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 June 30, 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 August 13, 1996
- ------------------------------- -------------------------------
Common Stock (no par value) 49,299,092 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 June 30, 1996
and December 31, 1995 3
Consolidated Statements of Operations for the three-
month and six-month periods ended June 30, 1996 and 1995 4
Consolidated Statements of Cash Flows for the six-
month periods ended June 30, 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
June 30, December 31,
1996 1995
----------- ------------
(Unaudited) (Note)
(in thousands, except
per share data)
ASSETS
Cash and amounts due from
depository institutions $ 141,155 $ 130,841
Interest-earning deposits 5,752 16,930
Loans held for resale (approximate fair
value of $19,381 and $71,297 at
June 30, 1996 and December 31, 1995,
respectively) 19,312 70,512
Investment and mortgage-backed securities
available-for-sale 478,547 889,509
Investment and mortgage-backed securities
held-to-maturity (approximate fair value
of $2,526,874 and $2,087,356 at June 30,
1996 and December 31, 1995, respectively) 2,580,747 2,077,212
Loans 5,717,061 4,674,364
Allowance for possible loan losses (34,620) (34,856)
Premises and equipment 55,851 56,951
Real estate owned 3,868 4,514
Accrued interest receivable 50,354 42,785
Goodwill and other intangible assets 117,444 123,243
Other assets 47,976 26,282
----------- -----------
TOTAL ASSETS $ 9,183,447 $ 8,078,287
=========== ===========
LIABILITIES
Deposits $ 4,941,897 $ 5,039,143
Borrowings:
Short-term 2,437,703 1,512,720
Long-term 1,246,509 1,017,936
Advance payments by borrowers
for taxes and insurance 34,675 22,117
Other liabilities 61,197 59,346
----------- -----------
TOTAL LIABILITIES 8,721,981 7,651,262
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock; no par value; $50 liquidation
preference; 7,500,000 shares
authorized; 2,000,000 shares issued at June 30, 1996
and December 31, 1995, respectively 96,446 96,446
Common stock; no par value;
100,000,000 shares authorized;
52,771,314 shares issued at June 30,
1996 and 50,860,861 shares issued at
December 31, 1995 275,655 248,875
Unallocated common stock held by the Employee
Stock Ownership Plan at cost;
3,198,036 shares at June 30, 1996
and 3,123,036 at December 31, 1995, respectively (30,278) (28,772)
Unrecognized gain on investment
and mortgage-backed securities
available-for-sale, net of tax 1,556 3,988
Retained earnings 118,087 106,488
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 461,466 427,025
----------- -----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 9,183,447 $ 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.
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three-Month Period Six-Month Period
Ended June 30, Ended June 30,
------------------ -----------------
1996 1995 1996 1995
---- ---- ---- ----
(in thousands, except
per share data)
Interest income:
Interest on interest-earning deposits $ 736 $ 661 $ 1,565 $ 1,893
Interest and dividends on investment
and mortgage-backed securities
available-for-sale 7,222 1,334 16,109 2,587
Interest and dividends on investment
and mortgage-backed securities
held-for-maturity 45,620 34,525 85,171 66,242
Interest and fees on loans 96,615 79,700 187,274 156,907
------- ------- ------- -------
Total interest income 150,193 116,220 290,119 227,629
------- ------- ------- -------
Interest expense:
Interest on deposits 48,397 52,362 100,097 101,740
Interest on borrowings 46,934 22,483 84,229 41,778
-------- -------- -------- --------
Total interest expense 95,331 74,845 184,326 143,518
-------- -------- -------- --------
Net interest income 54,862 41,375 105,793 84,111
Provision for possible loan losses 516 250 1,016 500
-------- -------- -------- --------
Net interest income after provision for
possible loan losses 54,346 41,125 104,777 83,611
-------- -------- -------- --------
Other income:
Other loan fees and service charges 1,328 1,051 2,401 2,296
Deposit fees 2,675 1,924 5,141 4,185
Gain on sale of loans and investment
and mortgage-backed securities
available-for-sale 20 25 178 136
Mortgage banking gains 442 4,149 929 4,789
Miscellaneous income 967 2,145 1,649 2,755
-------- -------- -------- --------
Total other income 5,432 9,294 10,298 14,161
-------- -------- -------- --------
General and administrative expenses:
Salaries and employee benefits 12,496 9,720 24,082 20,337
Occupancy and equipment expenses 5,670 5,187 11,146 9,843
Outside services 3,534 4,321 6,586 5,765
Deposit insurance premiums 2,416 2,775 4,901 5,592
Advertising 1,237 1,898 2,337 2,467
Other administrative expenses 4,576 1,842 7,804 7,002
-------- -------- -------- --------
Total general and administrative expenses 29,929 25,743 56,856 51,006
Other operating expenses:
Amortization of goodwill and other intangibles 2,946 3,053 5,887 6,080
Real estate owned (gains)/losses, net (168) 133 (49) 635
-------- -------- --------- --------
Total other operating expenses 2,778 3,186 5,838 6,715
-------- -------- -------- --------
Income before income taxes 27,071 21,490 52,381 40,051
Income tax provision 10,276 7,347 19,905 13,778
-------- -------- -------- --------
Net Income $ 16,795 $ 14,143 $ 32,476 $ 26,273
======== ======== ======== ========
Net Income Applicable to Common Stock $ 15,233 $ 12,580 $ 29,351 $ 24,710
======== ======== ======== ========
Earnings per share (1) $.28 $.25 $.55 $.49
======== ======== ======== ========
Dividends per share (1) $.021 $.021 $.042 $.042
======== ======== ======== ========
- -------------------
(1) Per share amounts have been adjusted to reflect all stock dividends and
stock splits.
See accompanying notes to consolidated financial statements.
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six-Month Period
Ended June 30,
-------------------------------
1996 1995
---- ----
(in thousands)
Cash Flows from Operating Activities:
Net income $ 32,476 $ 26,273
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for possible loan losses and deferred taxes 7,064 3,686
Depreciation 2,885 2,499
Amortization (1,326) (1,191)
(Gain)/loss on sale of loans, investment and
mortgage-backed securities and real estate owned (227) 1,886
Net change in:
Loans held for resale 51,200 (7,939)
Accrued interest receivable (7,015) (4,145)
Prepaid expenses and other assets (18,733) (7,580)
Other liabilities 813 1,871
----------- ---------
Net cash provided by operating activities 67,137 15,360
----------- ---------
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 66,199 -
Held-to-maturity 262,198 92,406
Purchases of investment and mortgage-backed securities:
Available-for-sale (172,955) (6,916)
Held-to-maturity (750,867) (336,815)
Proceeds from sales of loans 2,421 2,346
Purchase of loans (609,974) (75,455)
Net change in loans other than purchases and sales (365,631) (81,751)
Proceeds from sales of premises and equipment 1,669 10,392
Purchases of premises and equipment (2,858) (10,051)
Proceeds from sale of real estate owned 2,652 2,948
Net cash received from business combinations 4,983 -
----------- ---------
Net cash used by investing activities (1,047,199) (369,472)
----------- ---------
Cash Flows from Financing Activities:
Assumption of deposits - 748,631
Net decrease in deposits (184,177) (4,219)
Net increase/(decrease)in short-term borrowings 773,922 (550,772)
Proceeds from long-term borrowings 385,000 69,499
Repayments of long-term borrowings - (714)
Net increase in advance payments by
borrowers for taxes and insurance 12,443 10,304
Proceeds from issuance of common stock 2,271 1,567
Proceeds from issuance of preferred stock - 96,660
Cash dividends paid (5,261) (2,093)
Advance to the Employee Stock Ownership Plan (5,000) (20,000)
----------- ---------
Net cash provided by financing activities 979,198 348,863
----------- ---------
Net change in cash and cash equivalents (864) (5,249)
Cash and cash equivalents at beginning of period 147,771 139,401
----------- ---------
Cash and cash equivalents at end of period $ 146,907 $ 134,152
=========== =========
Reconciliation of Cash and Cash Equivalents to Consolidated
Balance Sheets:
Cash and amounts due from depository institutions $ 141,155 $ 104,638
Interest-earning deposits 5,752 29,514
----------- ---------
$ 146,907 $ 134,152
=========== =========
Supplemental Disclosures:
Income tax payments totaled $20.3 million for the six-month period ended June
30, 1996 and $11.6 million for the same period in 1995. Interest payments
totaled $176.5 million for the six-month period ended June 30, 1996 and $143.0
million for the same period in 1995. Noncash activity consisted of mortgage loan
securitization of $256.7 million for the six-month period ended June 30, 1996
and $30.5 million for the same period in 1995; reclassification of long-term
borrowings to short-term borrowings of $176.7 million for the six-month period
ended June 30, 1996 and $226.4 million for the same period in 1995;
reclassification of mortgage loans to real estate owned of $3.1 million for the
six-month period ended June 30, 1996 and $3.6 million for the same period in
1995.
See accompanying notes to consolidated financial statements.
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 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 result could
differ from those estimates.
The results of operations for the six-month period ended June 30, 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 and
six-month periods ended June 30, 1996 were 59.5 million and 59.2 million
compared to 56.3 million and 53.9 million for the same periods in 1995. Earnings
per share have been adjusted to reflect all stock dividends and stock splits.
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)
June 30, 1996
-------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
--------- ------------ ------------ -----
Investment Securities:
U.S. Treasury and
government agency $ 4,974 $ 27 $ - $ 5,001
Equity Securities 233,859 1,264 417 234,706
Mortgage-backed Securities:
FHLMC - - - -
FNMA - - - -
GNMA - - - -
Collateralized mortgage
obligations 237,163 2,092 415 238,840
---------- ------- ------- ----------
Total investment and
mortgage-backed securities
available-for-sale $ 475,996 $ 3,383 $ 832 $ 478,547
========= ======= ======= =========
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
======== ======= ====== ========
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)
June 30,1996
------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
--------- ------------ ------------ -----
Investment Securities:
U.S. Treasury and
government agency $ 8,777 $ 23 $ 22 $ 8,778
Corporate securities - - - -
Other securities 1,730 27 - 1,757
Mortgage-backed Securities:
FHLMC 153,492 688 6,478 147,702
FNMA 205,430 302 7,954 197,778
GNMA 197,063 1,430 1,706 196,787
RTC 26,519 - 4,480 22,039
Private issues 267,959 187 11,866 256,280
Collateralized mortgage
obligations 1,719,777 1,589 25,613 1,695,753
---------- ------- ------- ----------
Total investment and
mortgage-backed securities
held-to-maturity $2,580,747 $ 4,246 $58,119 $2,526,874
========== ======= ======= ==========
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
========== ======= ======= ==========
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)
June 30, 1996 December 31, 1995
------------- -----------------
Amount Percent Amount Percent
------ ------- ------ -------
Residential real estate loans $4,723,421 82.62% $3,998,048 85.53%
Real estate construction loans:
Residential (net of loans in process
of $42,811 and $23,365, respectively) 47,599 .83 38,151 .82
Residential development (net of loans
in process of $0 and $736,
respectively) 1,781 .03 1,676 .04
Multi-family loans 68,900 1.21 75,218 1.61
Home equity loans 474,163 8.29 456,922 9.77
---------- ------ --------- ------
Total Residential Loans 5,315,864 92.98 4,570,015 97.77
Commercial real estate loans 51,754 .90 47,177 1.01
Commercial loans 75,815 1.33 15,831 .34
Consumer loans 273,628 4.79 41,341 .88
---------- ------ ---------- ------
Total Loans $5,717,061 100.00% $4,674,364 100.00%
========== ====== ========== ======
Total Loans with:
Fixed rates $1,775,116 31.05% $1,134,542 24.27%
Variable rates 3,941,945 68.95 3,539,822 75.73
---------- ------ ---------- ------
Total Loans $5,717,061 100.00% $4,674,364 100.00%
========== ====== ========== ======
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)
June 30, 1996 December 31, 1995
------------- -----------------
Weighted Weighted
Average Average
Account Type Amount Percent Rate Amount Percent Rate
------------ ------ ------- -------- ------ ------- -----
Retail certificates $2,593,069 52.47% 5.21% $2,731,009 54.20% 5.48%
Jumbo certificates 87,376 1.77 5.41 112,063 2.22 5.70
Savings accounts 1,001,226 20.26 2.37 925,842 18.37 2.31
Demand deposit accounts 203,720 4.12 - 168,757 3.35 -
NOW accounts 404,567 8.19 1.26 380,475 7.55 1.26
Money market accounts 651,939 13.19 3.97 720,997 14.31 4.36
---------- ------ ---- ---------- ------ ----
Total Deposits $4,941,897 100.00% 3.94% $5,039,143 100.00% 4.24%
========== ====== ==== ========== ====== ====
(7) BORROWINGS
The following table presents information regarding borrowings at the
dates indicated: (dollars in thousands)
June 30, 1996 December 31, 1995
------------- -----------------
Weighted Weighted
Average Average
Balance Rate Balance Rate
------- ------- ------- --------
Securities sold under
repurchase agreements $ 255,901 5.50% $ 382,279 6.38%
FHLB advances 3,260,802 5.70 1,979,551 5.75
Other borrowings 167,509 7.46 168,826 7.49
---------- ---- ---------- ----
Total Borrowings $3,684,212 5.77% $2,530,656 5.96%
========== ==== ========== ====
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)
June 30, 1996
-------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
---------- ------ ---------- --------
Amortizing interest rate swaps:
Pay variable-receive fixed (1) $ 723,424 $ -- $ (18,019) 4.1
Pay fixed-receive variable (2) 421,139 -- 1,838 2.8
Non-amortizing interest rate swaps:
Pay variable-receive fixed (3) 50,000 -- (2,516) 4.1
Pay fixed-receive variable (4) 880,000 -- 3,951 2.3
Interest rate caps (5) 750,000 10,605 10,087 3.4
----------- --------- --------
$ 2,824,563 $ 10,605 $ (4,659)
=========== ========= ========
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 5.34% and 5.56% and the weighted
average receive rate was 5.93% and 5.61% at June 30, 1996 and December
31, 1995, respectively.
(2) The weighted average pay rate was 6.77% and 6.87% and the weighted
average receive rate was 6.20% and 6.92% at June 30, 1996 and December
31, 1995, respectively.
(3) The weighted average pay rate was 6.91% and 7.28% and the weighted
average receive rate was 6.75% and 6.75% at June 30, 1996 and December
31, 1995, respectively.
(4) The weighted average pay rate was 5.25% and 5.91% and the weighted
average receive rate was 5.49% and 5.89% at June 30, 1996 and December
31, 1995, respectively.
(5) The weighted average contract rate was 5.83% and 6.36% at June 30, 1996
and December 31, 1995, respectively.
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
---------- -------- ----------
Additions 300,000 200,000 500,000
Maturities/Amortization 23,080 - -
Terminations - - 996,000
---------- ------- ----------
Balance, June 30, 1996 $1,144,563 $930,000 $ 750,000
========== ======== ==========
(9) ACQUISITIONS
On June 25, 1996, Sovereign executed a Definitive Agreement to acquire
First State Financial Services ("First State"), a $666 million holding company
headquartered in West Caldwell, New Jersey. First State's sole banking
subsidiary, First Dewitt Bank, operates 13 branch offices located in central and
northern New Jersey. The transaction will add loans of approximately $540
million and deposits of approximately $590 million to Sovereign's balance sheet.
The terms of the agreement call for Sovereign to exchange $14.75 in Sovereign
common stock (subject to adjustment) for each share of First State common stock.
Sovereign expects to issue 5.8 million new shares in connection with the
transaction, which will be tax-free to First State and First State's
shareholders. Sovereign expects the transaction will close late in the fourth
quarter of 1996 or early in the first quarter of 1997.
On May 31, 1996, Sovereign acquired West Jersey Bancshares, Inc. ("West
Jersey") in a transaction accounted for as a pooling-of-interests; however, the
consolidated financial statements have not been restated due to immateriality.
Sovereign acquired approximately $100 million in assets consisting principally
of investment securities and loans and assumed approximately $73 million of
deposit liabilities. West Jersey shareholders received .8335 shares of Sovereign
common stock in exchange for each share of West Jersey common stock, or $8.91
per share. Sovereign issued approximately 1.7 million new shares of common stock
in connection with the transaction, which will be tax-free to West Jersey and
West Jersey shareholders.
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
(10) ACCOUNTING CHANGES
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 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 the period
enacted. In accordance with FASB guidance on this specific issue, no liability
or charge for this assessment is included in the June 30, 1996 financial
statements.
Sovereign has executed eight merger transactions since 1990 which have
resulted in the acquisition of loans and/or deposits of SAIF-insured
institutions which were accounted for under the purchase method of accounting.
At the time of acquisition, Sovereign had in good faith assumed that these
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
entities would be able to effectively compete with commercial banks in their
respective regions for the acquisition of customer loans and deposits.
As a result of the BIF/SAIF assessment rate disparity and potential
recapitalization described above, Sovereign has been placed in a significant
competitive disadvantage in the markets it serves. Because commercial banks
currently pay an annual deposit premium which is on average 24 basis points less
than the assessment charged to savings banks, commercial banks are able to more
aggressively price loans and deposits. As long as commercial banks maintain this
pricing advantage over Sovereign, it will become increasingly difficult for
Sovereign to maintain and grow its customer base.
While it is uncertain how long this BIF/SAIF assessment rate disparity will
remain in the marketplace, Sovereign believes that over time this inconsistency
may impact the value of Sovereign's franchise. Sovereign is currently monitoring
this issue, and if it determines in future periods that a material impairment to
franchise value has occurred, it will record this impairment in accordance with
generally accepted accounting principles.
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 June 30, 1996 was $16.8
million, an increase of 19% when compared to net income of $14.1 million for the
three-month period ended June 30, 1995. Earnings per share for the three-month
period ended June 30, 1996 were $.28 per share, an increase of 12% when compared
to $.25 for the same period in 1995. Net income for the six-month period ended
June 30, 1996 was $32.5 million or $.55 per share compared to $26.3 million or
$.49 per share 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 14.57% and .77%,
respectively, for the six-month period ended June 30, 1996 compared to 15.25%
and .76%, respectively, for the same period in 1995.
Net Interest Income
Net interest income for the three-month and six-month periods ended June
30, 1996 was $54.9 million and $105.8 million compared to $41.4 million and
$84.1 million for the same periods in 1995. The increase is attributable to an
increase in average balances resulting from internal growth and recent
acquisitions. 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 six-month period ended June 30, 1996 compared to 2.46% for the
same period in 1995.
Interest on investment and mortgage-backed securities available-for-sale
was $7.2 million and $16.1 million for the three-month and six-month periods
ended June 30, 1996 compared to $1.3 million and $2.6 million for the same
periods in 1995. The average balance of investment and mortgage-backed
securities available-for-sale was $475.4 million with an average yield of 6.79%
for the six-month period ended June 30, 1996 compared to an average balance of
$81.3 million with an average yield of 6.79% 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
$45.6 million and $85.2 million for the three-month and six-month periods ended
June 30, 1996 compared to $34.5 million and $66.2 million for the same periods
in 1995. The average balance of investment and mortgage-backed securities
held-to-maturity was $2.39 billion with an average yield of 7.14% for the
six-month period ended June 30, 1996 compared to an average balance of $1.95
billion with an average yield of 6.80% for the same period in 1995.
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Interest and fees on loans were $96.6 million and $187.3 million for the
three-month and six-month periods ended June 30, 1996 compared to $79.7 million
and $156.9 million for the same periods in 1995. The average balance of loans
was $5.06 billion with an average yield of 7.40% for the six-month period ended
June 30, 1996 compared to an average balance of $4.41 billion with an average
yield of 7.12% for the same period in 1995. The increase in the average balance
of loans is primarily due to the origination of new loans.
Interest on deposits was $48.4 million and $100.1 million for the
three-month and six-month periods ended June 30, 1996 compared to $52.4 million
and $101.7 million for the same periods in 1995. The average balance of deposits
was $4.94 billion with an average cost of 4.07% for the six-month period ended
June 30, 1996 compared to an average balance of $4.95 billion with an average
cost of 4.15% for the same period in 1995. Despite a general rise in interest
rates, the cost of deposits has decreased due to increased balances of lower
interest rate deposit products.
Interest on borrowings was $46.9 million and $84.2 million for the
three-month and six-month periods ended June 30, 1996 compared to $22.5 million
and $41.8 million for the same periods in 1995. The average balance of
borrowings was $2.85 billion with an average cost of 5.94% for the six-month
period ended June 30, 1996 compared to an average balance of $1.45 billion with
an average cost of 5.78% for the same period in 1995. The increase in the
average balance of borrowings is the result of balance sheet growth being funded
principally by borrowings. The cost of borrowings has increased due to a general
rise in interest rates.
Provision for Possible Loan Losses
The provision for possible loan losses was $516,000 and $1.0 million for
the three-month and six-month periods ended June 30, 1996 compared to $250,000
and $500,000 for the same periods in 1995. See "Financial Condition - 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)
Six-Month Period Ended June 30,
1996 1995
------- -------
Allowance, beginning of period $34,856 $36,289
Charge-offs:
Residential 1,713 1,448
Consumer 466 279
Commercial Real Estate 56 481
------- -------
Total Charge-offs 2,235 2,208
------- -------
Recoveries:
Residential 175 209
Consumer 30 13
Commercial Real Estate 64 -
------- ------
Total Recoveries 269 222
------- -------
Charge-offs, net of recoveries 1,966 1,986
Provision for possible loan losses 1,016 500
Acquired reserves and other additions 714 -
------- ------
Allowance, end of period $34,620 $34,803
======= =======
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Other Income
Other income was $5.4 million and $10.3 million for the three-month and
six-month periods ended June 30, 1996, compared to $9.3 million and $14.2
million for the same periods in 1995.
Other loan fees and service charges were $1.3 million and $2.4 million for
the three-month and six-month periods ended June 30, 1996 compared to $1.1
million and $2.3 million for the same periods in 1995. Other loan fees and
service charges result primarily from Sovereign's loan servicing portfolio.
Sovereign serviced $4.49 billion of its own loans and $1.11 billion of loans for
others at June 30, 1996 compared to $3.82 billion of its own loans and $852.0
million of loans for others at June 30, 1995.
Deposit fees were $2.7 million and $5.1 million for the three-month and
six-month periods ended June 30, 1996 compared to $1.9 million and $4.2 million
for the same periods in 1995. This increase is primarily the result of an
increase in the number of transaction accounts and recent acquisitions.
Mortgage banking gains were $442,000 and $929,000 for the three-month and
six-month periods ended June 30, 1996 compared to $4.1 million and $4.8 million
for the same periods in 1995. This decrease is largely due to a non-recurring
gain of $3.6 million from the sale of $238.5 million of mortgage servicing
rights in May 1995.
Miscellaneous income was $967,000 and $1.6 million for the three-month and
six-month periods ended June 30, 1996 compared to $2.1 million and $2.8 million
for the same periods in 1995. This decrease is primarily due to a non-recurring
gain of $1.5 million from the sale of deposits in April 1995.
General and Administrative Expenses
Total general and administrative expenses were $29.9 million and $56.9
million for the three-month and six-month periods ended June 30, 1996 compared
to $25.7 million and $51.0 million for the same periods in 1995. The ratio of
general and administrative expenses to average assets for the three-month period
ended June 30, 1996 was 1.39% 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 $2.8 million and $5.8 million for the
three-month and six-month periods ended June 30, 1996 compared to $3.2 million
and $6.7 million for the same periods in 1995.
Income Tax Provision
The income tax provision was $10.3 million and $19.9 million for the
three-month and six-month periods ended June 30, 1996 compared to $7.3 million
and $13.8 million for the same periods in 1995. The effective tax rate for both
the three-month and six-month periods ended June 30, 1996 was 38.0% compared to
34.2% and 34.4% for the same periods in 1995.
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
FINANCIAL CONDITION
Loan Portfolio
Sovereign's loan portfolio at June 30, 1996 was $5.72 billion compared to
$4.67 billion at December 31, 1995. This increase is the result of record level
residential first mortgage loan closings. During the six-month period ended June
30, 1996, Sovereign closed approximately $1.35 billion of first mortgage loans
including approximately $1.11 billion of variable rate mortgage loans. This
compares to first mortgage loan closings of $283.3 million including
approximately $195.0 million of variable rate mortgage loans for the same period
in 1995.
Sovereign is currently placing an increased emphasis on commercial loan and
consumer loan originations. As a result, during the six-month period ended June
30, 1996, Sovereign closed $42.4 million of commercial loans and approximately
$321.4 million of consumer loans, including the purchase of $200.0 million of
government guaranteed student loans. These results compare to $3.1 million of
commercial loans and $85.5 million of consumer loans closed during the same
period in 1995.
Sovereign's primary loan products are variable rate mortgage loans on owner
occupied residential real estate. As a result, 83% of Sovereign's total loan
portfolio is secured by residential real estate and 69% of the total loan
portfolio is comprised of variable rate loans. At June 30, 1996, Sovereign's
total loan portfolio included $4.72 billion of first mortgage loans secured
primarily by liens on owner-occupied one-to-four family residential properties
and $474.2 million of home equity loans secured primarily by second mortgages on
owner-occupied one-to-four family residential properties. With its increased
focus on non-residential lending, at June 30, 1996, Sovereign's total loan
portfolio also included $273.6 million of consumer loans and $75.8 million of
commercial loans.
Sovereign places substantially all loans 90 days or more delinquent on
non-performing status. At June 30, 1996, Sovereign's non-performing assets were
$45.4 million compared to $43.7 million at December 31, 1995. The ratio of
non-performing assets to total assets was .49% at June 30, 1996 compared to .54%
at December 31, 1995.
At June 30, 1996, 87% of non-performing assets consisted of loans or real
estate owned (REO) related to residential real estate compared to 84% 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 June 30, 1996 include
$3.9 million of REO which is carried at lower of cost or estimated fair market
value less estimated disposal costs.
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)
June 30, December 31,
1996 1995
-------- ------------
Non-Accrual Loans:
Past due 90 or more days
as to interest or principal:
Residential $35,887 $33,580
Other 4,155 3,902
Past due less than 90 days as to
interest and principal:
Residential 642 644
Other 733 739
------- -------
Total Non-Accrual Loans 41,417 38,865
Restructured Loans 146 296
------- -------
Total Non-Performing Loans 41,563 39,161
------- -------
Real Estate Owned:
Residential 3,167 2,437
Other 701 2,076
------- -------
Total Real Estate Owned 3,868 4,513
------- -------
TOTAL NON-PERFORMING ASSETS 45,431 43,674
------- -------
Past due 90 days or more as to
interest or principal and
accruing interest 97 -
Non-performing assets and loans
past due 90 days or more and
accruing $45,528 $43,674
======= =======
Non-Performing Assets as a
percentage of Total Assets .49% .54%
Non-Performing Loans as a
percentage of Total Loans .72% .83%
Non-Performing Assets as a
percentage of Total Loans
and Real Estate Owned .79% .92%
Allowance for Possible Loan
Losses as a percentage of
Total Non-Performing Assets 75.39% 78.95%
Allowance for Possible Loan
Losses as a percentage of
Total Non-Performing Loans 82.41% 88.05%
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 June 30, 1996, the allowance for
possible loan losses was $34.6 million or .61% 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)
June 30, December 31,
1996 1995
----------------- ---------------------
Balance at End of
Period Attributable to Amount Percent Amount Percent
- ---------------------- ------ ------- ------ -------
Residential real estate $11,944 34.50% $10,520 30.18%
Commercial real estate 1,253 3.62 698 2.00
Commercial 318 .92 181 .52
Consumer 5,156 14.89 4,190 12.02
Unallocated 15,949 46.07 19,267 55.28
------- ------ ------- ------
Total $34,620 100.00% $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 $4.3 million at June 30, 1996. These loans consist of
$2.7 million of multi-family loans, $1.4 million of commercial real estate loans
and $189,000 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 June 30,
1996, total investment and mortgage-backed securities available-for-sale were
$478.5 million compared to $889.5 million at December 31, 1995 and investment
and mortgage-backed securities held-to- maturity were $2.58 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.
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 the effect of
adoption was not material.
Goodwill and Other Intangible Assets
Total goodwill and other intangible assets at June 30, 1996 were $117.4
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 June 30, 1996 were $4.94 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 June 30, 1996 were $3.68 billion of which $2.44 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
balance sheet growth being funded principally by borrowings. For additional
information on borrowings, see Note 7 in the Notes to Consolidated Financial
Statements.
Stockholders' Equity
Total stockholders' equity at June 30, 1996 was $461.5 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 and the acquisition of West Jersey.
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 5.77% for June
30, 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 June 30, 1996, Sovereign had $2.43
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 six-month period ended June 30, 1996, cash and cash equivalents
decreased $864,000. Net cash provided by operating activities was $67.1 million
for the six-month period ended June 30, 1996. Net cash used by investing
activities for the six-month period ended June 30, 1996 was $1.05 billion
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. Net cash
used for purchases of loans was $610.0 million for the six-month period ended
June 30, 1996, an increase of $534.5 million over the same period last year.
This increase is primarily attributable to the purchase of $200.0 million of
government guaranteed student loans and increased purchases of residential
mortgage loans through the secondary market. Sovereign anticipates that this
purchasing activity in the secondary market will continue in the future as long
as market conditions remain favorable. Net cash provided by financing activities
for the six-month period ended June 30, 1996 was $979.2 million which includes
an increase in short-term borrowings of $773.9 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.
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 June 30, 1996, Sovereign Bank and Sovereign Community Bank are both
classified as well capitalized and are in compliance with all capital
requirements. Management anticipates that Sovereign Bank and Sovereign Community
Bank will each continue to be classified as well capitalized and will be in
compliance with all regulatory 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 June 30, 1996:
Sovereign
Sovereign Sovereign Community
Bancorp (1) Bank Bank Requirement
----------- --------- --------- -----------
Stockholders' equity to
total assets 5.02% 6.31% 12.42% None
Tangible capital to tangible
assets 3.78 5.09 8.71 1.50%
Leverage (core) capital to
tangible assets 3.78 5.09 8.71 3.00
Leverage (core) capital to
risk adjusted assets 8.40 11.54 19.90 4.00
Risk-based capital to risk
adjusted assets 13.35 12.27 21.15 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
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 5.62% at June 30, 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.
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 May 31, 1996 (date of earliest event May
31, 1996), contained a press release announcing Sovereign's
completion of the acquisition of West Jersey Bancshares, Inc.
Report on Form 8-K, dated July 29, 1996 (date of earliest event -
July 15, 1996), contained a press release announcing Sovereign's
earnings for the second quarter of 1996.
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.
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(Registrant)
Date August 13, 1996 /s/ Mark R. McCollom
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Mark R. McCollom
Chief Accounting Officer
Date August 13, 1996 /s/ Lawrence M. Thompson, Jr.
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Lawrence M. Thompson, Jr.
Chief Administrative Officer and Secretary