WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934
For the quarter ended March 31, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 34-16533
SOVEREIGN BANCORP, INC.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2453088
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1130 Berkshire Boulevard, Wyomissing, Pennsylvania 19610
- -----------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (610) 320-8400
N/A
----------------------------------------------------------------
(Former name, former address and former fiscal year, if changed
since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X . No .
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at May 12, 2000
- --------------------------- -----------------------------
Common Stock (no par value) 225,795,241 shares
FORWARD LOOKING STATEMENTS
Sovereign Bancorp, Inc. ("Sovereign") may from time to time make
"forward-looking statements," including statements contained in Sovereign's
filings with the Securities and Exchange Commission (including this Quarterly
Report on Form 10-Q and the Exhibits thereto), in its reports to shareholders
(including its 1999 Annual Report) and in other communications by Sovereign,
which are made in good faith by Sovereign, pursuant to the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include statements with respect to
Sovereign's vision, mission, strategies, goals, beliefs, plans, objectives,
expectations, anticipations, estimates, intentions, financial condition, results
of operations, future performance and business of Sovereign, including: (i)
statements relating to Sovereign's expectations and goals with respect to (a)
growth in earnings per share; (b) return on equity; (c) return on assets; (d)
efficiency ratio; (e) tier 1 leverage ratio; (f) annualized net charge-offs and
other asset quality measures; (g) fee income as a percentage of total revenue;
(h) tangible equity to assets; (i) book value and tangible book value per share;
(j) loan and deposit portfolio compositions, (ii) statements preceded by,
followed by or that include the words "may," "could," "should," "pro forma,"
"looking forward," "would," "believe," "expect," "anticipate," "estimate,"
"intend," "plan," or similar expression, and (iii) statements relating to some
or all of the foregoing which assume the successful completion of the three
staggered closings with respect to its FleetBoston acquisition, the successful
conversion of FleetBoston operating systems, and the retention of former
FleetBoston employees and customers. Although we believe that the expectations
reflected in our forward-looking statements are reasonable, these
forward-looking statements involve risks and uncertainties which are subject to
change based on various important factors (some of which, in whole or in part,
are beyond Sovereign's control). The following factors, among others, could
cause Sovereign's financial performance to differ materially from the goals,
plans, objectives, intentions and expectations, forecasts and projections (and
underlying assumptions) expressed in such forward-looking statements: (1) the
strength of the United States economy in general and the strength of the
regional and local economies in which Sovereign conducts operations, (2) the
effects of, and changes in, trade, monetary and fiscal policies and laws,
including interest rate policies of the Board of Governors of the Federal
Reserve System; (3) inflation, interest rate, market and monetary fluctuations;
(4) the timely development of competitive new products and services by Sovereign
and the acceptance of such products and services by customers; (5) the
willingness of customers to substitute competitors' products and services and
vice versa; (6) the success of Sovereign and Sovereign Bank in meeting the
conditions for regulatory approval for each of its two remaining staggered
closings with respect to its FleetBoston acquisition; (7) the impact of changes
in financial services' laws and regulations and the application of such laws and
regulations (including laws concerning taxes, capital, liquidity, proper
accounting treatment, securities and insurance); (8) technological changes; (9)
changes in consumer spending and savings habits; (10) the impact of the
FleetBoston acquisition and other acquisitions of Sovereign, including the
success of Sovereign in fully realizing, within the expected time frame,
earnings enhancements from such pending or completed acquisitions, including,
without limitation, the earnings enhancements expected from the acquisition of
loans, deposits and community banking offices from FleetBoston; (11) Sovereign's
ability to complete the FleetBoston acquisition and related systems conversions,
and Sovereign's ability to retain FleetBoston customers and employees;
FORWARD LOOKING STATEMENTS
(continued)
(12) changes in the amount, mix, yield, quality, and other characteristics of
the deposits and loans Sovereign expects to assume and acquire from FleetBoston;
(13) changes in the timing and structure of the FleetBoston acquisition and
related transactions and other changed facts and circumstances resulting from
the passage of time; (14) unanticipated regulatory or judicial proceedings; (15)
unanticipated changes in asset quality; and (16) the success of Sovereign at
managing the risks involved in the foregoing.
Operating earnings and cash operating earnings, as defined, are not a
substitute for other financial measures determined in accordance with generally
accepted accounting principles. Because all companies do not calculate operating
earnings and cash operating earnings in the same fashion, these measures as
presented may not be comparable to other similarly titled measures of other
companies.
Sovereign cautions that the foregoing list of important factors is not
exclusive, and neither such list nor any such forward-looking statement takes
into account the impact that any future acquisition may have on Sovereign and
any such forward-looking statement, Sovereign does not undertake to update any
forward-looking statement, whether written or oral, that may be made from time
to time by or on behalf of Sovereign.
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 2000
and December 31, 1999 5
Consolidated Statements of Operations for the three-month
periods ended March 31, 2000 and 1999 6 - 7
Consolidated Statement of Stockholders' Equity for
the three-month period ended March 31, 2000 8
Consolidated Statements of Cash Flows for the three-month
periods ended March 31, 2000 and 1999 9
Notes to Consolidated Financial Statements 10 - 21
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 22 - 37
PART II. OTHER INFORMATION
Item 6. Exhibits & Reports on Form 8-K 38
PART III. FINANCIAL DATA SCHEDULE 39
SIGNATURES 40
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2000 1999
------------ -----------
(Unaudited) (Note)
(in thousands, except
share data)
ASSETS
Cash and amounts due from
depository institutions $ 709,775 $ 373,996
Interest-earning deposits 338,003 19,238
Loans held for sale (approximate fair
value of $43,812 at March 31, 2000 and
$62,439 at December 31, 1999) 43,752 61,925
Investment securities available-for-sale 7,651,714 8,030,212
Investment securities held-to-maturity
(approximate fair value of $2,296,827 at March
31, 2000 and $2,367,025 at December 31, 1999 2,304,307 2,362,051
Loans 17,302,539 14,226,540
Allowance for loan losses (175,377) (132,986)
Premises and equipment 173,903 119,201
Other real estate owned
and other repossessed assets 6,178 5,329
Accrued interest receivable 192,546 164,720
Goodwill and other intangible assets 818,242 434,078
Other assets 1,512,447 942,808
------------ -----------
TOTAL ASSETS $30,878,029 $26,607,112
=========== ===========
LIABILITIES
Deposits $16,128,147 11,719,646
Borrowings:
Short-term 7,859,492 6,902,414
Long-term 4,508,725 5,760,724
Advance payments by borrowers
for taxes and insurance 33,362 28,222
Other liabilities 131,592 58,265
----------- -----------
TOTAL LIABILITIES 28,661,318 24,469,271
----------- -----------
Corporation-obligated mandatory redeemable
capital securities of subsidiary trust holding
solely subordinated debentures of Sovereign
Bancorp, Inc. ("Trust Preferred Securities") 317,120 316,346
----------- -----------
STOCKHOLDERS' EQUITY
Common stock; no par value; 400,000,000 shares
authorized; 230,827,495 shares issued at
March 31, 2000 and 230,647,896 shares
issued at December 31, 1999 1,255,243 1,254,037
Warrants 91,500 91,500
Unallocated common stock held by Employee Stock
Ownership Plans at cost; 4,856,254 shares at
March 31, 2000 and December 31, 1999 (36,295) (36,295)
Treasury stock at cost; 369,251 shares at March 31, 2000
and 383,875 shares at December 31, 1999 (3,460) (3,595)
Accumulated other comprehensive (loss) (166,549) (210,932)
Retained earnings 759,152 726,780
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 1,899,591 1,821,495
------------ -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $30,878,029 $26,607,112
=========== ===========
See accompanying notes to consolidated financial statements.
-5-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three-Month Period
Ended March 31,
-------------------------
2000 1999
-------- ---------
(in thousands, except
per share data)
Interest income:
Interest on interest-earning deposits $ 2,278 $ 1,505
Interest and dividends on investment
securities:
Available-for-sale 137,746 121,890
Held-to-maturity 37,204 27,966
Interest and fees on loans 294,653 216,667
-------- ---------
Total interest income 471,881 368,028
-------- ---------
Interest expense:
Interest on deposits 114,462 109,348
Interest on borrowings 198,167 118,888
-------- ---------
Total interest expense 312,629 228,236
-------- ---------
Net interest income 159,252 139,792
Provision for loan losses 8,000 7,500
-------- ---------
Net interest income after provision for
loan losses 151,252 132,292
-------- ---------
Other income:
Retail banking fees 13,779 11,059
Mortgage banking revenues 5,285 9,946
Loan fees and service charges 2,277 1,342
Capital markets revenue 3,732 -
Gain(loss) on sale of loans and
investment securities (22,872) 3,408
Miscellaneous income 19,057 6,549
-------- ---------
Total other income 21,258 32,304
-------- ---------
General and administrative expenses:
Compensation and benefits 46,109 36,477
Occupancy and equipment expenses 20,773 17,306
Outside services 22,262 15,349
Other administrative expenses 24,734 14,320
-------- ---------
Total general and administrative expenses 113,878 83,452
-------- ---------
-6-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(continued)
Three-Month Period
Ended March 31,
-----------------------
2000 1999
------- -------
(in thousands, except
per share data)
Other expenses:
Amortization of goodwill and other intangibles $ 9,684 $ 9,028
Trust Preferred Securities expense 8,928 3,049
Real estate owned loss/(gain), net (155) (160)
------- -------
Total other expenses 18,457 11,917
------- -------
Income before income taxes and extraordinary item 40,175 69,227
Income tax provision 13,250 23,914
------- -------
Income before extraordinary item 26,925 45,313
Gain on sale of FHLB advances (net of tax of $5,225) 10,775 -
------- -------
Net Income $37,700 $45,313
======= =======
Earnings per share before extraordinary item $ .12 $ .28
Gain on sale of FHLB advances net of tax .05 -
------- -------
Earnings per share $ .17 $ .28
======= =======
Dividends paid per common share $ .025 $ .025
======= =======
See accompanying notes to consolidated financial statements.
-7-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands)
Common
Shares Common Retained Treasury
Outstanding Stock Warrants Earnings Stock
----------- ------ -------- -------- --------
Balance, December 31, 1999 225,408 $ 1,254,037 $ 91,500 $ 726,780 $ (3,595)
Comprehensive income:
Net income -- -- -- 37,700 --
Change in unrecognized loss on
investment securities available-
for-sale, net of tax -- -- -- -- --
Total comprehensive income
Exercise of stock options 11 14 -- -- --
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan 168 1,192 -- -- --
Dividends paid on common stock -- -- -- (5,328) --
Treasury stock repurchase (7) -- -- -- (53)
Treasury stock sold 22 -- -- -- 188
------- ----------- ----------- ----------- -----------
Balance, March 31, 2000 225,602 $ 1,255,243 $ 91,500 $ 759,152 $ (3,460)
======= =========== =========== =========== ===========
Accumulated
Unallocated Other Total Stock-
Common Stock Comprehensive holders'
Held by ESOP Income/(Loss) Equity
------------ ------------- ------------
Balance, December 31, 1999 $ (36,295) $ (210,932) $ 1,821,495
Comprehensive income:
Net income -- -- 37,700
Change in unrecognized loss on
investment securities available-
for-sale, net of tax -- 44,383 44,383
-----------
Total comprehensive income 82,083
Exercise of stock options -- -- 14
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan -- -- 1,192
Dividends paid on common stock -- -- (5,328)
Treasury stock repurchase -- -- (53)
Treasury stock sold -- -- 188
----------- ----------- -----------
Balance, March 31, 2000 $ (36,295) $ (166,549) $ 1,899,591
=========== =========== ===========
See accompanying notes to consolidated financial statements.
-8-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three-Month Period
Ended March 31,
-------------------------------
2000 1999
---------- -----------
(in thousands)
Cash Flows from Operating Activities:
Net income $ 37,700 $ 45,313
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses and deferred taxes 8,000 8,173
Depreciation 5,718 4,294
Amortization & Accretion (7,079) 10,171
(Gain)/loss on sale of loans, investment securities
and real estate owned 22,717 (3,568)
(Gain)/loss on sale of FHLB advances (16,000)
Net change in:
Loans held for sale 18,173 178,704
Accrued interest receivable (3,382) (1,166)
Other assets (147,531) (167,968)
Other liabilities 51,548 139,678
---------- -----------
Net cash provided/(used) by operating activities $ (30,136) $ 213,631
---------- -----------
Cash Flows from Investing Activities:
Proceeds from sales of investment securities available-for-sale 2,339,143 354,479
Proceeds from repayments and maturities of
investment securities:
Available-for-sale 208,265 583,174
Held-to-maturity 1,044,165 313,238
Purchases of investment securities:
Available-for-sale (2,112,466) (2,351,911)
Held-to-maturity (977,210) (21,033)
Proceeds from sales of loans 132,819 462,639
Purchase of loans (564,950) (174,414)
Net change in loans other than purchases and sales 948,244 (587,025)
Proceeds from sales of premises and equipment 2,219 43
Purchases of premises and equipment (33,929) (16,126)
Proceeds from sale of real estate owned 750 5,930
Cash paid to acquire SBNE net of cash acquired (222,905) -
---------- -----------
Net cash provided/(used) by investing activities 764,145 (1,431,006)
---------- -----------
Cash Flows from Financing Activities:
Net (decrease)/increase in deposits 199,072 (282,391)
Net increase in short-term borrowings 631,353 662,737
Proceeds from long-term borrowings - 744,996
Sale of FHLB advances (911,037) -
Net increase in advance payments by
borrowers for taxes and insurance 5,140 518
Cash dividends paid to stockholders (5,334) (3,406)
Proceeds from issuance of common stock 1,206 2,511
Advance to the Employee Stock Ownership Plan 0 (437)
(Purchase)/issuance of treasury stock 135 (462)
---------- -----------
Net cash provided/(used) by financing activities (79,465) 1,124,066
---------- -----------
Net change in cash and cash equivalents 654,544 (93,309)
Cash and cash equivalents at beginning of period 393,234 553,724
---------- -----------
Cash and cash equivalents at end of period $1,047,778 $ 460,415
========== ===========
Supplemental Disclosures:
Income tax payments totaled $.1 million for the three-month period ended March
31, 2000 and $12.4 million for the same period in 1999. Interest payments
totaled $323 million for the three-month period ended March 31, 2000 and $211
million for the same period in 1999. Noncash activity consisted of the
acquisition of SBNE which included $3.4 billion of loans and assumption of $4.2
billion of deposits for the three-month period ended March 31, 2000; mortgage or
whole loan sales of $84 million for the three-month period ended March 31, 2000
and $414 million for the same period in 1999; reclassification of long-term
borrowings to short-term borrowings of $325 million for the three-month period
ended March 31, 2000 and $92.0 million for the same period in 1999; and
reclassification of mortgage loans to real estate owned of $1.7 million for the
three-month period ended March 31, 2000 and $4.1 million for the same period in
1999.
See accompanying notes to consolidated financial statements.
-9-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) BASIS OF PRESENTATION AND ACCOUNTING POLICIES
Basis of Presentation
The accompanying financial statements of Sovereign Bancorp, Inc. and
subsidiaries ("Sovereign") include the accounts of the parent company, Sovereign
Bancorp, Inc. and its wholly-owned subsidiaries: Sovereign Bank, Sovereign
Delaware Investment Corporation, Sovereign Delaware Escrow Company, Sovereign
Capital Trust I, Sovereign Capital Trust II and ML Capital Trust I. All material
intercompany balances and transactions have been eliminated in consolidation.
These financial statements have been prepared in accordance with the
instructions for Form 10-Q and therefore do not include certain information or
footnotes necessary for the presentation of financial condition, results of
operations, stockholders' equity, and cash flows in conformity with generally
accepted accounting principles. However, in the opinion of management, the
consolidated financial statements reflect all adjustments (which consist of
normal recurring accruals) necessary for a fair presentation of the results for
the unaudited periods.
Preparation of these financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates. Certain
amounts in the financial statements of prior periods have been reclassified to
conform with the presentation used in current period financial statements. These
reclassifications have no effect on net income.
The results of operations for the three-month period ended March 31, 2000
are not necessarily indicative of the results which may be expected for the
entire year. The consolidated financial statements should be read in conjunction
with Form 10-K for the year ended December 31, 1999.
Allowance for Loan Losses
The adequacy of Sovereign's allowance for loan losses is regularly
evaluated. Management's evaluation of the adequacy of the allowance to absorb
loan losses takes into consideration the risks inherent in the loan portfolio,
past loan loss experience, specific loans which are currently criticized,
geographic and industry concentrations, delinquency trends, economic conditions,
the level of originations and other relevant factors. Management also considers
loan quality, changes in the size and character of the loan portfolio,
consultation with regulatory authorities, the amount of non-performing loans,
delinquency trends, economic conditions and industry trends when determining the
unallocated allowance. For additional information on Sovereign's allowance for
loan losses, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Allowance for Loan Losses."
-10-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(2) EARNINGS PER SHARE
Basic earnings per share is calculated by dividing income before
extraordinary item available by the weighted average common shares outstanding,
excluding options and warrants. In calculating diluted earnings per share, the
dilutive effect of options and warrants is calculated using the treasury stock
method, using the average market price for the period.
The following table presents the computation of earnings per share for the
periods indicated (in thousands, except per share data).
Three-Month Period
Ended March 31,
-----------------------------
2000 1999
-------- --------
Basic Earnings Per Share:
- -------------------------
Income before extraordinary
item $ 26,925 $ 45,313
-------- --------
Average basic shares 225,552 159,890
======== ========
Basic earnings per share $ .12 $ .28
======== ========
Diluted Earnings Per Share:
Income before extraordinary
item $ 26,925 $ 45,313
-------- --------
Average diluted shares 225,552 159,890
Dilutive effect of average stock
options, net of shares assumed to
be repurchased under the treasury
stock method 1,000 1,855
-------- --------
Total average diluted shares 226,552 161,745
======== ========
Diluted earnings per share $ .12 $ .28
======== ========
-11-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(3) INVESTMENT SECURITIES AVAILABLE-FOR-SALE
The following table presents the composition and fair value of investment
securities available-for-sale at the dates indicated: (dollars in thousands)
March 31, 2000
------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
--------- ------------ ------------ -----
Investment Securities:
U.S. Treasury and gov't
agency securities $ 77,683 $ - $ 1,273 $ 76,410
Corporate securities/
Trust Preferred 256,428 3,247 9,278 250,397
Asset backed securities 645,910 - 21,514 624,396
Equities 29,703 402 2,538 27,567
FHLB stock 531,584 - - 531,584
Agency preferred stock 425,888 47 3,393 422,542
Municipal securities 40,735 397 9,945 31,187
Mortgage-backed Securities:
Passthroughs:
U.S. government agencies 644,439 2,153 22,919 623,673
Non-agencies 2,619,378 - 100,535 2,518,843
Collateralized mortgage
obligations 2,636,050 1,565 92,500 2,545,115
---------- ------ -------- ----------
Total investment and
mortgage-backed securities
available-for-sale $7,907,798 $7,811 $263,895 $7,651,714
========== ====== ======== ==========
-12-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(3) INVESTMENT SECURITIES AVAILABLE-FOR-SALE (continued)
December 31, 1999
-------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
--------- ------------ ------------ -----
Investment Securities:
U.S. Treasury and
government agency
securities $ 77,229 $ 2 $ 1,210 $76,021
Corporate securities/
Trust Preferred 243,915 650 14,231 230,334
Asset backed securities 685,274 - 21,149 664,125
Equities 32,142 31 11,420 20,753
FHLB stock 524,397 - - 524,397
Agency preferred stock 425,888 4,135 395 429,628
Municipal securities 32,813 745 1,379 32,179
Mortgage-backed Securities:
Passthroughs:
U.S. government agencies 478,462 909 21,004 458,367
Non-agencies 2,688,315 - 132,333 2,555,982
Collateralized mortgage
obligations 3,166,472 2,564 130,610 3,038,426
---------- ------- -------- ----------
Total investment and
mortgage-backed securities
available-for-sale $8,354,907 $ 9,036 $333,731 $8,030,212
========== ======= ======== ==========
-13-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(4) INVESTMENT SECURITIES HELD-TO-MATURITY
The following table presents the composition and fair value of investment
securities held-to-maturity at the dates indicated: (dollars in thousands)
March 31, 2000
------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
--------- ------------ ------------ -----
Investment Securities:
U.S. Treasury and
government agency
securities $ 6,385 $ - $ - $ 6,385
Corporate securities/
Trust Preferred 1,325,413 1,972 155 1,327,230
Municipal securities 3,043 136 10 3,169
Mortgage-backed Securities:
Passthroughs:
U.S. government agencies 481,845 2,047 2,891 481,001
Non-agency 49,077 344 428 48,993
Collateralized mortgage
obligations 438,544 553 9,048 430,049
---------- ------ ------- ----------
Total investment securities
held-to-maturity $2,304,307 $ 5,052 $12,532 $2,296,827
========== ======= ======= ==========
December 31, 1999
------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
--------- ------------ ------------ -----
Investment Securities:
U.S. Treasury and
government agency
securities $ 4,807 $ - $ 109 $ 4,698
Corporate securities/
Trust Preferred 1,326,827 9,852 165 1,336,514
Municipal securities 3,275 96 22 3,349
Mortgage-backed Securities:
Passthroughs:
U.S. government agencies 499,866 2,516 2,365 500,017
Non-agency 52,319 377 224 52,472
Collateralized mortgage
obligations 474,957 2,520 7,502 469,975
---------- ------ ------ ---------
Total investment securities
held-to-maturity $2,362,051 $15,361 $10,387 $2,367,025
========== ======= ======= ==========
-14-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(5) COMPOSITION OF LOAN PORTFOLIO
The following table presents the composition of the loan portfolio by type
of loan and by fixed and adjustable rates at the dates indicated: (dollars in
thousands)
March 31, 2000 December 31, 1999
-------------------------- --------------------------
Amount Percent Amount Percent
------ ------- ------ ------
Residential real estate loans $ 5,893,809 34.1% $ 5,623,295 39.5%
Residential construction loans 53,645 0.3 59,264 0.4
----------- ----- ----------- ------
Total Residential Loans 5,947,454 34.4 5,682,559 39.9
----------- ----- ----------- ------
Commercial real estate loans 1,917,105 11.1 1,516,953 10.7
Commercial and industrial loans 2,576,675 14.8 1,690,744 11.8
Automotive floor plan loans 1,101,216 6.4 730,623 5.2
Multi-family loans 136,419 0.8 137,019 1.0
----------- ----- ----------- ------
Total Commercial Loans 5,731,415 33.1 4,075,339 28.7
----------- ----- ----------- ------
Home equity loans 2,950,695 17.0 1,957,945 13.8
Auto loans 2,015,903 11.7 1,936,980 13.6
Loans to automotive lessors 285,738 1.7 288,636 2.0
Student loans 250,464 1.4 249,279 1.8
Other 120,870 0.7 35,802 .2
----------- ----- ----------- ------
Total Consumer Loans 5,623,670 32.5 4,468,642 31.4
----------- ----- ----------- ------
Total Loans (1) $17,302,539 100.0% $14,226,540 100.0%
=========== ===== =========== ======
Total Loans with:
Fixed rates $10,569,295 61.1% $ 8,707,951 61.2%
Variable rates 6,733,244 38.9 5,518,589 38.8
----------- ----- ----------- ------
Total Loans (1) $17,302,539 100.0% $14,226,540 100.0%
=========== ===== =========== ======
(1) Loan totals are net of deferred loan fees and unamortized premiums and
discounts of $25.4 million and $24.0 million at March 31, 2000 and December
31, 1999, respectively.
-15-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(6) DEPOSIT PORTFOLIO COMPOSITION
The following table presents the composition of deposits at the dates
indicated: (dollars in thousands)
March 31, 2000 December 31, 1999
---------------------------------------- ---------------------------------------
Weighted Weighted
Average Average
Account Type Amount Percent Rate Amount Percent Rate
------------ ------ ------- -------- ------ ------- ---------
Demand deposit accounts $ 1,553,295 9.6% -% $ 1,089,472 9.3% -%
NOW accounts 2,184,287 13.6 2.60 1,578,259 13.5 2.24
Savings accounts 2,763,154 17.1 2.48 2,142,708 18.3 2.69
Money market accounts 2,063,258 12.8 4.02 1,345,325 11.5 4.17
Retail certificates 6,768,853 42.0 5.35 4,708,057 40.2 5.00
Jumbo certificates 795,300 4.9 5.66 855,825 7.2 5.56
----------- ----- ----- ----------- ------ -----
Total Deposits $16,128,147 100.0% 3.82% $11,719,646 100.0% 3.64%
=========== ====== ===== =========== ====== =====
(7) BORROWINGS
The following table presents information regarding borrowings at the dates
indicated: (dollars in thousands)
March 31, 2000 December 31, 1999
-------------------------- ---------------------------
Weighted Weighted
Average Average
Balance Rate Balance Rate
------- -------- ------- ---------
Securities sold under
repurchase agreements $ 1,387,127 6.10% $ 584,553 4.69%
FHLB advances 9,339,419 5.81 10,484,904 5.43
Other borrowings 1,641,671 10.51 1,593,681 10.74
----------- ------ ----------- ------
Total Borrowings $12,368,217 6.47% $12,663,138 6.06%
=========== ====== =========== ======
In March, 2000, the Company auctioned $927 million of FHLB advances at a
premium of $16 million. Accordingly, the gain associated with the auction of the
FHLB advances is treated as an extraordinary item on the statement of
operations.
-16-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(8) INTEREST RATE EXCHANGE AGREEMENTS
Interest rate swaps are generally used to convert fixed rate assets and
liabilities to variable rate assets and liabilities and vice versa. Interest
rate caps are generally used to limit the exposure from the repricing and
maturity of liabilities. Interest rate floors are generally used to limit the
exposure from repricing and maturity of assets. In certain cases, interest rate
caps and floors are simultaneously bought and sold to create a range of
protection (interest rate corridors) against changing interest rates while
limiting the cost of that protection. The following table presents information
regarding interest rate exchange agreements at the dates indicated: (dollars in
thousands)
March 31, 2000
----------------------------------------------------------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
-------- ----- ---------- --------
Non-amortizing interest rate swaps:
Pay variable-receive fixed (1) $ 562,300 $ - $ (7,102) 7.9
Pay fixed-receive variable (2) 50,000 - 1 0.6
Interest rate caps/floors(3) 1,200,000 3,778 (1,412) 2.4
---------- ------- ---------
$1,812,300 $ 3,778 $ (8,513)
========== ======= =========
December 31, 1999
--------------------------------------------------------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
-------- ----- ---------- --------
Non-amortizing interest rate swaps:
Pay variable-receive fixed (1) $ 252,300 $ - $ (6,846) 7.0
Pay fixed-receive variable (2) 200,000 - 8,853 3.1
Interest rate caps/floors (3) 1,200,000 4,463 (809) 2.6
---------- -------- ----------
$1,652,300 $ 4,463 $ 1,198
========== ======== =========
(1) The weighted average pay rate was 6.68% and 7.24% and the weighted average
receive rate was 7.76% and 7.82% at March 31, 2000 and December 31, 1999,
respectively.
(2) The weighted average pay rate was 6.08% and 5.41% and the weighted average
receive rate was 6.04% and 6.13% at March 31, 2000 and December 31, 1999,
respectively.
(3) The strike price range was 5.25% - 9.00% at March 31, 2000 and December 31,
1999.
-17-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
The following table summarizes by notional amounts the activity of
Sovereign's interest rate exchange agreements: (dollars in thousands)
Balance Balance
December 31, Maturities/ March 31,
1999 Additions Amortization Terminations 2000
----------- --------- ------------ ------------ --------
Non-amortizing interest
rate swaps $ 452,300 $ 310,000 $ - $ 150,000 $ 612,300
Interest rate
caps/floors 1,200,000 - - - 1,200,000
---------- -------- ---------- --------- ----------
$1,652,300 $310,000 $ -0- $150,000 $1,812,300
========== ======== ========== ======== ==========
Net interest expense resulting from interest rate exchange agreements for
the three-month period ended March 31, 2000 was $81 thousand.
-18-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(9) ACQUISITIONS
On March 24, 2000, Sovereign successfully completed the first phase of the
purchase and assumption agreement creating Sovereign Bank New England (SBNE) as
described in the following paragraphs. Sovereign's results include the
operations of the acquired SBNE branches, assets and liabilities from March 24,
2000 and thereafter.
Total deposits transferred in this first phase of the acquisition were $4.2
billion. Additionally, loan balances transferred to Sovereign approximated $3.4
billion, which included $1.3 billion of commercial loans and leases, $1.0
billion of consumer loans, $1.1 billion of residential mortgages and $181
million of precious metals inventory.
On September 3, 1999, Sovereign entered into a purchase and assumption
agreement with FleetBoston Financial to acquire branch banking offices located
in Connecticut, Massachusetts, New Hampshire and Rhode Island, and related
deposit liabilities, loans and other assets associated with the business of
those branches. On February 28, 2000, Sovereign and FleetBoston Financial agreed
to restructure certain terms of the agreement. Sovereign will purchase
approximately $12 billion of deposits, $9 billion of loans and 285 community
banking offices. The acquisition, which results in the creation of Sovereign
Bank New England, the third largest bank in New England, includes the following:
the former Fleet Bank community banking franchise in eastern Massachusetts; the
entire former BankBoston community banking franchise in Rhode Island; and select
community banking offices of Fleet Bank in Southern New Hampshire and BankBoston
in Connecticut. In addition, Sovereign is acquiring a substantial portion of the
middle market and small business-lending group from Fleet in Massachusetts and
New Hampshire, and from BankBoston in Rhode Island and Connecticut. The
acquisition includes 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.
Sovereign has obtained the receipt of all required regulatory approvals for this
acquisition.
Acquisition Timetable
Date Divested Units Deposits Branches Loans
- -------------- ---------------------- ------------ -------- ------------
Completed:
March 24, 2000 RI, CT (BankBoston) $4.2 billion 90 $3.4 billion
Pending:
June 16, 2000 Eastern MA (Fleet) $3.9 billion 86 $3.4 billion
July 21, 2000 Central MA, NH (Fleet) $3.9 billion 109 $2.3 billion
Total consideration for the entire consumer and banking franchise is 12% of
acquired deposits, or approximately $1.4 billion. Sovereign will pay
approximately $1.1 billion as the purchases are completed according to the above
schedule. Sovereign will pay the remaining $340 million in periodic installments
between January 2001 and October 2001 if FleetBoston complies with its
non-compete obligations under the agreement and certain other conditions are
met. Sovereign paid a non-refundable deposit of $200 million to FleetBoston to
be credited against amounts due on the remaining closings, and is required to
comply at each closing with the acquisition plan included with its application
as approved by the Office of Thrift Supervision.
-19-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(9) ACQUISITIONS (continued)
In the first dosing Sovereign paid a net premium of $280 million, recorded
a fair value reduction on acquired loans of $71 million and established an
initial allowance for loan losses of $42 million. These items result in total
intangibles of $393 million including goodwill of $278 million and core deposit
intangible of $115 million to be amortized over 25 years and 10 years,
respectively. These adjustments are based upon preliminary information and are
subject to further revision throughout the year.
On June 30, 1999, Sovereign acquired Peoples Bancorp Inc. ("Peoples"), a
$1.4 billion bank holding company headquartered in Lawrenceville, New Jersey
whose principal operating subsidiary operated fourteen (14) community banking
offices in Mercer, Burlington and Ocean counties, New Jersey. The transaction
added investments, loans and deposits to Sovereign of approximately $922
million, $503 million and $515 million, respectively. In accordance with the
merger agreement, Peoples' shareholders received .80 shares of Sovereign common
stock for each outstanding share of Peoples common stock. Sovereign issued
approximately 23.6 million shares of Sovereign common stock in connection with
the transaction, which was accounted for as a purchase. Sovereign recorded total
intangibles of $39.5 million, of which $9.8 million was allocated to a core
deposit intangible and $29.7 million was allocated to goodwill. The goodwill and
core deposit intangible are being amortized over 25 years and 10 years,
respectively. Sovereign's results of operations include the operations of
Peoples from June 30, 1999 and thereafter.
On June 15, 1999, Sovereign acquired The Network Companies ("Network"), a
privately held specialty leasing company headquartered in Commack, New York.
Network provides financing for the purchase or lease of equipment and specialty
vehicles plus other specialty products for businesses throughout the United
States, with transactions ranging from $15,000 to $250,000. The purchase price
of $6 million consisted of $4 million of stock and $2 million of cash. The
acquisition was accounted for as a purchase. Sovereign paid a premium of $6
million, all of which was allocated to goodwill. Network had total assets of
approximately $50 million. The goodwill is being amortized over 25 years.
Sovereign's results of operations include the operations of Network from June
15, 1999 and thereafter.
-20-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(10) COMPREHENSIVE INCOME
The following table presents the components of comprehensive income, net of
related tax, based on the provisions of SFAS No. 130 for the periods indicated:
(dollars in thousands)
Three-Month Period
Ended March 31,
----------------------
2000 1999
---- ----
Net income $37,700 $45,313
------- -------
Unrealized gains/(losses) on
securities during the period 37,282 (36,622)
Less reclassification adjustment (7,101) (2,211)
------- -------
Net unrealized gains/(losses)
recognized in other comprehensive
income 44,383 (34,411)
------- -------
Comprehensive income $82,083 $10,902
======= =======
Accumulated other comprehensive income, net of related tax, consisted
of net unrealized loss on securities of $167 million at March 31, 2000 and net
unrealized loss on securities of $211 million at December 31, 1999.
-21-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RESULTS OF OPERATIONS
- ---------------------
General
- -------
Cash earnings for the quarter period ended March 31, 2000 increased 15% to
$60.4 million, or $0.33 per share, up from $52.7 million, or $0.33 per share,
for the same period in 1999. Operating earnings for 2000 increased 17% to $52.8
million, or $0.29 per share, as compared to $45.3 million, or $0.28 per share,
for 1999.
Operating earnings exclude the following special charges for 2000:
merger-related and integration charges related to acquisitions, as well as the
impact on net interest income and shares outstanding from the early issuance of
certain debt and equity instruments issued to finance Sovereign's pending New
England retail banking and middle market lending acquisition ("Sovereign Bank
New England" or "SBNE"). Special charges for the quarter ended March 31, 2000
were $15.1 million after tax and are outlined in Reconciliation of Net Income to
Operating Earnings table following. Cash earnings are operating earnings
excluding amortization of intangible assets and ESOP-related expense.
Net income, reduced by the special charges noted above, was $37.7
million, or $0.17 per share, for the three-month period ended March 31, 2000
including an extraordinary gain on the sale of FHLB advances (debt
extinguishment) of $10.8 million, $0.05 per share (net of taxes of $5.2 million)
as compared to $45.3 million, $0.28 per share, for the same period in 1999.
Return on average equity, return on average tangible equity and return on
average total assets, excluding special charges discussed above, were 15.15%,
25.89% and .84% for the three-month period ended March 31, 2000 compared to
15.07%, 26.43% and .81% for the same period in 1999.
-22-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Reconciliation of Net Income to Operating Earnings
--------------------------------------------------
($ in thousands, except per share data - all amounts are after tax)
Three-months Ended March 31,
---------------------------------
Total Per Share
------------- ------------
2000 1999 2000 1999
---- ---- ---- ----
Net income as reported $37,700 $45,313 $0.17 $0.28
Net negative carry on escrowed
bond proceeds(1) 8,596 -- 0.04 --
Merger-related and integration
costs recorded during the period 8,171 -- 0.03 --
Expense on convertible trust
preferred securities ("PIERS")(1) 3,820 -- 0.02 --
Assumed interest expense reduction
due to paydown of other borrowings
with net proceeds of common
equity and PIERS (1) (5,456) -- (0.02) --
Impact of additional shares outstanding
for 1999 common and PIERS
securities offerings (2) -- -- 0.05 --
------- ------- ----- -----
Operating earnings (2) $52,831 $45,313 $0.29 $0.28
======= ======= ===== =====
Cash earnings (2) $60,361 $52,663 $0.33 $0.33
======= ======= ===== =====
(1) As part of the agreement to purchase Sovereign Bank New England,
Sovereign raised a total of $1.8 billion of debt and equity capital in
November and December, 1999 of which $1.3 billion of debt proceeds remain
in escrow with limited ability to reinvest the proceeds until the
acquisition is completed on July 21, 2000. Consequently, the excess of
negative carry and trust preferred expense over interest expense reduction
realized on the raised capital has resulted in a net reduction in pre-tax
income of $10.4 million ($6.9 million after tax) for the quarter ended
March 31, 2000, comprised of the following components: a) a reduction of
net interest income of $12.8 million ($8.6 million after-tax); b) expense
of $5.7 million ($3.8 million after-tax) associated with PIERS issued in
November, 1999; c) an assumed $8.1 million ($5.5 million after-tax)
interest expense reduction from the paydown of other borrowings with the
proceeds of the Trust Preferred Securities and the common stock offerings
in November, 1999.
(2) Operating earnings per share and cash earnings per share are calculated
using weighted average shares of 183,854,612 which includes, for the period
from March 24, 2000 through period end, shares issued in November, 1999 in
proportion to deposits acquired on March 24, 2000 over total estimated
SBNE deposits to be acquired through the final closing on July 21, 2000.
-23-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Successful Formation of Sovereign Bank New England
- --------------------------------------------------
Sovereign successfully completed the first phase of the SBNE conversion on
March 24, 2000. Sovereign's results include the operations of the aforementioned
branches, assets and liabilities from March 24, 2000. The remaining planned
acquisitions are scheduled to close on June 16, 2000 and July 21, 2000. The
transaction represents the largest branch acquisition in banking history and
will create the third largest bank in New England with 285 retail banking
offices, over 550 automated teller machines ("ATMs") and approximately $12.0
billion of deposits and $9.1 billion of commercial, consumer and mortgage loans.
Total deposits transferred in this first phase of the acquisition were $4.2
billion. Additionally, loan balances transferred to Sovereign approximated $3.4
billion, which included $1.3 billion of commercial loans and leases, $1.0
billion of consumer loans and $1.1 billion of residential mortgages, and $181
million of precious metals inventory. The residential mortgage loans were not
relationship assets and were subsequently sold as part of Sovereign's
asset-liability management strategy to reduce interest rate risk.
Net Interest Income
- -------------------
Net interest income for the three-month period ended March 31, 2000 was
$159 million compared to $140 million for the same period in 1999. This increase
was attributable to an increase in average balances resulting primarily from
internal loan growth. 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 2.82% for the three-month period ended March 31, 2000 compared to
2.80% for the same period in 1999.
Interest on investment securities available-for-sale was $138 million for
the three-month period ended March 31, 2000 compared to $122 million for the
same period in 1999. The average balance of investment securities
available-for-sale was $8.0 billion with an average tax equivalent yield of
7.05% for the three-month period ended March 31, 2000 compared to an average
balance of $7.4 billion with an average yield of 6.74% for the same period in
1999.
Interest on investment securities held-to-maturity was $37 million for the
three-month period ended March 31, 2000 compared to $28 million for the same
period in 1999. The average balance of investment securities held-to-maturity
was $2.3 billion with an average tax equivalent yield of 6.54% for the
three-month period ended March 31, 2000 compared to an average balance of $1.6
billion with an average yield of 6.83% for the same period in 1999.
Interest and fees on loans were $295 million for the three-month period
ended March 31, 2000 compared to $217 million for the same period in 1999. The
average balance of loans was $14.9 billion with an average yield of 7.95% for
the three-month period ended March 31, 2000 compared to an average balance of
$11.4 billion with an average yield of 7.63% for the same period in 1999.
-24-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Interest on deposits was $114 million for the three-month period ended
March 31, 2000 compared to $109 million for the same period in 1999. The average
balance of deposits was $12.1 billion with an average cost of 3.80% for the
three-month period ended March 31, 2000 compared to an average balance of $12.1
billion with an average cost of 3.66% for the same period in 1999. The increase
in the average cost of deposits was primarily due to higher rates due to
competition for retail deposit customers.
Interest on borrowings was $198 million for the three-month period ended
March 31, 2000 compared to $119 million for the same period in 1999. The average
balance of borrowings was $12.7 billion with an average cost of 6.20% for the
three-month period ended March 31, 2000 compared to an average balance of $8.9
billion with an average cost of 5.37% for the same period in 1999. The increase
in the average balance and average cost of borrowings was the result of balance
sheet growth being funded by borrowings, and the additional $1.2 billion in
borrowings raised to finance the Sovereign Bank New England Transaction.
Provision for Loan Losses
- -------------------------
The provision for loan loss expense is based upon credit loss experience
and on estimation of losses inherent in the current loan portfolio. The
provision for loan losses for the three-month period ended March 31, 2000 was
$8.0 million compared to $7.5 million for the same period in 1999.
Over the last few years, through several strategic acquisitions and
internal restructuring initiatives, Sovereign has diversified its lending
efforts and increased its emphasis on providing its customers with small
business loans and an expanded line of commercial and consumer products, such as
asset-based lending and automobile loans. As a result of the increased risk
inherent in these loan products, and as Sovereign continues to place emphasis on
commercial and consumer lending in future years, management will regularly
evaluate its loan portfolio and record additional loan loss allowance 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. The
provision recorded during the quarter of $8.0 million exceeded net charge-offs
by $0.4 million. In Sovereign's experience, a strategy that involves the
accelerated resolution of problem assets is more appropriate than a long-term
workout approach. For additional information with respect to Sovereign's asset
quality, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Loan Portfolio."
Sovereign's net charge-offs for the three-month period ended March 31, 2000
were $7.6 million and consisted of charge-offs of $12.8 million and recoveries
of $5.2 million. This compared to net charge-offs of $7.5 million consisting of
charge-offs of $12.5 million and recoveries of $5.0 million for the three-month
period ended March 31, 1999.
-25-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table presents the activity in the allowance for loan losses
for the periods indicated: (dollars in thousands)
Three-month Period Ended March 31,
2000 1999
----------------------------------
Allowance, beginning of period $ 132,986 $ 133,802
Charge-offs:
Residential 1,587 1,423
Commercial real estate 2,211 218
Commercial 2,212 2,103
Consumer 6,754 8,710
--------- ---------
Total Charge-offs 12,764 12,454
--------- ---------
Recoveries:
Residential 948 763
Commercial real estate 784 439
Commercial 784 406
Consumer 2,637 3,375
--------- ---------
Total Recoveries 5,153 4,983
--------- ---------
Charge-offs, net of recoveries 7,611 7,471
Provision for loan losses 8,000 7,500
Initial allowance for acquired
SBNE loans 42,002 --
--------- ---------
Allowance, end of period $ 175,377 $ 133,831
========= =========
Other Income and Extraordinary Item
- -----------------------------------
Non-interest income including a related extraordinary item grew to $37.3
million in the first quarter 2000 from $32.3 million in the first quarter 1999.
Retail banking fees approached $13.8 million for the quarter. Due to a favorable
shift into core and corporate deposit products over the last year, retail
banking fees increased 24.6% in the quarter ended March 31, 2000 from the same
period last year.
During the quarter, Sovereign expanded its sources of non-interest revenue
from its newly formed Capital Markets Group, which will provide capital markets
services for Sovereign's balance sheet, as well as commercial and retail
clients. The Group will focus its initial efforts in three product areas:
restructuring Sovereign and customer assets; providing derivatives and hedging
capabilities for commercial and retail clients; and foreign exchange services
international banking clients. The Capital Markets Group provided revenues of
$3.7 million during the quarter.
Sovereign also sold certain investment securities and FHLB advances and
paid-off certain short-term advances during the quarter as part of its balance
sheet repositioning for SBNE. Upon repayment of the short-term advances, related
swaps hedging these instruments were terminated. These transactions resulted in
securities losses of $23 million included in gain (loss) on sale of loans and
investments, $9.5 million of swap termination gains included as other income,
and a $16.0 million gain on sale (extinguishment) of FHLB advances ($10.8
million net of tax) reported as an extraordinary item.
-26-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
General and Administrative Expenses
- -----------------------------------
General and administrative expenses for the first quarter 2000 were $113.9
million, compared to $83.5 million for the same period last year. Included in
operating expenses for the current quarter were $12.2 million of merger-related,
integration and other charges related to Sovereign's recent and pending
acquisitions. Excluding these charges, operating expenses were $101.7 million
for the quarter ended March 31, 2000 consistent with operating expenses in the
fourth quarter of 1999. Sovereign's efficiency ratio measured on an operating
basis (general and administrative expenses excluding merger-related and other
integration as a percentage of net interest margin excluding the negative carry
from escrowed financing proceeds) for the three-month period ended March 31,
2000 was 54.9% compared to 48.5% for the same period in 1999. The year-over-year
increase in general and administrative expenses for the three-month period ended
March 31, 2000, excluding the special charges noted previously, was primarily
due to Sovereign's franchise growth and the effect of acquisitions of Peoples
and Network during the third quarter of 1999.
Other expenses were $18.5 million for the three-month period ended March
31, 2000 compared to $11.9 million for the same period in 1999. The increase is
principally due to expenses related to additional preferred trust securities
issued in November, 1999 to finance the SBNE acquisition.
Income Taxes
- ------------
The income tax provision was $13.3 million for the three-month period ended
March 31, 2000 compared to $23.9 million for the same period in 1999. The
effective tax rate for the three-month period ended March 31, 2000 was 33.0%
compared to 34.5% for the same period in 1999. The decrease in the effective tax
rate for 2000 versus 1999 was primarily attributable to the favorable impact in
2000 of Sovereign's additional investment in BOLI in 1999.
FINANCIAL CONDITION
- -------------------
Loan Portfolio
- --------------
Sovereign has increased its emphasis on commercial and consumer lending
as part of its overall strategy. Commercial originations generated internally
for the first quarter of 2000 were $450 million. At March 31, 2000, commercial
loans totaled $5.7 billion representing 33.1% of Sovereign's loan portfolio,
compared to $4.1 billion and 29% of the loan portfolio at December 31, 1999 and
$2.7 billion and 23% of the loan portfolio at March 31, 1999. Strong business
loan demand in Sovereign's market area resulting from a strong regional economy,
recent bank mergers affecting the region, and significant staffing increases in
Sovereign's commercial banking unit continue to drive performance in this area.
The SBNE acquisition increased commercial loans by $1.3 billion.
Consumer loans originated during the first quarter of 2000 totaled $640
million. The consumer loan portfolio (including home equity loans, lines of
credit, automobile loans, and other consumer loans) totaled $5.6 billion at
-27-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
March 31, 2000, representing 32.5% of Sovereign's loan portfolio, compared to
$4.5 billion and 31.4% of the loan portfolio at December 31, 1999 and $4.1
billion and 35.2% of the loan portfolio at March 31, 1999. This increase was
primarily the result of strong home equity and auto loan originations during the
three-month period ended March 31, 2000. The SBNE acquisition increased the
consumer loan portfolio by $1.0 billion.
Residential mortgage loans increased $265 million during the quarter to
$5.9 billion and now represent 34.4% of Sovereign's loan portfolio as compared
to 39.9% at December 31, 1999 and 41.3% at March 31, 1999.
During the three-month period ended March 31, 2000, Sovereign closed $622
million of first mortgage loans of which approximately 22% were fixed rate and
sold in the secondary market. This compares to first mortgage loan closings of
$498 million the majority of which were fixed rate and sold for the same period
in 1999.
Non-Performing Assets
- ---------------------
At March 31, 2000 Sovereign's non-performing assets were $98 million
compared to $84 million at December 31, 1999. This increase was due primarily to
a purchased consumer loan portfolio. Non-performing assets as a percentage of
total assets was .32% at March 31, 2000 and at December 31, 1999. At March 31,
2000 40% of non-performing assets consisted of loans related to real estate or
OREO. The remainder of Sovereign's non-performing assets consist principally of
consumer loans, many of which are secured by collateral. Sovereign places all
loans 90 days or more delinquent (except auto loans and loans guaranteed by the
government) 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.
-28-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table presents the composition of non-performing assets at
the dates indicated: (dollars in thousands)
March 31, December 31,
2000 1999
--------- ------------
Non-Accrual Loans:
Past due 90 days or more as to interest or principal:
Real estate related $34,943 $36,510
Other 51,302 36,923
------- -------
Total Non-Accrual Loans 86,245 73,433
Other 2,196 1,978
Restructured Loans 3,755 3,755
------- -------
Total Non-Performing Loans 92,196 79,166
------- -------
Other Real Estate Owned and Other
Repossessed Assets:
Other real estate owned 4,451 3,567
Other repossessed assets 1,727 1,762
------- -------
Total Other Real Estate Owned and
Other Repossessed Assets 6,178 5,329
------- -------
TOTAL NON-PERFORMING ASSETS $98,374 $84,495
======= =======
Past due 90 days or more as to
interest or principal and
accruing interest (1) $10,331 $10,238
Non-Performing Assets as a
percentage of Total Assets .32% .32%
Non-Performing Loans as a
percentage of Total Loans .53% .56%
Non-Performing Assets as a
percentage of Total Loans
and Real Estate Owned .57% .59%
Allowance for Loan Losses
as a percentage of
Total Non-Performing Assets 178.3% 157.4%
Allowance for Loan Losses
as a percentage of
Total Non-Performing Loans 190.2% 168.0%
(1) Represents student loans which are government-guaranteed and Sovereign
retains minimal risk of credit losses related to these loans. The amount
also includes $2.2 million and $1.9 million at March 31, 2000 and December
31, 1999 of auto loans past due between 90 and 120 days.
-29-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Impaired Loans
At March 31, 2000 and December 31, 1999, the gross recorded investment in
impaired loans totaled $117 million and $108 million, respectively. The increase
in the investment in impaired loans was primarily the result of Sovereign's
recent balance sheet transformation strategy which places more emphasis on
building the commercial and consumer loan portfolios. Along with higher yields,
these loan types also bring greater risk of impairment, especially as the
portfolio becomes more seasoned. Sovereign classifies all commercial loans that
are greater than 90 days delinquent on non-accrual status, and also includes as
impaired loans certain potential problem loans discussed in a following
paragraph. These are primarily commercial loans that have been classified
internally but are not necessarily 90 days delinquent.
Potential problem loans (consisting of loans as to 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 $123 million at March 31, 2000 and consisted principally of
commercial loans.
Allowance for Loan Losses
The following table presents the allocation of the allowance for loan
losses and the percentage of such allocation to each loan type at the dates
indicated:
(dollars in thousands)
March 31, December 31,
2000 1999
------------------------ ---------------------------
% of Loans % of Loans
to to
Amount Total Loans Amount Total Loans
------ ----------- ------ -----------
Allocated allowances:
Commercial loans $ 76,704 33% $ 58,784 29%
Residential real estate
mortgage loans 24,987 34 19,535 40
Consumer loans 60,228 33 43,455 31
Unallocated allowances 13,458 n/a 11,212 n/a
-------- ------ -------- ------
Total allowance for loan losses $175,377 100% $132,986 100%
======== ====== ======== ======
The adequacy of Sovereign's allowance for loan losses is regularly evaluated.
Management's evaluation of the adequacy of the allowance to absorb loan losses
takes into consideration the risks inherent in the loan portfolio, past loan
loss experience, specific loans which have loss potential, geographic and
industry concentrations, delinquency trends, economic conditions, the level of
originations and other relevant factors. Management also considers loan quality,
changes in the size and character of the loan portfolio, consultation with
regulatory authorities, amount of non-performing loans, delinquency trends,
economic conditions and industry trends when determining the allowance. Along
with higher yields, management believes the shift in loan composition from
residential into commercial and consumer brings higher inherent risk.
At March 31, 2000, Sovereign's loan delinquencies (all loans greater than 30
days delinquent) as a percentage of total loans was 1.65% compared to 1.79% at
December 31, 1999. As part of the SBNE acquisition 1.66% of loans acquired were
past due greater than 30 days. Overall, management believes delinquencies,
charge-offs and non-performing statistics are improved compared to previous
years because of
-30-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
changes in Sovereign's underwriting and credit monitoring process
during 1999. Along with higher yields, management believes the shift in loan
composition from residential into commercial and consumer brings higher inherent
risk.
Sovereign maintains an allowance for loan losses sufficient to absorb
inherent losses in the loan portfolio and believes the current allowance to be
at a level adequate to cover such inherent losses. The Company gives
consideration to other risk indicators when determining the appropriate
allowance level.
The allowance for loan losses consists of two elements: (i) an allocated
allowance, which is comprised of allowances established on specific loans, and
class allowances based on historical loan loss experience and current trends,
and (ii) unallocated allowances based on both general economic conditions and
other risk factors in the Company's individual markets and portfolios, and to
account for a level of imprecision in management's estimation process.
The specific allowance element of the allocated allowance is based on a
regular analysis of criticized loans where internal credit ratings are below a
predetermined classification. This analysis is performed at the relationship
manager level, and periodically reviewed by the loan review department. The
specific allowance established for these criticized loans is based on a careful
analysis of related collateral value, cash flow considerations and, if
applicable, guarantor capacity.
The class allowance element of the allocated allowance is determined by an
internal loan grading process in conjunction with associated allowance factors.
These class allowance factors are updated annually and are based primarily on
actual historical loss experience, consultation with regulatory authorities, and
peer groups loss experience. While this analysis is conducted annually, the
Company has the ability to revise the class allowance factors whenever necessary
in order to address improving or deteriorating credit quality trends or specific
risks associated with a given loan pool classification.
Regardless of the extent of the Company analysis of customer performance,
portfolio evaluations, trends or risk management processes established, certain
inherent, but undetected losses are probable within the loan portfolio. This is
due to several factors including inherent delays in obtaining information
regarding a customer's financial condition or changes in their unique business
conditions; the judgmental nature of individual loan evaluations, collateral
assessments and the interpretation of economic trends; volatility of economic or
customer-specific conditions affecting the identification and estimation of
losses for larger non-homogeneous credits; and the sensitivity of assumptions
utilized to establish allocated allowances for homogeneous groups of loans among
other factors. The Company maintains an unallocated allowance to recognize the
existence of these exposures. These other risk factors are continuously reviewed
and revised by management where conditions indicate that the estimates initially
applied are different from actual results.
A comprehensive analysis of the allowance for loan losses is performed
by the Company on a quarterly basis. In addition, a review of allowance levels
based on nationally published statistics is conducted on an annual basis. The
Company has an Asset Review Committee, which has the responsibility of affirming
allowance methodology and assessing the general and specific allowance factors
in relation to estimated and actual net charge-off trends. This Committee is
also responsible for assessing the appropriateness of the allowance for loan
losses for each loan pool classification at Sovereign.
Acquired Portfolio - The Company established and initial allowance for
loan losses of $42 million upon acquisition of the SBNE loan portfolio. That, in
management judgment, were inherent in the loan portfolio as of the acquisition
date. The $42 million is comprised of $17 million for commercial loans, $20
pmillion for consumer loans, and $5 million of unallocated allowance. The
Company utilized its existing allowance for loan loss methodology on the
acquired SBNE loan portfolio, including performing credit reviews on each
significant loan or a sample of credit reviews on pool of homogeneous loans, and
assigning initial risk ratings to such loans or pools of loans. Sovereign also
established a $5 million unallocated allowance related to such loans or pools of
loans. Sovereign also establihed a $5 million unallocated allowance related to
the loans acquired due to the unfamiliarity of the portfolio acquired, and to
account for a level of impression in its original estimate.
Residential Portfolio. The allowance for the residential mortgage
portfolio increased from $19.5 million at December 31, 1999 to $25.0 million at
March 31, 2000. The change was due primarily to the increase in outstanding
balances and temporarily higher past due balances, prior to April resolution, in
a purchased whole loan portfolio.
Consumer Portfolio. The allowance for the consumer loan portfolio
increased from $43.5 million at December 31, 1999, to $60.2 million at March 31,
2000.
-31-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
This increase is primarily attributable to the acquired SBNE consumer portfolio.
Commercial Portfolio. The portion of the allowance for loan losses
related to the Commercial portfolio has increased from $58.8 million at December
31, 1999 to $16.7 million at March 31, 2000. This increase is primarily
attributable to the acquired SBNE commercial portfolio.
Unallocated Allowance - The unallocated allowance for loan losses
increased $2.3 million to $13.5 million at March 31, 2000 from $11.2 million at
December 31, 1999. This increase can be attributed primarily to the SBNE
acquisiton."
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 March 31, 2000 was 3.4 years.
At March 31, 2000, total investment securities available-for-sale were
$7.7 billion compared to $8.0 billion at December 31, 1999 and investment
securities held-to-maturity were $2.3 billion compared to $2.4 billion at
December 31, 1999. For additional information with respect to Sovereign's
investment securities, see Notes 3 and 4 in the Notes to Consolidated Financial
Statements.
Goodwill and Other Intangible Assets
Total goodwill and other intangible assets at March 31, 2000 were $818
million compared to $434 million at December 31, 1999. This increase is
primarily due to the $393 million goodwill and core deposit intangibles
resulting from the first phase purchase of $3.4 billion in loans and $4.2
billion in deposits from FleetBoston Financial, less amortization of intangibles
during the period.
Deposits
Deposits are attracted from within Sovereign's primary market area
through the offering of various deposit instruments including NOW accounts,
money market accounts, savings accounts, certificates of deposit and retirement
savings plans.
Total deposits at March 31, 2000 were $16.1 billion compared to $11.7
billion at December 31, 1999. The increase is primarily due to $4.2 billion in
deposits acquired from FleetBoston Financial as part of the Sovereign Bank New
England transaction. For additional information with respect to Sovereign's
deposit portfolio composition, see Note 6 in the Notes to Consolidated Financial
Statements.
Borrowings
Sovereign utilizes borrowings as a source of funds for its asset growth
and its asset/liability management. Collateralized advances are available from
-32-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
the FHLB provided certain standards related to creditworthiness have been met.
Another source of funds for Sovereign is reverse repurchase agreements. Reverse
repurchase agreements are short-term obligations collateralized by investment
securities.
Total borrowings at March 31, 2000 were $12.3 billion of which $7.9
billion were short-term compared to $12.7 billion of which $6.9 billion were
short-term at December 31, 1999. This decrease in borrowings is a result of
Sovereign's plan to be less reliant on its leveraged investment portfolio and
wholesale borrowings. For additional information with respect to Sovereign's
borrowings, see Note 7 in the Notes to Consolidated Financial Statements.
Through the use of interest rate swaps, $50 million of FHLB advances at
March 31, 2000 have been effectively converted from variable rate obligations to
fixed rate obligations. In addition, at March 31, 2000, $1.2 billion of
borrowings have been protected from upward repricing through the use of interest
rate caps and floors.
During the quarter, Sovereign sold FHLB advances as part of its balance
sheet repositioning to prepare for the Sovereign Bank New England transaction.
As a result, the Company recognized a gain on the sale of $16.0 million which is
treated as an extraordinary item.
LIQUIDITY AND CAPITAL RESOURCES
Sovereign's banking subsidiaries are required under applicable federal
regulations to maintain specified levels of "liquid" investments in cash and
U.S. Treasury and other qualifying investments. Regulations currently in effect
require Sovereign's banking subsidiaries to maintain liquid assets of not less
than 4% of its net withdrawable accounts plus short-term borrowings. These
levels are changed from time to time by the Office of Thrift Supervision ("OTS")
to reflect economic conditions. The liquidity ratio of Sovereign Bank for March
31, 2000 was 41.9%.
Sovereign's primary financing sources are deposits obtained in its own
market area, borrowings in the form of securities sold under repurchase
agreements and advances from the FHLB. While the majority of Sovereign's
certificate of deposit accounts are expected to mature within a one year period,
historically, the retention rate has been approximately 70%. If a significant
portion of maturing certificates would not renew at maturity, the impact on
Sovereign's operations and liquidity would be minimal due to cash flows produced
by Sovereign's investment portfolio which currently approximate $85 million per
month. Sovereign Bank can also borrow from the FHLB, subject to required
collateralization. Other sources of funds include operating activities, payments
of principal and interest on investment securities, payments of principal and
interest on loans and other investing activities. Sovereign also maintains
strong relationships with numerous investment banking firms, and has the ability
to access capital markets through a variety of products and structures, should
liquidity or capital needs arise.
At March 31, 2000, the Company had a $200 million non-refundable
deposit at Fleet that will be utilized for the remaining closings and $1.3
billion in escrow that will be released upon the completition of the 3rd
closing.
For the three-month period ended March 31, 2000, cash and cash
equivalents increased $655 million. Net cash used for operating activities was
$30.1 million including an extraordinary gain on the sale of FHLB stock of $10.8
million, net of tax. Net cash provided by investing activities for the
three-month period ended March 31, 2000 was $764 million consisting primarily of
proceeds from the sale of investment securities available-for-sale offset by the
purchase of mortgage backed securities. Net cash used for financing activities
for the three-month period ended March 31, 2000 was $79.5 million which includes
the repayment/sale of long-term borrowings of $927 million offset by proceeds
from short-term borrowings and an increase in deposits.
The Financial Institutions Reform, Recovery and Enforcement Act
("FIRREA"), requires institutions regulated by the Office of Thrift Supervision
(OTS) to have a minimum leverage capital ratio equal to 3% of tangible assets,
and 4% of risk-adjusted assets, and a risk-based capital ratio equal to 8%. The
Federal Deposit Insurance Corporation Improvement Act ("FDICIA") requires OTS
-33-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
regulated institutions to have a minimum tangible capital equal to 2% of total
tangible assets.
At March 31, 2000, Sovereign Bank was classified as well-capitalized
and in compliance with all capital requirements. Management anticipates that
Sovereign Bank will continue to be classified as well-capitalized and will be in
compliance with all regulatory capital requirements.
OTS capital regulations do not apply to savings and loan holding
companies. These ratios are computed for Sovereign Bancorp using average
tangible assets which is consistent with the method used by bank holding
companies.
-34-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA")
established five capital tiers: well-capitalized, adequately-capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. A depository institution's capital tier depends upon its
capital levels in relation to various relevant capital measures, which include
leverage and risk-based capital measures and certain other factors. Depository
institutions that are not classified as well-capitalized or
adequately-capitalized are subject to various restrictions regarding capital
distributions, payment of management fees, acceptance of brokered deposits and
other operating activities. At March 31, 2000, Sovereign Bank was classified as
well-capitalized an in compliance with all capital requirements. Management
anticipates that Sovereign Bank will continue to be classified as
well-capitalized and will be in compliance with all regulatory capital
requirements. Although Sovereign Bancorp is not subject to OTS capital
requirements, depending upon the specific facts regarding a proposed
acquisition, the OTS could determine that the pro forma financial condition of a
savings and loan holding company may be inadequate and therefore condition
approval on making prescribed capital levels.
The following table sets forth the capital ratios of Sovereign Bancorp and
Sovereign Bank and the current regulatory requirements at March 31, 2000:
Sovereign Sovereign Minimum Capitalized
Bancorp Bank Requirement Requirement
--------- --------- ----------- -----------
Stockholders' equity to
total assets 6.15% 8.12% None None
Tangible capital to tangible
assets 4.08 6.02 2.00% None
Leverage (core) capital to
tangible assets 5.90 6.02 3.00 5.00%
Leverage (core) capital to
risk adjusted assets 8.00 9.59 4.00 6.00
Risk-based capital to risk
adjusted assets 10.87 10.55 8.00 10.00
ASSET AND LIABILITY MANAGEMENT
The objective of Sovereign's asset and liability management is to
identify, measure and control its interest rate risk in order to produce
consistent earnings that are not contingent upon favorable trends in interest
rates. Sovereign manages its assets and liabilities to attain a stable net
interest margin across a wide spectrum of interest rate environments. This is
attained by monitoring the levels of interest rates, the relationships between
the rates earned on assets and the rates paid on liabilities, the absolute
amount of assets and liabilities which reprice or mature over similar periods,
off-balance sheet positions and the effect of all of these factors on the
estimated level of net interest income.
-35-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Sovereign measures interest rate risk utilizing three tools: net interest
income simulation analysis in multiple interest rate environments, instantaneous
parallel interest rate shocks and lastly, gap analysis, which is a schedule
measuring the difference between assets, liabilities and off-balance sheet
positions which will mature or reprice within specific terms. Income simulation
considers not only the impact of changing market interest rates on forecasted
net income, but also other factors, such as yield curve relationships, the
volume and mix of assets and liabilities, customer preferences and general
market conditions.
Sovereign manages the impact to net interest income in a +/- 200 basis
point instantaneous parallel rate shock environment to be generally within a 10%
variance. At March 31, 2000, Sovereign estimates that if interest rates decline
by 200 basis points, net interest income would decrease by $20 million or 1.8%;
conversely, if interest rates increase by 200 basis points, net interest income
would decrease by $35 million for the three-month period ended March 31, 2000 or
3.2%. At December 31, 1999, if interest rates increased by 200 basis points, net
interest income would have decreased by $76 million or 7.6%. This change in
sensitivity was primarily related to a decrease in short-term, variable rate
borrowings.
On a pro-forma basis after the closing on the acquisition of assets and
liabilities from Fleet BankBoston, Sovereign's interest rate risk position is
expected to be neutral. The addition of core deposits and variable rate loans
from the acquisition is expected to offset the liability sensitivity in that was
evident in the March 31, 2000 analysis. The reduction in wholesale funding of
over $4 billion is expected to also improve the liability sensitivity.
Pro-forma, net interest income will fall 2.6% in an instantaneous upward shock
of 100 basis point and is expected to fall 2.2% in an instantaneous downward
shock of 100 basis points.
Sovereign manages the one year interest rate gap within +/- 10% range. A
positive gap position implies that the bank is asset sensitive which could cause
net interest income to decrease if interest rates fall. Conversely, a negative
gap position implies that the bank is liability sensitive which could cause net
interest income to decrease if interest rates rise. Sovereign estimates its one
year gap position was a negative 17.5% at March 31, 2000. On a pro forma basis,
the one year gap is projected to be a negative 10% at September 30, 2000.
Pursuant to its interest rate risk management strategy, Sovereign enters
into off-balance sheet transactions which involve interest rate exchange
agreements (swaps, caps and floors) for interest rate risk management purposes.
Sovereign's objective in managing its interest rate risk is to provide
sustainable levels of net interest income while limiting the impact that changes
in interest rates have on net interest income. For additional information on
interest rate exchange agreements, see Note 8 in the Notes to Consolidated
Financial Statements.
Interest rate swaps are generally used to convert fixed rate assets and
liabilities to variable rate assets and liabilities and vice versa. Sovereign
utilizes interest rate swaps that have a high degree of correlation to the
related financial instrument. At March 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.
-36-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Interest rate caps are generally used to limit the exposure from the
repricing and maturity of liabilities and interest rate floors are generally
used to limit the exposure from repricing and maturity of assets. Interest rate
caps and floors are also used to limit the exposure created by other interest
rate swaps. In certain cases, interest rate caps or floors are simultaneously
bought and sold to create a range of protection against changing interest rates
while limiting the cost of that protection.
As part of its mortgage banking strategy, Sovereign originates fixed rate
residential mortgages. It sells the majority of these loans to FHLMC, FNMA and
private investors. The loans are exchanged for cash or marketable fixed rate
mortgage-backed securities which are generally sold. This helps insulate
Sovereign from the interest rate risk associated with these fixed rate assets.
Sovereign uses forward sales, cash sales and options on mortgage-backed
securities as a means of hedging loans in the mortgage pipeline which are
originated for sale.
Sovereign's primary funding source is deposits obtained in its own
marketplace. Deposits were significantly increased with the first phase of
Sovereign Bank New England. The transaction added approximately $4.2 billion to
deposits at March 31, 2000. The remaining two phases of the transaction are
scheduled to close June 24, 2000 and July 21, 2000 and are expected to add an
additional $7.8 billion in deposits. Deposit programs at Sovereign are priced to
meet management's asset/liability objectives, while taking into account the
rates available on investment opportunities and also considering the cost of
alternative funding sources. Borrowings are also a significant funding source
for Sovereign and have primarily been in the form of securities sold under
repurchase agreements and advances from the FHLB. Since borrowings are not
subject to the market constraints to which deposits are, Sovereign uses
borrowings to add flexibility to its interest rate risk position.
-37-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Items 1 through 5 are not applicable or the responses are negative.
Item 6 - Exhibits and Reports on Form 8-K.
(a) Exhibits
(3.1) Articles of Incorporation, as amended and restated, of
Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit
3.2 to Sovereign's Annual Report on Form 10K for the fiscal
year ended December 31, 1998.)
(3.2) By-Laws of Sovereign Bancorp, Inc. (Incorporated by
reference to Exhibit 3.2 to Sovereign's Annual Report on
Form 10K for the fiscal year ended December 31, 1998.)
(27) Financial Data Schedule
(b) Reports on Form 8-K
Report on Form 8-K, dated February 28, 2000 (date of earliest event -
February 28, 2000), contained Item 5 and Item 7(a).
-38-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SOVEREIGN BANCORP, INC.
--------------------------------
(Registrant)
Date May 15, 2000 By /s/Dennis S. Marlo
--------------------------- ---------------------------------------
Dennis S. Marlo
Chief Financial Officer
(Authorized Officer & Principal
Financial Officer)
Date May 15, 2000 By /s/Mark R. McCollom
--------------------------- ---------------------------------------
Mark R. McCollom
Chief Accounting Officer