 96 22 3,349
Mortgage-backed securities:
Passthroughs:
U.S. government
agencies ............ 1,562,525 14,780 16,502 1,560,803 499,866 2,516 2,365 500,017
Non-agency ............ 39,117 378 234 39,261 52,319 377 224 52,472
Collateralized mortgage
obligations ......... 333,720 505 7,566 326,659 474,957 2,520 7,502 469,975
---------- ------- ------- ---------- ---------- ------- ------- ----------
Total investment securities
held-to-maturity ........ $1,978,268 $18,080 $24,452 $1,971,896 $2,362,051 $15,361 $10,387 $2,367,025
========== ======= ======= ========== ========== ======= ======= ==========
46
NOTE 4 - INVESTMENT SECURITIES - (Continued)
The amortized cost and estimated fair value of investment securities at
December 31, 2000 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 Securities Available-for-Sale:
Due in one year or less ................. $ 773,882 $ 754,790
Due after one year through five years ... 1,991,715 1,958,767
Due after five years through ten years .. 1,055,179 1,038,032
Due after ten years ..................... 878,061 860,661
Equity securities ....................... 676,340 703,334
---------- ----------
Total investment securities available-for-sale $5,375,177 $5,315,584
========== ==========
AMORTIZED
COST FAIR VALUE
---------- -----------
Investment Securities Held-to-Maturity:
Due in one year or less ................. $ 354,108 $ 350,083
Due after one year through five years ... 982,805 961,177
Due after five years through ten years .. 399,816 394,765
Due after ten years ..................... 241,539 265,871
---------- ----------
Total investment securities held-to-maturity . $1,978,268 $1,971,896
========== ==========
- --------------------------------------------------------------------------------
Proceeds from sales of investment securities available for sale and the
realized gross gains and losses from those sales are as follows (in thousands):
- --------------------------------------------------------------------------------
AVAILABLE-FOR-SALE
YEAR ENDED DECEMBER 31,
----------------------------------------------
2000 1999 1998
----------- ----------- -----------
Proceeds from sales ....... $ 8,248,463 $ 5,553,469 $ 2,145,929
=========== =========== ===========
Gross realized gains ...... 3,039 8,335 27,729
Gross realized losses ..... (123,916) (4,603) (11,449)
----------- ----------- -----------
Net realized gains/(losses) $ (120,877) $ 3,732 $ 16,280
=========== =========== ===========
- --------------------------------------------------------------------------------
Tax-exempt income included in interest and dividends on investment
securities for the years ended December 31, 2000, 1999 and 1998 was $27.1
million, $27.1 million and $17.9 million, respectively. Tax expense/(benefit)
related to net realized gains and losses from sales of investment securities for
the years ended December 31, 2000, 1999 and 1998 were $(42.3) million, $1.2
million and $5.7 million, respectively.
Investment securities with an estimated fair value of $2.3 billion and $2.7
billion were pledged as collateral for borrowings, interest rate agreements and
public deposits at December 31, 2000 and 1999, respectively.
47
NOTE 5 - LOANS
A summary of loans included in the consolidated balance sheets (in
thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
-------------------------------
2000 1999
----------- -----------
Residential real estate loans .......... $ 7,927,442 $ 5,685,220
Residential construction loans ......... 51,415 59,264
----------- -----------
Total Residential Loans ........... 7,978,857 5,744,484
----------- -----------
Commercial real estate loans ........... 2,793,616 1,516,953
Commercial loans ....................... 4,397,009 1,690,744
Automotive floor plan loans ............ 513,641 730,623
Multi-family loans ..................... 127,141 137,019
----------- -----------
Total Commercial Loans ............ 7,831,407 4,075,339
----------- -----------
Home equity loans ...................... 3,256,598 1,957,945
Auto loans ............................. 2,309,025 1,936,980
Loans to automotive lessors ............ 317,281 288,636
Student loans .......................... 26,283 249,279
Other .................................. 192,794 35,802
----------- -----------
Total Consumer Loans .............. 6,101,981 4,468,642
----------- -----------
Total Loans(1)(2) ................. $21,912,245 $14,288,465
=========== ===========
Total Loans with:
Fixed rate ........................ $14,165,535 $ 8,769,876
Variable rate ..................... 7,746,710 5,518,589
----------- -----------
Total Loans(1) .................... $21,912,245 $14,288,465
=========== ===========
(1) Loan totals are net of deferred loan fees of $33 million for 2000 and $24
million for 1999.
(2) Loan totals are net of unamortized premium/(discount) of ($65) million and
($3) million for 2000 and 1999.
- --------------------------------------------------------------------------------
Maturities of residential real estate loans are presented as follows (in
thousands):
AT DECEMBER 31, 2000
-----------------------
Maturing:
In one year or less ............................. $ 142,517
One to five years ............................... 513,599
After five years ................................ 7,322,741
------------
Total ...................................... $ 7,978,857
============
- --------------------------------------------------------------------------------
Loans to related parties include loans made to certain officers, directors
and their affiliated interests. At December 31, 2000 and 1999, loans to related
parties totaled $14.6 million and $9.2 million, respectively.
48
NOTE 5 - LOANS - (Continued)
The activity in the allowance for loan losses is as follows (in thousands):
- --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
------------------------------------
2000 1999 1998
-------- -------- --------
Balance, beginning of period ................. $132,986 $133,802 $116,823
Allowance established/acquired in acquisitions 134,706 4,799 22,660
Provision for loan losses .................... 56,500 30,000 27,961
Charge-offs .................................. 92,892 55,023 46,330
Recoveries ................................... 25,056 19,408 12,688
-------- -------- --------
Balance, end of period ....................... $256,356 $132,986 $133,802
======== ======== ========
- --------------------------------------------------------------------------------
Impaired loans are summarized as follows (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
------------------------
2000 1999
-------- --------
Impaired loans without a related allowance ..... $ -- $ --
Impaired loans with a related allowance ........ 232,817 108,215
-------- --------
Total impaired loans ...................... $232,817 $108,215
======== ========
Allowance for impaired loans ................... $ 56,311 $ 23,033
======== ========
- --------------------------------------------------------------------------------
If Sovereign's 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, 2000, 1999 and
1998 would have increased by approximately $7.0 million, $5.0 million and $9.8
million, respectively. Interest income recorded on these loans for the years
ended December 31, 2000, 1999 and 1998 was $3.8 million, $2.1 million and $3.3
million, respectively.
NOTE 6 - MORTGAGE BANKING ACTIVITY
At December 31, 2000, 1999, and 1998, Sovereign serviced loans for the
benefit of others totaling $4.2 billion, $5.7 billion, and $6.7 billion,
respectively. The following table presents the activity of Sovereign's mortgage
servicing rights for the years indicated. This activity does not reflect the
reduction from the activity in Sovereign's valuation allowance for mortgage
servicing rights presented in the table below (in thousands):
- --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
------------------------------------
2000 1999 1998
-------- -------- --------
Balance, beginning of year ................... $ 77,349 $ 75,627 $ 68,063
Servicing assets sold ........................ (34,842) -- --
Net servicing assets recognized .............. 7,971 14,605 19,439
Amortization and other ....................... (8,937) (12,883) (11,875)
-------- -------- --------
Balance, end of year ......................... $ 41,541 $ 77,349 $ 75,627
======== ======== ========
49
NOTE 6 - MORTGAGE BANKING ACTIVITY - (Continued)
For valuation purposes, at December 31, 2000, a weighted average discount
rate of 9.6% was assumed and assumed prepayment speeds were consistent with
published secondary market rates for Sovereign's market area. Sovereign also
takes into consideration any inherent risks, 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.
Activity in the valuation allowance for mortgage servicing rights for the
years indicated consisted of the following (in thousands):
- --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
------------------------------------
2000 1999 1998
-------- -------- --------
Balance, beginning of year ................... $ 4,858 $ 13,295 $ 3,295
Change in valuation allowance for mortgage
servicing rights ........................ (2,675) (8,437) 10,000
-------- -------- --------
Balance, end of year ......................... $ 2,183 $ 4,858 $ 13,295
======== ======== ========
- --------------------------------------------------------------------------------
NOTE 7 - PREMISES AND EQUIPMENT
A summary of premises and equipment, less accumulated depreciation and
amortization, follows (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
------------------------
2000 1999
-------- --------
Land ........................................... $ 13,200 $ 15,790
Office buildings ............................... 108,890 84,130
Furniture, fixtures, and equipment ............. 214,106 116,163
Leasehold improvements ......................... 57,723 22,154
Automobiles .................................... 605 883
-------- --------
394,524 239,120
Less accumulated depreciation .................. (104,390) (119,919)
-------- --------
Total premises and equipment .............. $290,134 $119,201
======== ========
- --------------------------------------------------------------------------------
Included in occupancy and equipment expense for 2000, 1999 and 1998 was
depreciation expense of $36.6 million, $15.1 million, and $11.8 million
respectively. Sovereign also recorded rental expense of $52.0 million, $16.5
million and $10.6 million, net of $5.2 million $1.2 million, and $1.1 million of
sublease income in 2000, 1999 and 1998, respectively.
On June 30, 2000, Sovereign was party to a structured real estate
transaction pursuant to which 127 commercial properties, including 104
commercial properties that were owned by FleetBoston and 23 commercial
properties of Sovereign's existing franchise, were sold to the Sovereign Bank
Lease Pass-Through Trust, a non-affiliated third party. The Company
simultaneously entered into 127 separate operating leases, each of which had an
initial lease term of approximately 20 years. Sovereign recorded a gain on the
sale of $11.9 million, which was deferred and will be amortized over the lease
term of the 23 properties sold and subsequently leased back.
50
NOTE 8 - ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
------------------------
2000 1999
-------- --------
Accrued interest receivable on:
Investment securities ..................... $ 55,465 $ 58,749
Loans ..................................... 175,049 105,971
-------- --------
Total interest receivable ................. $230,514 $164,720
======== ========
NOTE 9 - DEPOSITS
Deposits are summarized as follows (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
------------------------------------------------------------------
2000 1999
------------------------------------------------------------------
BALANCE PERCENT RATE BALANCE PERCENT RATE
------- ------- ---- ------- ------- ----
Demand deposit accounts ...... $ 3,475,994 14% --% $ 1,089,472 9% --%
NOW accounts ................. 4,247,194 17 2.67 1,871,288 16 2.44
Savings accounts ............. 2,952,960 12 2.38 2,142,708 18 2.69
Money market accounts ........ 4,553,020 19 4.44 1,345,325 11 4.17
Retail certificates of deposit 8,371,936 34 5.91 4,708,057 39 5.00
Jumbo certificates of deposit 897,813 4 6.55 855,825 7 5.56
----------- --- ---- ----------- --- ----
Total deposits .......... $24,498,917 100% 3.83% $12,012,675 100% 3.68%
=========== === ==== =========== === ====
- --------------------------------------------------------------------------------
Deposits of related parties include deposits made by certain officers,
directors and their affiliated interests. At December 31, 2000 and 1999,
deposits of related parties totaled $1.2 million and $2.4 million, respectively.
- --------------------------------------------------------------------------------
Interest expense on deposits is summarized as follows (in thousands):
AT DECEMBER 31,
------------------------------------
2000 1999 1998
-------- -------- --------
Demand deposit and NOW accounts .............. $ 81,842 $ 34,622 $ 19,920
Savings accounts ............................. 67,880 58,333 62,694
Money market accounts ........................ 132,131 50,246 45,055
Certificates of deposit ...................... 453,234 297,625 316,164
-------- -------- --------
Total interest expense on deposits ...... $735,087 $440,826 $443,833
======== ======== ========
- --------------------------------------------------------------------------------
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,
2000 (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
---------------
2000
----------
Three months or less ...................... $ 539,437
Over three through six months ............. 499,845
Over six through twelve months ............ 360,013
Over twelve months ........................ 169,361
----------
Total ..................................... $1,568,656
==========
51
NOTE 9 - DEPOSITS - (Continued)
The following table sets forth the maturity of Sovereign's certificates of
deposit as scheduled to mature contractually at December 31, 2000 (in
thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
---------------
2000
----------
2001 ............................................. $7,491,297
2002 ............................................. 1,172,202
2003 ............................................. 144,637
2004 ............................................. 76,856
2005 ............................................. 76,256
Thereafter ....................................... 308,501
----------
Total ............................................ $9,269,749
==========
- --------------------------------------------------------------------------------
NOTE 10 - BORROWINGS
Borrowings. Short-term borrowings included in the consolidated balance
sheets are as follows (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
--------------------------------------------------
2000 1999
---------------------- -----------------------
Balance W.A. Rate Balance W.A. Rate
------- --------- ------- ---------
Federal funds purchased ................... $ 130,000 5.23% $ -- --
Securities sold under repurchase agreements 230,900 6.58% 102,944 5.85%
Federal Home Loan
Bank advances ............................. 970,000 6.62% 6,054,995 5.67%
---------- ----------
Total borrowings .......................... $1,330,900 6.48% $6,157,939 5.67%
========== ==========
- --------------------------------------------------------------------------------
Included in borrowings are sales of securities under repurchase agreements.
Securities underlying sales of securities under repurchase agreements consisted
of investment securities which had an amortized cost of $243 million and $141
million and a market value of $239 million and $139 million at December 31, 2000
and 1999, respectively.
Short-term FHLB advances are collateralized by qualifying mortgage-related
assets as defined by the FHLB. Short-term FHLB advances had weighted average
interest rates of 6.62% and 5.67% at December 31, 2000 and 1999, respectively.
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 primarily
broker/dealers reporting to the Federal Reserve Bank of New York.
Through the use of interest rate swaps, $400 million of FHLB advances at
December 31, 2000 have been effectively converted from variable rate obligations
to fixed rate obligations. An additional $500 million of borrowings have been
protected from upward repricing through the use of interest rate caps.
52
NOTE 11 - LONG-TERM DEBT
Long-term Debt. Long-term debt (borrowings with original maturities of more
than one year) at December 31 consisted of the following (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
-----------------------
2000 1999
---------- ----------
Securities sold under repurchase agreements ......... $ -- $ 188,580
FHLB advances, maturing January 2001 to April 2012 .. 3,544,984 4,429,909
Senior secured credit facility, due November 15, 2003 350,792 500,000
6.625% senior notes, due March 15, 2001 ............. 239,973 239,843
10.25% senior notes, due May 15, 2004 .............. 200,000 200,000
10.50% senior notes, due November 15, 2006 .......... 500,000 500,000
6.75% subordinated debentures, due 2000 ............ -- 77,892
8.50% subordinated debentures, due 2002 ............ 19,992 19,987
8.00% subordinated debentures, due 2003 ............ 49,960 49,943
Other ............................................... 3,707 6,016
---------- ----------
$4,909,408 $6,212,170
========== ==========
Long-term debt includes sales of securities under repurchase agreements
with weighted average interest rates of 5.84%at December 31, 1999. Securities
underlying these repurchase agreements consist of investment securities which
had a book value of $195 million, and a market value of $192 million at December
31, 1999.
Long-term FHLB advances are collateralized by qualifying mortgage-related
assets as defined by the FHLB. Long-term FHLB advances had weighted average
interest rates of 5.47% and 5.09% at December 31, 2000 and 1999, respectively.
The Senior Secured Credit Facility will mature November 15, 2003.The
facility's original amortization schedule was as follows: 2000 - 5%, $25
million; 2001 - 15%, $75 million; 2002 - 40%, $200 million; and 2003 - 40%, $200
million with mandatory prepayments occurring if Sovereign's cash flow exceeds
predetermined levels. Interest is calculated, at the option of the borrower, at
LIBOR plus 3.5%, or the sum of a) the highest of (i) lender's base rate, (ii)
.50% over lender's three month CD rate, or (iii) .50% over the Federal Funds
Effective Rate, plus b) 2.50%. Interest was calculated under the LIBOR option
(9.96%) at December 31, 2000. The Senior Secured Credit Facility is secured
primarily by first perfected security interest in the stock of Sovereign Bank
owned by Sovereign Bancorp. The Senior Secured Credit Facility subjects
Sovereign to a number of affirmative and negative covenants. On March 1, 2001,
Sovereign refinanced this facility as described in Note 26.
The 6.625%, 10.25% and 10.50% senior notes are non-amortizing and are
redeemable, at a significant premium, at any time prior to maturity. The 8.00%
subordinated debentures are non-amortizing and are not redeemable prior to
maturity. The 8.50% subordinated debentures are non-amortizing and are
redeemable at the option of Sovereign in whole or in part.
The following table sets forth the maturity of Sovereign's long-term debt
as scheduled to mature contractually at December 31, 2000 (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31,
---------------
2000
----------
2001 ........................... $ 582,722
2002 ........................... 519,992
2003 ........................... 350,753
2004 ........................... 300,700
2005 ........................... 12,750
Thereafter ..................... 3,142,491
----------
Total .......................... $4,909,408
==========
- --------------------------------------------------------------------------------
53
NOTE 12 - TRUST PREFERRED SECURITIES
On November 15, 1999, Sovereign issued 5,750,000 units of Trust Preferred
Income Equity Redeemable Securities (PIERS) resulting in net proceeds to
Sovereign of $278.3 million with a stated maturity of January 15, 2030, of which
$91.5 million has been allocated to the value of the warrants and is treated as
original issue discount. The original issue discount is accreted into Trust
Preferred Securities expense over the life of the unit resulting in an effective
yield of 11.74%. Each PIERS unit consists of:
A preferred capital security (Trust Preferred II) issued by Sovereign
Capital Trust II (Trust II), valued at $32.50, having a stated
liquidation amount of $50, representing an undivided beneficial
ownership interest in Trust II, which assets consist solely of
debentures issued by Sovereign. Distributions are payable quarterly
beginning February 15, 2000 at an annual rate of 7.5% of the stated
liquidation value; and
A warrant to purchase, subject to antidilution adjustments, 5.3355
shares of Sovereign common stock at any time prior to November 20,
2029. The warrants were valued at $17.50 per unit.
The Trust Preferred II securities were issued by a special-purpose
statutory trust created expressly for the issuance of these securities.
Distributions on Trust II will be payable at an annual rate of 7.5% of the
stated liquidation amount of $50 per capital security, payable quarterly. After
original issue discount and issuance costs, proceeds of $186.8 million were
invested in Junior Subordinated Debentures of Sovereign, at terms identical to
the Trust Preferred II offering. Cash distributions on Trust Preferred II will
be made to the extent interest on the debentures is received by Trust II.
Sovereign may defer interest payments on the debentures for a period not
exceeding 20 consecutive quarters or beyond the original maturity date. Holders
may require Sovereign to repurchase the Trust Preferred II securities at
accreted value following exercise of the warrants.
In the event of certain changes or amendments to regulatory requirements or
federal tax rules, Sovereign may elect to redeem the Trust Preferred II
securities at 100% of accreted value and to redeem the warrants at their value
(combined value $50). Sovereign may elect to redeem the Trust Preferred II
securities and the warrants at $50, if the value of Sovereign's common stock on
20 trading days out of the preceding 30 consecutive trading days and on the day
the election is made exceeds $14.99 after November 20, 2002; $13.12 after
November 15, 2003; or $11.25 after November 15, 2004.
The Trust Preferred offerings are classified as and are similar to a
minority interest and are presented as "Mandatorily redeemable capital
securities (or "Trust Preferred")." The Trust Preferred offerings qualify for
Tier I capital treatment for Sovereign and the loan payments from Sovereign to
the Trust are fully tax deductible. The warrants, included in the PIERS units,
are classified as additional capital within stockholders' equity.
NOTE 13 - MINORITY INTEREST
On August 21, 2000 Sovereign received approximately $140 million of net
proceeds from the issuance of $161.8 million of 12% Series A Noncumulative
Preferred Interests in Sovereign Real Estate Investment Trust ("SREIT"), a
subsidiary of Sovereign Bank which holds primarily residential real estate
loans. The preferred stock was issued at a discount, which is being amortized
over the life of the preferred shares. The preferred shares may be redeemed at
any time on or after May 16, 2020, at the option of Sovereign subject to the
approval of the OTS. Under certain circumstances, the preferred shares are
automatically exchangeable into preferred stock of Sovereign Bank. The offering
was made exclusively to institutional investors; however, by mid-2001 these
SREIT preferred shares are expected to be registered so that they may be offered
to other investors. The proceeds of this offering were principally used to repay
corporate debt.
NOTE 14 - STOCKHOLDERS' EQUITY
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, 2000, 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 acquiree at a substantially reduced price.
54
NOTE 14 - STOCKHOLDERS' EQUITY - (Continued)
On November 15, 1999, Sovereign raised $1.3 billion of debt and equity.
This included issuance of 43.8 million shares of common stock resulting in net
proceeds of $331.5 million. In connection with the PIERS offering as described
in Note 12, Sovereign issued 5.75 million warrants with a fair value, net of
offering expenses, of $91.5 million, classified as stockholders' equity. The
conversion of all warrants would result in an additional 30.7 million shares
outstanding before the effect of repurchase of shares assumed under the treasury
stock method used for fully diluted EPS calculations.
On May 15, 1998, Sovereign redeemed all outstanding shares of its 6 1/4%
Cumulative Convertible Preferred Stock, Series B and issued 14.3 million shares
of common stock in connection with this redemption.
Retained earnings at December 31, 2000 included $79.6 million in bad debt
reserves, for which no deferred taxes have been provided due to the indefinite
nature of the recapture provisions. Our debt agreements impose customary
limitations on dividends, other payments and transactions. These limits are not
expected to affect dividend payments at current levels and reasonably
anticipated increases.
NOTE 15 - REGULATORY MATTERS
The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA")
requires institutions regulated by the Office of Thrift Supervision (OTS) to
have a minimum leverage capital ratio equal to 3% of tangible assets, and 4% of
risk-adjusted assets, and a risk-based capital ratio equal to 8% as defined. The
Federal Deposit Insurance Corporation Improvement Act ("FDICIA") requires OTS
regulated institutions to have a minimum tangible capital equal to 2% of total
tangible assets. Management believes, as of December 31, 2000 and 1999, that
Sovereign Bank met all capital adequacy requirements to which they are subject
in order to be well-capitalized.
The 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. As of December 31, 2000, Sovereign was
"well-capitalized" under the regulatory framework for FDICIA.
The OTS order, as amended, applicable to the approval of the SBNE
acquisition (the "OTS order") requires Sovereign Bank to be "Well Capitalized",
and also to meet certain additional capital ratio requirements and other
conditions. Various agreements with our lenders also require us to cause
Sovereign Bank to be "Well Capitalized" at all times and in compliance with all
regulatory requirements. To be "well capitalized", a thrift institution must
maintain a Tier 1 Leverage ratio of at least 5%, a Tier 1 risk-based capital
ratio of 6% and total risk-based capital of 10%. Although OTS capital
regulations do not apply to savings and loan holding companies, the OTS Order
requires Sovereign to maintain certain Tier 1 capital levels.
At December 31, 2000, Sovereign had met all quantitative thresholds
necessary to be classified as well-capitalized under regulatory guidelines.
Federal banking laws, regulations and policies also limit Sovereign Bank's
ability to pay dividends and make other distributions to Sovereign Bancorp.
Sovereign Bank must obtain prior OTS approval to declare a dividend or make any
other capital distribution if, after such dividend or distribution, Sovereign
Bank's total distributions to us within that calendar year would exceed 100% of
its net income during the year plus retained net income for the prior two years,
Sovereign Bank would not meet capital levels imposed by the OTS in connection
with any order, including the OTS order applicable to the New England
Acquisition, as amended, or if Sovereign Bank is not adequately capitalized at
the time. In addition, OTS prior approval would be required if Sovereign Bank's
examination or CRA ratings fall below certain levels or Sovereign Bank is
notified by the OTS that it is a problem association or an association in
troubled condition.
55
NOTE 15 - REGULATORY MATTERS - (Continued)
The following schedule summarizes the actual capital balances of Sovereign
Bank at December 31, 2000 (in thousands):
- --------------------------------------------------------------------------------
TIER 1 TOTAL
REGULATORY CAPITAL TANGIBLE LEVERAGE RISK-BASED RISK-BASED
CAPITAL TO CAPITAL TO CAPITAL TO CAPITAL TO
TANGIBLE TANGIBLE RISK-ADJUSTED RISK-ADJUSTED
ASSETS ASSETS ASSETS ASSETS
----------- ----------- ----------- -----------
Sovereign Bank:
Regulatory capital ...................................... $ 2,216,886 $ 2,216,886 $ 2,097,654 $ 2,348,935
Minimum capital requirement.............................. 1,280,869 1,280,869 1,280,869 1,823,347
----------- ----------- ----------- -----------
Excess ............................................. $ 936,017 $ 936,017 $ 816,785 $ 525,588
=========== =========== =========== ===========
Capital ratio ........................................... 6.92% 6.92% 9.20% 10.31%
- --------------------------------------------------------------------------------
NOTE 16 - STOCK OPTION PLANS
Beginning in 1990, Sovereign initiated its stock option plan. This plan
grants stock options for a fixed number of shares to key officers, certain
employees and directors with an exercise price equal to the fair market value of
the shares at the date of grant. Sovereign's stock options expire not more than
ten years and one month after the date of grant and become fully vested and
exercisable within a one to five year period after 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 14.2 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.
The following table provides a summary of Sovereign's stock option activity
for the years ended December 31, 2000, 1999 and 1998 and stock options
exercisable at the end of each of those years (number of options in thousands).
- --------------------------------------------------------------------------------
PRICE PER
SHARES SHARE
----------- -----------
Options outstanding December 31, 1997 (4,351,317 shares exercisable)...................... $ 6,033,453 $ .96 - 16.77
Granted................................................................................... 934,070 13.38 - 20.25
Exercised................................................................................. (2,295,265) .97 - 10.54
Forfeited................................................................................. (172,550) 8.22 - 20.25
-----------
Options outstanding December 31, 1998 (3,371,038 shares exercisable)...................... 4,499,708 .96 - 20.25
-----------
Options exchanged in conjunction with Peoples acquisition ................................ 473,531 4.41 - 6.86
Granted................................................................................... 2,216,479 8.28 - 12.44
Exercised................................................................................. (720,811) .96 - 8.83
Forfeited................................................................................. (110,015) 3.78 - 16.35
-----------
Options outstanding December 31, 1999 (4,154,213 shares exercisable)...................... 6,358,892 1.30 - 20.25
-----------
Granted................................................................................... 1,762,744 6.69 - 7.81
Exercised................................................................................. (195,873) 1.30 - 6.53
Forfeited................................................................................. (306,430) 4.11 - 16.35
-----------
Options outstanding December 31, 2000 (6,031,898 shares exercisable)...................... $ 7,619,333 1.30 - 20.25
===========
- --------------------------------------------------------------------------------
The following table summarizes Sovereign's stock options outstanding at
December 31, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- ----------------------
WEIGHTED
WEIGHTED AVERAGE WEIGHTED
AVERAGE REMAINING AVERAGE
EXERCISE CONTRACTUAL EXERCISE
EXERCISE PRICES SHARES PRICE LIFE SHARES PRICE
- --------------- --------- -------- ----------- --------- --------
$1.30 - $6.69 ....................... 2,291,227 $ 4.41 3.91 2,155,477 $ 4.26
$6.72 - $10.57 ...................... 2,274,864 $ 7.37 8.49 823,179 $ 8.15
$11.80 - $20.25 ..................... 3,053,242 $ 13.11 7.84 3,053,242 $ 13.11
--------- --------- -------
Total ............................. 7,619,333 $ 8.78 6.85 6,031,898 $ 9.27
========= ======= ==== ========= =======
- --------------------------------------------------------------------------------
Companies have 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). Sovereign follows
the disclosure only method.
56
NOTE 16 - STOCK OPTION PLANS - (Continued)
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:
- --------------------------------------------------------------------------------
Grant date year 2000 1999 1998
------------- -------------- ---------------
Expected volatility .............................. .325 .296 .278
Expected life in years ........................... 6.00 6.00 6.00
Stock price on date of grant ..................... $6.69 - $7.81 $8.28 - $12.44 $13.38 - $20.25
Exercise price ................................... $6.69 - $7.81 $8.28 - $12.44 $13.38 - $20.25
Weighted average exercise price .................. $ 6.90 $ 11.34 $ 15.41
Weighted average fair value ...................... $ 2.73 $ 3.98 $ 5.45
Expected dividend yield .......................... 1.21% 1.40% .67%
Risk-free interest rate .......................... 6.67%-6.85% 5.17% - 6.75% 4.65% - 5.72%
Vesting period in years .......................... 1-5 1-5 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 net income for 2000, 1999 and 1998, was $3.5
million, $3.2 million and $2.8 million, respectively. The pro forma reduction to
diluted earnings per share was $.02, each year.
NOTE 17 - EMPLOYEE BENEFIT PLANS
Sovereign sponsored several non-contributory defined benefit pension plan
which covered substantially all employees, and former employees of certain
institutions acquired by Sovereign. Benefits were frozen effective March 31,
1999. Sovereign recorded a curtailment gain of $1.6 million in 1999 and a
settlement gain of $1.3 million (net of excise tax expense of $1.2 million) in
2000. $2.0 million of plan assets were transferred to Sovereign's 401(k) plan
and $6.2 million was returned to Sovereign in 2000 after settlement of benefit
obligations was completed. Sovereign also sponsors a supplemental executive
retirement plan ("SERP") and several postemployment benefit plans of several
institutions acquired by Sovereign. Increasing or decreasing the assumed health
care cost trend rate would not have a significant impact on the accumulated post
retirement benefit obligation at December 31, 2000, and the aggregate of the
service and interest components of net benefit expense for the year ended
December 31, 2000.
The following tables present net periodic expense, change in benefit
obligation and change in plan assets and funded status at or for the periods
indicated (in thousands of dollars):
NET PERIODIC EXPENSE FOR THE YEAR ENDED DECEMBER 31,
PENSION AND SERP PLANS POSTEMPLOYMENT PLANS
----------------------------------- ----------------------------------
2000 1999 1998 2000 1999 1998
------- ------- ------- ------- ------- -------
Service cost .................................... $ 332 $ 348 $ 2,245 $ -- $ 3 $ 3
Interest on benefit obligation .................. 2,076 2,507 2,444 74 61 54
Actual return on assets ......................... (1,703) (224) (7,028) -- -- --
Amortization and deferrals ...................... 50 (2,297) 3,772 -- (11) (11)
Curtailment gain ................................ -- (1,564) -- -- -- --
Settlement gain (net of excise tax
expense $1,233) ............................... (1,330) -- -- -- -- --
------- ------- ------- ------- ------- -------
Net periodic expense ............................ $ (575) $(1,230) $ 1,433 $ 74 $ 53 $ 46
======= ======= ======= ======= ======= =======
57
NOTE 17 - EMPLOYEE BENEFIT PLANS - (Continued)
BENEFIT OBLIGATION, PLAN ASSETS AND FUNDED STATUS AT DECEMBER 31,
-----------------------------------------------------------------
PENSION AND SERP PLANS POSTEMPLOYMENT PLANS
------------------------- -------------------------
2000 1999 2000 1999
-------- -------- -------- --------
Change in benefit obligation:
Benefit obligation at beginning of year $ 42,950 $ 37,176 $ 1,131 $ 983
Service cost 332 348 -- 3
Interest cost 2,076 2,507 74 61
Actuarial (gains) losses (2,123) 4,093 39 (244)
Benefits paid and annuity purchases (39,402) (5,868) (129) (104)
Acquisitions -- 4,509 -- 432
Curtailment -- (4,174) -- --
Assumption changes -- 4,359 -- --
-------- -------- -------- --------
Benefit obligation at end of year $ 3,833 $ 42,950 $ 1,115 $ 1,131
======== ======== ======== ========
Change in plan assets:
Fair value of assets at beginning of year $ 45,942 $ 46,901 $ -- $ --
Actual return on assets 1,703 213 -- --
Company contributions -- -- 129 104
Benefits paid and annuity purchases (39,418) (5,878) (129) (104)
Acquisitions -- 4,706 -- --
Assets transferred to 401K plan or reverted to
Sovereign upon settlement (8,227) -- -- --
-------- -------- -------- --------
Fair value of assets at end of year $ -- $ 45,942 $ -- $ --
======== ======== ======== ========
Funded status of the plan $ (3,833) $ 2,992 $ (1,115) $ (1,131)
Unrecognized net actuarial (gain) loss 1,313 871 197 60
Unrecognized net transition asset -- -- -- --
Unrecognized prior service cost 605 660 (97) --
-------- -------- -------- --------
(Accrued) prepaid benefit cost $ (1,915) $ 4,523 $ (1,015) $ (1,071)
======== ======== ======== ========
Weighted average assumptions as of December 31:
Discount rate 6.75% 6.30% 6.75% 6.75%
Rate of compensation increase 4.50% 4.50% 4.50% 4.50%
Expected return on plan assets n/a 5.13% n/a n/a
Medical benefits rate of increase n/a n/a 6.00% 5.20%
58
NOTE 17 - EMPLOYEE BENEFIT PLANS - (Continued)
Substantially all employees of Sovereign are eligible to participate in the
401(k) retirement plan following their completion of six months service and
attaining age 21. Sovereign recognized expense for contributions to this plan of
$5.2 million, $2.1 million and $1.5 million during 2000, 1999 and 1998,
respectively. Pursuant to this plan, employees can contribute up to 12% of their
compensation to the plan. Sovereign contributes 100% of the employee
contribution up to 3% of compensation and 50% of the employee contribution from
3% to 5% of compensation in the form of Sovereign common stock.
Sovereign maintains an Employee Stock Ownership Plan ("Sovereign ESOP"),
and substantially all employees of Sovereign are eligible to participate
following completion of one year of service and attaining age 21. Peoples also
sponsored a leveraged ESOP that Sovereign assumed upon acquisition in 1999
(collectively, "the ESOPs"). The Sovereign ESOPs are defined contribution plans
which provide retirement benefits for participants and beneficiaries in the form
of Sovereign common stock purchased in the open market.
On November 21, 1994, Sovereign's Board of Directors authorized an
amendment to the Sovereign 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 Sovereign ESOP is funded through direct loans from
Sovereign. 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 Sovereign 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 debt requirements of the ESOPs.
Sovereign recognized as expense $2.6 million, $3.4 million and $4.0 million for
the ESOPs in 2000,1999 and 1998, respectively.
At December 31, 2000, the ESOPs held 6.4 million shares of Sovereign stock
of which 1.9 million shares were allocated to participant accounts. The
unallocated ESOP shares are presented as a reduction of stockholders' equity in
the consolidated financial statements. At December 31, 2000, the unallocated
ESOP shares had a fair market value of $37.1 million and the ESOPs had $44.1
million of loans outstanding from Sovereign.
Sovereign maintains several bonus deferral plans for selected management
and executive employees. These plans allow employees to defer 50% or more of
their bonus to purchase Sovereign stock. The deferred amount is placed in a
grantor trust and invested in Sovereign common stock. Matching contributions
ranging from 25% to 100% are made by Sovereign into the trust and are also
invested in Sovereign stock. Earnings on the deferral and matching contributions
are also invested in Sovereign stock. Expense is recognized ratably over the
vesting periods of the plans. Benefits vest ratably over three years under the
management plan and after five years under the executive plan. Benefits also
vest under the plans in the event of termination by reason of death, disability,
retirement, involuntary termination or the occurrence of a change of control as
defined by the plans. Voluntary termination or termination for cause (as
defined) generally result in forfeiture of the unvested balance including
employee deferrals. Sovereign recognized as expense $1.9 million, $1.0 million,
and $285,000 for these plans in 2000, 1999 and 1998, respectively.
NOTE 18 - 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,
----------------------------------------
2000 1999 1998
-------- -------- --------
Current:
Federal ............................. $ (9,796) $ 69,656 $ 92,311
State ............................... 736 807 1,121
-------- -------- --------
(9,060) 70,463 93,432
Deferred .............................. (50,930) 18,852 (18,681)
-------- -------- --------
Total income tax expense (benefit) .. $(59,990) $ 89,315 $ 74,751
======== ======== ========
- --------------------------------------------------------------------------------
59
NOTE 18 - INCOME TAXES - (Continued)
The following is a reconciliation of the actual tax provisions with taxes
computed at the federal statutory rate of 35% for each of the years indicated:
- --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
---------------------------
2000 1999 1998
------ ------ ------
Statutory federal tax rate ....................... (35.0)% 35.0% 35.0%
Increase/(decrease) in taxes resulting from:
Tax-exempt income ......................... (5.4) (2.8) (3.2)
Bank owned life insurance.................. (12.9) (3.0) (2.0)
State income taxes,
net of federal tax benefit ................ 6.0 0.2 0.3
Amortization of intangible
assets and other purchase
accounting adjustments .................. 3.5 0.9 0.8
Sale of minority interest ................. (26.0) -- --
Non-deductible,
merger-related costs .................... -- -- 3.1
Other ..................................... 3.3 2.9 1.4
------ ------ ------
Effective federal tax rate ....................... (66.5)% 33.2% 35.4%
====== ====== ======
- --------------------------------------------------------------------------------
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,
------------------------------------
2000 1999 1998
--------- --------- ---------
Deferred tax assets:
Allowance for possible loan losses .................................................... $ 42,031 $ 43,766 $ 37,849
Purchased mortgage servicing rights ................................................... (1,076) 3,532 4,356
Employee benefits ..................................................................... 736 1,344 888
Merger-related liabilities ............................................................ 14,384 6,339 2,313
Purchase accounting adjustments ....................................................... 6,982 8,765 370
Unrealized loss on available-for-sale portfolio ....................................... 29,300 113,764 --
Net operating loss carry forwards, net of valuation allowance of $5,340 in 2000 ....... 4,542 8,630 1,393
Non-solicitation covenant ............................................................. 33,383 -- --
Other ................................................................................. 34,168 5,472 847
--------- --------- ---------
Total gross deferred tax assets ................................................... $ 164,450 $ 191,612 $ 48,016
--------- --------- ---------
Deferred tax liabilities:
Purchase accounting adjustments ....................................................... $ 7,077 $ 8,177 $ 5,402
Deferred loan fees .................................................................... 16,433 10,505 7,144
Tax bad debt reserve recapture ........................................................ 5,354 4,393 2,406
Originated mortgage servicing rights .................................................. (2,654) 8,269 3,843
Option premiums ....................................................................... -- 2,716 2,716
Unrealized gain on available-for-sale portfolio ....................................... -- -- 9,757
Other ................................................................................. 27,399 11,145 4,163
--------- --------- ---------
Total gross deferred tax liabilities .............................................. $ 53,609 $ 45,205 $ 35,431
--------- --------- ---------
Net deferred tax asset ..................................................................... $ 110,841 $ 146,407 $ 12,585
========= ========= =========
- ------------------------------------------------------------------------------------------------------------------------------------
During 2000, Sovereign established a $5 million valuation allowance related
to previously recognized state tax net operating losses. The valuation allowance
was necessary due to structural changes at Sovereign resulting from the SBNE
acquisition. For the remainder of Sovereign's deferred tax assets, no valuation
allowance is necessary due to 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, the prospects for continued growth including an analysis of
potential uncertainties that may affect future operating results and potential
tax planning strategies that could be employed in the future. Sovereign will
continue to review the criteria related to the recognition of deferred tax
assets on a quarterly basis.
60
NOTE 19 - 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,
------------------------
2000 1999
---------- ----------
Financial instruments whose contract
amounts represent credit risk:
Commitments to extend credit .......... $5,812,328 $2,189,743
Standby letters of credit ............. 564,226 76,775
Loans sold with recourse .............. 20,647 25,214
Financial instruments whose
notional or contract amounts
exceed the amount of credit risk:
Forward contracts ..................... 115,914 75,639
Interest rate swaps ................... 1,258,294 452,300
Interest rate caps .................... 500,000 1,200,000
- --------------------------------------------------------------------------------
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 by June 2003. 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 single-family residential
loans. These are seasoned loans with decreasing balances and historical loss
experience has been minimal.
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 counter
parties 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
counter parties default. Sovereign minimizes this risk by performing credit
reviews on counter parties.
61
NOTE 19 - COMMITMENTS AND CONTINGENCIES - (Continued)
Notional principal amounts often are used to express the volume of these
transactions, but the amounts potentially subject to credit risk are
significantly smaller.
Litigation
At December 31, 2000, Sovereign was party to a number of lawsuits, which
arise during the normal course of business. 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.
Leases
Sovereign is committed under various non-cancelable operating leases
relating to branch facilities having initial or remaining terms in excess of one
year. Future minimum annual rentals under non-cancelable leases, net of sublease
income at December 31, 2000, are summarized as follows (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31, 2000
-----------------------------------
Future Minimum
-----------------------------------
Lease Sublease Net
Payments Income Payments
-------- -------- --------
2001 ................. $ 85,422 $ (7,481) $ 77,941
2002 ................. 82,093 (6,820) 75,273
2003 ................. 78,299 (3,323) 74,976
2004 ................. 73,167 (1,815) 71,352
2005 ................. 148,217 (1,045) 147,172
Thereafter ........... 228,745 (2,194) 226,551
-------- -------- --------
Total ........... $695,943 $(22,678) $673,265
======== ======== ========
62
NOTE 20 - 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,
--------------------------------------------------------------
2000 1999
--------------------------------------------------------------
CARRYING CARRYING
VALUE FAIR VALUE VALUE FAIR VALUE
----------- ----------- ----------- -----------
Financial Assets:
Cash and amounts due from depository institutions ......... $ 945,196 $ 945,196 $ 373,996 $ 373,996
Interest-earning deposits ................................. 14,447 14,447 19,238 19,238
Loans held for sale ....................................... 59,993 60,148 61,925 62,439
Investment securities:
available-for-sale ...................................... 5,315,584 5,315,584 8,030,212 8,030,212
held-to-maturity ........................................ 1,978,268 1,971,896 2,362,051 2,367,025
Loans, net ................................................ 21,655,889 21,604,291 14,093,554 13,955,482
Mortgage servicing rights ................................. 41,541 44,618 72,491 76,606
Financial Liabilities:
Deposits .................................................. 24,498,917 22,428,033 12,012,675 11,979,123
Borrowings(1) ............................................ 6,240,308 6,202,987 12,370,109 12,149,668
Unrecognized Financial Instruments:(2)
Commitments to extend credit .............................. 44,432 44,306 16,003 16,086
Loans sold with recourse .................................. 20,647 -- 126 50
Interest rate swaps, caps and floors ...................... 957 5,167 4,463 1,198
Exchange traded futures ................................... 38,849 38,849 -- --
(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 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.
Investment securities available-for-sale. The fair value of investment
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 securities held-to-maturity. The carrying amounts for short-term
investment 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 investment securities held-to-maturity is
estimated based upon bid quotations received from securities dealers and an
independent pricing servicing bureau.
63
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS - (Continued)
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 are
estimated using quoted rates based upon secondary market sources. The estimated
fair value approximates the amount for which the servicing could currently be
sold.
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 counter parties. For fixed rate loan
commitments, fair value also considers the difference between current levels of
interest rates and the committed rates.
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
counter parties are obtained from dealer quotes.
NOTE 21 - FINANCIAL DERIVATIVES
Sovereign uses a variety of off-balance-sheet financial derivatives as part
of its overall interest rate risk management process and to manage risk
associated with mortgage banking activities. 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 repricing of liabilities. Interest rate floors are generally used
to limit the exposure from repricing of assets. 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. Forward contracts are used to manage risk positions associated with
mortgage origination. Substantially all forward contracts mature within 90 days
of origination. Forward contracts are traded in over-the-counter markets and do
not have standardized terms. Counterparties to Sovereign's forward contracts are
primarily U.S. government agencies and brokers and dealers in mortgage-backed
securities.
64
NOTE 21 - FINANCIAL DERIVATIVES - (Continued)
Sovereign's Capital Markets Group provides risk management services for its
customers. Sovereign purchases and sells certain derivatives including interest
rate swaps, caps and floors. Customer related derivative financial instrument
transactions are generally marked to market and any gains or losses are recorded
in the income statement. Sovereign also holds derivatives in connection with its
securities trading activities and, at times, takes minimal positions in the
expectation of profiting from favorable movements in interest rates. The
following table presents information regarding financial derivatives at the
dates indicated (in thousands):
- --------------------------------------------------------------------------------
AT DECEMBER 31, 2000
--------------------------------------------------
NET
NOTIONAL POSITIVE NEGATIVE ASSET
AMOUNT FAIR VALUE FAIR VALUE (LIABILITY)
---------- ---------- ---------- ----------
Interest Rate Risk Management:
Interest rate swaps:
Pay variable-receive fixed(1) $ 858,294 $ 16,395 $ (975) $ 15,420
Pay fixed-receive variable(2) 400,000 -- (10,087) (10,087)
Interest rate caps/floors/collars(3) 500,000 -- (166) (166)
Mortgage banking risk management
Forward commitments:
To buy loans 34,000 115 (27) 88
To sell loans 149,914 77 (1,333) (1,256)
---------- ---------- ---------- ----------
Total interest rate risk management 1,942,208 16,587 (12,588) 3,999
---------- ---------- ---------- ----------
Customer Related:
Interest rate swaps:
Pay variable-receive fixed 502,532 496 (11,320) (10,824)
Pay fixed-receive variable 512,390 13,008 (404) 12,604
Interest rate caps/floors/collars 105,701 105 (105) --
Exchange traded futures(4) 38,849 -- -- --
---------- ---------- ---------- ----------
Total customer related 1,159,472 13,609 (11,829) 1,780
---------- ---------- ---------- ----------
Total derivatives $3,101,680 $ 30,196 $ (24,417) $ 5,779
========== ========== ========== ==========
AT DECEMBER 31, 1999
--------------------------------------------------
NET
NOTIONAL POSITIVE NEGATIVE ASSET
AMOUNT FAIR VALUE FAIR VALUE (LIABILITY)
---------- ---------- ---------- ----------
Interest Rate Risk Management:
Interest rate swaps:
Pay variable-receive fixed(1) $ 252,300 $ 637 $ (7,483) $ (6,846)
Pay fixed-receive variable(2) 200,000 8,853 -- 8,853
Interest rate caps/floors/collars(3) 1,200,000 -- (809) (809)
Mortgage banking risk management
Forward commitments:
To buy loans -- -- -- --
To sell loans 75,639 116 (178) (62)
---------- ---------- ---------- ----------
Total interest rate risk management 1,727,939 9,606 (8,470) 1,136
---------- ---------- ---------- ----------
Customer Related:
Interest rate swaps:
Pay variable-receive fixed -- -- -- --
Pay fixed-receive variable -- -- -- --
Interest rate caps/floors/collars -- -- -- --
Exchange traded futures(4) -- -- -- --
---------- ---------- ---------- ----------
Total customer related -- -- -- --
---------- ---------- ---------- ----------
Total derivatives $1,727,939 $ 9,606 $ (8,470) $ 1,136
========== ========== ========== ==========
(1) The weighted average pay rate was 6.48% and 7.24% and the weighted average
receive rate was 7.31% and 7.00% at December 31, 2000 and 1999.
(2) The weighted average pay rate was 7.12% and 5.41% and the weighted average
receive rate was 6.49% and 6.13% at December 31, 2000, and 1999
respectively.
(3) The weighted average strike price range was 6.00% - 6.55% at December 31,
2000 and 5.25% - 9.00% at December 31, 1999.
(4) Represents futures to sell metal forward which are related to Sovereign's
precious metals business.
- --------------------------------------------------------------------------------
Net interest income resulting from interest rate exchange agreements
included $6.4 million of income and $.1 million of expense for 2000, $.5 million
of income and $8.9 million of expense for 1999 and $6.8 million of income and
$4.5 million of expense for 1998. At December 31, 2000, $9.4 million of net
gains resulting from terminations of interest rate contracts were reflected in
other liabilities on the statement of financial condition.
NOTE 22 - ASSET SECURITIZATIONS
During 2000, the Company sold home equity loans and automotive floor plan
loans in securitization transactions. In all those securitizations, the Company
retained servicing responsibilities. The Company retained a subordinated
interest in the automotive floor plan loans. In addition, during 2000 the
Company acquired the servicing responsibilities, and retained interest only
strips, related to home equity and recreational vehicle loans which were
previously securitized, as part of the SBNE acquisition. The Company receives
annual servicing fees approximating .50 percent for home equity loans, and for
boat and recreational vehicle loans, and 1.00 percent (for automotive floor plan
loans) of the outstanding balance and rights to future cashflows arising after
the investors in the securitization trust have received the return for which
they contracted. The investors and securitization trusts have no recourse to the
Company's other assets for failure of debtors to pay when due. The Company's
retained interests are subordinate to investors interests. Their value is
subject to credit, prepayment, and interest rate risks on the transferred
financial assets.
In 2000, the Company recognized a pretax gain of $2.5 million on the
securitization of home equity loans and a pretax loss of $(2.3) million on the
securitization of automotive floor plan loans.
65
NOTE 22 - ASSET SECURITIZATIONS - (Continued)
The components of securitized financial assets and the related average
balances, delinquencies, and net credit losses are as follows:
For the Year Ended
At December 31, 2000 December 31, 2000
-------------------------------- ------------------
Total Principal 90 Days Net Credit
Principal Past Due Losses
---------- ---------- ----------
Loans Securitized:
Home Equity Loans .................. $1,167,879 $ 40,193 $ 3,492
Boat Loans ......................... 153,708 13 698
Recreational Vehicle Loans ......... 315,840 835 2,175
Automotive Floor Plan Loans ........ 579,000 -- --
---------- ---------- ----------
Total Securitized .................. 2,216,427 $ 41,041 $ 6,365
---------- ========== ==========
Loans Held in Portfolios:
Home Equity Loans .................. 3,256,598
Boat Loans (1) ..................... 6,521
Recreational Vehicle Loans ......... --
Automotive Floor Plan Loans ........ 317,281
----------
Total Held in Portfolio ............ 3,580,400
----------
Total Loans Managed ................ $5,796,827
==========
(1) Boat loans are included in other consumer loans.
- --------------------------------------------------------------------------------
The components of retained interest and key economic assumptions used in
measuring the retained interest at the date of securitization resulting from
securitizations completed during the year were as follows (in thousands):
- --------------------------------------------------------------------------------
Recreational Automotive
Home Equity Boat Vehicles Floor Plan
----------- ------- ------------ ----------
Components of Retained Interest:
Subordinated interest retained .......... $ -- $ 519 $ 511 $21,085
Servicing rights ........................ 9,195 1,066 1,950 --
Excess servicing ........................ 55,496 17,099 17,844 657
Cash reserve ............................ -- -- -- 4,947
------- ------- ------- -------
Total Retained Interest ................. $64,691 $18,684 $20,305 $26,689
======= ======= ======= =======
Key economic assumptions:
Prepayment speed ........................ 15% 22% 22% --
Weighted average life (in years) ........ 17.99 15.00 11.75 .17
Expected credit losses .................. 0.75% 0.40% 0.40% 0.25%
Residual cashflows discount rate ........ 12.00% 11.00% 11.00% 10.00%
- --------------------------------------------------------------------------------
The table below summarizes certain cash flows received from and paid to
securitization trusts or special purpose entities (in thousands):
For the Year Ended
December 31, 2000
------------------
Proceeds from new securitizations .................... $948,456
Servicing fees received .............................. 1,577
Other cash flows received on retained interests ...... 22,581
Purchases of delinquent or foreclosed assets ......... 262
Servicing advances ................................... 1,916
Repayments of servicing advances ..................... 856
- --------------------------------------------------------------------------------
66
NOTE 22 - ASSET SECURITIZATIONS - (Continued)
At December 31, 2000, key economic assumptions and the sensitivity of the
current fair value of residual cashflows to immediate 10 percent and 20 percent
adverse changes in those assumptions are as follows (in thousands):
Automotive
Home Equity Boat Recreational Floor Plan
Loans Loans Vehicle Loans Loans
-------- -------- -------- --------
Carrying amount/fair value of retained interests ...... $ 64,691 $ 18,684 $ 20,305 $ 26,689
Weighted-average life (in years) ...................... 17.99 15.00 11.75 .17
Prepayment speed assumption (annual rate) ............. 27.0% 2.0% 1.8% --
Impact on fair value of 10% adverse change ......... $ (1,900) $ (200) $ (200) $ (26)
Impact on fair value of 20% adverse change ......... $ (4,700) $ (300) $ (300) $ (47)
Expected credit losses (annual rate) .................. 0.75% 0.26% 0.45% 0.25%
Impact on fair value of 10% adverse change ......... $ (2,100) $ (100) $ (100) $ (18)
Impact on fair value of 20% adverse change ......... $ (3,500) $ (100) $ (100) $ (36)
Residual cash flows discount rate (annual) ............ 12.0% 11.0% 11.0% 10.0%
Impact on fair value of 10% adverse change ......... $ (3,000) $ (500) $ (400) $ (220)
Impact on fair value of 20% adverse change ......... $ (5,700) $ (900) $ (1,500) $ (428)
- --------------------------------------------------------------------------------
These sensitivities are hypothetical and should be used with caution. As
the figures indicate, changes in fair value based on a 10 percent variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another
(for example, increased in market interest rates may result in lower prepayments
and increased credit losses), which might magnify or counteract the
sensitivities.
Expected static pool credit losses as a % of the original pool balance are
as follows:
- --------------------------------------------------------------------------------
Actual and Projected Credit Losses as of December 31, 2000: 2000 2001 2002
- ----------------------------------------------------------- ---- ---- ----
Home Equity Loans .............................................. 0.29% 0.75% 0.75%
Boat Loans ..................................................... 0.17% 0.40% 0.40%
Recreational Vehicle Loans ..................................... 0.26% 0.40% 0.40%
Automotive Floor Plan Loans .................................... -- 0.25% 0.25%
- --------------------------------------------------------------------------------
67
NOTE 23 - EARNINGS PER SHARE
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):
2000 1999 1998
--------- --------- ---------
Calculation of income/(loss) for EPS:
Income/(loss) before extraordinary item .................................... $ (41,017) $ 179,299 $ 136,455
Less preferred dividends ................................................... -- -- (1,496)
--------- --------- ---------
Income /(loss) before extraordinary item for basic EPS ..................... (41,017) $ 179,299 $ 134,959
Extraordinary item, after tax .............................................. 10,775 -- --
--------- --------- ---------
Net income for basic EPS ................................................... $ (30,242) $ 179,299 $ 134,959
========= ========= =========
Income/(loss) before extraordinary item for fully diluted EPS .............. $ (41,017) $ 179,299 $ 136,455
Extraordinary item, after tax .............................................. 10,775 -- --
--------- --------- ---------
Net income/(loss) for fully diluted EPS .................................... $ (30,242) $ 179,299 $ 136,455
========= ========= =========
Calculation of shares:
Weighted average basic shares .............................................. 225,881 176,021 152,910
Assumed conversion of preferred shares ..................................... -- -- 5,262
Dilutive effect of average stock options ................................... -- 2,146 3,039
--------- --------- ---------
Weighted average fully diluted shares ...................................... 225,881 178,167 161,211
========= ========= =========
Earnings/(loss) per share:
Basic
Income/(loss) before extraordinary item ............................... $ (0.18) $ 1.02 $ 0.88
Extraordinary item .................................................... 0.05 -- --
--------- --------- ---------
Net income/(loss) ..................................................... $ (0.13) $ 1.02 $ 0.88
========= ========= =========
Diluted
Income/(loss) before extraordinary item ............................... $ (0.18) $ 1.01 $ 0.85
Extraordinary item .................................................... 0.05 -- --
--------- --------- ---------
Net income/(loss) ..................................................... $ (0.13) $ 1.01 $ 0.85
========= ========= =========
- --------------------------------------------------------------------------------
NOTE 24 - COMPREHENSIVE INCOME/(LOSS)
The following table presents the components of comprehensive income, net of
related tax, based on the provisions of SFAS No. 130 for the years indicated (in
thousands):
YEAR ENDED DECEMBER 31,
---------------------------------------------
2000 1999 1998
--------- --------- ---------
Net income/(loss) ..................................................... $ (30,242) $ 179,299 $ 136,455
--------- --------- ---------
Unrealized (losses) gains on securities arising during the year ....... 93,841 (227,550) 10,647
Less reclassification adjustment ...................................... (78,570) 1,502 11,471
--------- --------- ---------
Net unrealized (losses) gains recognized in other
comprehensive income ............................................. 172,411 (229,052) (824)
--------- --------- ---------
Comprehensive income/(loss) .......................................... $ 142,169 $ (49,753) $ 135,631
========= ========= =========
68
NOTE 25 - PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Sovereign Bancorp is as follows (in
thousands):
BALANCE SHEETS
AT DECEMBER 31,
------------------------------
2000 1999
----------- -----------
Assets
Cash and due from banks ...................................................................... $ -- $ 2
Investment securities:
Available-for-sale ...................................................................... 1,075 278
Held-to-maturity ........................................................................ -- 765,458
Investment in subsidiaries:
Bank subsidiary ......................................................................... 3,497,002 2,299,508
Non-bank subsidiaries ................................................................... 131,199 664,908
Other assets ................................................................................. 135,283 51,189
----------- -----------
Total Assets ................................................................................. $ 3,764,559 $ 3,781,343
=========== ===========
Liabilities and Stockholders' Equity
Borrowings:
Long-term debt .......................................................................... $ 1,359,925 $ 1,587,667
Borrowings from non-bank subsidiaries ................................................... 365,970 347,605
Other liabilities ............................................................................ 89,780 24,576
----------- -----------
Total liabilities ............................................................................ 1,815,675 1,959,848
----------- -----------
Stockholders' Equity ......................................................................... 1,948,884 1,821,495
----------- -----------
Total Liabilities and Stockholders' Equity ................................................... $ 3,764,559 $ 3,781,343
=========== ===========
STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
-------------------------------------------------
2000 1999 1998
----------- ----------- -----------
Dividends from:
Bank subsidiary ...................................................... $ 100,000 $ -- $ --
Non-bank subsidiaries ................................................ 16,828 -- --
Interest income ........................................................... 35,016 6,847 12,222
Other income .............................................................. (2,388) 149 5,749
----------- ----------- -----------
Total income .............................................................. 149,456 6,996 17,971
----------- ----------- -----------
Interest expense .......................................................... 180,761 56,668 29,556
Other expense ............................................................. 8,317 28,976 8,122
----------- ----------- -----------
Total expense ............................................................. 189,078 85,644 37,678
----------- ----------- -----------
Loss before income taxes and equity in earnings of subsidiaries ........... (39,622) (78,648) (19,707)
Income taxes .............................................................. (81,282) (26,058) (6,461)
----------- ----------- -----------
Income/(loss) before equity in earnings of subsidiaries ................... 41,660 (52,590) (13,246)
Equity in undistributed earnings/(loss) of:
Bank subsidiary ...................................................... (68,336) 226,219 149,442
Non-bank subsidiaries ................................................ (3,566) 5,670 259
----------- ----------- -----------
Net income/(loss) ......................................................... $ (30,242) $ 179,299 $ 136,455
=========== =========== ===========
69
NOTE 25 - PARENT COMPANY FINANCIAL INFORMATION - (Continued)
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-----------------------------------------
2000 1999 1998
----------- ----------- -----------
Cash Flows from Operating Activities:
Net income/(loss) ...................................................................... $ (30,242) $ 179,299 $ 136,455
Adjustments to reconcile net income/(loss) to net cash provided by operating activities:
Undistributed (earnings)/loss of:
Bank subsidiary ................................................................... 68,336 (226,219) (149,442)
Non-bank subsidiaries ............................................................. 3,566 (5,670) (259)
Other, net ............................................................................. (16,222) (25,969) 29,117
----------- ----------- -----------
Net cash provided (used) by operating activities ....................................... 25,438 (78,559) 15,871
----------- ----------- -----------
Cash Flows from Investing Activities:
Net capital contributed to subsidiaries ................................................ (563,275) (739,777) (346,648)
Investment securities:
Maturity and repayments ........................................................... 764,661 -- 6,183
Net purchase and sales ............................................................ -- (994,788) 97,084
Net cash received from business combinations ........................................... -- 51 --
Net change in other assets and other liabilities ....................................... -- -- (4,228)
----------- ----------- -----------
Net cash provided (used) by investing activities ....................................... 201,386 (1,734,514) (247,609)
----------- ----------- -----------
Cash Flows from Financing Activities:
Net change in borrowings:
Repayment of long-term debt ....................................................... (227,742) -- --
Net proceeds received from long-term debt ......................................... -- 1,239,894 167,076
Net change in borrowings from non-bank subsidiaries ............................... 18,365 202,735 52,139
Sale (acquisition) of treasury stock ................................................... (194) (46,867) (901)
Cash dividends paid to stockholders .................................................... (22,499) (17,104) (14,286)
Net proceeds from issuance of common stock ............................................. 5,244 342,803 20,451
Net proceeds from issuance of warrants ................................................. -- 91,500 --
----------- ----------- -----------
Net cash provided (used) by financing activities ....................................... (226,826) 1,812,961 224,479
----------- ----------- -----------
(Decrease) increase in cash and cash equivalents ....................................... (2) (112) (7,259)
Cash and cash equivalents at beginning of period ....................................... 2 114 7,373
----------- ----------- -----------
Cash and cash equivalents at end of period ............................................. $ -- $ 2 $ 114
=========== =========== ===========
- --------------------------------------------------------------------------------
NOTE 26 - SUBSEQUENT EVENTS
On February 9, 2001, Sovereign issued $150 million of common equity
consisting of 20 million shares sold at $7.50 per share.
On February 20, 2001, Sovereign issued $175 million of senior unsecured
notes at 8.625% which will mature on March 15, 2004. On March 1, 2001, Sovereign
refinanced the $500 million senior secured credit facility described in Note 11
(outstanding balance at December 31, 2000 of $350 million) with a variable rate
$400 million senior secured credit facility consisting of a $350 million
revolving line and a $50 million term note. The revolving line matures in 2007
and the term note matures in 2005.
70
Item 9. Changes in and Disagreements with Accountants or Accounting and
Financial Disclosure.
Not applicable.
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 2001 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
"Section 16(a) Beneficial Ownership Reporting Compliance" 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 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" and "Other" in the Proxy
Statement.
71
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(A) 1. FINANCIAL STATEMENTS.
The following financial statements are filed as part of this report:
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
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 Registration Statement No. 333-86961-01 on Form
S-3.)
(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, 1998.)
(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 to the Commission on request.
(10.1) Sovereign Bancorp, Inc. Stock Option Plan. (Incorporated by
reference to Exhibit 10.1 to Sovereign's Annual Report on Form
10-K, SECFile No. 0-16533, 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) Employment 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
Amended Quarterly Report on Form 10-Q/A, SEC File No. 0-16533,
for the fiscal quarter ended March 31, 1997.)
(10.4) Employment Agreement, dated as of May 1, 1997, between ML
Bancorp, Inc. (a predecessor company of Sovereign Bancorp, Inc.)
and Dennis S. Marlo.
(10.5) Employment Agreement, dated as of September 25, 1997, between
Sovereign Bancorp, Inc. and Lawrence M. Thompson, Jr.
(Incorporated by reference to Exhibit 10.5 to Sovereign's Annual
Report on Form 10-K, SEC File No. 0-16533, for the fiscal year
ended December 31, 1997.)
(10.6) Rights Agreement, dated September 19, 1989, between Sovereign
Bancorp, Inc. and Harris Trust Company of New York.
(Incorporated by reference to Exhibit 4 on Sovereign's Current
Report on Form 8-K, SEC File No. 0-16533, filed on October 12,
1989.)
(10.7) Sovereign Bancorp, Inc. Non-Employee Directors Services
Compensation Plan.
(10.8) 1993 Sovereign Bancorp, Inc. Stock Option Plan. (Incorporated by
reference to Exhibit 10.23 to Sovereign's Annual Report on Form
10-K, SEC File No. 0-16533, for the fiscal year ended
December 31, 1992.)
(10.9) 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, SEC
File No. 0-16533, for the fiscal year ended December 31, 1993.)
(10.10) 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 4.1 to Sovereign's Current
Report on Form 8-K/A, SEC File No. 0-16533, filed on January 22,
1996.)
72
(10.11) Sovereign Bancorp, Inc. 1997 Non-Employee Director's Stock
Option Plan. (Incorporated by reference to Exhibit "A" to
Sovereign's definitive proxy statement, SEC File No. 0-16533,
dated March 15, 1996.)
(10.12) Sovereign Bancorp, Inc. 1996 Stock Option Plan. (Incorporated by
reference to Exhibit 4.3 to Sovereign's Registration Statement
No. 33-89586 on Form S-8.)
(10.13) Employment Agreement, dated January 7, 2000, between Sovereign
Bancorp, Inc. and John Hamill.
(10.14) Employment Agreement, dated as of July 1, 1997, between
Sovereign Bancorp, Inc. and Joseph P. Campanelli.
(21) Subsidiaries of the Registrant.
(23.1) Consent of Ernst & Young LLP.
(B) REPORTS ON FORM 8-K
None.
73
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)
March 22, 2001 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 March 22, 2001
- -------------------------
John A. Fry
Director March 22, 2001
- -------------------------
Brian Hard
/s/ RICHARD E. MOHN Chairman of Board and Director March 22, 2001
- -------------------------
Richard E. Mohn
/s/ RHODA S. OBERHOLTZER Director March 22, 2001
- -------------------------
Rhoda S. Oberholtzer
/s/ DANIEL K. ROTHERMEL Director March 22, 2001
- -------------------------
Daniel K. Rothermel
/s/ JAY S. SIDHU Director, President and Chief March 22, 2001
- ------------------------- Executive Officer (Principal
Jay S. Sidhu Executive Officer)
/s/ CAMERON C. TROILO Director March 22, 2001
- -------------------------
Cameron C. Troilo
/s/ DENNIS S. MARLO Chief Financial Officer March 22, 2001
- -------------------------
Dennis S. Marlo
/s/ MARK R. MCCOLLOM Chief Accounting Officer March 22, 2001
- -------------------------
Mark R. McCollom
74