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, 2001
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.)
2000 Market Street, Philadelphia, Pennsylvania 19103
- ----------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (215) 557-4630
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 9, 2001
- ------------------------------- ------------------------------
Common Stock (no par value) 246,905,532 shares
FORWARD LOOKING STATEMENTS
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Sovereign Bancorp, Inc. ("Sovereign" or "the Company") may from time to
time make "forward-looking statements," including statements contained in
Sovereign's filings with the Securities and Exchange Commission (including this
Quarterly Report on Form 10-Q and the Exhibits hereto), in its reports to
shareholders (including its 2000 Annual Report) and in other communications by
Sovereign, which are made in good faith by Sovereign, pursuant to the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include statements with respect to
Sovereign's vision, mission, strategies, goals, beliefs, plans, objectives,
expectations, anticipations, estimates, intentions, financial condition, results
of operations, future performance and business of Sovereign, including: (i)
statements relating to Sovereign's expectations and goals with respect to (a)
growth in cash earnings, operating earnings, net income, shareholder value and
internal tangible equity generation; (b) growth in earnings per share; (c)
return on equity; (d) return on assets; (e) efficiency ratio; (f) tier 1
leverage ratio; (g) annualized net charge-offs and other asset quality measures;
(h) fee income as a percentage of total revenue; (i) tangible equity to assets;
(j) book value and tangible book value per share; (k) loan and deposit portfolio
compositions, employee retention, deposit retention, asset quality, reserve
adequacy; and (ii) statements preceded by, followed by or that include the words
"may," "could," "should," "pro forma," "looking forward," "would," "believe,"
"expect," "anticipate," "estimate," "intend," "plan," "strive," "hopefully,"
"try," or similar expressions. Although we believe that the expectations
reflected in our forward-looking statements are reasonable, these
forward-looking statements involve risks and uncertainties which are subject to
change based on various important factors (some of which, in whole or in part,
are beyond Sovereign's control). The following factors, among others, could
cause Sovereign's financial performance to differ materially from the goals,
plans, objectives, intentions and expectations, forecasts and projections (and
underlying assumptions) expressed in such forward-looking statements: (1) the
strength of the United States economy in general and the strength of the
regional and local economies in which Sovereign conducts operations, (2) the
effects of, and changes in, trade, monetary and fiscal policies and laws,
including interest rate policies of the Board of Governors of the Federal
Reserve System; (3) inflation, interest rate, market and monetary fluctuations;
(4) the ability of Sovereign and Sovereign Bank to successfully integrate the
assets, liabilities, customers, systems and management we acquire into our
operations; (5) expected revenue synergies and cost savings from Sovereign and
Sovereign Bank's acquisitions may not be fully realized or realized within the
expected time frame; (6) the timely development of competitive new products and
services by Sovereign and the acceptance of such products and services by
customers; (7) the willingness of customers to substitute competitors' products
and services and vice versa; (8) the success of Sovereign and Sovereign Bank in
meeting the post-closing regulatory requirements with respect to the FleetBoston
acquisition and the ability to pay installments on a timely basis related to the
non-solicitation agreement in connection with the acquisition; (9) the impact of
changes in financial services' laws and regulations and the application of such
laws and regulations (including laws concerning taxes, capital, liquidity,
proper accounting treatment, securities and insurance) and the impact of changes
in generally accepted accounting principles; (10) technological changes; (11)
changes in consumer spending and
FORWARD LOOKING STATEMENTS
(continued)
savings habits; (12) unanticipated regulatory or judicial proceedings; (13)
changes in asset quality; and (14) the success of Sovereign at managing the
risks involved in the foregoing.
Sovereign cautions that the foregoing list of important factors is not
exclusive, and neither such list nor any such forward-looking statement takes
into account the impact that any future acquisition may have on Sovereign and
any such forward-looking statement, Sovereign does not undertake to update any
forward-looking statement, whether written or oral, that may be made from time
to time by or on behalf of Sovereign.
Operating earnings, cash earnings and core revenue, as defined, and the
related ratios using these measures are not a substitute for other financial
measures determined in accordance with generally accepted accounting principles
("GAAP"). Because all companies do not calculate these non-GAAP measures in the
same fashion, these measures as presented may not be comparable to other
similarly titled measures of other companies.
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at June 30, 2001
and December 31, 2000 5
Consolidated Statements of Operations for the three-
month and six-month periods ended June 30, 2001 and 2000 6 - 7
Consolidated Statement of Stockholders' Equity for
the six-month period ended June 30, 2001 8
Consolidated Statements of Cash Flows for the six-month
periods ended June 30, 2001 and 2000 9
Notes to Consolidated Financial Statements 10 - 18
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 19 - 34
PART II. OTHER INFORMATION
Item 6. Reports on Form 8-K 35
SIGNATURES 36
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2001 2000
------------ ------------
(Unaudited)
(in thousands, except
per share data)
ASSETS
Cash and amounts due from
depository institutions $ 920,217 $ 945,196
Interest-earning deposits 54,780 14,447
Investment securities:
Available-for-sale 8,125,693 5,315,584
Held-to-maturity
(fair value of $1,030,361 and $1,971,896) 1,033,680 1,978,268
Loans (including loans held for sale
at approximate fair value of $259,824
and $59,993) 20,762,751 21,912,245
Allowance for loan losses (256,048) (256,356)
Premises and equipment 260,200 290,134
Other real estate owned
and other repossessed assets 10,886 8,183
Accrued interest receivable 201,657 230,514
Goodwill and other intangible assets ($940,203
and $968,631 net of tax) 1,408,595 1,455,331
Bank owned life insurance 687,889 668,654
Other assets 1,180,800 895,597
------------ ------------
TOTAL ASSETS $ 34,391,100 $ 33,457,797
============ ============
LIABILITIES
Deposits and other customer accounts $ 23,340,962 $ 24,498,917
Short-term borrowings 2,894,409 1,331,692
Long-term borrowings:
FHLB advances and repurchase agreements 4,060,935 3,544,984
Senior secured credit facility 350,000 350,000
Senior notes and subordinated debentures 947,285 1,013,632
Advance payments by borrowers
for taxes and insurance 24,204 24,009
Other liabilities 209,465 287,464
------------ ------------
TOTAL LIABILITIES 31,827,260 31,050,698
------------ ------------
Mandatorily redeemable capital securities
("Trust Preferred Securities") and other
minority interest of subsidiaries 460,355 458,215
------------ ------------
STOCKHOLDERS' EQUITY
Common stock; no par value; 400,000,000 shares
authorized; 252,008,729 shares
issued at June 30, 2001 and 231,465,030 shares
issued at December 31, 2000 1,411,834 1,259,374
Warrants 91,500 91,500
Unallocated common stock held by the Employee
Stock Ownership Plan at cost;
4,565,924 shares at June 30, 2001
and December 31, 2000 (33,230) (33,230)
Treasury stock at cost; 125,188 shares at
June 30, 2001 and 397,756 shares at
December 31, 2000 (629) (3,789)
Restricted stock at cost; 559,791 shares
at June 30, 2001 (6,272) --
Accumulated other comprehensive (loss) (55,813) (38,521)
Retained earnings 696,095 673,550
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 2,103,485 1,948,884
------------ ------------
TOTAL LIABILITIES, MINORITY INTERESTS
AND STOCKHOLDERS' EQUITY $ 34,391,100 $ 33,457,797
============ ============
See accompanying notes to consolidated financial statements.
- 5 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three-Month Period Six-Month Period
Ended June 30, Ended June 30,
----------------------------- -----------------------------
2001 2000 2001 2000
----------- ----------- ----------- -----------
(in thousands, except
per share data)
Interest income:
Interest-earning deposits $ 340 $ 7,920 $ 854 $ 10,198
Investment securities:
Available-for-sale 120,432 135,861 227,199 273,607
Held-to-maturity 18,052 38,322 37,449 75,526
Interest and fees on loans 418,783 375,490 871,951 670,143
----------- ----------- ----------- -----------
Total interest income 557,607 557,593 1,137,453 1,029,474
----------- ----------- ----------- -----------
Interest expense:
Interest on deposits
and other customer accounts 192,981 163,945 414,095 282,144
Interest on short-term and
long-term borrowings 106,303 206,834 217,555 401,264
----------- ----------- ----------- -----------
Total interest expense 299,284 370,779 631,650 683,408
Net interest income 258,323 186,814 505,803 346,066
Provision for loan losses 23,100 10,000 43,100 18,000
----------- ----------- ----------- -----------
Net interest income after provision for
loan losses 235,223 176,814 462,703 328,066
----------- ----------- ----------- -----------
Non-interest income:
Consumer banking fees 39,480 19,427 78,912 34,796
Commercial banking fees 17,762 9,734 36,027 12,209
Mortgage banking revenues 14,757 7,383 36,071 12,669
Capital markets revenue 2,427 413 5,896 4,145
Bank owned life insurance 10,076 7,772 19,667 13,771
Miscellaneous income 33,953 1,765 42,621 13,034
----------- ----------- ----------- -----------
Total fees and other income 118,455 46,494 219,194 90,624
Gain/(loss) on investment
securities transactions 5,752 (58,216) 13,096 (81,088)
----------- ----------- ----------- -----------
Total non-interest income 124,207 (11,722) 232,290 9,536
----------- ----------- ----------- -----------
General and administrative expenses:
Compensation and benefits 81,087 69,115 158,717 115,224
Occupancy and equipment expenses 54,330 31,043 111,084 51,816
Technology expense 18,769 11,734 34,788 20,889
Outside services 14,854 43,206 28,553 56,313
Other administrative expenses 33,503 52,997 61,664 77,731
----------- ----------- ----------- -----------
Total general and administrative expenses 202,543 208,095 394,806 321,973
----------- ----------- ----------- -----------
- 6 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(continued)
Three-Month Period Six-Month Period
Ended June 30, Ended June 30,
--------------------------- ----------------------------
2001 2000 2001 2000
--------- --------- --------- ---------
(in thousands, except
per share data)
Other expenses:
Amortization of goodwill $ 32,788 $ 20,461 $ 68,864 $ 30,145
Trust Preferred Securities and
other minority interest expense 14,590 9,320 29,074 18,248
Real estate owned loss/(gain), net 111 (66) 123 (221)
Non-solicitation expense 72,216 -- 144,432 --
Restructuring expense -- -- 8,500 --
--------- --------- --------- ---------
Total other expenses 119,705 29,715 250,993 48,172
--------- --------- --------- ---------
Income/(loss) before income taxes
and extraordinary item 37,182 (72,718) 49,194 (32,543)
Income tax provision/(benefit) 7,000 (24,016) 7,900 (10,766)
--------- --------- --------- ---------
Income/(loss) before extraordinary item 30,182 (48,702) 41,294 (21,777)
Extraordinary item (net of tax of
($3,526) and $5,225) -- -- (6,549) 10,775
--------- --------- --------- ---------
Net income/(loss) $ 30,182 $ (48,702) $ 34,745 $ (11,002)
========= ========= ========= =========
Earnings/(loss) per share:
Basic
Income/(loss) before extraordinary item $ .12 $ (.22) $ .17 $ (.10)
Extraordinary item -- -- (.03) .05
--------- --------- --------- ---------
Net income/(loss) $ .12 $ (.22) $ .14 $ (.05)
========= ========= ========= =========
Diluted
Income/(loss) before extraordinary item $ .12 $ (.22) $ .17 $ (.10)
Extraordinary item -- -- (.03) .05
--------- --------- --------- ---------
Net income/(loss) $ .12 $ (.22) $ .14 $ (.05)
========= ========= ========= =========
Dividends declared per common share $ .025 $ .025 $ .050 $ .050
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
- 7 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(unaudited)
(in thousands)
Common
Shares Common Retained Treasury
Outstanding Stock Warrants Earnings Stock
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2000 226,501 $ 1,259,374 $ 91,500 $ 673,550 $ (3,789)
Comprehensive income:
Net income -- -- -- 34,745 --
Effect of change in accounting
principle -- -- -- -- --
Change in unrecognized gain/(loss)
net of tax on investments
available-for-sale and derivative
financial instruments -- -- -- -- --
Total comprehensive income -- -- -- -- --
Issuance of common stock 20,000 149,000 -- -- --
Exercise of stock options 319 1,659 -- -- --
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan 225 1,833 -- -- --
Dividends paid on common stock -- -- -- (12,200) --
Treasury stock purchases (45) -- -- -- (479)
Treasury stock sold 318 (32) -- -- 451
Purchase and transfer of shares
for restricted stock plan (560) -- -- -- 3,188
----------- ----------- ----------- ----------- -----------
Balance, June 30, 2001 246,758 $ 1,411,834 $ 91,500 $ 696,095 $ (629)
=========== =========== =========== =========== ===========
[RESTUBBED]
Accumulated Total
Unallocated Other Stock-
Restricted Common Stock Comprehensive Holders'
Stock Held by ESOP Income/(Loss) Equity
----------- ----------- ----------- -----------
Balance, December 31, 2000 $ -- $ (33,230) $ (38,521) $ 1,948,884
Comprehensive income:
Net income -- -- -- 34,745
Effect of change in accounting
principle -- -- (9,951) (9,951)
Change in unrecognized gain/(loss)
net of tax on investments
available-for-sale and derivative
financial instruments -- -- (7,341) (7,341)
Total comprehensive income -- -- -- 17,453
Issuance of common stock -- -- -- 149,000
Exercise of stock options -- -- -- 1,659
Sale of stock under Dividend
Reinvestment Plan and Employee
Stock Purchase Plan -- -- -- 1,833
Dividends paid on common stock -- -- -- (12,200)
Treasury stock purchases -- -- -- (479)
Treasury stock sold -- -- -- 419
Purchase and transfer of shares
for restricted stock plan (6,272) -- -- (3,084)
----------- ----------- ----------- -----------
Balance, June 30, 2001 $ (6,272) $ (33,230) $ (55,813) $ 2,103,485
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
- 8 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six-Month Period
Ended June 30,
------------------------------------
2001 2000
----------- -----------
(in thousands)
Cash Flows from Operating Activities:
Net income $ 34,745 $ (11,002)
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses 43,100 18,000
Deferred taxes (38,327) (899)
Depreciation and amortization 64,587 39,864
Net amortization/(accretion) of investment
securities and loan discounts 9,456 (35,406)
(Gain)/loss on sale of loans, investment
securities and real estate owned (13,219) 80,999
(Gain)on sale of fixed assets (688) (48)
(Gain)on sale of FHLB advances -- (16,000)
Loss on the retirement of Bancorp debt 10,075 --
Net change in:
Unrealized (gain)/loss on derivatives (7,099) --
Accrued interest receivable 28,857 (14,586)
Prepaid expenses and other assets (100,095) (1,281,289)
Other liabilities (77,999) 101,076
----------- -----------
Net cash(used) by operating activities (46,607) (1,119,291)
----------- -----------
Cash Flows from Investing Activities:
Proceeds from sales of investment securities:
Available-for-sale 2,704,924 4,846,462
Proceeds from repayments and maturities of
investment securities:
Available-for-sale 673,523 474,520
Held-to-maturity 139,315 2,439,408
Purchases of investment securities:
Available-for-sale (4,793,933) (3,929,617)
Held-to-maturity (1,224) (2,317,893)
Proceeds from sales of loans 1,953,368 258,233
Purchase of loans (1,480,113) (890,872)
Net change in loans other than purchases and sales (140,947) 502,620
Proceeds from sales of premises and equipment 20,793 19,979
Purchases of premises and equipment (7,497) (113,778)
Proceeds from sale of real estate owned 3,069 1,752
Net cash (paid)received due to acquisitions net
of cash acquired -- (494,826)
----------- -----------
Net cash provided(used) by investing activities (928,722) 795,988
----------- -----------
Cash Flows from Financing Activities:
Net (decrease)/increase in deposits
and other customer accounts (1,157,955) 3,635
Net increase/(decrease) in short-term borrowings 1,562,621 2,563,505
Net increase/(decrease) in long-term borrowings 513,674 --
Proceeds from Bancorp debt 525,000 --
Repayments of Bancorp debt (590,000) (569,982)
Sale of FHLB advances -- (911,037)
Net increase in advance payments by
borrowers for taxes and insurance 195 10,659
Cash dividends paid to stockholders (12,200) (11,097)
Proceeds from issuance of common stock 152,460 2,863
Net change in treasury and restricted stock (3,112) 134
----------- -----------
Net cash provided(used) by financing activities 990,683 1,088,680
----------- -----------
Net change in cash and cash equivalents 15,354 765,377
Cash and cash equivalents at beginning of period 959,643 393,234
----------- -----------
Cash and cash equivalents at end of period $ 974,997 $ 1,158,611
=========== ===========
Supplemental Disclosures:
Income tax payments totaled $10 million for the six-month period ended June 30,
2001 and $6 million for the same period in 2000. Interest payments totaled $632
million for the six-month period ended June 30, 2001 and $677 million for the
same period in 2000. Noncash activity consisted of securitization of mortgage
loans into mortgage-backed investment securities of $587 million for the
six-month period ended June 30, 2001, and acquisitions which included $7 billion
of loans and assumption of $8 billion of deposits for the six-month period ended
June 30, 2000.
See accompanying notes to consolidated financial statements.
- 9 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)(continued)
(1) BASIS OF PRESENTATION AND ACCOUNTING POLICIES
Basis of Presentation
- ---------------------
The accompanying financial statements of Sovereign Bancorp, Inc. and
Subsidiaries ("Sovereign") include the accounts of the parent company, Sovereign
Bancorp, Inc. and its wholly-owned subsidiaries: Sovereign Bank, Sovereign
Delaware Investment Corporation, Sovereign Delaware Escrow Corporation
(dissolved July 21, 2000), Sovereign Capital Trust I, Sovereign Capital Trust II
and ML Capital Trust I. All material intercompany balances and transactions have
been eliminated in consolidation.
These financial statements have been prepared in accordance with the
instructions for Form 10-Q and therefore do not include certain information or
footnotes necessary for the presentation of financial condition, results of
operations, stockholders' equity, and cash flows in conformity with accounting
principles generally accepted in the United States. 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
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates. Certain amounts in the financial statements of prior
periods have been reclassified to conform with the presentation used in current
period financial statements. These reclassifications have no effect on net
income.
The results of operations for the six-month period ended June 30, 2001
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 Form 10-K for the year ended December 31, 2000.
Goodwill and other intangibles on the consolidated balance sheet
include amounts which are deductible for federal and state income tax purposes.
The parenthetical amounts presented on the face of the statement reflect the
amounts of goodwill and other intangibles, after reducing such amounts for the
future tax benefits to be received as these amounts are amortized against future
earnings. During the quarter ended June 30, 2001, the Company adjusted its
purchase allocation for the SBNE acquisition resulting in total intangibles of
$1.2 billion, before amortization, including $826 million of goodwill and $352
million of core deposit intangibles. In finalizing a purchase allocation, the
Company considers all the facts and circumstances that comes to its attention
during the acquisition period, not to exceed 12 months, and if necessary, will
adjust the purchase price allocation accordingly based upon such facts.
Restricted stock was granted to employees during the quarter ended June 30,
2001. These shares are reported as a reduction of stockholders' equity and are
excluded from outstanding share calculations until annual vesting requirements
are met. The shares are allocated to employees and vest over a three year period
from the grant date. The Company purchased shares and utilized existing treasury
shares to fund the shares required by the grants. Compensation expense is
recognized ratably over the vesting period based upon average fair value of the
shares.
- 10 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
(2) EARNINGS PER SHARE
Basic earnings per share is calculated by dividing income before
extraordinary item by the weighted average common shares outstanding, excluding
options and warrants. The dilutive effect of options and warrants is calculated
using the treasury stock method.
The following table presents the computation of earnings per share for
the periods indicated (in thousands, except per share data).
Three-Month Period Six-Month Period
Ended June 30, Ended June 30,
--------------------------- -------------------------------
2001 2000 2001 2000
-------- ----------- ----------- -----------
Calculation of income/(loss) for EPS:
- -------------------------------------
Income/(loss) before extraordinary
item for basic EPS $ 30,182 $ (48,702) $ 41,294 $ (21,777)
Extraordinary item, after tax -- -- (6,549) 10,775
-------- ----------- ----------- -----------
Net income/(loss) for basic EPS $ 30,182 $ (48,702) $ 34,745 $ (11,002)
======== =========== =========== ===========
Weighted average shares for EPS:
- --------------------------------
Weighted average basic shares 246,698 225,846 242,321 225,699
Dilutive effect of average stock
options and warrants 15,285 -- 8,335 --
-------- ----------- ----------- -----------
Weighted average diluted shares 261,983 225,846 250,656 225,699
======== =========== =========== ===========
Earnings per share:
- -------------------
Basic
Income/(loss) before
extraordinary item $ .12 $ (.22) $ .17 $ (.10)
Extraordinary item -- -- (.03) .05
-------- ----------- ----------- -----------
Net income/(loss) $ .12 $ (.22) $ .14 $ (.05)
======== =========== =========== ===========
Diluted
Income/(loss) before
extraordinary item $ .12 $ (.22) $ .17 $ (.10)
Extraordinary item -- -- (.03) .05
-------- ----------- ----------- -----------
Net income/(loss) $ .12 $ (.22) $ .14 $ (.05)
======== =========== =========== ===========
- 11 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
(3) INVESTMENT SECURITIES AVAILABLE-FOR-SALE
The following table presents the composition and fair value of
investment securities available-for-sale at the dates indicated: (dollars in
thousands)
June 30, 2001
-------------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ ----------
Investment Securities:
U.S. Treasury and gov't
agency securities $ 24,856 $ 50 $ 18 $ 24,888
Corporate securities/
trust preferred 328,378 3,059 25,661 305,776
Asset backed securities 457,535 1,040 6,712 451,863
Equities 11,475 117 415 11,177
FHLB stock 339,997 -- -- 339,997
Agency preferred stock 475,801 871 104 476,568
Municipal securities 38,479 1,914 438 39,955
Mortgage-backed securities:
Passthroughs:
U.S. government & agency 3,862,179 18,801 35,230 3,845,750
Non-agency 1,950,769 6,262 28,276 1,928,755
Collateralized mortgage
obligations 711,175 2,713 12,924 700,964
---------- ---------- ---------- ----------
Total investment securities
available-for-sale $8,200,644 $ 34,827 $ 109,778 $8,125,693
========== ========== ========== ==========
December 31, 2000
-------------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ ----------
Investment Securities:
U.S. Treasury and gov't
agency securities $ 92,341 $ 55 $ 455 $ 91,941
Corporate securities/
trust preferred 300,206 11,333 5,727 305,812
Asset backed securities 523,466 248 12,118 511,596
Equities 25,196 126 3,427 21,895
FHLB stock 225,797 -- -- 225,797
Agency preferred stock 425,888 267 2,472 423,683
Municipal securities 36,549 2,693 473 38,769
Mortgage-backed securities:
Passthroughs:
U.S. government & agency 676,593 3,025 5,679 673,939
Non-agency 2,553,289 556 40,275 2,513,570
Collateralized mortgage
obligations 515,852 535 7,805 508,582
---------- ---------- ---------- ----------
Total investment securities
available-for-sale $5,375,177 $ 18,838 $ 78,431 $5,315,584
========== ========== ========== ==========
- 12 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
(4) INVESTMENT SECURITIES HELD-TO-MATURITY
The following table presents the composition and fair value of
investment securities held-to-maturity at the dates indicated: (dollars in
thousands)
June 30, 2001
-------------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ ----------
Investment Securities:
U.S. Treasury and gov't
agency securities $ 1,905 $ 55 $ -- $ 1,960
Corporate securities/
trust preferred -- -- -- --
Municipal securities 5,414 35 4 5,445
Mortgage-backed securities:
Passthroughs:
U.S. government & agency 1,020,385 13,337 16,719 1,017,003
Non-agency 5,976 56 79 5,953
---------- ---------- ---------- ----------
Total investment securities
held-to-maturity $1,033,680 $ 13,483 $ 16,802 $1,030,361
========== ========== ========== ==========
December 31, 2000
-------------------------------------------------------------------------
Amortized Unrealized Unrealized Fair
Cost Appreciation Depreciation Value
---------- ------------ ------------ ----------
Investment Securities:
U.S. Treasury and gov't
agency securities $ 6,382 $ -- $ 138 $ 6,244
Corporate securities/
trust preferred 35,785 2,282 6 38,061
Municipal securities 739 135 6 868
Mortgage-backed securities:
Passthroughs:
U.S. government & agency 1,562,525 14,780 16,502 1,560,803
Non-agency 39,117 378 234 39,261
Collateralized mortgage
obligations 333,720 505 7,566 326,659
---------- ---------- ---------- ----------
Total investment securities
held-to-maturity $1,978,268 $ 18,080 $ 24,452 $1,971,896
========== ========== ========== ==========
- 13 -
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, 2001 December 31, 2000
----------------------------- -----------------------------
Amount Percent Amount Percent
----------- ------- ----------- -------
Commercial real estate loans $ 2,782,869 13.4% $ 2,793,616 12.7%
Commercial and industrial loans 4,525,597 21.9 4,397,009 20.1
Other 654,465 3.1 640,782 3.0
----------- ------- ----------- -------
Total Commercial Loans 7,962,931 38.4 7,831,407 35.8
----------- ------- ----------- -------
Home equity loans 3,660,706 17.6 3,256,598 14.9
Auto loans 2,840,604 13.7 2,309,025 10.5
Other 518,291 2.5 536,358 2.4
----------- ------- ----------- -------
Total Consumer Loans 7,019,601 33.8 6,101,981 27.8
----------- ------- ----------- -------
Total Residential
Real Estate Loans 5,780,219 27.8 7,978,857 36.4
----------- ------- ----------- -------
Total Loans (1) $20,762,751 100.0% $21,912,245 100.0%
=========== ======= =========== =======
Total Loans with:
Fixed rate $13,367,192 64.4% $14,165,535 64.6%
Variable rate 7,395,559 35.6 7,746,710 35.4
----------- ------- ----------- -------
Total Loans (1) $20,762,751 100.0% $21,912,245 100.0%
=========== ======= =========== =======
(1) Loan totals include deferred loan fees and unamortized premiums and
discounts. These fees, premiums and discounts resulted in a net increase in
loans of $16 million at June 30, 2001 and a net decrease of $32 million at
December 31, 2000.
- 14 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
(6) DEPOSIT PORTFOLIO COMPOSITION
The following table presents the composition of deposits and other
customer accounts at the dates indicated: (dollars in thousands)
June 30, 2001 December 31, 2000
----------------------------- ------------------------------
Weighted Weighted
Average Average
Account Type Amount Percent Rate Amount Percent Rate
------------ ------ ------- -------- ------ ------- --------
Demand deposit accounts $ 3,331,937 14% --% $ 3,475,994 14% -- %
NOW accounts 4,205,709 18 1.74 4,247,194 17 2.67
Savings accounts 2,944,332 13 2.02 2,952,960 12 2.38
Money market accounts 4,874,100 21 3.05 4,553,020 19 4.44
Retail certificates 7,623,434 33 5.42 8,371,936 34 5.91
Jumbo certificates 361,450 1 5.17 897,813 4 6.55
----------- ---- ----- ----------- ---- ------
Total Deposits $23,340,962 100% 3.06% $24,498,917 100% 3.83%
=========== ==== ===== =========== ==== ======
(7) SHORT-TERM BORROWINGS
The following table presents information regarding borrowings at the
dates indicated: (dollars in thousands)
June 30, 2001 December 31, 2000
--------------------- -----------------------
Weighted Weighted
Average Average
Balance Rate Balance Rate
------- -------- ------- ---------
Federal funds purchased $ -- --% $ 130,000 5.23%
Securities sold under
repurchase agreements -- -- 230,900 6.58
FHLB advances 2,894,409 4.28 970,792 6.62
--------- ---- ---------- ----
Total Borrowings $2,894,409 4.28% $1,331,692 6.48%
========== ===== ========== ====
(8) LONG-TERM BORROWINGS
Long-term borrowings (original maturities greater than one year)
consisted of the following: (dollars in thousands)
June 30, 2001 December 31, 2000
------------- -----------------
Securities sold under
repurchase agreements $ 155,000 $ --
FHLB advances 3,905,935 3,544,984
Senior secured credit facility 350,000 350,000
Senior and subordinated notes 947,285 1,013,632
---------- ----------
$5,358,220 $4,908,616
========== ==========
- 15 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
(9) RESTRUCTURING EXPENSE
In November, 2000, the Company announced the results of a restructuring
initiative in which management analyzed front and back office operations and
computer operating platforms which were duplicated as a result of the SBNE
acquisition and eliminated approximately 600 positions. In total, Sovereign
recorded $18.5 million in restructuring costs, which was comprised of $14
million of severance and outplacement costs, and $4.5 million write-off of a
redundant computer-operating platform. During the first quarter of 2001, the
Company incurred an additional $8.5 million pre-tax ($5.5 million after-tax) of
restructuring charges related to the closure of 14 "in-store" offices and a
redirection of e-commerce efforts.
(10) COMPREHENSIVE INCOME
The following table presents the components of comprehensive
income/(loss), net of related tax, based on the provisions of SFAS No. 130 for
the periods indicated: (dollars in thousands)
Three-Month Period Six-Month Period
Ended June 30, Ended June 30,
--------------------------- ---------------------------
2001 2000 2001 2000
-------- -------- -------- --------
Net income/(loss) $ 30,182 $(48,702) $ 34,745 $(11,002)
Effect of change in accounting
principle -- -- (9,951) --
Net unrealized (losses)/gains:
available-for-sale securities (29,370) (33,446) (1,649) 3,931
derivatives 2,807 -- 2,853 --
Reclassification adjustment (3,584) 37,842 (8,545) 52,710
-------- -------- -------- --------
Net unrealized (losses)/gains
recognized in other comprehensive
income (30,147) 4,396 (17,292) 48,779
-------- -------- -------- --------
Comprehensive income/(loss) $ 35 $(44,306) $ 17,453 $ 37,777
======== ======== ======== ========
Accumulated other comprehensive loss, net of related tax, consisted of
net unrealized losses on securities of $48.7 million and net unrealized losses
on derivatives of $7.1 million at June 30, 2001 and net unrealized losses on
securities of $38.5 million at December 31, 2000.
(11) DERIVATIVES
Sovereign uses a variety of off-balance-sheet financial derivatives as
part of its overall interest rate risk management process and to manage risk
associated with mortgage banking activities. Interest rate swaps are generally
used to convert fixed rate assets and liabilities to variable rate assets and
liabilities and vice versa. Interest rate caps are generally used to limit the
exposure from repricing of liabilities. Interest rate floors are generally used
to limit the exposure from repricing of assets. In certain cases, interest rate
caps and floors are simultaneously bought and sold to create a range of
protection against changing interest rates while limiting the cost of that
protection. Forward contracts are
- 16 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
(11) DERIVATIVES (continued)
used to manage risk positions associated with mortgage origination.
Substantially, all forward contracts mature within 90 days of origination.
Forward contracts are traded in over-the-counter markets and do not have
standardized terms. Counterparties to Sovereign's forward contracts are
primarily U.S. government agencies and brokers and dealers in mortgage-backed
securities.
Effective January 1, 2001, the Company adopted Financial Accounting
Standard No. 133, "Accounting for Derivative Instruments and Hedging
Activities", as amended, which required that all derivative instruments be
reported on the balance sheet at fair value and establishes criteria for
designation and effectiveness of hedging relationships. Upon adoption, Sovereign
designated derivative instruments used for risk management into hedging
relationships in accordance with the requirements of the new standard.
Derivative instruments used to hedge changes in the fair value of assets and
liabilities due to changes in interest rates or other factors were designated in
fair value hedge relationships. The Company accounts for changes in the value of
both the fair value hedges and the corresponding hedged items as a component of
other operating income. Derivative instruments used to hedge the variability of
forecasted cash flows attributable to a specific risk, generally interest rate
risk, were designated in cash flow hedge relationships. The changes in fair
value of cash flow hedges are recorded as other comprehensive income to the
extent effective. The ineffective portion, if any, of cash flow hedges is
recorded as other operating income. On January 1, 2001, after-tax transition
amounts associated with establishing the fair values of the derivative
instruments and hedged items on the balance sheet of $0.7 million and $(6.7)
million were recorded as an increase of net income and a reduction in other
comprehensive income, respectively. Additionally, as allowed by FAS 133, the
Company reclassified $800 million of held-to-maturity securities to
available-for-sale on January 1, 2001. These securities had an unrealized loss
of $(4.9) million, ($3.2 million net of tax), at January 1, 2001 which was
recorded as a reduction in other comprehensive income.
At June 30, 2001, the fair value of the Corporation's interest rate
swap agreements that were designated as fair value hedges was $8.6 million. Fair
value hedges are utilized to convert fixed rate long-term debt and brokered
deposits to variable rate. In certain instances, the interest rate swaps
utilized have embedded call options that mirror embedded purchased call options
in the underlying liability being hedged. At June 30, 2001, the fair value of
the Corporation's interest rate swap agreements that were designated as cash
flow hedges was $12.1 million which was a change of $22.1 million since January
1, 2001. Cash flow hedges are utilized to convert certain long-term variable
rate FHLB advances to fixed rate. The difference attributable to ineffectiveness
for both the fair value hedges and the cash flow hedges for the six-month period
ended June 30, 2001 was immaterial.
Sovereign's Capital Markets Group provides risk management services for
its customers. Sovereign purchases and sells certain derivatives including
interest rate swaps, caps and floors. Customer related derivative financial
instrument transactions are generally marked to market and any gains or losses
are recorded in the income statement. Sovereign also holds derivatives in
connection with its securities trading activities and, at times, takes minimal
positions in the expectation of profiting from favorable movements in interest
rates.
- 17 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
(12) PENDING ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 141, Business Combinations, and
No. 142, Goodwill and Other Intangible Assets, effective for fiscal years
beginning after December 15, 2001. Under the new rules, goodwill will no longer
be amortized but will be subject to annual impairment tests in accordance with
the Statements. Other intangible assets will continue to be amortized over their
useful lives.
The Company will apply the new rules on accounting for goodwill and
other intangible assets beginning in the first quarter of 2002. Application of
the non-amortization provisions of the Statement is expected to result in an
increase in net income of $30 million net of tax ($.11 per share) per year.
During 2002, the Company will perform the first of the required impairment tests
of goodwill and indefinite lived intangible assets as of January 1, 2002 and has
not yet determined what the effect of these tests will be on the earnings and
financial position of the Company.
(13) PENDING ACQUISITION OF MAIN STREET BANCORP
On July 17, 2001 Sovereign announced the signing of a definitive
agreement to acquire Main Street Bancorp, Inc. ("Main Street") for approximately
$170 million in stock and cash. Main Street is a $1.5 billion bank holding
company headquartered in Reading, Pennsylvania with 42 community banking offices
serving southeastern Pennsylvania.
The transaction, which is expected to close in the first quarter of
2002, adds $1.3 billion of customer deposits, $850 million of loans, and
enhances Sovereign's small business and middle market lending capabilities in
the region.
- 18 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
RESULTS OF OPERATIONS
- ---------------------
General
- -------
Cash earnings, as defined below, for the six-month period ended June
30, 2001 increased 42% to $187.6 million, or $.75 per share, up from $132.2
million, or $.69 per share, for the same period in 2000. Operating earnings for
2001 increased 28% to $140.7 million, or $.56 per share, as compared to $110.1
million, or $.57 per share, for 2000.
Operating earnings exclude certain special charges for 2001 and 2000.
Special charges for the quarters ended June 30, 2001 and 2000 were $47 million
and $106 million, respectively, after tax, and are outlined in the
Reconciliation of Net Income to Operating Earnings table on the following page.
Cash earnings are operating earnings excluding amortization (after-tax) of
intangible assets and ESOP-related expense.
Net income, including the special charges noted above, was $34.7
million, or $.14 per share, for the six-month period ended June 30, 2001, as
compared to net loss of $11.0 million, or $(.05) per share, for the same period
in 2000.
Cash return on average equity, cash return on average tangible equity
and cash return on average total assets, excluding special charges discussed
above, were 18.25%, 58.08% and 1.13% for the six-month period ended June 30,
2001 compared to 18.02%, 32.68% and .95% for the same period in 2000.
- 19 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Reconciliation of Net Income to Operating Earnings
(In thousands, except per share data - all amounts are after tax)
Three-Month Period Six-Month Period
Ended June 30 Ended June 30
-------------------------------------------- --------------------------------------------
Total Per Share Total Per Share
---------------------- ----------------- ---------------------- -----------------
2001 2000 2001 2000 2001 2000 2001 2000
--------- --------- ------- ------- --------- --------- ------- -------
Net income/(loss) as reported $ 30,182 $ (48,702) $ .12 $ (.22) $ 34,745 $ (11,002) $ .14 $ (.05)
Loss on the early extinguish-
ment of debt -- -- -- -- 6,549 -- .03 --
Net negative carry on escrowed
bond proceeds (1) -- 8,420 -- .04 -- 17,015 -- .07
Merger-related and integration
costs recorded during the
period (2) -- 59,920 -- .27 -- 68,090 -- .30
Expense on convertible trust
preferred securities
("PIERS") (1) -- 2,548 -- .01 -- 6,368 -- .03
Loss on securities due to
restructuring of the
balance sheet -- 38,531 -- .17 -- 38,531 -- .17
Restructuring expense -- -- -- -- 5,525 -- .02 --
Non-solicitation expense 46,940 -- .17 -- 93,881 -- .37 --
Assumed interest expense
reduction due to paydown
of other borrowings
with net proceeds of
common equity and PIERS (1) -- (3,419) -- (.02) -- (8,874) -- (.04)
Impact of additional shares
outstanding for 1999 common
stock offerings (3) -- -- -- .04 -- -- -- .09
--------- --------- ------- ------- --------- --------- ------- -------
Operating earnings (3) $ 77,122 $ 57,298 $ .29 $ .29 $ 140,700 $ 110,128 $ .56 $ .57
--------- --------- ------- ------- --------- --------- ------- -------
Cash earnings (3) $ 99,569 $ 71,857 $ .38 $ .36 $ 187,643 $ 132,218 $ .75 $ .69
========= ========= ======= ======= ========= ========= ======= =======
Average shares:
Before adjustment
for offering 261,983 226,670 250,656 226,612
After adjustment
for offering 261,983 199,711 250,656 191,789
(1) As a part of the agreement to purchase Sovereign Bank New England,
Sovereign raised a total of $1.8 billion of debt and equity capital in
November and December, 1999 of which $1.3 billion of debt proceeds were
in escrow with limited ability to reinvest the proceeds until the
acquisition was completed on July 21, 2000. Consequently, the excess of
negative carry and trust preferred expense over interest expense
reduction realized on the raised capital resulted in a net reduction in
pre-tax income of $11.3 million ($7.5 million after tax) and $21.8
million ($14.5 million after tax) comprised of the following components
for the three and six-month periods ending June 30, 2000, respectively:
a) a reduction of net interest income of $12.7 million ($8.4 million
after-tax) and $25.6 million ($17.0 million after tax), respectively;
b) expense of $3.8 million ($2.5 million after tax) and $9.5 million
($6.4 million after tax) associated with PIERS issued in November,
1999; c) an assumed $5.1 million ($3.4 million after tax) and $13.3
million ($8.9 million after tax) of interest expense reduction from the
assumed paydown of other borrowings with the proceeds of the Trust
Preferred Securities and the common stock offering.
(2) Merger-related integration charges related to recent acquisitions
include direct costs associated with the SBNE acquisition, including
investment banking and debt commitment fees, indirect costs incurred to
integrate recent acquisitions into Sovereign's back-office systems,
costs of training, relocation and associated travel, and management's
estimate of the carrying costs of certain facilities and personnel
acquired in the first closing on March 24, 2000 that were not fully
operational until July 21, 2000, the date of the final closing.
(3) Operating earnings per share and cash earnings per share are calculated
using a weighted average number of shares which include, for the three
and six month periods ended June 30, 2000, a pro rata portion of the
shares issued in November, 1999 in proportion to deposits acquired on
March 24, 2000, June 16, 2000 and July 21, 2000 over total estimated
SBNE deposits acquired in each phase of the SBNE acquisition.
- 20 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
CONSOLIDATED AVERAGE BALANCE SHEET / NET INTEREST MARGIN ANALYSIS
SIX-MONTH PERIOD ENDED JUNE 30, 2001 and 2000
(in thousands)
2001 2000
------------------------------------------ ---------------------------------------------
Average Yield/ Average Yield/
Balance Interest(1) Rate Balance Interest(1) Rate
------------ ------------ ------- ------------ ------------ -------
EARNING ASSETS
Investments $7,584,628 $270,298 7.14% $10,297,758 $364,117 7.07%
Loans:
Residential loans 7,231,292 280,872 7.77% 6,158,976 231,128 7.50%
Commercial loans 7,877,199 321,428 8.19% 5,141,526 224,457 8.71%
Consumer loans 6,758,356 272,174 8.12% 5,217,072 216,148 8.33%
------------ ------------ ------- ------------ ------------ -------
Total loans 21,866,847 874,474 8.03% 16,517,574 671,733 8.14%
Allowance for loan losses (253,662) -- -- (146,235) -- --
------------ ------------ ------- ------------ ------------ -------
Net loans 21,613,185 874,474 8.12% 16,371,339 671,733 8.21%
------------ ------------ ------- ------------ ------------ -------
Total earning assets 29,197,813 1,144,772 7.87% 26,669,097 1,035,850 7.77%
Other assets 4,419,741 -- -- 2,702,172 -- --
------------ ------------ ------- ------------ ------------ -------
TOTAL ASSETS $ 33,617,554 1,144,772 6.83% $ 29,371,269 $ 1,035,850 7.06%
============ ============ ======= ============ ============ =======
FUNDING LIABILITIES
Deposits:
Core deposits $ 15,093,504 163,386 2.18% $ 7,879,523 98,502 2.51%
Time deposits 8,784,649 250,708 5.75% 6,719,265 183,642 5.50%
------------ ------------ ------- ------------ ------------ -------
Total deposits 23,878,153 414,094 3.50% 14,598,788 282,144 3.88%
------------ ------------ ------- ------------ ------------ -------
Borrowed funds:
FHLB advances 5,218,772 144,168 5.50% 10,108,733 297,880 5.83%
Repurchase agreements 323,250 7,500 4.61% 765,735 24,264 6.27%
Other borrowings 1,344,231 65,888 9.82% 1,628,090 79,120 9.88%
------------ ------------ ------- ------------ ------------ -------
Total borrowed funds 6,886,253 217,556 6.30% 12,502,558 401,264 6.38%
------------ ------------ ------- ------------ ------------ -------
Total funding liabilities 30,764,406 631,650 4.12% 27,101,346 683,408 5.04%
Other liabilities 779,710 -- -- 433,498 -- --
------------ ------------ ------- ------------ ------------ -------
Total liabilities 31,544,116 631,650 4.02% 27,534,844 683,408 4.96%
STOCKHOLDERS' EQUITY 2,073,438 -- -- 1,836,425 -- --
------------ ------------ ------- ------------ ------------ -------
TOTAL LIABILITIES
AND STOCKHOLDERS' EQUITY $ 33,617,554 631,650 3.77% $ 29,371,269 683,408 4.65%
============ ------------ ------- ============ ------------ -------
NET INTEREST INCOME $513,122 $ 352,442
============ ============
NET INTEREST SPREAD (2) 3.06% 2.41%
===== =====
NET INTEREST MARGIN (3) 3.52% 2.65%
===== =====
(1) Tax-equivalent basis
(2) Represents the difference between the yield on total assets and the
cost of total liabilities and stockholders' equity.
(3) Represents taxable equivalent net interest income divided by average
interest-earning assets
- 21 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Net interest income for the three-month and six-month periods ended
June 30, 2001 was $258 and $506 million compared to $187 million and $346
million for the same periods in 2000. This increase was attributable to an
increase in average balances, resulting from the SBNE acquisition and internal
growth, and improvements in net interest margin. Net interest margin was 3.60%
and 3.52% for the three-month and six-month periods ended June 30, 2001 compared
to 2.70% and 2.65% for the same periods in 2000, an improvement of 90 basis
points and 87 basis points, respectively.
Interest on investment securities and interest earning deposits was
$139 million and $266 million for the three-month and six-month periods ended
June 30, 2001 compared to $182 million and $359 million for the same periods in
2000. The average balance of investment securities was $7.6 billion with an
average tax equivalent yield of 7.14% for the six-month period ended June 30,
2001 compared to an average balance of $10.3 billion with an average yield of
7.07% for the same period in 2000. The decrease in average investment securities
is due principally to restructuring of the balance sheet in the second and third
quarters of 2000 and the maturity of $1.3 billion of commercial paper
investments at escrow break on the final closing of the SBNE acquisition on July
21, 2000. Proceeds were used to reduce wholesale borrowings.
Interest and fees on loans were $419 million and $872 million for the
three-month and six-month periods ended June 30, 2001 compared to $375 million
and $670 million for the same periods in 2000. The average balance of loans was
$21.9 billion with an average yield of 8.03% for the six-month period ended June
30, 2001 compared to an average balance of $16.5 billion with an average yield
of 8.14% for the same period in 2000. Although the SBNE acquisition resulted in
a higher proportion of commercial loans, which are typically higher yielding
than consumer and residential loans, this favorable increase is more than offset
by the impact of falling market rates.
Interest on deposits was $193 million and $414 million for the three-month
and six-month periods ended June 30, 2001 compared to $164 million and $282
million for the same periods in 2000. The average balance of deposits was $23.9
billion with an average cost of 3.50% for the six-month period ended June 30,
2001 compared to an average balance of $14.6 billion with an average cost of
3.88% for the same period in 2000.
Interest on borrowings was $106 million and $218 million for the
three-month and six-month periods ended June 30, 2001 compared to $207 million
and $401 million for the same periods in 2000. The average balance of borrowings
was $6.9 billion with an average cost of 6.30% for the six-month period ended
June 30, 2001 compared to an average balance of $12.5 billion with an average
cost of 6.38% for the same period in 2000. The decrease in borrowings was the
result of balance sheet restructuring accomplished throughout 2000.
Provision for Loan Losses
- -------------------------
The provision for loan loss expense is based upon credit loss
experience and on the estimation of losses inherent in the current loan
portfolio. The provision for loan losses for the three-month and six-month
periods ended June 30, 2001 was $23 million and $43 million compared to $10
million and $18 million
- 22 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
for the same periods in 2000. The increase over 2000 is primarily due to
increased loan volumes resulting from the SBNE acquisition, internal loan
growth, seasoning of purchased loan portfolios, and the current economic
environment.
Over the last few years, through several strategic acquisitions and
internal restructuring initiatives, Sovereign has diversified its lending
efforts and increased its emphasis on providing its customers with small
business loans and an expanded line of commercial and consumer products, such as
middle market asset-based lending and automobile loans. As a result of the
increased risk inherent in these loan products and as Sovereign continues to
place emphasis on commercial business and consumer lending in future periods,
management will regularly evaluate its loan portfolio and record additional loan
loss provision as is necessary.
Sovereign's net charge-offs for the six-month period ended June 30,
2001 were $43.4 million and consisted of charge-offs of $62.6 million and
recoveries of $19.2 million. This compared to net charge-offs of $18.1 million
consisting of charge-offs of $28.0 million and recoveries of $9.9 million for
the six-month period ended June 30, 2000. Sovereign's increased level of net
charge-offs was primarily the result of higher overall loan balances, a general
seasoning of recent loan portfolio acquisitions and general economic conditions.
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,
2001 2000
-------- --------
Allowance, beginning of period $256,356 $132,986
Charge-offs:
Residential 5,841 2,539
Commercial 20,968 6,471
Consumer 35,770 19,008
-------- --------
Total Charge-offs 62,579 28,018
-------- --------
Recoveries:
Residential 1,859 974
Commercial 985 2,310
Consumer 16,327 6,601
-------- --------
Total Recoveries 19,171 9,885
-------- --------
Charge-offs, net of recoveries 43,408 18,133
Provision for possible loan losses 43,100 18,000
Initial allowance related to
acquisitions -- 67,858
-------- --------
Allowance, end of period $256,048 $200,711
======== ========
- 23 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Non-Interest Income
- -------------------
Other income/(loss) was $124.2 million and $232.3 million for the
three-month and six-month periods ended June 30, 2001 compared to $(11.7)
million and $9.5 million for the same periods in 2000. Excluding securities
transactions, other income for the three-month and six-month periods ended June
30, 2001 was $118.5 million and $219.2 million as compared to $46.5 million and
$90.6 million for the same periods in 2000.
Consumer banking fees were $39.5 million and $78.9 million for the
three-month and six-month periods ended June 30, 2001 as compared to $19.4
million and $34.8 million for the same periods in 2000. This increase of $20.1
million and $44.1 million was primarily due to a favorable shift into core
deposit products and higher deposit levels both due to the SBNE acquisition.
Commercial banking fees were $17.7 million and $36.0 million for the three-month
and six-month periods ended June 30, 2001 as compared to $9.7 million and $12.2
million for the same periods in 2000. This increase of $8.0 million and $23.8
million was primarily due to higher loan volumes from internal growth and the
SBNE acquisition.
Mortgage banking revenue was $14.8 million and $36.1 million for the
three-month and six-month periods ended June 30, 2001 as compared to $7.4
million and $12.7 million for the same periods in 2000. The first quarter of
2001 includes a gain of $19.3 million related to the sale of $580 million of
residential mortgages offset by a charge of $6.8 million to reduce the valuation
of mortgage servicing rights.
Gain/(loss) on investment securities transactions were $5.8 million and
$13.1 million for the three-month and six-month periods ended June 30, 2001
compared to $(58.2) million and $(81.1) million for the same periods in 2000.
During the first and second quarters of 2000 Sovereign sold certain investment
securities and paid-off certain short-term advances as part of its balance sheet
repositioning. In the first quarter of 2000, swaps hedging short term advances
were terminated when the advances were paid off. Additionally, Sovereign sold
FHLB advances. These first quarter of 2000 transactions resulted in $9.5 million
of swap termination gains included as miscellaneous income, and a $16.0 million
gain on sale (extinguishment) of FHLB advances ($10.8 million net of tax)
reported as an extraordinary item.
Miscellaneous income was $33.9 million and $42.6 million for the
three-month and six-month periods ended June 30, 2001 compared to $1.8 million
and $13.0 million for the same periods in 2000. The three and six months ended
June 30, 2001 includes a $28.1 million gain related to the sale of branches
located in southern New Jersey, Delaware and eastern Pennsylvania. The impact of
the sale is not expected to significantly impact future results.
General and Administrative Expenses
- -----------------------------------
General and administrative expenses for the three-month and six-month
periods ended June 30, 2001 were $203 million and $395 million, compared to $208
million and $322 million for the same periods in 2000. Excluding merger related
and integration charges related to acquisitions of $90.1 million and $102.3
million for the three and six month periods ended June 30, 2000, general and
- 24 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
administrative expense increased $84.6 million and $175.1 million, respectively
over the 2000 levels. This increase was due mainly to the SBNE acquisition which
was completed on July 21, 2000. The increased compensation and occupancy
expenses reflect more than 3,000 additional staff and 280 community banking
offices added from the acquisition. In addition, technology, outside services
and other administrative expenses increased to support the necessary additional
infrastructure.
Other operating expenses were $119.7 million and $251.0 million for the
three-month and six-month periods ended June 30, 2001 compared to $29.7 million
and $48.2 million for the same periods in 2000. Results for the three-month and
six-month periods ended June 30, 2001 included amortization of goodwill and
intangibles of $32.8 million and $68.9 million compared to $20.5 million and
$30.1 million for the same periods in 2000. The increase in goodwill
amortization is a result of the additional intangibles recorded for the SBNE
acquisition. The $5.3 million increase in Trust Preferred Securities and other
minority interest expense is attributable to the August 2000 issuance of
preferred shares of Sovereign Real Estate Investment Trust to institutional
investors. The three-month and six-month periods ended June 30, 2001, include
$72.2 million and $144.4 million of non-compete expense related to the
non-solicitation provisions of the SBNE purchase and assumption agreement. Also
during the three-month period ended March 31, 2001, Sovereign recorded an $8.5
million charge ($5.6 million net of tax) as the last portion of restructuring
charges related to its company-wide restructuring announced in November of 2000.
The restructuring, completed over the first quarter of 2001 and last quarter of
2000, resulted in elimination of over 600 positions, closure of 14 in-store
offices and redirection of e-commerce efforts to consolidate efforts within our
geographic footprint.
Adoption of Statements of Financial Accounting Standards No. 141,
Business Combinations and No. 142, Goodwill and Other Intangible Assets, in the
first quarter of 2002 is expected to reduce amortization expense by $30 million
(net of tax) ($.11 per share) for all of 2002. Impact of required impairment
tests has not yet been determined.
Income Tax Provision
- --------------------
The income tax provision (benefit) was $7.0 million and $7.9
million for the three-month and six-month periods ended June 30, 2001 compared
to $(24.0) million and $(10.8) million for the same periods in 2000. The
effective tax rate for the three-month and six-month periods ended June 30, 2001
was 18.8% and 16.1%, compared to 33.0% and 33.1% for the same periods in 2000.
The current year tax rate differs from the statutory rate of 35% due to the high
proportion of non-taxable income including bank owned life insurance income and
tax-free investment securities, combined with 35% tax benefit recorded on the
extraordinary loss related to the extinguishment of debt compared to the
Company's pre-tax income.
Extraordinary Items
- -------------------
In March 2001, Sovereign completed a $400 million term and revolving
credit facility with Bank of Scotland of which $350 million was drawn to prepay
an existing $350 million senior secured credit facility. In connection with this
transaction, Sovereign wrote-off $6.5 million net of tax ($10.1 million pre-tax)
- 25 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
of deferred issuance costs remaining from the existing line of credit. These
costs were reflected net of tax as an extraordinary item in accordance with
generally accepted accounting principles.
As previously discussed, during the first quarter of 2000 Sovereign
sold FHLB advances which resulted in a pre-tax gain of $16.0 million ($10.8
million after-tax) and is treated as an early extinguishment of debt under
generally accepted accounting principles.
FINANCIAL CONDITION
- -------------------
Loan Portfolio
- --------------
At June 30, 2001, commercial loans totaled $8.0 billion representing
38% of Sovereign's loan portfolio, compared to $7.8 billion and 36% of the loan
portfolio at December 31, 2000 and $6.8 billion and 32% of the loan portfolio at
June 30, 2000.
The consumer loan portfolio (including home equity loans and lines of
credit, automobile loans, and other consumer loans) totaled $7.0 billion at June
30, 2001, representing 34% of Sovereign's loan portfolio, compared to $6.1
billion and 28% of the loan portfolio at December 31, 2000 and $6.2 billion and
29% of the loan portfolio at June 30, 2000.
Residential mortgage loans decreased $2.2 billion during the quarter to
$5.8 billion and now represent 28% of Sovereign's loan portfolio as compared to
$8.0 billion and 36% at December 31, 2000. The decrease is primarily due to
securitizations of loans into mortgage-backed securities and sales. At June 30,
2000 residential mortgage loans totaled $8.4 billion representing 39% of the
loan portfolio.
Non-Performing Assets
- ---------------------
At June 30, 2001 Sovereign's non-performing assets were $182.2 million
compared to $187.4 million at December 31, 2000. This decrease is comprised of
an $8.8 million decrease in non-performing loans partially offset by a $3.6
million increase in other real estate owned and repossessed assets. The decrease
in non-performing loans is due mainly to a decrease of $12.7 million in consumer
loans relating to a reduction in non-accrual loans and from applying a
non-accrual policy of 120 days consistently to all consumer loan products.
Commercial non-accrual loans decreased slightly, $0.6 million, and residential
non-accrual loans increased $4.5 million. Non-performing assets as a percentage
of total assets was .53% at June 30, 2001, down from .56% at December 31, 2000.
At June 30, 2001 60% of non-performing assets consisted of loans related to real
estate, consumer loans or OREO which are primarily secured by collateral.
Sovereign places commercial loans on non-performing status at 90 days (unless
return to current status is expected imminently). Consumer, residential and
government guaranteed loans continue to accrue until they are 120 days
delinquent, at which point they are either charged-off or fully reserved.
- 26 -
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,
2001 2000
-------- -----------
Non-accrual loans:
Residential $ 64,863 $ 60,322
Commercial 78,576 76,888
Consumer 25,493 38,239
-------- --------
Total non-accrual loans 168,932 175,449
-------- --------
Restructured loans 1,483 3,755
-------- --------
Total non-performing loans 170,415 179,204
Other real estate owned 5,391 4,425
Other repossessed assets 6,366 3,758
-------- --------
Total non-performing assets $182,172 $187,387
======== ========
Past due 90 days or more as to interest
or principal and accruing interest (1) $ 49,866 $ 16,733
Non-performing assets as a percentage
of total assets .53% .56%
Non-performing loans as a percentage
of total loans .82% .82%
Non-performing assets as a percentage of
total loans and real estate owned .88% .85%
Allowance for loan losses as a percentage
of total non-performing assets 140.56% 136.8%
Allowance for loan losses as a percentage
of total non-performing loans 150.22% 143.1%
(1) Includes consumer and residential loans past due between 90 and 120
days.
Potential problem loans (consisting principally of commercial loans
delinquent more than 30 days but less than 90 days, although not currently
classified as non-performing loans) amounted to approximately $81 million and
$97 million at June 30, 2001 and December 31, 2000, respectively.
- 27 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Allowance for Loan Losses
- -------------------------
The following table presents the allocation of the allowance for loan
losses and the percentage of each loan type of total loans at the dates
indicated:
(dollars in thousands)
June 30, 2001 December 31, 2000
--------------------------- ---------------------------
% of Loans % of Loans
to to
Amount Total Loans Amount Total Loans
-------- ----------- -------- -----------
Allocated allowance:
Commercial loans $139,636 38% $149,828 36%
Residential real estate
mortgage loans 22,251 28 34,629 36
Consumer loans 59,773 34 48,053 28
--------
Unallocated allowance 34,388 n/a 23,846 n/a
-------- -------- -------- --------
Total allowance for loan losses $256,048 100% $256,356 100%
======== ======== ======== ========
The adequacy of Sovereign's allowance for loan losses is regularly
evaluated. Management's evaluation of the adequacy of the allowance to absorb
loan losses takes into consideration the risks inherent in the loan portfolio,
past loan loss experience, specific loans which have loss potential, geographic
and industry concentrations, delinquency trends, economic conditions, the level
of originations and other relevant factors. Management also considers loan
quality, changes in the size and character of the loan portfolio, consultation
with regulatory authorities, amount of non-performing loans, delinquency trends,
economic conditions and industry trends when determining the allowance. Along
with higher yields, management believes the shift in loan composition from
residential into commercial and consumer brings higher inherent risk.
Sovereign maintains an allowance for loan losses sufficient to absorb
inherent losses in the loan portfolio and believes the current allowance to be
at a level adequate to cover such inherent losses. The Company gives
consideration to other risk indicators when determining the appropriate
allowance level.
The allowance for loan losses consists of two elements: (i) an allocated
allowance, which is comprised of allowances established on specific loans, and
class allowances based on risk ratings, historical loan loss experience and
current trends, and (ii) unallocated allowances based on both general economic
conditions and other risk factors in the Company's individual markets and
portfolios, and to account for a level of imprecision in management's estimation
process.
The specific allowance element of the allocated allowance is based on a
regular analysis of criticized loans where internal credit ratings are below a
predetermined classification. This analysis is performed at the relationship
manager level, and periodically reviewed by the loan review department. The
specific allowance established for these criticized loans is based on a careful
analysis of related collateral value, cash flow considerations and, if
applicable, guarantor capacity.
- 28 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The class allowance element of the allocated allowance is determined by
an internal loan grading process in conjunction with associated allowance
factors. These class allowance factors are updated as required and are based
primarily on actual historical loss experience, consultation with regulatory
authorities, and peer group loss experience. While this analysis is conducted
quarterly, the Company has the ability to revise the class allowance factors
whenever necessary in order to address improving or deteriorating credit quality
trends or specific risks associated with a given loan pool classification.
Regardless of the extent of the Company analysis of customer performance,
portfolio evaluations, trends or risk management processes established, certain
inherent, but undetected losses are probable within the loan portfolio. This is
due to several factors including inherent delays in obtaining information
regarding a customer's financial condition or changes in their unique business
conditions; the judgmental nature of individual loan evaluations, collateral
assessments and the interpretation of economic trends; volatility of economic or
customer-specific conditions affecting the identification and estimation of
losses for larger non-homogeneous credits; and the sensitivity of assumptions
utilized to establish allocated allowances for homogeneous groups of loans among
other factors. The Company maintains an unallocated allowance to recognize the
existence of these exposures. These other risk factors are continuously reviewed
and revised by management where conditions indicate that the estimates initially
applied are different from actual results.
A comprehensive analysis of the allowance for loan losses is performed
by the Company on a quarterly basis. In addition, a review of allowance levels
based on nationally published statistics is conducted on an annual basis. The
Company has an Asset Review Committee, which has the responsibility of affirming
allowance methodology and assessing the general and specific allowance factors
in relation to estimated and actual net charge-off trends. This Committee is
also responsible for assessing the appropriateness of the allowance for loan
losses for each loan pool classification at Sovereign.
Residential Portfolio. The allowance for the residential mortgage
portfolio decreased from $34.6 million at December 31, 2000 to $22.3 million at
June 30, 2001. This change was due primarily to a decrease in the residential
portfolio balances.
Consumer Portfolio. The allowance for the consumer loan portfolio
increased from $48.1 million at December 31, 2000, to $59.8 million at June 30,
2001. This change is primarily attributable to increases in consumer portfolio
balance.
Commercial Portfolio. The portion of the allowance for loan losses
related to the commercial portfolio has decreased from $149.8 million at
December 31, 2000 to $139.6 million at June 30, 2001. This change reflects a
reduction in classified loans while the commercial loan portfolio remained
essentially unchanged.
Unallocated Allowance. The unallocated allowance for loan losses
increased to $34.4 million at June 30, 2001 from $23.8 million at December 31,
2000. Management continuously evaluates current economic conditions, loan
portfolio trends, and recently acquired portfolios. The increase in the
unallocated
- 29 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
allowance is a result of increased uncertainty with respect to current economic
conditions, along with a shift in the Company's loan composition, which may
bring higher inherent risk.
Investment 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"). Investment securities also include mortgage-backed
securities which consist of collateralized mortgage obligations issued by
federal agencies or private label issues. Sovereign's mortgage-backed securities
are generally either guaranteed as to principal and interest by the issuer or
have ratings of "AAA" by Standard and Poor's and Fitch/IBCA at the date of
issuance. The classes are backed by single-family residential loans which are
primary residences geographically dispersed throughout the United States.
Sovereign purchases classes which are senior positions backed by subordinate
classes. The subordinate classes absorb the losses and must be completely
eliminated before any losses flow through the senior positions. The effective
duration of the total investment portfolio at June 30, 2001 was 3.4 years.
At June 30, 2001, total investment securities available-for-sale were
$8.1 billion compared to $5.3 billion at December 31, 2000 and investment
securities held-to-maturity were $1.0 billion compared to $2.0 billion at
December 31, 2000. The reduction in held-to-maturity investment balances is due
principally to the redesignation of $800 million of investments from
held-to-maturity to available-for-sale upon adoption of SFAS 133 on January 1,
2001. Additionally, investments available-for-sale have increased from December
31, 2000 due to conversions of residential mortgages into mortgage-backed
securities and purchases of mortgage-backed securities. For additional
information with respect to Sovereign's investment securities, see Notes 3 and 4
in the Notes to Consolidated Financial Statements.
Goodwill and Other Intangible Assets
- ------------------------------------
Total goodwill and other intangible assets decreased $46.7 million to
$1.4 billion at June 30, 2001. Adjustments to the SBNE purchase allocation
increased goodwill and other intangibles by $22.2 million offset by year-to-date
amortization of $68.9 million.
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, 2001 were $23.3 billion compared to $24.5
billion at December 31, 2000. The decrease in deposits is primarily due to
reduction in time deposit balances as wholesale borrowing rates are currently
more attractive than aggressive pricing of jumbo and retail CDs.
- 30 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Short-term Borrowings
- ---------------------
Sovereign utilizes short-term borrowings as a source of funds for its asset
growth and its asset/liability management. 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
securities fully guaranteed as to principal and interest by the U.S. Government
or an agency thereof.
Total short-term borrowings at June 30, 2001 were $2.9 billion compared
to $1.3 billion at December 31, 2000. This increase is principally attributable
to Sovereign's decision to avoid high cost time deposits when wholesale
borrowings are attractively priced. See Note 7 in the Notes to Consolidated
Financial Statements for additional information.
Long-term Borrowings
- --------------------
Long-term borrowings increased to $5.4 billion at June 30, 2001 from
$4.9 billion at December 31, 2000. This increase was in FHLB advances and
repurchase agreements with attractive current pricing.
Sovereign issued $175 million of senior debt, at an 8.625% coupon, on
February 20, 2001. A portion of the proceeds, along with a portion of an $150
equity offering completed earlier in February, were used to retire a $240
million senior note which matured during the first quarter.
Sovereign also completed a $400 million revolving and term credit
facility with Bank of Scotland on March 1, 2001. Proceeds of the issue were used
to prepay an existing $350 million senior secured credit facility. The new line
provides Sovereign a 1% interest rate savings, or $3.5 million per year, has no
prepayment penalties and offers greater financial flexibility as compared to the
previous line of credit. At June 30, 2001, this credit facility had an annual
interest cost of 6.85%.
Bank Regulatory Capital
- -----------------------
Federal law requires institutions regulated by the Office of Thrift
Supervision to have a minimum leverage capital ratio equal to 3% of tangible
assets and 4% of risk-adjusted assets and a risk-based capital ratio equal to
8%. Federal law also requires OTS regulated institutions to have a minimum
tangible capital equal to 2% of total tangible assets.
The Office of Thrift Supervision issued an order, as amended,
applicable to the approval of the SBNE acquisition (the "OTS Order") that
requires Sovereign Bank to be "Well Capitalized" and also to meet certain
additional requirements and other conditions. Various agreements with our
lenders also require Sovereign Bank to be "Well Capitalized" at all times and in
compliance with all regulatory requirements. To be "well capitalized", a thrift
institution must maintain a Tier 1 Leverage ratio of at least 5%, a Tier 1
risk-based capital ratio of 6% and total risk-based capital of 10%.
- 31 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Sovereign Bank, at June 30, 2001, met all capital adequacy requirements
to which they are subject in order to be "Well Capitalized". Management expects
that Sovereign Bank will continue to be classified as well-capitalized and in
compliance with such capital requirements and conditions. Although OTS capital
regulations do not apply to savings and loan holding companies, the OTS Order
requires the Corporation to maintain certain Tier 1 capital levels. The
Corporation is presently in compliance with this requirement and expect to
remain as such.
The following table presents the capital ratios of Sovereign Bank and
the current regulatory requirements at June 30, 2001:
Sovereign Bank
------------------------------------------
Well
June 30, Minimum Capitalized
2001 Requirement Requirement
---------- ----------- -----------
Stockholders' equity to total assets 10.25% None None
Tangible capital to tangible assets 6.99 2.00% None
Tier 1 capital to tangible assets 7.01 3.00 5.00%
Tier 1 capital to risk adjusted assets 9.51 4.00 6.00
Total risk-based capital to risk
adjusted assets 10.57 8.00 10.00
Liquidity and Capital Resources
- -------------------------------
Liquidity represents the ability of Sovereign to obtain cost effective
funding to meet the needs of customers, as well as Sovereign's financial
obligations. Sovereign's primary sources of liquidity include retail deposit
gathering, Federal Home Loan Bank (FHLB) borrowings, reverse repurchase
agreements and wholesale deposit purchases. Other sources of liquidity include
federal funds purchased, asset securitizations, liquid investment portfolio
securities and debt issuances.
Factors which impact the liquidity position of Sovereign include loan
origination volumes, loan prepayment rates, maturity structure of existing
loans, core deposit growth levels, CD maturity structure and retention,
Sovereign's credit ratings, investment portfolio cash flows, maturity structure
of wholesale funding, etc. These risks are monitored and centrally managed. This
process includes reviewing all available wholesale liquidity sources. As of June
30, 2001, Sovereign had $6.0 billion in available overnight liquidity in the
form of unused federal funds purchased lines, unused FHLB borrowing capacity and
unencumbered investment portfolio securities. Sovereign also forecasts future
liquidity needs and develops strategies to ensure that adequate liquidity is
available at all times.
Pending Acquisition of Main Street Bancorp
- ------------------------------------------
On Tuesday, July 17, Sovereign announced the signing of a definitive
agreement to acquire Main Street Bancorp, Inc. ("Main Street") for approximately
$170 million in stock and cash. Main Street is a $1.5 billion bank holding
company headquartered in Reading, Pennsylvania with 42 community banking offices
serving southeastern Pennsylvania.
- 32 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The transaction, which is expected to close in the first quarter of
2002, adds $1.3 billion of customer deposits, $850 million of loans, and
enhances Sovereign's small business and middle market lending capabilities in
the region.
Asset and Liability Management
- ------------------------------
The objective of Sovereign's asset and liability management is to
identify, measure and control its interest rate risk in order to produce
consistent earnings that are not contingent upon favorable trends in interest
rates. Sovereign manages its assets and liabilities to attain a stable net
interest margin across a wide spectrum of interest rate environments. This is
attained by monitoring the levels of interest rates, the relationships between
the rates earned on assets and the rates paid on liabilities, the absolute
amount of assets and liabilities which reprice or mature over similar periods,
off-balance sheet positions and the effect of all of these factors on the
estimated level of net interest income.
Sovereign measures interest rate risk utilizing three tools: net
interest income simulation analysis in multiple interest rate environments,
instantaneous parallel interest rate shocks and lastly, gap analysis, which is a
schedule measuring the difference between assets, liabilities and off-balance
sheet positions which will mature or reprice within specific terms. Income
simulation considers not only the impact of changing market interest rates on
forecasted net income, but also other factors, such as yield curve
relationships, the volume and mix of assets and liabilities, customer
preferences and general market conditions.
Sovereign manages the impact to net interest income in a +/- 100 basis
point instantaneous parallel rate shock environment to be generally within a 5%
variance. At June 30, 2001, Sovereign estimates that if interest rates decline
by 100 basis points, net interest income, over the next twelve months, would
decrease by $50.5 million or 4.58%; conversely, if interest rates increase by
100 basis points, net interest income would increase by $38.5 million, or 3.49%.
At December 31, 2000, if interest rates increased by 100 basis points, net
interest income would have decreased by $10.5 million, or 1.0% and if interest
rates had decreased by 100 basis points, net interest income would have
decreased by $9.8 million, or .9%. The increase in sensitivity is due to the
decrease in rates and the steepening of the yield curve during the first half of
2001.
Sovereign manages the one year interest rate gap within +/- 10% range. A
positive gap position implies that the bank is asset sensitive which could cause
net interest income to decrease if interest rates fall. Conversely, a negative
gap position implies that the bank is liability sensitive which could cause net
interest income to decrease if interest rates rise. Sovereign estimates its one
year gap position was a positive 5.95% at June 30, 2001.
Pursuant to its interest rate risk management strategy, Sovereign
enters into off-balance sheet transactions including interest rate swaps, caps
and floors. Sovereign's objective in managing its interest rate risk is to
provide stable levels of net interest income across various interest rate
scenarios. For additional information on interest rate exchange agreements, see
Note 8 in the Notes to Consolidated Financial Statements.
- 33 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Interest rate swaps are used to convert fixed rate assets and
liabilities to variable rate assets and liabilities. Sovereign utilizes interest
rate swaps that have a high degree of correlation to the related financial
instrument.
As part of its mortgage banking strategy, Sovereign originates fixed
rate residential mortgages. It sells the majority of these loans to FHLMC, FNMA
and private investors. The loans are exchanged for cash or marketable fixed rate
mortgage-backed securities which are generally sold. This helps insulate
Sovereign from the interest rate risk associated with these fixed rate assets.
Sovereign uses forward sales, cash sales and options on mortgage-backed
securities as a means of hedging loans in the mortgage pipeline which are
originated for sale.
Sovereign's primary funding source is deposits obtained in its own
marketplace. Deposits increased significantly with the completion of the SBNE
acquisition in 2000 which added $12.3 billion of deposits. Deposit programs at
Sovereign are priced to meet management's asset/liability objectives, while
taking into account the rates available on investment opportunities and also
considering the cost of alternative funding sources. Borrowings are also a
significant funding source for Sovereign and have primarily been in the form of
securities sold under repurchase agreements and advances from the FHLB. Since
borrowings are not subject to the market constraints to which deposits are,
Sovereign uses borrowings to add flexibility to its interest rate risk position.
- 34 -
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Items 1 through 5 not applicable or the responses are negative.
Item 6 - Exhibits Reports on Form 8-K.
(a) Exhibits
(3.1) Articles of Incorporation, as amended and restated,
of Sovereign Bancorp, Inc. (Incorporated by reference
to Exhibit 3.1 to Sovereign's Registration Statement
No. 333-86961-01 on Form S-3)
(3.2) By-Laws of Sovereign Bancorp, Inc. (Incorporated by
reference to Exhibit 3.2 to Sovereign's Annual Report
on Form 10-K for year ended December 31, 1998.)
(b) Reports on Form 8-K
On July 3, 2001, the Company filed a Current Report
on Form 8-K/A dated July 2, 2001, reporting information under
Items 5 and 7.
On July 17, 2001, the Company filed a Current Report
on Form 8-K dated July 17, 2001, reporting information under
Items 5 and 7.
- 35 -
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 August 13, 2001 /s/Jay S. Sidhu
--------------------------- -----------------------------------------
Jay S. Sidhu
President and Chief Executive Officer
(Authorized Officer)
Date August 13, 2001 /s/George S. Rapp
--------------------------- -----------------------------------------
George S. Rapp
Chief Accounting Officer