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, 1996
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 10, 1996
- ---------------------------- ---------------------------
Common Stock (no par value) 47,492,326 shares
Preferred Stock (no par value) 2,000,000 shares
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 1996
and December 31, 1995 3
Consolidated Statements of Operations for the three-
month periods ended March 31, 1996 and 1995 4
Consolidated Statements of Cash Flows for the three-
month periods ended March 31, 1996 and 1995 5
Notes to Consolidated Financial Statements 6 - 14
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 15 - 24
PART II. OTHER INFORMATION
Item 6. Reports on Form 8-K 25
PART III. FINANCIAL DATA SCHEDULE 26
SIGNATURES 27
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
1996 1995
---------- ------------
(Unaudited) (Note)
(in thousands, except
per share data)
ASSETS
Cash and amounts due from
depository institutions $ 126,388 $ 130,841
Interest-earning deposits 12,471 16,930
Loans held for resale (approximate fair
value of $70,327 and $71,297 at
March 31, 1996 and December 31, 1995,
respectively) 70,327 70,512
Investment and mortgage-backed securities
available-for-sale 380,094 889,509
Investment and mortgage-backed securities
held-to-maturity (approximate fair value
of $2,637,386 and $2,087,356 at March 31,
1996 and December 31, 1995, respectively) 2,659,974 2,077,212
Loans 4,940,125 4,674,364
Allowance for possible loan losses (34,321) (34,856)
Premises and equipment 56,072 56,951
Real estate owned 4,859 4,514
Accrued interest receivable 45,266 42,785
Goodwill and other intangible assets 120,643 123,243
Other assets 29,210 26,282
----------- -----------
TOTAL ASSETS $ 8,411,108 $ 8,078,287
=========== ===========
LIABILITIES
Deposits $ 4,964,515 $ 5,039,143
Borrowings:
Short-term 1,794,856 1,512,720
Long-term 963,055 1,017,936
Advance payments by borrowers
for taxes and insurance 24,158 22,117
Other liabilities 226,063 59,346
----------- -----------
TOTAL LIABILITIES 7,972,647 7,651,262
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock; no par value; $50 liquidation
preference; 7,500,000 shares
authorized; 2,000,000 shares issued at March 31, 1996
and December 31, 1995, respectively 96,446 96,446
Common stock; no par value;
100,000,000 shares authorized;
50,960,906 shares issued at March 31,
1996 and 48,438,944 shares issued at
December 31, 1995 273,982 248,875
Unallocated common stock held by the Employee
Stock Ownership Plan at cost;
3,123,063 shares at March 31, 1996
and 2,974,346 at December 31, 1995, respectively (30,344) (28,772)
Unrecognized gain on investment
and mortgage-backed securities
available-for-sale, net of tax 1,774 3,988
Retained earnings 96,603 106,488
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 438,461 427,025
----------- -----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 8,411,108 $ 8,078,287
=========== ===========
See accompanying notes to consolidated financial statements.
Note: The balance sheet at December 31, 1995 is taken from the audited financial
statements at that date but does not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
-3-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three-Month Period
Ended March 31,
------------------
1996 1995
---- ----
(in thousands, except
per share data)
Interest income:
Interest on interest-earning deposits $ 829 $ 1,232
Interest and dividends on investment
and mortgage-backed securities
available-for-sale 8,887 1,253
Interest and dividends on investment
and mortgage-backed securities
held-to-maturity 39,551 31,717
Interest and fees on loans 90,659 77,207
-------- --------
Total interest income 139,926 111,409
-------- --------
Interest expense:
Interest on deposits 51,700 49,378
Interest on borrowings 37,295 19,295
-------- --------
Total interest expense 88,995 68,673
-------- --------
Net interest income 50,931 42,736
Provision for possible loan losses 500 250
-------- --------
Net interest income after provision for
possible loan losses 50,431 42,486
-------- --------
Other income:
Other loan fees and service charges 1,073 1,245
Deposit fees 2,466 2,261
Gain on sale of loans and investment
and mortgage-backed securities
available-for-sale 158 111
Mortgage banking gains 487 640
Miscellaneous income 682 610
-------- --------
Total other income 4,866 4,867
-------- --------
General and administrative expenses:
Salaries and employee benefits 11,586 10,617
Occupancy and equipment expenses 5,476 4,656
Outside services 3,052 2,884
Deposit insurance premiums 2,485 2,817
Advertising 1,100 569
Other administrative expenses 3,228 3,720
-------- --------
Total general and administrative expenses 26,927 25,263
-------- --------
Other operating expenses:
Amortization of goodwill and other intangibles 2,941 3,027
Real estate owned losses, net 119 502
-------- --------
Total other operating expenses 3,060 3,529
-------- --------
Income before income taxes 25,310 18,561
Income tax provision 9,629 6,431
-------- --------
Net Income $ 15,681 $ 12,130
======== ========
Net Income Applicable to Common Stock $ 14,119 $ 11,927
======== ========
Earnings per share (1) $ .27 $ .24
======== ========
Dividends per common share (1) $ .0210 $ .0209
======== ========
(1) Per share amounts have been adjusted to reflect all stock dividends and
stock splits.
See accompanying notes to consolidated financial statements.
-4-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three-Month Period
Ended March 31,
--------------------
1996 1995
---- ----
(in thousands)
Cash Flows from Operating Activities:
Net income $ 15,681 $ 12,130
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for possible loan losses and deferred taxes 6,548 1,108
Depreciation 1,309 1,224
Amortization 2,890 81
(Gain)/loss on sale of loans, investment and
mortgage-backed securities and real estate owned (39) 391
Net change in:
Loans held for resale 185 3,834
Other liabilities 9,441 517
Other assets (12,040) (7,910)
--------- ---------
Net cash provided by operating activities 23,975 11,375
--------- ---------
Cash Flows from Investing Activities:
Proceeds from sales of investment
and mortgage-backed securities:
Available-for-sale 514,964 33,424
Proceeds from repayments and maturities of investment
and mortgage-backed securities:
Available-for-sale 28,762 --
Held-to-maturity 130,681 38,817
Purchases of investment and mortgage-backed securities:
Available-for-sale (37,273) (6,635)
Held-to-maturity (554,690) (182,586)
Proceeds from sales of loans 955 995
Purchase of loans (276,952) (272)
Net change in loans other than purchases and sales 8,342 (72,221)
Proceeds from sales of premises and equipment 438 494
Purchases of premises and equipment (923) (7,831)
Proceeds from sale of real estate owned 655 1,709
--------- ---------
Net cash used by investing activities (185,041) (194,106)
--------- ---------
Cash Flows from Financing Activities:
Assumption of deposits -- 842,410
Net (decrease)/increase in deposits (74,335) 71,305
Net increase/(decrease)in short-term borrowings 226,479 (747,191)
Prepayments of long-term borrowings -- (714)
Net increase/(decrease)in advance payments by
borrowers for taxes and insurance 2,041 (1,755)
Proceeds from issuance of common stock 598 688
Cash dividends paid (2,629) (1,039)
Advance to the Employee Stock Ownership Plan -- (5,000)
--------- ---------
Net cash provided by financing activities 152,154 158,704
--------- ---------
Net change in cash and cash equivalents (8,912) (24,027)
Cash and cash equivalents at beginning of period 147,771 139,401
--------- ---------
Cash and cash equivalents at end of period $ 138,859 $ 115,374
========= =========
Reconciliation of Cash and Cash Equivalents to Consolidated
Balance Sheets:
Cash and amounts due from depository institutions $ 126,388 $ 83,348
Interest-earning deposits 12,471 32,026
--------- ---------
$ 138,859 $ 115,374
========= =========
Supplemental Disclosures:
Income tax payments totaled $3.2 million for the three-month period ended March
31, 1996 and $440,000 for the same period in 1995. Interest payments totaled
$90.6 million for the three-month period ended March 31, 1996 and $74.7 million
for the same period in 1995. Noncash activity consisted of mortgage loan
securitization of $125.8 million for the three-month period ended March 31, 1996
and $10.9 million for the same period in 1995; reclassification of long-term
borrowings to short-term borrowings of $75.0 million for the three-month period
ended March 31, 1996 and $176.4 million for the same period in 1995;
reclassification of mortgage loans to real estate owned of $1.7 million for the
three-month period ended March 31, 1996 and $3.1 million for the same period in
1995.
See accompanying notes to consolidated financial statements.
-5-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) GENERAL
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, F.S.B.
("Sovereign Bank"), Sovereign Investment Company and Sovereign Community Bank,
formerly Colonial State Bank. 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, and cash flows in
conformity with generally accepted accounting principles. However, in the
opinion of management, the consolidated financial statements reflect all
adjustments (which consist of normal recurring accruals) necessary for a fair
presentation of the results for the unaudited periods. The results of operations
for the three-month period ended March 31, 1996 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 the annual report on
Form 10-K for the year ended December 31, 1995.
(2) EARNINGS PER SHARE
Earnings per share have been computed on a fully diluted basis based on the
weighted average number of common shares (including assumed conversion of
preferred shares) and common equivalent shares (dilutive stock options)
outstanding during the periods. Fully diluted shares for the three-month periods
ended March 31, 1996 and 1995 were 58.9 million and 51.5 million, respectively.
Earnings per share have been adjusted to reflect all stock dividends and stock
splits.
-6-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(3) INVESTMENT AND MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE
The following table presents the composition and fair value of
investments available-for-sale at the dates indicated: (dollars in thousands)
March 31, 1996
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
--------- ------------ ------------ -----
Investment Securities:
U.S. Treasury and
government agency $ 4,972 $ 71 $ -- $ 5,043
Equity Securities 152,166 1,437 27 153,576
Mortgage-backed Securities:
FHLMC -- -- -- --
FNMA -- -- -- --
GNMA -- -- -- --
Collateralized mortgage
obligations 220,048 2,140 713 221,475
-------- -------- -------- --------
Total investment and
mortgage-backed securities
available-for-sale $377,186 $ 3,648 $ 740 $380,094
======== ======== ======== ========
December 31, 1995
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
--------- ------------ ------------ -----
Investment Securities:
U.S. Treasury and
government agency $150,242 $ 131 $ 1,264 $149,109
Equity Securities 135,494 1,166 89 136,571
Mortgage-backed Securities:
FHLMC 156,123 763 1,357 155,529
FNMA 136,861 2,241 657 138,445
GNMA 59,215 2,697 -- 61,912
Collateralized mortgage
obligations 245,037 3,568 662 247,943
-------- -------- -------- --------
Total investment and
mortgage-backed securities
available-for-sale $882,972 $ 10,566 $ 4,029 $889,509
======== ======== ======== ========
-7-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(4) INVESTMENT AND MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY
The following table presents the composition and fair value of investment
and mortgage-backed securities held-to-maturity at the dates indicated: (dollars
in thousands)
March 31, 1996
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
--------- ------------ ------------ -----
Investment Securities:
U.S. Treasury and
government agency $ 2,246 $ 10 $ 1 $ 2,255
Corporate securities 1,009 38 -- 1,047
Other securities 441 -- -- 441
Mortgage-backed Securities:
FHLMC 160,538 1,089 5,375 156,252
FNMA 212,903 694 7,314 206,283
GNMA 180,464 4,461 375 184,550
RTC 28,389 -- 4,081 24,308
Private issues 414,226 118 8,719 405,625
Collateralized mortgage
obligations 1,659,758 6,927 10,060 1,656,625
---------- ---------- ---------- ----------
Total investment and
mortgage-backed securities
held-to-maturity $2,659,974 $ 13,337 $ 35,925 $2,637,386
========== ========== ========== ==========
December 31, 1995
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
--------- ------------ ------------ -----
Investment Securities:
U.S. Treasury and
government agency $ 4,993 $ 37 $ -- $ 5,030
Corporate securities 1,010 60 -- 1,070
Other securities 482 -- -- 482
Mortgage-backed Securities:
FHLMC 168,713 1,730 1,274 169,169
FNMA 221,046 1,240 2,026 220,260
GNMA 170,064 6,548 80 176,532
RTC 28,954 -- 4,456 24,498
Private issues 284,640 622 2,626 282,636
Collateralized mortgage
obligations 1,197,310 10,556 187 1,207,679
---------- ---------- ---------- ----------
Total investment and
mortgage-backed securities
held-to-maturity $2,077,212 $ 20,793 $ 10,649 $2,087,356
========== ========== ========== ==========
-8-
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, 1996 December 31, 1995
-------------- -----------------
Amount Percent Amount Percent
------ ------- ------ -------
Residential real estate loans $4,248,468 86.00% $3,998,048 85.53%
Real estate construction loans:
Residential (net of loans in process
of $26,370 and $23,365, respectively) 34,229 .69 38,151 .82
Residential development (net of loans
in process of $663 and $736,
respectively) 1,537 .03 1,676 .04
Multi-family loans 73,572 1.49 75,218 1.61
Home equity loans 459,342 9.30 456,922 9.77
---------- ------ ---------- ------
Total Residential Loans 4,817,148 97.51 4,570,015 97.77
Commercial real estate loans 49,277 1.00 47,177 1.01
Commercial loans 27,410 .55 15,831 .34
Consumer loans 46,290 .94 41,341 .88
---------- ------ ---------- ------
Total Loans $4,940,125 100.00% $4,674,364 100.00%
========== ====== ========== ======
Total Loans with:
Fixed rates $1,340,643 27.14% $1,134,542 24.27%
Variable rates 3,599,482 72.86 3,539,822 75.73
---------- ------ ---------- ------
Total Loans $4,940,125 100.00% $4,674,364 100.00%
========== ====== ========== ======
-9-
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, 1996 December 31, 1995
-------------- -----------------
Weighted Weighted
Average Average
Account Type Amount Percent Rate Amount Percent Rate
------------ ------ ------- -------- ------ ------- -----
Retail certificates $2,619,258 52.76% 5.34% $2,731,009 54.20% 5.48%
Jumbo certificates 119,100 2.40 4.66 112,063 2.22 5.70
Savings accounts 986,438 19.87 2.35 925,842 18.37 2.31
Demand deposit accounts 172,652 3.48 - 168,757 3.35 -
NOW accounts 392,153 7.90 1.26 380,475 7.55 1.26
Money market accounts 674,914 13.59 4.00 720,997 14.31 4.36
---------- ------ ---- ---------- ------ ----
Total Deposits $4,964,515 100.00% 4.04% $5,039,143 100.00% 4.24%
========== ====== ==== ========== ====== ====
(7) BORROWINGS
The following table presents information regarding borrowings at the
dates indicated: (dollars in thousands)
March 31, 1996 December 31, 1995
-------------- -----------------
Weighted Weighted
Average Average
Balance Rate Balance Rate
------- -------- ------- --------
Securities sold under
repurchase agreements $ 225,474 6.89% $ 382,279 6.38%
FHLB advances 2,364,210 5.64 1,979,551 5.75
Other borrowings 168,227 7.48 168,826 7.49
---------- ---- ---------- ----
Total Borrowings $2,757,911 5.85% $2,530,656 5.96%
========== ==== ========== ====
-10-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(8) INTEREST RATE EXCHANGE AGREEMENTS
Amortizing and non-amortizing interest rate swaps are generally used to
convert fixed rate assets and liabilities to variable rate assets and
liabilities and vice versa. Interest rate caps are generally used to limit the
exposure from the repricing and maturity of liabilities. Interest rate floors
are generally used to limit the exposure from repricing and maturity of assets.
Interest rate caps and floors are also used to limit the exposure created by
other interest rate swaps. In certain cases, interest rate caps or floors are
simultaneously bought and sold to create a range of protection against changing
interest rates while limiting the cost of that protection. The following table
presents information regarding interest rate exchange agreements at the dates
indicated: (dollars in thousands)
March 31, 1996
--------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
-------- ----- ---------- ---------
Amortizing interest rate swaps:
Pay variable-receive fixed (1) $ 584,482 $ -- $ (15,048) 3.9
Pay fixed-receive variable (2) 283,161 -- 199 3.1
Non-amortizing interest rate swaps:
Pay variable-receive fixed (3) 50,000 -- (2,058) 4.4
Pay fixed-receive variable (4) 680,000 -- 1,876 2.3
Interest rate caps (5) 1,246,000 12,137 2,578 1.6
----------- --------- ---------
$ 2,843,643 $ 12,137 $ (12,453)
=========== ========= =========
December 31, 1995
-----------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
-------- ----- ---------- --------
Amortizing interest rate swaps:
Pay variable-receive fixed (1) $ 585,429 $ -- $ (4,066) 4.2
Pay fixed-receive variable (2) 295,701 -- (3,653) 3.3
Non-amortizing interest rate swaps:
Pay variable-receive fixed (3) 50,000 -- (837) 4.6
Pay fixed-receive variable (4) 280,000 -- (2,780) 1.8
Interest rate caps (5) 1,446,000 12,777 1,463 1.6
----------- ----------- --------
$ 2,657,130 $ 12,777 $ (9,873)
=========== =========== ========
(1) The weighted average pay rate was 5.07% and 5.56% and the weighted
average receive rate was 5.61% and 5.61% at March 31, 1996 and December
31, 1995, respectively.
(2) The weighted average pay rate was 6.87% and 6.87% and the weighted
average receive rate was 6.92% and 6.92% at March 31, 1996 and December
31, 1995, respectively.
(3) The weighted average pay rate was 6.67% and 7.28% and the weighted
average receive rate was 6.75% and 6.75% at March 31, 1996 and December
31, 1995, respectively.
(4) The weighted average pay rate was 5.23% and 5.91% and the weighted
average receive rate was 5.38% and 5.89% at March 31, 1996 and December
31, 1995, respectively.
(5) The weighted average contract rate was 6.50% and 6.36% at March 31, 1996
and December 31, 1995, respectively.
-11-
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)
Amortizing Non-Amortizing Interest
Interest Interest Rate
Rate Swaps Rate Swaps Caps
---------- -------------- --------
Balance, December 31, 1995 $ 881,130 $ 330,000 $1,446,000
---------- ---------- ----------
Additions -- 400,000 --
Maturities/Amortization 13,487 -- 200,000
Terminations -- -- --
---------- ---------- ----------
Balance, March 31, 1996 $ 867,643 $ 730,000 $1,246,000
========== ========== ==========
(9) ACQUISITIONS
On November 17, 1995, Sovereign acquired two branch offices and related
deposits of Berkeley Federal Bank & Trust, FSB ("Berkeley"). Sovereign assumed
approximately $111.7 million of deposits for a premium of $5.5 million. Of this
premium, $604,000 was recorded as a core deposit intangible and $4.9 million was
recorded as goodwill. The balances of this core deposit intangible and goodwill
at December 31, 1995 were $579,000 and $4.9 million, respectively.
On November 15, 1995, Sovereign acquired Colonial State Bank ("Colonial")
in a transaction accounted for as a purchase. Sovereign acquired $46.5 million
of assets consisting principally of loans and investment securities. Sovereign
also assumed approximately $42.0 million of deposit liabilities. Sovereign
acquired Colonial in exchange for $6.3 million in cash. This transaction added
goodwill of $3.3 million to Sovereign's balance sheet. The balance of the
goodwill at December 31, 1995 was $3.3 million. Colonial will operate as a
separate Banking subsidiary of Sovereign under the name Sovereign Community
Bank.
On November 10, 1995, Sovereign completed the sale of its Pottsville,
Pennsylvania branch office with related deposits totaling $23.9 million to
Northwest Savings Bank ("Northwest") and the sale of its English Village branch
office in North Wales, Pennsylvania with related deposits of $12.4 million to
Union National Bank & Trust Company ("Union National"). As a result of these
transactions, Sovereign recognized a pre-tax gain of $1.1 million and reduced
goodwill by $568,000, respectively.
On October 2, 1995, Sovereign executed a Definitive Agreement to acquire
West Jersey Bancshares, Inc. ("West Jersey"). West Jersey is a $100 million
commercial bank headquartered in Fairfield, New Jersey. The terms of the
Agreement call for Sovereign to exchange $8.40 in Sovereign Common Stock
(subject to adjustment) for each share of West Jersey Common Stock. The
transaction will be tax free to Sovereign, West Jersey and West Jersey
shareholders and will be accounted for as a pooling-of-interests. The
transaction is expected to close during the second quarter of 1996.
-12-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(10) ACCOUNTING CHANGES
On November 15, 1995, the Financial Accounting Standards Board ("FASB")
issued a Special Report, "A Guide to Implementation of Statement 115 on
Accounting for Certain Investments in Debt and Equity Securities". On December
7, 1995, in accordance with provisions in that Special Report, Sovereign
reclassified $750.2 million of securities from held-to-maturity to
available-for-sale. This reclassification resulted in a $1.7 million unrealized
gain, net of tax, which is included in Sovereign's stockholders' equity at
December 31, 1995.
In October 1995, the FASB issued SFAS No. 123 "Accounting for Stock-Based
Compensation" which provides companies with a choice either to expense the fair
value of employee stock options over the vesting period (recognition method) or
to continue the previous practice but disclose the pro forma effects on net
income and earnings per share had the fair value method been used (disclosure
only method). Companies electing the disclosure only method will be required to
include the pro forma effects of all awards granted in fiscal years beginning
after December 15, 1994. Sovereign plans to adopt the disclosure only method
during 1996.
In March 1995, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed of", which requires impairment losses to be
recorded on long-lived assets used in operations when indicators of impairment
are present and the undiscounted cash flows estimated to be generated by those
assets are less than the assets' carrying amount. SFAS No. 121 also addresses
the accounting for long-lived assets that are expected to be disposed of.
Sovereign adopted SFAS No. 121 in the first quarter of 1996, and based on
current circumstances, the effect of adoption was not material.
(11) RECENT DEVELOPMENTS
Sovereign Bank is insured by the Savings Association Insurance Fund
("SAIF") of the Federal Deposit Insurance Corporation ("FDIC") and pays
insurance fees equal to $.23 per $100.00 (23 basis points of insured deposits
annually, the lowest rate permitted. The average SAIF premium is 24 basis
points. Sovereign Community Bank is insured by the Bank Insurance Fund ("BIF")
of the FDIC. During recent years, the FDIC's BIF, which insures commercial banks
and certain savings banks, has also charged an average premium to its members of
24 basis points, and a minimum assessment of 23 basis points.
Effective September 30, 1995, the average BIF premium was reduced from 24
basis points to 4.4 basis points, with the minimum assessment being reduced from
23 basis points to 4 basis points. Subsequently, the minimum BIF assessment was
reduced to 0 basis points effective January 1, 1996, subject to the minimum FDIC
annual assessment of $1,000. The average and minimum SAIF premiums remain at 24
and 23 basis points, respectively, until the SAIF reserves reach $1.25 per
$100.00 in insured deposits.
In order to accelerate the recapitalization of the SAIF, it has been
proposed that SAIF-insured institutions such as Sovereign Bank be assessed a
one-time charge of between 85 and 90 basis points of their insured deposits as
of March 31, 1995. If enacted, this assessment would result in a pre-tax charge
to Sovereign Bank's earnings of approximately $36.0 million to $38.1 million.
This charge would have a significant negative impact on earnings in
-13-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
the period enacted. In accordance with FASB guidance on this specific issue, no
liability or charge for this assessment is included in the March 31, 1996
financial statements.
While it cannot be determined at this time what the outcome of these events
and proposals will be, Sovereign Bank has been placed at a significant
competitive disadvantage.
-14-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
RESULTS OF OPERATIONS
General
Net income for the three-month period ended March 31, 1996 was $15.7
million, an increase of 29% when compared to net income of $12.1 million for the
three-month period ended March 31, 1995. Earnings per share for the three-month
period ended March 31, 1996 were $.27 per share, an increase of 13% when
compared to $.24 for the same period in 1995. Earnings per share have been
adjusted to reflect all stock dividends and stock splits.
Return on average equity and return on average assets were 14.31% and .77%,
respectively, for the three-month period ended March 31, 1996 compared to 15.12%
and .70%, respectively, for the same period in 1995.
Net Interest Income
Net interest income for the three-month period ended March 31, 1996 was
$50.9 million compared to $42.7 million for the same period in 1995. The
increase is attributable to an increase in average balances resulting from
recent acquisitions and internal growth. Sovereign's interest rate spread (the
difference between the yield on total assets and the cost of total liabilities
and stockholders' equity) was 2.54% for the three-month period ended March 31,
1996 compared to 2.50% for the same period in 1995.
Interest on interest-earning deposits was $829,000 for the three-month
period ended March 31, 1996 compared to $1.2 million for the same period in
1995. The average balance of interest-earning deposits was $16.3 million with an
average yield of 20.41% for the three-month period ended March 31, 1996 compared
to an average balance of $44.5 million with an average yield of 11.23% for the
same period in 1995.
Interest on investment and mortgage-backed securities available-for-sale
was $8.9 million for the three-month period ended March 31, 1996 compared to
$1.3 million for the same period in 1995. The average balance of investment and
mortgage-backed securities available-for-sale was $531.1 million with an average
yield of 6.79% for the three-month period ended March 31, 1996 compared to an
average balance of $79.4 million with an average yield of 6.74% for the same
period in 1995. The increase in average balance is a result of the
reclassification of $750.2 million of securities from held-to-maturity to
available-for-sale in December 1995.
Interest on investment and mortgage-backed securities held-to-maturity was
$40.0 million for the three-month period ended March 31, 1996 compared to $31.7
million for the same period in 1995. The average balance of investment and
mortgage-backed securities held-to-maturity was $2.21 billion with an average
yield of 7.16% for the three-month period ended March 31, 1996 compared to an
average balance of $1.86 billion with an average yield of 6.81% for the same
period in 1995.
Interest and fees on loans were $90.7 million for the three-month period
ended March 31, 1996 compared to $77.2 million for the same period in 1995. The
average balance of loans was $4.89 billion with an average yield of 7.43% for
the three-month period ended March 31, 1996 compared to an average balance of
$4.40 billion with an average yield of 7.03% for the same period in 1995. The
increase in the average balance of loans is due to the origination of new
mortgage loans.
-15-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Interest on deposits was $51.7 million for the three-month period ended
March 31, 1996 compared to $49.4 million for the same period in 1995. The
average balance of deposits was $4.99 billion with an average cost of 4.17% for
the three-month period ended March 31, 1996 compared to an average balance of
$4.97 billion with an average cost of 4.03% for the same period in 1995. The
cost of deposits has increased due to a general rise in interest rates.
Interest on borrowings was $37.3 million for the three-month period ended
March 31, 1996 compared to $19.3 million for the same period in 1995. The
average balance of borrowings was $2.50 billion with an average cost of 5.98%
for the three-month period ended March 31, 1996 compared to an average balance
of $1.38 billion with an average cost of 5.64% for the same period in 1995. The
increase in the average balance of borrowings is the result of the growth of the
balance sheet being funded principally by borrowings. The cost of borrowings has
increased due to the rise in interest rates.
Provision for Possible Loan Losses
The provision for possible loan losses was $500,000 for the three-month
period ended March 31, 1996 compared to $250,000 for the same period in 1995.
See "Financial Condition and Loan Portfolio" for a discussion of credit quality
of Sovereign's loan portfolio.
The following table presents the activity in the allowance for possible
loan losses for the periods indicated: (dollars in thousands)
Three-Month Period Ended March 31,
----------------------------------
1996 1995
---- ----
Allowance, beginning of period $34,856 $36,289
Charge-offs:
Residential 1,005 293
Consumer 95 132
Commercial Real Estate -- 472
------- -------
Total Charge-offs 1,100 897
------- -------
Recoveries:
Residential 47 18
Consumer 18 9
Commercial Real Estate -- --
------- -------
Total Recoveries 65 27
------- -------
Charge-offs, net of recoveries 1,035 870
Provision for possible loan losses 500 250
------- -------
Allowance, end of period $34,321 $35,669
======= =======
Other Income
Other income was $4.9 million for the three-month period ended March 31,
1996, unchanged from $4.9 million for the same period in 1995.
Other loan fees and service charges were $1.1 million for the three-month
period ended March 31, 1996 compared to $1.2 million for the same period in
1995. Other loan fees and service charges result primarily from
-16-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Sovereign's loan servicing portfolio. Sovereign serviced $4.04 billion of its
own loans and $1.04 billion of loans for others at March 31, 1996 compared to
$3.98 billion of its own loans and $1.10 billion of loans for others at March
31, 1995.
Deposit fees were $2.5 million for the three-month period ended March 31,
1996 compared to $2.3 million for the same period in 1995. This increase is
primarily the result of an increase in the number of transaction accounts and
recent acquisitions.
General and Administrative Expenses
Total general and administrative expenses were $26.9 million for the
three-month period ended March 31, 1996 compared to $25.3 million for the same
period in 1995. The ratio of general and administrative expenses to average
assets for the three-month period ended March 31, 1996 was 1.35% compared to
1.50% for the same period in 1995. This improvement in the expense ratio is the
result of efficiencies realized from recent acquisitions and an increase in
average balances.
Other operating expenses were $3.1 million for the three-month period ended
March 31, 1996 compared to $3.5 million for the same period in 1995.
Income Tax Provision
The income tax provision was $9.6 million for the three-month period ended
March 31, 1996 compared to $6.4 million for the same period in 1995. The
effective tax rate for the three-month period ended March 31, 1996 was 38.0%
compared to 34.6% for the same period in 1995.
-17-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
FINANCIAL CONDITION
Loan Portfolio
Loans at March 31, 1996 were $4.94 billion compared to $4.67 billion at
December 31, 1995. During the three-month period ended March 31, 1996, Sovereign
closed approximately $576.0 million of first mortgage loans including
approximately $435.5 million of variable rate mortgage loans, the majority of
which were retained in Sovereign's loan portfolio.
Sovereign's primary loan products are variable rate mortgage loans on owner
occupied residential real estate. As a result of Sovereign's focus on these
products, 86.00% of Sovereign's total loan portfolio is secured by residential
real estate and 72.86% of the total loan portfolio is comprised of variable rate
loans. At March 31, 1996, Sovereign's total loan portfolio included $4.25
billion of first mortgage loans secured primarily by liens on owner occupied
one-to-four family residential properties and $459.3 million of home equity
loans secured primarily by second mortgages on owner occupied one-to-four family
residential properties.
Sovereign places substantially all loans 90 days or more delinquent on
non-performing status. At March 31, 1996, Sovereign's non-performing assets were
$46.1 million compared to $43.7 million at December 31, 1995. The ratio of
non-performing assets to total assets was .55% at March 31, 1996 compared to
.54% at December 31, 1995.
At March 31, 1996, 85.56% of non-performing assets consisted of loans or
real estate owned (REO) related to residential real estate compared to 83.94% at
December 31, 1995. Historically, losses on disposition of non-performing
residential real estate have been lower than non-performing commercial and
commercial real estate loans. Non-performing assets at March 31, 1996 include
$4.9 million of REO which is carried at lower of cost or estimated fair market
value less estimated disposal costs.
-18-
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,
1996 1995
---- ----
Non-Accrual Loans:
Past due 90 or more days
as to interest or principal:
Residential $35,301 $33,580
Other 4,265 3,902
Past due less than 90 days
as to interest and principal:
Residential 643 644
Other 736 739
------- -------
Total Non-Accrual Loans 40,945 38,865
Restructured Loans 295 296
------- -------
Total Non-Performing Loans 41,240 39,161
------- -------
Real Estate Owned:
Residential 3,499 2,437
Other 1,360 2,076
------- -------
Total Real Estate Owned 4,859 4,513
------- -------
TOTAL NON-PERFORMING ASSETS 46,099 43,674
------- -------
Past due 90 days or more as to
interest or principal and
accruing interest 31 --
Non-performing assets and loans
past due 90 days or more and
accruing $46,130 $43,674
======= =======
Non-Performing Assets as a
percentage of Total Assets .55% .54%
Non-Performing Loans as a
percentage of Total Loans .82% .83%
Non-Performing Assets as a
percentage of Total Loans
and Real Estate Owned .92% .92%
Allowance for Possible Loan
Losses as a percentage of
Total Non-Performing Assets 73.59% 78.95%
Allowance for Possible Loan
Losses as a percentage of
Total Non-Performing Loans 82.26% 88.05%
-19-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Management constantly evaluates the adequacy of its allowance for possible
loan losses. 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 could have loss
potential, geographic and industry concentrations, delinquency trends, economic
conditions and other relevant factors. At March 31, 1996, the allowance for
possible loan losses was $34.3 million or .69% of loans compared to $34.9
million or .75% of loans at December 31, 1995.
The following table presents the allocation of the allowance for possible
loan losses and the percentage of such allocation to each loan type for the
dates indicated: (dollars in thousands)
March 31, December 31,
1996 1995
Balance at End of --------- ------------
Period Attributable to Amount Percent Amount Percent
------ ------- ------ -------
Residential real estate $11,197 32.63% $10,520 30.18%
Commercial real estate 803 2.34 698 2.00
Commercial 206 .60 181 .52
Consumer 4,305 12.54 4,190 12.02
Unallocated 17,810 51.89 19,267 55.28
------- ------ ------- ------
Total $34,321 100.00% $34,856 100.00%
======= ====== ======= ======
Potential problem loans (consisting of loans as to which management has
serious doubts as to the ability of such borrowers to comply with present
repayment terms, although not currently classified as non-performing loans)
amounted to approximately $4.1 million. These loans consist of $2.6 million of
multi-family loans and $1.3 million of commercial real estate loans and $233,000
of consumer loans.
Investment and Mortgage-backed Securities
Investment securities consist primarily of U.S. Treasury and government
agency securities, corporate debt securities and stock in the Federal Home Loan
Bank of Pittsburgh ("FHLB"). Mortgage-backed securities consist of obligations
issued by FHLMC, FNMA, GNMA, RTC or private issuers. Sovereign's mortgage-backed
securities are generally either guaranteed as to principal and interest by the
issuer or rated "AAA" or "AA" by Standard and Poor's or Moody's. At March 31,
1996, total investment and mortgage-backed securities available-for-sale were
$380.1 million compared to $889.5 million at December 31, 1995 and investment
and mortgage-backed securities held-to-maturity were $2.66 billion compared to
$2.08 billion at December 31, 1995. For additional information on the investment
and mortgage-backed securities, see Notes 3 and 4 in the Notes to Consolidated
Financial Statements.
-20-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Long-Lived Assets
In March 1995, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed of", which requires impairment losses to be
recorded on long-lived assets used in operations when indicators of impairment
are present and the undiscounted cash flows estimated to be generated by those
assets are less than the assets' carrying amount. SFAS No. 121 also addresses
the accounting for long-lived assets that are expected to be disposed of.
Sovereign adopted SFAS No. 121 in the first quarter of 1996, and based on
current circumstances, the effect of adoption was not material.
Goodwill and Other Intangible Assets
Total goodwill and other intangible assets at March 31, 1996 were $120.6
million compared to $123.2 million at December 31, 1995.
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, 1996 were $4.96 billion, compared to $5.04
billion at December 31, 1995. For additional information on the 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.
Collateralized advances are available from the FHLB provided certain standards
related to creditworthiness have been met. Another source of funds for Sovereign
is reverse repurchase agreements. Reverse repurchase agreements are short-term
obligations collateralized by a security interest in U.S. Treasury securities or
securities fully guaranteed as to principal and interest by the U.S. Government
or an agency thereof.
Total borrowings at March 31, 1996 were $2.76 billion of which $1.79
billion were short-term compared to $2.53 billion of which $1.51 billion were
short-term at December 31, 1995. This increase in short-term borrowings is the
result of the growth of the balance sheet being funded principally by
borrowings. For additional information on the borrowings, see Note 7 in the
Notes to Consolidated Financial Statements.
Stockholders' Equity
Total stockholders' equity at March 31, 1996 was $438.5 million compared to
$427.0 million at December 31, 1995. This increase is primarily attributable to
the retention of earnings less dividends paid to shareholders, net of
unallocated common stock held by ESOP.
-21-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
LIQUIDITY AND CAPITAL RESOURCES
Sovereign Bank is required under applicable federal regulations to maintain
specified levels of "liquid" investments in cash and U.S. Treasury and other
qualifying investments. Regulations currently in effect require Sovereign Bank
to maintain liquid assets of not less than 5% of its net withdrawable accounts
plus short-term borrowings, of which short-term liquid assets must consist of
not less than 1%. These levels are changed from time to time by the OTS to
reflect economic conditions. Sovereign Bank's liquidity ratio was 6.01% for
March 31, 1996.
Sovereign's primary financing sources are deposits obtained in its own
market area and borrowings in the form of securities sold under repurchase
agreements and advances from the FHLB. At March 31, 1996, Sovereign had $2.40
billion in unpledged investments and mortgage-backed securities which could be
used to collateralize additional borrowings. Sovereign Bank can also borrow from
the FHLB, subject to required collateralization. Other sources of funds include
operating activities, repayments of principal on investment and mortgage-backed
securities, repayment of principal on loans and other investing activities.
For the three-month period ended March 31, 1996, cash and cash equivalents
decreased $8.9 million. Net cash provided by operating activities was $23.4
million for the three-month period ended March 31, 1996. Net cash used by
investing activities for the three-month period ended March 31, 1996, was $185.0
million consisting primarily of purchases of mortgage-backed securities which
are classified as held-to-maturity and loans, partially offset by proceeds from
sales of investment and mortgage-backed securities available-for-sale. The
considerable flattening of the yield curve has diminished the market for
originating adjustable rate mortgage loans. As a result, Sovereign has focused
on the mortgage-backed security portfolio to provide earning assets. Net cash
provided by financing activities for the three-month period ended March 31,
1996, was $152.2 million which includes an increase in short-term borrowings of
$226.5 million which was partially offset by a decrease in deposits.
The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA"),
requires the OTS to prescribe uniformly applicable capital standards for all
savings associations. These standards require savings associations to maintain a
minimum tangible capital ratio of not less than 1.5%, a minimum leverage capital
ratio of not less than 3% of tangible assets and not less than 4% of risk
adjusted assets and a minimum risk-based capital ratio (based upon credit risk)
of not less than 8%. In all cases, these standards are to be no less stringent
than the capital standards that are applicable to national banks. The OTS has
issued a regulation that requires a minimum leverage capital requirement of 3%
for associations rated composite 1 under the OTS MACRO rating system. For all
other savings associations, the minimum leverage capital requirement will be 3%
plus at least an additional 100 to 200 basis points.
The OTS issued its final regulations on the incorporation of an interest
rate risk component into its risk-based capital requirements. Under the
regulation, savings associations which are deemed to have an "above normal"
level of interest rate risk must deduct a portion of that risk from total
capital for regulatory capital purposes. Implementation of this interest rate
risk capital deduction has been delayed by the OTS until further notification.
-22-
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, under
capitalized, significantly under capitalized and critically under capitalized. 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 are subject to various restrictions
regarding capital distributions, payment of management fees, acceptance of
brokered deposits and other operating activities.
At March 31, 1996, Sovereign Bank is classified as well capitalized and is
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 capital requirements.
The following table sets forth the capital ratios of Sovereign Bancorp,
Sovereign Bank and Sovereign Community Bank and the current regulatory
requirements at March 31, 1996:
Sovereign
Sovereign Sovereign Community
Bancorp (1) Bank Bank Requirement
----------- --------- --------- -----------
Stockholders' equity to
total assets 5.21% 6.51% 8.20% None
Tangible capital to tangible
assets 3.78 5.15 5.55 1.50%
Leverage (core) capital to
tangible assets 3.78 5.15 5.55 3.00
Leverage (core) capital to
risk adjusted assets 8.52 11.81 14.57 4.00
Risk-based capital to risk
adjusted assets 13.98 12.61 15.39 8.00
(1) OTS capital regulations do not apply to savings and loan holding companies.
These ratios are computed as if those regulations did apply to Sovereign
Bancorp.
ASSET AND LIABILITY MANAGEMENT
The objective of Sovereign's asset and liability management is to identify,
manage and control its interest rate risk in order to produce consistent
earnings that are not largely 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
accomplished 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.
There are a number of industry standards used to measure an institution's
interest rate risk position. Most common among these is the one year gap which
is the ratio representing the difference between assets, liabilities and
off-balance sheet positions which will mature or reprice within one year
expressed as a percentage of total assets. Using management's estimates of asset
prepayments, core deposit decay and borrowing repricing in its
-23-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
computation, Sovereign estimates that its cumulative one year gap position was a
negative 4.78% at March 31, 1996.
Sovereign also utilizes income simulation modeling in measuring its
interest rate risk and managing its interest rate sensitivity. Income simulation
considers not only the impact of changing market interest rates on forecasted
net interest income, but also other factors such as yield curve relationships,
the volume and mix of assets and liabilities, customer preferences and general
market conditions.
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 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 Statement.
Amortizing and non-amortizing interest rate swaps are generally used to
convert fixed rate assets and liabilities to variable rate assets and
liabilities and vice versa. Sovereign utilizes amortizing interest rate swaps to
convert discounted adjustable rate loans to fixed rate for a period of time. The
amortization of the notional amount of the interest rate swaps are tied to the
level of an index such as the One Year Treasury Constant Maturity, LIBOR, or a
prepayment rate of a pool of mortgage-backed securities. In order for interest
rate swaps to achieve the desired objective, Sovereign selects interest rate
swaps that will have a high degree of correlation to the related financial
instrument. Sovereign generally utilizes non-amortizing swaps to convert fixed
rate liabilities to floating rate, to reduce Sovereign's overall cost of funds.
Interest rate caps are generally used to limit the exposure from the
repricing and maturity of liabilities and interest rate floors are generally
used to limit the exposure from 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.
Due to competitive conditions, Sovereign originates fixed rate residential
mortgages. It exchanges the majority of these loans with FHLMC, FNMA and private
investors. The loans are exchanged for marketable fixed rate mortgage-backed
securities which are generally sold, or cash. 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 means of
hedging loans in the mortgage pipeline which are originated for resale.
Sovereign's primary funding source is deposits obtained in its own
marketplace. Deposit programs at Sovereign are priced to meet management's
asset/liability objectives, while taking into account the rates available on
investment opportunities and also considering the cost of alternative funding
sources. Borrowings are a significant funding source for Sovereign and have
primarily been in the form of securities sold under repurchase agreements and
advances from the FHLB. Since borrowings are not subject to the market
constraints to which deposits are, Sovereign uses borrowings to add flexibility
to its interest rate risk position.
-24-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Items 1 through 5 are not applicable or the responses are negative.
Item 6 - Reports on Form 8-K.
Report on Form 8-K, dated February 2, 1996 (date of earliest event -
January 31, 1996), contained a press release outlining the Company's
strategic vision for year 2000.
Report on Form 8-K, dated February 13, 1996 (date of earliest event -
January 18, 1996), contained a press release announcing the Company's
earnings for the year ended December 31, 1995.
Report on Form 8-K/A, dated January 8, 1996 (date of earliest event -
September 18, 1989), described the Company's amendment to their
Rights Agreement with Chemical Bank, as Rights Agent.
-25-
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 10, 1996 /s/ Karl D. Gerhart
------------------------- ----------------------------
Karl D. Gerhart
Chief Financial Officer and Treasurer
Date May 10, 1996 /s/Lawrence M. Thompson, Jr.
------------------------- ----------------------------
Lawrence M. Thompson, Jr.
Chief Administrative Officer and Secretary
-26-