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 September 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 November 13, 1996
- -------------------------- --------------------------------
Common Stock (no par value) 49,342,712 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 September 30, 1996
and December 31, 1995 3
Consolidated Statements of Operations for the three-
month and nine-month periods ended September 30,
1996 and 1995 4
Consolidated Statements of Cash Flows for the nine-
month periods ended September 30, 1996 and 1995 5
Notes to Consolidated Financial Statements 6 - 13
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 14 - 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
September 30, December 31,
1996 1995
------------- ------------
(Unaudited) (Note)
(in thousands, except
per share data)
ASSETS
Cash and amounts due from
depository institutions $ 122,973 $ 130,841
Interest-earning deposits 19,479 16,930
Loans held for resale (approximate fair
value of $14,483 and $71,297 at
September 30, 1996 and December 31, 1995,
respectively) 14,324 70,512
Investment and mortgage-backed securities
available-for-sale 526,700 889,509
Investment and mortgage-backed securities
held-to-maturity (approximate fair value
of $2,434,266 and $2,087,356 at September 30,
1996 and December 31, 1995, respectively) 2,478,239 2,077,212
Loans 5,990,552 4,674,364
Allowance for possible loan losses (34,018) (34,856)
Premises and equipment 53,869 56,951
Real estate owned 4,774 4,514
Accrued interest receivable 52,490 42,785
Goodwill and other intangible assets 114,524 123,243
Other assets 20,730 26,282
---------- ----------
TOTAL ASSETS $9,364,636 $8,078,287
========== ==========
LIABILITIES
Deposits $5,007,118 $5,039,143
Borrowings:
Short-term 2,621,199 1,512,720
Long-term 1,193,629 1,017,936
Advance payments by borrowers
for taxes and insurance 20,866 22,117
Other liabilities 61,743 59,346
---------- ----------
TOTAL LIABILITIES 8,904,555 7,651,262
---------- ----------
STOCKHOLDERS' EQUITY
Preferred stock; no par value; $50 liquidation preference; 7,500,000 shares
authorized; 2,000,000 shares issued at September 30, 1996
and December 31, 1995, respectively 96,446 96,446
Common stock; no par value;
100,000,000 shares authorized;
52,912,514 shares issued at September 30,
1996 and 48,438,944 shares issued at
December 31, 1995 276,498 248,875
Unallocated common stock held by the Employee
Stock Ownership Plan at cost;
3,198,036 shares at September 30, 1996
and 2,974,346 at December 31, 1995, respectively (30,278) (28,772)
Unrecognized gain on investment
and mortgage-backed securities
available-for-sale, net of tax 1,989 3,988
Retained earnings 115,452 106,488
Treasury stock at cost; 2,556 shares
at September 30, 1996 (26) --
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 460,081 427,025
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $9,364,636 $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 Nine-Month Period
Ended September 30, Ended September 30,
------------------- -------------------
1996 1995 1996 1995
---- ---- ---- ----
(in thousands, except per share data)
Interest income:
Interest on interest-earning deposits $ 785 $ 1,037 $ 2,350 $ 2,930
Interest and dividends on investment
and mortgage-backed securities
available-for-sale 8,083 1,683 24,192 4,270
Interest and dividends on investment
and mortgage-backed securities
held-for-maturity 45,174 41,776 130,345 108,018
Interest and fees on loans 107,633 84,331 294,907 241,238
-------- -------- -------- -------
Total interest income 161,675 128,827 451,794 356,456
-------- -------- -------- -------
Interest expense:
Interest on deposits 50,356 53,678 150,453 155,418
Interest on borrowings 56,103 31,472 140,332 73,250
-------- -------- -------- -------
Total interest expense 106,459 85,150 290,785 228,668
-------- -------- -------- -------
Net interest income 55,216 43,677 161,009 127,788
Provision for possible loan losses 500 250 1,516 750
-------- -------- -------- -------
Net interest income after provision for
possible loan losses 54,716 43,427 159,493 127,038
-------- -------- -------- -------
Other income:
Other loan fees and service charges 1,348 1,053 3,749 3,349
Deposit fees 2,852 2,211 7,993 6,396
Gain on sale of loans and investment
and mortgage-backed securities
available-for-sale 1,360 36 1,538 172
Gain on sale of loans held for resale 239 757 1,168 5,546
Miscellaneous income 935 837 2,584 3,592
-------- -------- -------- -------
Total other income 6,734 4,894 17,032 19,055
-------- -------- -------- -------
General and administrative expenses:
Salaries and employee benefits 14,298 9,960 38,380 30,297
Occupancy and equipment expenses 5,387 4,526 16,533 14,369
Outside services 3,986 2,213 10,572 7,978
Deposit insurance premiums 2,343 2,867 7,244 8,459
Advertising 682 724 3,019 3,191
Other administrative expenses 3,854 3,391 11,658 10,393
-------- -------- ------- ------
Total general and administrative expenses 30,550 23,681 87,406 74,687
-------- -------- ------- ------
Other operating expenses:
Non-recurring SAIF assessment 27,818 -- 27,818 --
Amortization of goodwill and other intangibles 2,942 2,998 8,829 9,078
Real estate owned losses/(gains), net 106 (232) 57 403
-------- -------- ------- ------
Total other operating expenses 30,866 2,766 36,704 9,481
-------- -------- ------- ------
Income before income taxes 34 21,874 52,415 61,925
Income tax provision 6 7,436 19,911 21,214
-------- -------- -------- --------
Net Income (2) $ 28 $ 14,438 $ 32,504 $ 40,711
======== ======== ======== ========
Net (Loss)/Income Applicable to Common Stock $ (1,534) $ 12,875 $ 27,817 $ 37,585
======== ======== ======== ========
Earnings per share (1) (2) $.00 $.24 $.55 $.73
======== ======== ======== ========
Dividends per share (1) $.021 $.021 $.063 $.063
======== ======== ======== ========
(1) Per share amounts have been adjusted to reflect all stock dividends and
stock splits.
(2) Excluding the non-recurring SAIF assessment of $27.8 million
paid in September 1996, net income and earnings per share were $17.3 million and
$.29 per share, respectively, for the three-month period ended September 30,
1996 and $49.8 million and $.84 per share, respectively, for the nine-month
period ended September 30, 1996.
See accompanying notes to consolidated financial statements.
-4-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine-Month Period
Ended September 30,
-----------------------------------
1996 1995
---- ----
(in thousands)
Cash Flows from Operating Activities:
Net income $ 32,504 $ 40,711
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for possible loan losses and deferred taxes 7,564 3,936
Depreciation 4,402 3,734
Amortization 2,781 1,331
Gain on sale of loans, investment and
mortgage-backed securities and real estate owned (744) (1,480)
Net change in:
Loans held for resale 56,188 (32,114)
Accrued interest receivable (9,151) (10,797)
Prepaid expenses and other assets 1,053 4,521
Other liabilities 1,359 3,790
----------- ----------
Net cash provided by operating activities 95,956 13,632
----------- ----------
Cash Flows from Investing Activities:
Proceeds from sales of investment
and mortgage-backed securities:
Available-for-sale 519,227 36,285
Proceeds from repayments and maturities of investment
and mortgage-backed securities:
Available-for-sale 90,800 --
Held-to-maturity 366,488 179,127
Purchases of investment and mortgage-backed securities:
Available-for-sale (248,060) (64,719)
Held-to-maturity (750,867) (1,082,382)
Proceeds from sales of loans 6,219 5,954
Purchase of loans (666,412) (228,449)
Net change in loans other than purchases and sales (580,134) (52,523)
Proceeds from sales of premises and equipment 2,527 10,497
Purchases of premises and equipment (3,305) (11,946)
Proceeds from sale of real estate owned 4,345 4,328
Net cash received from business combinations 4,983 --
----------- ----------
Net cash used by investing activities (1,254,189) (1,203,828)
----------- ----------
Cash Flows from Financing Activities:
Assumption of deposits -- 748,631
Net (decrease)/increase in deposits (118,671) 152,958
Net increase/(decrease)in short-term borrowings 502,786 (509,309)
Proceeds from long-term borrowings 785,001 732,499
Repayments of long-term borrowings -- (714)
Net increase in advance payments by
borrowers for taxes and insurance (1,366) (6,477)
Proceeds from issuance of common stock 3,114 2,238
Proceeds from issuance of preferred stock -- 96,660
Cash dividends paid (7,924) (6,284)
Advance to the Employee Stock Ownership Plan (10,000) (30,000)
Purchase of Treasury Stock (26) --
----------- -----------
Net cash provided by financing activities 1,152,914 1,180,202
----------- -----------
Net change in cash and cash equivalents (5,319) (9,994)
Cash and cash equivalents at beginning of period 147,771 39,401
----------- -----------
Cash and cash equivalents at end of period $ 142,452 $ 129,407
=========== ===========
Reconciliation of Cash and Cash Equivalents to Consolidated
Balance Sheets:
Cash and amounts due from depository institutions $ 122,973 $ 116,406
Interest-earning deposits 19,479 13,001
----------- -----------
$ 142,452 $ 129,407
=========== ===========
Supplemental Disclosures:
Income tax payments totaled $27.9 million for the nine-month period ended
September 30, 1996 and $12.1 million for the same period in 1995. Interest
payments totaled $278.5 million for the nine-month period ended September 30,
1996 and $215.3 million for the same period in 1995. Noncash activity consisted
of mortgage loan securitization of $313.1 million for the nine-month period
ended September 30, 1996 and $112.3 million for the same period in 1995;
reclassification of long-term borrowings to short-term borrowings of $629.7
million for the nine-month period ended September 30, 1996 and $226.4 million
for the same period in 1995; and reclassification of mortgage loans to real
estate owned of $5.6 million for the nine-month period ended September 30, 1996
and $4.2 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.
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 results could differ from those estimates.
The results of operations for the nine-month period ended September 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
nine-month periods ended September 30, 1996 were 60.3 million and 59.6 million
compared to 59.6 million and 55.8 million for the same periods in 1995. 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)
September 30, 1996
------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
--------- ------------ ------------ -----
Investment Securities:
U.S. Treasury and
government agency $ 4,976 $ 47 $ -- $ 5,023
Equity Securities 305,506 1,780 32 307,254
Mortgage-backed Securities:
FHLMC -- -- -- --
FNMA -- -- -- --
GNMA -- -- -- --
Collateralized mortgage
obligations 212,957 1,702 236 214,423
-------- ------- ------ --------
Total investment and
mortgage-backed securities
available-for-sale $523,439 $ 3,529 $ 268 $526,700
======== ======= ====== ========
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 57 138,445
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)
September 30, 1996
------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
--------- ------------ ------------ -----
Investment Securities:
U.S. Treasury and
government agency $ 8,772 $ 54 $ 42 $ 8,784
Corporate securities 1,007 28 -- 1,035
Other securities 400 -- -- 400
Mortgage-backed Securities:
FHLMC 143,864 789 4,930 139,723
FNMA 197,099 297 6,893 190,503
GNMA 192,862 2,556 933 194,485
RTC 25,563 -- 4,276 21,287
Private issues 258,146 11 8,669 249,488
Collateralized mortgage
obligations 1,650,526 2,671 24,636 1,628,561
---------- ------- ------- ----------
Total investment and
mortgage-backed securities
held-to-maturity $2,478,239 $ 6,406 $50,379 $2,434,266
========== ======= ======= ==========
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)
September 30, 1996 December 31, 1995
-------------------------- --------------------------
Amount Percent Amount Percent
------ ------- ------ -------
Residential real estate loans $4,938,544 82.44% $3,998,048 85.53%
Real estate construction loans:
Residential (net of loans in process
of $54,036 and $23,365, respectively) 65,711 1.10 38,151 .82
Residential development (net of loans
in process of $0 and $736,
respectively) 4,239 .07 1,676 .04
Multi-family loans 62,264 1.04 75,218 1.61
---------- ------ ---------- ------
Total Residential Loans 5,070,758 84.65 4,113,093 88.00
Commercial real estate loans 64,048 1.07 47,177 1.01
Commercial loans 82,855 1.38 15,831 .34
Consumer loans (1) 722,891 12.90 498,263 10.65
---------- ------- ---------- -------
Total Loans $5,990,552 100.00% $4,674,364 100.00%
========== ======= ========== =======
Total Loans with:
Fixed rates $1,197,727 19.99% $1,134,542 24.27%
Variable rates 4,792,825 80.01 3,539,822 75.73
---------- ------- ---------- -------
Total Loans $5,990,552 100.00% $4,674,364 100.00%
========== ======= ========== =======
(1) Consumer loan balances include home equity loans of $495.5 million at
September 30, 1996 and $456.9 million at December 31, 1995.
-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)
September 30, 1996 December 31, 1995
-------------------------------------- --------------------------------------
Weighted Weighted
Average Average
Account Type Amount Percent Rate Amount Percent Rate
------ ------- -------- ------ ------- --------
Retail certificates $2,710,924 54.14% 5.30% $2,731,009 54.20% 5.48%
Jumbo certificates 81,826 1.64 5.43 112,063 2.22 5.70
Savings accounts 992,333 19.82 2.38 925,842 18.37 2.31
Demand deposit accounts 207,309 4.14 -- 168,757 3.35 --
NOW accounts 398,161 7.95 1.25 380,475 7.55 1.26
Money market accounts 616,565 12.31 3.98 720,997 14.31 4.36
---------- ------ ---- ---------- ------ ----
Total Deposits $5,007,118 100.00% 4.02% $5,039,143 100.00% 4.24%
========== ====== ==== ========== ====== ====
(7) BORROWINGS
The following table presents information regarding borrowings at the
dates indicated: (dollars in thousands)
September 30, 1996 December 31, 1995
-------------------------- ---------------------------
Weighted Weighted
Average Average
Balance Rate Balance Rate
------- -------- ------- --------
Securities sold under
repurchase agreements $ 49,753 5.65% $ 382,279 6.38%
FHLB advances 3,597,446 5.82 1,979,551 5.75
Other borrowings 167,629 7.46 168,826 7.49
---------- ---- ---------- ----
Total Borrowings $3,814,828 5.89% $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)
September 30, 1996
----------------------------------------------------------------
Weighted
Average
Notional Book Estimated Maturity
Amount Value Fair Value In Years
-------- ----- ---------- --------
Amortizing interest rate swaps:
Pay variable-receive fixed (1) $ 715,756 $ -- $ (15,822) 3.9
Pay fixed-receive variable (2) 409,614 -- 1,329 2.6
Non-amortizing interest rate swaps:
Pay variable-receive fixed (3) 50,000 -- (2,264) 3.9
Pay fixed-receive variable (4) 830,000 -- 2,487 1.9
Interest rate caps (5) 750,000 9,892 8,707 3.1
---------- ---------- ---------
$2,755,370 $ 9,892 $ (5,563)
========== ========== =========
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 5.60% and 5.56% and the weighted
average receive rate was 5.93% and 5.61% at September 30, 1996 and
December 31, 1995, respectively.
(2) The weighted average pay rate was 6.76% and 6.87% and the weighted
average receive rate was 6.20% and 6.92% at September 30, 1996 and
December 31, 1995, respectively.
(3) The weighted average pay rate was 6.97% and 7.28% and the weighted
average receive rate was 6.75% and 6.75% at September 30, 1996 and
December 31, 1995, respectively.
(4) The weighted average pay rate was 5.26% and 5.91% and the weighted
average receive rate was 5.60% and 5.89% at September 30, 1996 and
December 31, 1995, respectively.
(5) The weighted average contract rate was 5.83% and 6.36% at
September 30, 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
---------- -------- ----------
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
---------- -------- ----------
Additions -- -- --
Maturities/Amortization 19,193 -- --
Terminations -- 50,000 --
---------- -------- ----------
Balance, September 30, 1996 $1,125,370 $880,000 $ 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 14 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 5.1 million new shares in connection with the
transaction, which will be tax-free to First State and First State's
shareholders, and is anticipated to be accounted for as a pooling-of-interests.
Sovereign expects the transaction will close early in the first quarter of 1997.
(10) ACCOUNTING CHANGES
In June 1996, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities". This Statement supersedes SFAS No. 122,
"Accounting for Mortgage Servicing Rights", and SFAS No. 65, "Accounting for
Certain Mortgage Banking Activities", although the practice of recording a
servicing asset based on fair value is retained in SFAS No. 125. The Statement
adopts the concept of recording only one "loan servicing asset", which is a
departure from current accounting guidance and results in the elimination of the
terms "normal servicing fee" and "excess servicing fee".
-12-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
Companies are required to adopt SFAS No. 125 on a prospective basis only for
transactions occurring after December 31, 1996. Sovereign intends to adopt
SFAS No. 125 in 1997.
(11) RECENT DEVELOPMENTS
The majority of Sovereign's deposits are insured by the Savings Association
Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC").
As a result, Sovereign pays insurance fees equal to $.23 per $100.00 (23 basis
points) of insured deposits annually, the lowest rate permitted. Banks which are
insured by the Bank Insurance Fund ("BIF") of the FDIC have been required to pay
rates as low as 4.4 basis points since September 30, 1995, and most BIF-insured
institutions have been required to pay only $2,000 in annual insurance premiums
since January 2, 1996. Also, prior to September 30, 1996, legislation was being
considered which would require SAIF-insured banks to pay a one-time assessment
to recapitalize the SAIF fund.
This disparity between SAIF and BIF insurance premiums over the last five
quarters has placed Sovereign at a competitive disadvantage in the markets it
serves. Because BIF-insured institutions have been paying annual deposit
insurance premiums which are up to 23 basis points lower than the rate charged
to Sovereign and other SAIF-insured institutions, BIF-insured banks could more
aggressively price loans and deposits.
In previous quarters, Sovereign disclosed that it was monitoring the
BIF/SAIF disparity and its potential impact on the value of Sovereign's
franchise, specifically certain of its intangible assets. However, at that time
Sovereign was unable to quantify whether or not the value of certain long-lived
assets had been impaired, due to the uncertainty surrounding both the one-time
assessment and the timing of the BIF/SAIF premium disparity.
On September 30, 1996, legislation was signed into law which effectively
ends the BIF/SAIF disparity by the year 2000. As part of the new law, SAIF-
insured institutions were required to make a one-time payment of 65.7 basis
points for all SAIF-insured deposits held as of March 31, 1995. At Sovereign,
this amounted to an after tax charge of $17.2 million.
As a result of the legislation, previous market uncertainties were now
quantifiable, and Sovereign was able to complete its asset impairment study.
After an extensive internal review and consultation with external advisors,
Sovereign has determined that no impairment of franchise value has occurred at
this time. In accordance with generally accepted accounting principles,
Sovereign will continue to monitor the carrying value of its intangible assets
in accordance with its stated policy.
-13-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
RESULTS OF OPERATIONS
General
On September 30, 1996, legislation resolving the disparity between
insurance premiums paid by the Federal Deposit Insurance Corporation's ("FDIC")
Bank Insurance Fund ("BIF") and Savings Association Insurance Fund ("SAIF") was
signed into law. In order to recapitalize the SAIF, all banks and thrifts in the
nation which have SAIF-insured FDIC deposits were required to make a one-time
payment to the FDIC of 65.7 basis points for all SAIF-insured deposits held as
of March 31, 1995. Sovereign's one-time after tax charge was $17.2 million. The
following paragraph presents Sovereign's results of operations for the third
quarter of 1996 excluding this non-recurring charge.
Operating net income for the three-month period ended September 30, 1996
was $17.3 million, an increase of 20% when compared to net income of $14.4
million for the three-month period ended September 30, 1995. Operating earnings
per share for the three-month period ended September 30, 1996 was $.29 per
share, an increase of 21% when compared to $.24 per share for the same period in
1995. Operating net income for the nine-month period ended September 30, 1996
was $49.8 million or $.84 operating earnings per share compared to $40.7 million
or $.73 per share for the same period in 1995.
Actual net income for the three-month period ended September 30, 1996,
which includes the impact of the non-recurring charge for the SAIF assessment,
was $28,000. Hence, Sovereign's reported net income for the nine-month period
ended September 30, 1996 was $32.5 million and earnings per share was $.55.
Earnings per share have been adjusted to reflect all stock dividends and stock
splits.
Return on average equity and return on average assets, excluding the
non-recurring charge, were 14.69% and .77%, respectively, for the nine-month
period ended September 30, 1996 compared to 14.88% and .77% for the same period
in 1995.
Net Interest Income
Net interest income for the three-month and nine-month periods ended
September 30, 1996 was $55.2 million and $161.0 million compared to $43.7
million and $127.8 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 2.50% for the nine-month period ended September 30,
1996 compared to 2.43% for the same period in 1995.
Interest on investment and mortgage-backed securities available-for-sale
was $8.1 million and $24.2 million for the three-month and nine-month periods
ended September 30, 1996 compared to $1.7 million and $4.3 million for the same
periods in 1995. The average balance of investment and mortgage-backed
securities available-for-sale was $474.2 million with an average yield of 7.09%
for the nine-month period ended September 30, 1996 compared to an average
balance of $88.5 million with an average yield of 6.82% 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.
-14-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Interest on investment and mortgage-backed securities held-to-maturity was
$45.2 million and $130.3 million for the three-month and nine-month periods
ended September 30, 1996 compared to $41.8 million and $108.0 million for the
same periods in 1995. The average balance of investment and mortgage-backed
securities held-to-maturity was $2.43 billion with an average yield of 7.15% for
the nine-month period ended September 30, 1996 compared to an average balance of
$2.10 billion with an average yield of 6.87% for the same period in 1995.
Interest and fees on loans were $107.6 million and $294.9 million for the
three-month and nine-month periods ended September 30, 1996 compared to $84.3
million and $241.2 million for the same periods in 1995. The average balance of
loans was $5.34 billion with an average yield of 7.37% for the nine-month period
ended September 30, 1996 compared to an average balance of $4.48 billion with an
average yield of 7.18% for the same period in 1995. The increase in the average
balance of loans is primarily due to stronger loan origination levels in 1996
compared to 1995.
Interest on deposits was $50.4 million and $150.5 million for the
three-month and nine-month periods ended September 30, 1996 compared to $53.7
million and $155.4 million for the same periods in 1995. The average balance of
deposits was $4.95 billion with an average cost of 4.06% for the nine-month
period ended September 30, 1996 compared to an average balance of $4.93 billion
with an average cost of 4.22% 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 $56.1 million and $140.3 million for the
three-month and nine-month periods ended September 30, 1996 compared to $31.5
million and $73.3 million for the same periods in 1995. The average balance of
borrowings was $3.14 billion with an average cost of 5.96% for the nine-month
period ended September 30, 1996 compared to an average balance of $1.66 billion
with an average cost of 5.87% 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 and an extension of the maturity dates of certain
borrowings in order to further reduce interest rate risk.
Provision for Possible Loan Losses
The provision for possible loan losses was $500,000 and $1.5 million for
the three-month and nine-month periods ended September 30, 1996 compared to
$250,000 and $750,000 for the same periods in 1995. See "Financial Condition --
Loan Portfolio" for a discussion of credit quality of Sovereign's loan
portfolio.
-15-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table presents the activity in the allowance for possible
loan losses for the periods indicated: (dollars in thousands)
Nine-Month Period Ended September 30,
1996 1995
-------------------------------------
Allowance, beginning of period $34,856 $36,289
Charge-offs:
Residential 2,777 2,048
Consumer 730 363
Commercial Real Estate 192 486
------- -------
Total Charge-offs 3,699 2,897
------- -------
Recoveries:
Residential 501 291
Consumer 63 19
Commercial Real Estate 65 28
------- -------
Total Recoveries 629 338
------- -------
Charge-offs, net of recoveries 3,070 2,559
Provision for possible loan losses 1,516 750
Acquired reserves and other additions 716 --
------- -------
Allowance, end of period $34,018 $34,480
======= =======
Other Income
Other income was $6.7 million and $17.0 million for the three-month and
nine-month periods ended September 30, 1996, compared to $4.9 million and $19.1
million for the same periods in 1995.
Other loan fees and service charges were $1.3 million and $3.7 million for
the three-month and nine-month periods ended September 30, 1996 compared to $1.1
million and $3.3 million for the same periods in 1995. Other loan fees and
service charges result primarily from Sovereign's loan servicing portfolio.
Sovereign serviced $4.73 billion of its own loans and $1.13 billion of loans for
others at September 30, 1996 compared to $4.03 billion of its own loans and
$891.9 million of loans for others at September 30, 1995.
Deposit fees were $2.9 million and $8.0 million for the three-month and
nine-month periods ended September 30, 1996 compared to $2.2 million and $6.4
million for the same periods in 1995. This increase is primarily the result of
an increase in the number of transaction accounts in 1996 compared to 1995.
Gains on sales of loans and investment and mortgage-backed securities
available-for-sale were $1.4 million and $1.5 million for the three-month and
nine-month periods ended September 30, 1996 compared to $36,000 and $172,000 for
the same periods in 1995. This increase is primarily attributable to the
liquidation of $3.5 million of equity securities in September 1996 in order to
take advantage of favorable market conditions.
Gains on sales of loans held for resale were $239,000 and $1.2 million for
the three-month and nine-month periods ended September 30, 1996 compared to
$757,000 and $5.5 million for the same periods in 1995. The year-to-date
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.
-16-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Miscellaneous income was $935,000 and $2.6 million for the three-month and
nine-month periods ended September 30, 1996 compared to $837,000 and $3.6
million for the same periods in 1995. The year-to-date 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 $30.6 million and $87.4
million for the three-month and nine-month periods ended September 30, 1996
compared to $23.7 million and $74.7 million for the same periods in 1995. The
ratio of general and administrative expenses to average assets for the
three-month period ended September 30, 1996 was 1.32%, a slight increase from
1.27% for the same period in 1995, however a decrease from 1.39% in the second
quarter of 1996 and 1.35% in the first quarter of 1996. The ratio of general and
administrative expenses to average assets for the nine-month period ended
September 30, 1996 was 1.35%, an improvement from 1.42% for the same period in
1995.
Other operating expenses were $30.9 million and $36.7 million for the
three-month and nine-month periods ended September 30, 1996 compared to $2.8
million and $9.5 million for the same periods in 1995. This increase is
primarily the result of a non-recurring assessment charge of $27.8 million paid
to the FDIC for the recapitalization of the SAIF in September 1996.
Income Tax Provision
The income tax provision was $6,000 and $19.9 million for the three-month
and nine-month periods ended September 30, 1996 compared to $7.4 million and
$21.2 million for the same periods in 1995. The effective tax rate for the
three-month and nine-month periods ended September 30, 1996 was 17.6% and 38.0%
compared to 34.0% and 34.3% for the same periods in 1995. The decrease in the
income tax provision and the effective tax rate for the three-month period ended
September 30, 1996 is attributable to pre-tax income for the third quarter of
1996 of $34,000 resulting from a non-recurring assessment charge of $27.8
million paid to the FDIC for the recapitalization of SAIF in September 1996.
Sovereign's after tax assessment charge was $17.2 million.
FINANCIAL CONDITION
Loan Portfolio
Sovereign's loan portfolio at September 30, 1996 was $5.99 billion compared
to $4.67 billion at December 31, 1995. This increase is the result of record
level residential first mortgage loan closings in 1996. During the nine-month
period ended September 30, 1996, Sovereign closed approximately $1.80 billion of
first mortgage loans including approximately $1.49 billion of variable rate
mortgage loans. This compares to first mortgage loan closings of $525.7 million
including approximately $288.9 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 nine-month period ended
September 30, 1996, Sovereign closed $83.1 million of commercial loans and
approximately $406.9 million of consumer loans, including the purchase of
-17-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
$200.0 million of government guaranteed student loans during the second quarter.
These results compare to $3.1 million of commercial loans and $134.4 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, 82% of Sovereign's total loan
portfolio is secured by residential real estate and 80% of the total loan
portfolio is comprised of variable rate loans. At September 30, 1996,
Sovereign's total loan portfolio included $4.94 billion of first mortgage loans
secured primarily by liens on owner-occupied one-to-four family residential
properties. With its increased focus on non-residential lending, at September
30, 1996, Sovereign's total loan portfolio also included $82.9 million of
commercial loans and $772.9 million of consumer loans, including $495.5 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 September 30, 1996, Sovereign's non-performing assets
were $51.4 million compared to $43.7 million at December 31, 1995. The ratio of
non-performing assets to total assets was .55% at September 30, 1996 compared to
.54% at December 31, 1995.
At September 30, 1996, 89% 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 September 30, 1996
include $4.8 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)
September 30, December 31,
1996 1995
------------- ------------
Non-Accrual Loans:
Past due 90 or more days
as to interest or principal:
Residential $40,752 $33,580
Other 4,401 3,902
Past due less than 90 days as to interest and principal:
Residential 640 644
Other 730 739
------- -------
Total Non-Accrual Loans 46,523 38,865
Restructured Loans 146 296
------- ------
Total Non-Performing Loans 46,669 39,161
------- ------
Real Estate Owned:
Residential 4,144 2,437
Other 630 2,076
------- ------
Total Real Estate Owned 4,774 4,513
------- ------
TOTAL NON-PERFORMING ASSETS 51,443 43,674
------- ------
Past due 90 days or more as to
interest or principal and
accruing interest (1) 11,860 --
Non-performing assets and loans
past due 90 days or more and
accruing $63,303 $43,674
======= =======
Non-Performing Assets as a
percentage of Total Assets .55% .54%
Non-Performing Loans as a
percentage of Total Loans .78% .83%
Non-Performing Assets as a
percentage of Total Loans
and Real Estate Owned 1.05% .92%
Allowance for Possible Loan
Losses as a percentage of
Total Non-Performing Assets 64.69% 78.95%
Allowance for Possible Loan
Losses as a percentage of
Total Non-Performing Loans 71.30% 88.05%
(1) At September 30, 1996, non-performing assets past due 90 days or more as to
interest or principal and accruing interest include $11.6 million of
government-guaranteed student loans which are 100% guaranteed and Sovereign
retains minimal risk of credit losses related to these loans.
-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 September 30, 1996, the allowance for
possible loan losses was $34.0 million or .57% 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)
September 30, December 31,
1996 1995
Balance at End of ----------------------------------------
Period Attributable to Amount Percent Amount Percent
- ---------------------- ------ ------- ------ -------
Residential real estate $12,455 36.61% $10,520 30.18%
Commercial real estate 1,665 4.89 698 2.00
Commercial 359 1.06 181 .52
Consumer 5,394 15.86 4,190 12.02
Unallocated 14,145 41.58 19,267 55.28
------- ------ ------- ------
Total $34,018 100.00% $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 $6.8 million at September 30, 1996. These loans
consist of $5.7 million of multi-family loans and $1.1 million of commercial
real estate 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 September
30, 1996, total investment and mortgage-backed securities available-for-sale
were $526.7 million compared to $889.5 million at December 31, 1995 and
investment and mortgage-backed securities held-to-maturity were $2.48 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.
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
-20-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
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 September 30, 1996 were
$114.5 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 September 30, 1996 were $5.01 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 September 30, 1996 were $3.81 billion of which $2.62
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 September 30, 1996 was $460.1 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
Bancshares, Inc. during the second quarter of 1996.
-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's banking subsidiaries are required under applicable federal
regulations to maintain specified levels of "liquid" investments in cash and
U.S. Treasury and other qualifying investments. Regulations currently in effect
require Sovereign's banking subsidiaries to maintain liquid assets of not less
than 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. The
liquidity ratio of Sovereign Bank and Sovereign Community Bank for September 30,
1996 was 5.56% and 114.96%, respectively.
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 September 30, 1996, Sovereign had
$2.80 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 nine-month period ended September 30, 1996, cash and cash
equivalents decreased $5.3 million. Net cash provided by operating activities
was $96.0 million for the nine-month period ended September 30, 1996. Net cash
used by investing activities for the nine-month period ended September 30, 1996
was $1.25 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 $666.4 million for
the nine-month period ended September 30, 1996, an increase of $438.0 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. Net cash
provided by financing activities for the nine-month period ended September 30,
1996 was $1.15 billion which includes an increase in short-term borrowings of
$502.8 million and an increase in proceeds from long-term borrowings of $785.0
million which were the result of a year-to-date 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
-22-
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
capital for regulatory capital purposes. Implementation of this interest rate
risk capital deduction has been delayed by the OTS until further notification.
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 September 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 September 30, 1996:
Sovereign
Sovereign Sovereign Community
Bancorp (1) Bank Bank Requirement
----------- --------- --------- -----------
Stockholders' equity to
total assets 4.91% 6.22% 6.81% None
Tangible capital to tangible
assets 3.63 5.04 5.02 1.50%
Leverage (core) capital to
tangible assets 3.63 5.04 5.02 3.00
Leverage (core) capital to
risk adjusted assets 7.80 11.16 14.38 4.00
Risk-based capital to risk
adjusted assets 12.43 11.85 15.63 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
-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 7.65% at September 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 and prepayment 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.
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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 October 30, 1996 (date of earliest event -
October 22, 1996), contained a press release announcing Sovereign's
earnings for the third quarter of 1996.
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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 November 13, 1996 /s/Karl D. Gerhart
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Karl D. Gerhart
Chief Financial Officer
Date November 13, 1996 /s/Mark R. McCollom
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Mark R. McCollom
Chief Accounting Officer
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