-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, I+y7x1P0BJ5ck7tDsV4McFX59ScHInM7XJebyZnjvXajOqqGz1WRjmwIw0cSYftT 2sd+8AK1FYcnhleRmtkV4A== 0000903594-96-000027.txt : 19960401 0000903594-96-000027.hdr.sgml : 19960401 ACCESSION NUMBER: 0000903594-96-000027 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19951231 FILED AS OF DATE: 19960329 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOVEREIGN BANCORP INC CENTRAL INDEX KEY: 0000811830 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 232453088 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-16533 FILM NUMBER: 96540935 BUSINESS ADDRESS: STREET 1: 1130 BERKSHIRE BLVD CITY: READING STATE: PA ZIP: 19610 BUSINESS PHONE: 6103208400 MAIL ADDRESS: STREET 1: PO BOX 12646 CITY: READING STATE: PA ZIP: 19612 10-K 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934, for the fiscal year ended December 31, 1995, or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934, for the transition period from N/A to __________. Commission File Number 0-16533 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: (215) 320-8400 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock (without par value) (Title of class) 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. . Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the shares of Common Stock of the Registrant held by nonaffiliates of the Registrant was $508,253,463 at March 4, 1996. As of March 4, 1996, the Registrant had 47,835,620 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE The Registrant's definitive Proxy Statement to be used in connection with its 1996 Annual Meeting of Shareholders is incorporated herein by reference in response to Part III hereof. PART I Item 1. BUSINESS. General Sovereign Bancorp, Inc. ("Sovereign") is a Pennsylvania business corporation and is the holding company for Sovereign Bank, a Federal Savings Bank ("Sovereign Bank") and for Colonial Bank for Savings, a Federal Savings Bank ("Colonial Bank"). Both Sovereign and Sovereign Bank are headquartered in Wyomissing, Pennsylvania, a suburb of Reading, Pennsylvania. Colonial Bank is headquartered in Freehold, New Jersey. Sovereign Bank was created in 1984 under the name Penn Savings Bank, F.S.B. through the merger of two financial institutions with market areas primarily in Berks and Lancaster Counties, Pennsylvania. Sovereign Bank assumed its current name on December 31, 1991. Sovereign was incorporated by Sovereign Bank in 1987. From 1989 through 1994, Sovereign expanded its markets throughout eastern Pennsylvania and central New Jersey by completing ten acquisitions with assets totaling approximately $3.3 billion. At December 31, 1994, Sovereign had 130 offices and $6.6 billion in assets. On November 17, 1995, Sovereign acquired two branch offices located in Bergen County, New Jersey, and related deposits from Berkeley. Sovereign assumed approximately $111.7 million in deposits for a premium of $5.5 million. The acquisition was accounted for as a purchase. On November 15, 1995, Sovereign acquired Colonial State Bank in a transaction accounted for as a purchase. After receipt of regulatory approvals and pursuant to the terms of the agreement entered into by Sovereign and Colonial State Bank, upon acquisition, Colonial State Bank became a wholly-owned, BIF insured, subsidiary of Sovereign and converted to a federal savings bank under the name Colonial Bank for Savings, a Federal Savings Bank. Sovereign acquired Colonial Bank in exchange for $6.3 million in cash. Sovereign acquired $46.5 million in assets, consisting principally of loans and investment securities, and also assumed approximately $42.0 million in deposit liabilities. On November 10, 1995, Sovereign completed the sale of its Pottsville, Pennsylvania, branch office with related deposits totaling $23.9 million to Northwest Savings Bank and the sale of its English Village branch office in North Wales, Pennsylvania with related deposits of $12.4 million to Union National Bank & Trust Company. On April 21, 1995, Sovereign completed its sale of seven southern New Jersey offices with related deposits totalling $106.7 million to Collective Bancorp, Inc. ("Collective"). Six of these offices had previously been purchased from Berkeley as part of the transaction which closed on January 1, 1995. In addition, Sovereign acquired $7.0 million in deposits from Collective's Wilmington, Delaware branch office. On January 1, 1995, Sovereign acquired 23 branch offices located in New Jersey and Delaware, $909.3 million of related deposits, cash and fixed assets from Berkeley Federal Bank & Trust, FSB ("Berkeley") for a premium of $66.6 million. The acquisition was accounted for as a purchase. On November 1, 1994, Sovereign acquired Charter FSB Bancorp, Inc. ("Charter"), with assets of $405.8 million and 10 offices located in Morris and Sussex Counties, New Jersey. Sovereign exchanged a total of 7.0 million new shares (7.7 million shares as adjusted for all subsequent stock dividends) of Sovereign common stock for all the outstanding shares of Charter. The acquisition was accounted for as a pooling-of-interests. On September 16, 1994, Sovereign acquired the Chadds Ford Pennsylvania office and $14.4 million of related deposits of Second National Federal Savings Association ("Second National") from the Resolution Trust Corporation, receiver for Second National, and received approximately $13.7 million of cash. The acquisition was accounted for as a purchase. On August 5, 1994, Sovereign acquired all the capital stock of Shadow Lawn Savings Bank ("Shadow Lawn") with assets of $787.5 million and 17 offices located in Monmouth and Ocean Counties, New Jersey. Sovereign also assumed approximately $730.6 million of deposit liabilities. Sovereign acquired Shadow Lawn in exchange for $78.4 million of cash. The acquisition was accounted for as a purchase. On November 5, 1993, Sovereign acquired Valley Federal Savings and Loan Association ("Valley Federal"). At September 30, 1993, Valley Federal had total assets, deposits and stockholders' equity of $315.7 million, $256.4 million and $18.6 million, respectively. Sovereign exchanged a total of 2.9 million new shares (3.5 million shares as adjusted for all subsequent stock dividends) of Sovereign common stock with a value of $32.3 million for all of the outstanding shares of Valley Federal common stock. The acquisition was accounted for as a pooling-of-interests. On August 27, 1993, Sovereign assumed $252.3 million of deposit liabilities and received $233.7 million of cash from the RTC as receiver of 9 branch offices of Home Unity Federal Savings and Loan Association. On January 15, 1993, Sovereign formally acquired Harmonia Bancorp, Inc. ("Harmonia") in a transaction that was accounted or as a purchase. Sovereign acquired total assets of $621.0 million and assumed liabilities consisting principally of deposits in exchange for $19.6 million of cash and 9.6 million new shares (11.6 million shares as adjusted for all subsequent stock dividends) of Sovereign common stock, issued at a value of $66.1 million. On October 2, 1995, Sovereign entered into an Agreement to acquire West Jersey Bancshares, Inc. ("West Jersey") and West Jersey's wholly-owned subsidiary, West Jersey Community Bank ("WJCB"). WJCB is a $101 million New Jersey commercial bank headquartered in Fairfield, New Jersey. The terms of the Agreement call for Sovereign to exchange $8.40 in Sovereign common stock (subject to adjustment) for each share of West Jersey common stock. Subject to regulatory approvals and pursuant to the Agreement, the acquisition will be effected by the merger of West Jersey with and into Sovereign and the merger of WJCB with and into Sovereign Bank. The acquisition is expected to close in April 1996, and is expected to be tax free and accounted for as a pooling-of-interests. At December 31, 1995, Sovereign's consolidated assets, deposits and shareholders' equity were approximately $8.08 billion, $5.04 billion and $427.0 million, respectively. Based on assets at December 31, 1995, Sovereign is the largest thrift holding company headquartered in Pennsylvania. Sovereign's primary business consists of attracting deposits from its network of community banking offices, located in Pennsylvania, New Jersey and Delaware, and originating residential mortgage loans and home equity lines of credit in those communities. Sovereign Bank originates mortgage loans through its community banking offices and its Outside Sales Division that consists of commissioned employees who conduct business out of loan production offices. Sovereign also originates mortgage loans through its Wholesale Division that uses a network of independent mortgage bankers and brokers. All underwriting for the Wholesale Division is performed by Sovereign Bank. Sovereign operates in a heavily regulated environment. Changes in laws and regulations affecting it and its subsidiaries may have an impact on its operations. See "Business - Supervision and Regulation." For additional information with respect to Sovereign's business activities see Part III, Item 7 hereof. The following table sets forth the maturity schedule for Sovereign's loan portfolio (excluding residential real estate and consumer loans):
Amounts at December 31, 1995, Maturing ------------------------------------------------- LOAN MATURITY SCHEDULE In One Year After One Year After (IN THOUSANDS) or Less - Five Years Five Years Total ----------- -------------- ---------- ----- Commercial real estate loans: $2,487 $ 7,793 $36,897 $ 47,177 Real estate construction loans: Residential (net of loans in process of $23,365) 267 791 37,093 38,151 Residential development (net of loans in process of $736) 1,255 - 421 1,676 Commercial loans 4,871 3,674 7,286 15,831 ------- ------- ------- -------- Total $ 8,880 $12,258 $81,697 $102,835 ======= ======= ======= ======== Loans with: Fixed rates $ 2,403 $ 8,631 $15,742 $ 26,776 Variable rates 6,477 3,627 65,955 76,059 ------- ------- ------- -------- Total $ 8,880 $12,258 $81,697 $102,835 ======= ======= ======= ========
The following table summarizes the allocation of the allowance for possible loan losses and the percentage of such allocation to each loan type for the past five years: ALLOCATION OF THE ALLOWANCE FOR POSSIBLE LOAN LOSSES (IN THOUSANDS)
December 31, -------------------------------------------------------------------------------------------------------- Balance at end of Period Attributable to: 1995 1994 1993 1992 1991 - ----------------------- ------------------- ------------------- ------------------ ------------------ ------------------ Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- Residential real estate $10,520 30.18% $10,540 29.05% $ 6,737 20.35% $ 7,316 27.54% $ 4,061 30.77% Commercial real estate 698 2.00 657 1.81 1,180 3.57 1,663 6.26 777 5.89 Commercial 181 .52 164 0.45 125 0.38 135 0.51 225 1.70 Consumer 4,190 12.02 4,435 12.22 927 2.80 997 3.75 754 5.71 Unallocated 19,267 55.28 20,493 56.47 24,130 72.90 16,451 61.94 7,381 55.93 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Total $34,856 100.00% $36,289 100.00% $33,099 100.00% $26,562 100.00% $13,198 100.00% ======= ======= ======= ====== ======= ====== ======= ====== ======= ======
The following table sets forth the maturity and yields of Sovereign's investment and mortgage-backed securities held-to- maturity at December 31, 1995. The maturities of mortgage-backed securities held-to-maturity are based upon contractually scheduled repayments. Expected maturities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties. Yields on tax-exempt securities were computed on a tax equivalent basis using Sovereign's federal tax rate of 35%.
Amounts at December 31, 1995, Due ---------------------------------------------------------------- INVESTMENT AND MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY (IN THOUSANDS) After One After Five In One Year Year- Years- After or Less Five Years Ten Years Ten Years Total ----------- ---------- ---------- --------- ----- Investment Securities: - ---------------------- U.S. Treasury and U.S. $498 $2,995 $1,500 -- $4,993 Government Agency 6.84% 6.40% 7.09% -- 6.65% Securities Corporate securities -- 1,010 -- -- 1,010 -- 8.20% -- -- 8.20% Other securities -- 305 177 -- 482 -- 4.17% 1.94% -- 3.35% Mortgage-backed Securities: - --------------------------- FHLMC 6,022 63,896 88,237 10,558 168,713 7.61% 7.34% 6.36% 7.97% 6.88% FNMA 633 48,131 156,822 15,460 221,046 7.77% 7.11% 6.45% 7.01% 6.64% GNMA -- 540 12,891 156,633 170,064 -- 9.61% 6.61% 8.90% 8.73% RTC -- -- 28,954 -- 28,954 -- -- 6.80% -- 6.80% Private Issues -- 139,489 91,509 53,642 284,640 -- 6.33% 6.82% 6.98% 6.61% Collateralized Mortgage Obligations 478 1,088,394 42,168 66,270 1,197,310 7.75% 7.40% 6.45% 6.52% 7.32% ----- --------- ------ ------ --------- TOTAL $7,631 $1,344,760 $422,258 $302,563 $2,077,212 ====== ========== ======== ======== ========== 7.58% 7.27% 6.54% 7.91% 7.22% ====== ========== ======== ======== ==========
The following table sets forth the maturities and yields of Sovereign's investment and mortgage-backed securities available-for-sale at December 31, 1995. The maturities of the mortgage-backed securities available-for-sale are based upon contractually scheduled repayments. Expected maturities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties. Yields on tax-exempt securities were computed on a tax equivalent basis using Sovereign's federal tax rate of 35%.
Amounts at December 31, 1995, Due INVESTMENT AND MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE (IN THOUSANDS) No After One After Five Stated In One Year Year- Years- After Maturity or Less Five Years Ten Years Ten Years or Rate Total Investment Securities: U.S. Treasury and U.S. Government Agency Securities $12,001 $133,234 $5,007 $ -- $ -- $150,242 4.61% 5.26% 6.25% -- -- 5.24% Equity Securities -- -- -- -- 135,494 135,494 -- -- -- -- 4.75% 4.75% Mortgage-backed Securities: FHLMC -- 131,370 -- 24,753 -- 156,123 -- 5.42% -- 7.61% -- 5.77% FNMA -- 64,906 -- 71,955 -- 136,861 -- 5.63% -- 7.65% -- 6.69% GNMA -- -- -- 59,215 -- 59,215 -- -- -- 8.87% -- 8.87% Collateralized Mortgage Obligations 46,201 198,836 -- -- -- 245,037 7.50% 7.54% -- -- -- 7.53% TOTAL $58,202 $528,346 $5,007 $155,923 $135,494 $882,972 6.90% 6.20% 6.25% 8.11% 4.75% 6.36%
At December 31, 1995, Sovereign held the following securities of single issuers (other than obligations of the United States and its political subdivisions, agencies and corporations) having an aggregate book value in excess of 10% of Sovereign's shareholders' equity: INVESTMENT AND MORTGAGE-BACKED SECURITIES At December 31, 1995 (IN THOUSANDS) Issuer Book Value Market Value G.E. Capital Mortgage Servicing, Inc. $ 189,944 $ 190,868 Prudential Home Mortgage Securities, Inc. 162,809 164,260 Residential Funding Mortgage Securities, Inc. 138,472 139,262 Securitized Asset Sales, Inc. 136,244 136,804 PHH Mortgage Servicing Corp. 101,097 102,986 Housing Security, Inc. 91,682 90,581 Independent National Mortgage Corp. 73,095 73,508 Capstead Mortgage Corp. 72,906 72,969 Saxon Mortgage Securities Corp. 55,822 54,820 TOTAL $1,022,071 $1,026,058 ========== ========== The following table sets forth the maturity of certificates of deposit of $100,000 or more at December 31, 1995: At December 31, 1995 (IN THOUSANDS) Three months or less. . . . . . . . $94,918 Over three through six months. . . 71,231 Over six through twelve months. . . 40,002 Over twelve months. . . . . . . . . 20,245 Total. . . . . . . . . . . . . $226,396 ======== Subsidiaries Sovereign has three wholly-owned subsidiaries: Sovereign Bank, Colonial Bank and Sovereign Investment Corporation, a Delaware corporation that purchases and holds investment securities. In 1995, Sovereign Bank reorganized its existing subsidiary structure. Sovereign Bank now has the following wholly-owned subsidiaries: First Lancaster Financial Corp. and 201 Associates, Inc. 201 Associates, Inc. is a Delaware corporation whose primary purpose is to purchase and hold certain investment securities. First Lancaster Financial Corp. is a Pennsylvania business corporation whose primary function is to act as a holding company for The Sovereign Annuity Corp. and The Sovereign Agency, Inc. Sovereign Annuity Corp. is a New Jersey corporation whose primary purpose is to market investment securities and mutual funds. The Sovereign Agency, Inc. is a New Jersey corporation whose primary purpose is to market insurance annuities. Colonial Bank has one subsidiary: CSB Building Corporation, a New Jersey corporation whose primary purpose is to hold title to property. Federal regulations generally permit federally-chartered savings institutions to invest up to 2% of assets in the capital stock of, and make secured and unsecured loans to, certain types of subsidiary service corporations. At December 31, 1995, Sovereign Bank was authorized to have a maximum investment of approximately $160.2 million in such subsidiaries, pursuant to applicable federal regulations. As of such date, Sovereign Bank had a total investment of $28.4 million in subsidiary service corporations. Employees At December 31, 1995, Sovereign had 1,272 full-time and 232 part-time employees. None of these employees is represented by a collective bargaining agent, and Sovereign believes it enjoys good relations with its personnel. Competition Sovereign experiences substantial competition in attracting and retaining deposits and in lending funds. The primary factors in competing for deposits are the ability to offer attractive rates and the convenience of office locations. Direct competition for deposits comes primarily from other thrift institutions and commercial banks. Competition for deposits also comes from money market mutual funds, corporate and government securities, and credit unions. The primary factors in the competition for loans are interest rates, loan origination fees and the range of products and services offered. Competition for origination of real estate loans normally comes from other thrift institutions, commercial banks, mortgage bankers, mortgage brokers and insurance companies. Environmental Laws Environmentally related hazards have become a source of high risk and potentially unlimited liability for financial institutions relative to their loans. Environmentally contaminated properties owned by an institution's borrowers may result in a drastic reduction in the value of the collateral securing the institution's loans to such borrowers, high environmental clean up costs to the borrower affecting its ability to repay the loans, the subordination of any lien in favor of the institution to a state or federal lien securing clean up costs, and liability to the institution for clean up costs if it forecloses on the contaminated property or becomes involved in the management of the borrower. To minimize this risk, Sovereign Bank and Colonial Bank may require an environmental examination of and report with respect to the property of any borrower or prospective borrower if circumstances affecting the property indicate a potential for contamination, taking into consideration the potential loss to the institution in relation to the burdens to the borrower. Such examination must be performed by an engineering firm experienced in environmental risk studies and acceptable to the institution, and the costs of such examinations and reports are the responsibility of the borrower. These costs may be substantial and may deter a prospective borrower from entering into a loan transaction with Sovereign Bank or Colonial Bank. Sovereign is not aware of any borrower who is currently subject to any environmental investigation or clean up proceeding which is likely to have a material adverse effect on the financial condition or results of operations of Sovereign Bank or of Colonial Bank. Supervision and Regulation General. Sovereign is a "savings and loan holding company" registered with the Office of Thrift Supervision ("OTS") under the Home Owners' Loan Act ("HOLA") and, as such, Sovereign is subject to OTS regulation, examination, supervision and reporting. The deposits of Sovereign Bank are insured by the Savings Association Insurance Fund (the "SAIF") of the Federal Deposit Insurance Corporation (the "FDIC"). The deposits of Colonial Bank are insured by the Bank Insurance Fund (the "BIF") of the FDIC. The SAIF and the BIF are administered by the FDIC, but are required to be separately maintained and not combined. See "Insurance of Deposit Accounts" below. Sovereign Bank and Colonial Bank are required to file reports with the OTS describing their respective activities and financial condition and are periodically examined to test compliance with various regulatory requirements. Sovereign Bank and Colonial Bank are also subject to examination by the FDIC. Such examinations are conducted for the purpose of protecting depositors and the insurance fund and not for the purpose of protecting holders of equity or debt securities of Sovereign, Sovereign Bank or Colonial Bank. Sovereign Bank is a member of the Federal Home Loan Bank ("FHLB") of Pittsburgh, which is one of the twelve regional banks comprising the FHLB system. Colonial Bank is a member of the FHLB of New York. Sovereign Bank and Colonial Bank are also subject to regulation by the Board of Governors of the Federal Reserve System with respect to reserves maintained against deposits and certain other matters. Except as described herein, Sovereign's management is not aware of any current recommendations by regulatory authorities that would have a material effect on Sovereign's operations, capital resources or liquidity. Holding Company Regulation. The HOLA prohibits a registered savings and loan holding company from directly or indirectly acquiring control, including through an acquisition by merger, consolidation or purchase of assets, of any savings association (as defined in HOLA to include a federal savings bank) or any other savings and loan holding company, without prior OTS approval. Generally, a savings and loan holding company may not acquire more than 5% of the voting shares of any savings association unless by merger, consolidation or purchase of assets. Certain regulations of the OTS describe standards for control under the HOLA. See "Control of Sovereign" below. Federal law empowers the Director of the OTS to take substantive action when the Director determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of any particular activity constitutes a serious risk to the financial safety, soundness or stability of a savings and loan holding company's subsidiary savings institution. The Director of the OTS has oversight authority for all holding company affiliates, not just the insured institution. Specifically, the Director of the OTS may, as necessary, (i) limit the payment of dividends by the savings institution; (ii) limit transactions between the savings institution, the holding company and the subsidiaries or affiliates of either; (iii) limit any activities of the savings institution that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings institution. Any such limits would be issued in the form of a directive having the legal efficacy of a cease and desist order. Control of Sovereign. Under the Savings and Loan Holding Company Act and the related Change in Bank Control Act (the "Control Act"), individuals, corporations or other entities acquiring Sovereign common stock may, alone or "in concert" with other investors, be deemed to control Sovereign and thereby Sovereign Bank and Colonial Bank. If deemed to control Sovereign, such person or group will be required to obtain OTS approval to acquire Sovereign's common stock and will be subject to certain ongoing reporting procedures and restrictions under federal law and regulations. Under the regulations, ownership of 25% of the capital stock of Sovereign will be deemed to constitute "control," and ownership of more than 10% of the capital stock may also be deemed to constitute "control" if certain other control factors are present. It is possible that even lower levels of ownership of such securities could constitute "control" under the regulations. Regulatory Capital Requirements. OTS Regulations require savings associations to maintain a minimum tangible capital ratio of not less than 1.5%, a minimum core capital, or "leverage," ratio of not less than 3% and a minimum risk-based capital ratio (based upon credit risk) of not less than 8%. These standards are the same as the capital standards that are applicable to other insured depository institutions, such as banks. Federal banking agencies are required to ensure that their risk-based capital guidelines take adequate account of interest rate risk, concentration of credit risk and risks of nontraditional activities. In August, 1995, the federal banking agencies, including the OTS, issued a rule modifying their then-existing risk-based capital standards to provide for consideration of interest rate risk when assessing the capital adequacy of an institution. This new rule implements the first step of a two-step process by explicitly including a depository institution's exposure to declines in the value of its capital due to changes in interest rates as one factor that the banking agencies will consider in evaluating an institution's capital adequacy. The new rule does not establish a measurement framework for assessing an institution's interest rate risk exposure level. Examiners will use data collected by the banking agencies to determine the adequacy of an individual institution's capital in light of interest rate risk. Examiners will also consider historical financial performance, earnings exposure to interest rate movements and the adequacy of internal interest rate risk management, among other things. This case-by-case approach for assessing an institution's capital adequacy for interest rate risk is transitional. The second step of the Federal banking agencies' interest rate risk regulation will be to establish an explicit minimum capital charge for interest rate risk, based on measured levels of interest rate risk exposure. The banking agencies will implement this second step at some future date. The federal banking agencies, including the OTS, also adopted final rules relating to concentration of credit risk and risks of non-traditional activities effective on January 17, 1995. The agencies declined to adopt a quantitative test for concentrations of credit risk and, instead, provided that such risk would be considered in addition to other risks in assessing an institution's overall capital adequacy. Institutions with higher concentration of credit risk will be required to maintain greater levels of capital. Similarly, the federal agencies incorporated the evaluation of the risks of non-traditional activities into the overall assessment of capital adequacy. The agencies also indicated that proposed rules regarding specific types of non-traditional activities will be promulgated from time to time. Under the Federal Deposit Insurance Act ("FDIA") insured depository institutions must be classified in one of five defined categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized). Under OTS regulations, an institution will be considered "well capitalized" if it has (i) a total risk-based capital ratio of 10% or greater, (ii) a Tier 1 risk-based capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv) is not subject to any order or written directive to meet and maintain a specific capital level. An "adequately capitalized" institution is one that has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier 1 risk-based capital ratio of 4% or greater, (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of a bank with the highest composite regulatory examination rating) and (iv) does not meet the definition of a well capitalized institution. An institution will be considered (A) "undercapitalized" if it has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier 1 risk- based capital ratio of less than 4% or (iii) a leverage ratio of less than 4% (or 3% in the case of an institution with the highest regulatory examination rating); (B) "significantly undercapitalized" if the institution has (i) a total risk-based capital ratio of less than 6%, (ii) a Tier 1 risk-based capital ratio of less than 3% or (iii) a leverage ratio of less than 3%; and (C) "critically undercapitalized" if the institution has a ratio of tangible equity to total assets of equal to or less than 2%. The OTS may, under certain circumstances, reclassify a "well capitalized" institution as "adequately capitalized" or require an "adequately capitalized" or "undercapitalized" institution to comply with supervisory actions as if it were in the next lower category. Such a reclassification could be made if the OTS determines that the institution is in an unsafe or unsound condition (which could include unsatisfactory examination ratings). A savings institution's capital category is determined with respect to its most recent thrift financial report filed with the OTS. In the event an institution's capital deteriorates to the undercapitalized category or below, the FDIA and OTS regulations prescribe an increasing amount of regulatory intervention, including the adoption by the institution of a capital restoration plan, a guarantee of the plan by its parent holding company and the placement of a hold on increases in assets, number of branches and lines of business. If capital has reached the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and (in critically undercapitalized situations) appointment of a receiver or conservator. Critically undercapitalized institutions generally may not, beginning 60 days after becoming critically undercapitalized, make any payment of principal or interest on their subordinated debt. All but well capitalized institutions are prohibited from accepting brokered deposits without prior regulatory approval. Pursuant to the FDIA and OTS regulations, savings associations which are not categorized as well capitalized or adequately capitalized are restricted from making capital distributions which include cash dividends, stock redemptions or repurchases, cash-out mergers, interest payments on certain convertible debt and other transactions charged to the capital account of a savings association. At December 31, 1995, Sovereign Bank and Colonial Bank each met the criteria to be classified as "well capitalized." Standards for Safety and Soundness. The federal banking agencies adopted, effective in August, 1995, certain operational and managerial standards for depository institutions, including internal audit system components, loan documentation requirements, asset growth parameters, and compensation standards for officers, directors and employees. Sovereign does not anticipate that the implementation or enforcement of these guidelines will have a material adverse effect on its results of operations. Insurance of Deposit Accounts. The FDIC has implemented a risk-related premium schedule for all insured depository institutions that results in the assessment of premiums based on capital and supervisory measures. Under the risk-related premium schedule, the FDIC assigns, on a semiannual basis, each institution to one of three capital groups (well-capitalized, adequately capitalized or undercapitalized) and further assigns such institution to one of three subgroups within a capital group. The institution's subgroup assignment is based upon the FDIC's judgment of the institution's strength in light of supervisory evaluations, including examination reports, statistical analyses and other information relevant to measuring the risk posed by the institution. Only institutions with a total capital to risk-adjusted assets ratio of 10.00% or greater, a Tier 1 capital to risk-based assets ratio of 6% or greater, and a Tier 1 leverage ratio of 5.0% or greater, are assigned to the well-capitalized group. As of December 31, 1995, Sovereign Bank and Colonial Bank were classified as well capitalized for purposes of calculating insurance assessments. Institutions are prohibited from disclosing the risk classification to which they have been assigned. As of December 31, 1995, the FDIC calculated deposit insurance assessments at the rate of $.23 for every $100 of deposits for the members of SAIF in the lowest risk-based premium category and $0.31 for every $100 of insured deposits for members of SAIF in the highest risk-based premium category. In August, 1995, the FDIC adopted an amendment to the BIF risk-based assessment schedule that lowers the deposit insurance assessment rate for most (90% or more) commercial banks and other depository institutions with deposits insured by BIF to $.04 per $100 of insured deposits. On November 14, 1995, the FDIC further reduced the BIF assessment rates to a range of $.00 per $100 of insured deposits (subject to a minimum annual premium of $2,000) for those institutions with the least risk to $0.27 for every $100 of insured deposits for institutions deemed to have the highest risk, beginning January 1, 1996. At the same time, the FDIC voted to retain the existing assessment rates for SAIF- insured institutions. The reduced BIF assessment rates result in a substantial disparity in the deposit insurance premiums paid by BIF and SAIF members and could place SAIF-insured savings associations at a significant competitive disadvantage to BIF-insured institutions. Sovereign Bank is subject to FDIC deposit insurance assessments at the rate applicable to SAIF-insured institutions except, however, that the deposits acquired, on January 15, 1993, when Sovereign acquired Harmonia Bancorp, Inc., remain subject to BIF insurance assessment rates. The balance of these Harmonia deposits was $756.0 million at December 31, 1995. Colonial Bank, acquired by Sovereign on November 15, 1995, is subject to FDIC deposit insurance assessments at the rate applicable to BIF insured institutions. Federal savings banks like Sovereign Bank and Colonial Bank are required by OTS regulations to pay assessments to the OTS to fund the operations of the OTS. The general assessment is paid on a quarterly basis and is computed based on total assets of the institution, including subsidiaries. Taxation Federal Taxation. Sovereign and its subsidiaries are subject to those rules of federal income taxation generally applicable to corporations and report their respective income and expenses on the accrual basis method of accounting. Sovereign and its subsidiaries file a consolidated federal income tax return on a calendar year basis. Each member of the consolidated group separately computes its income and deductions. Intercompany distributions (including dividends) and certain other items of income and loss derived from intercompany transactions are eliminated upon consolidation of all the consolidated group members' respective taxable income and losses. In computing separate taxable income and loss, Sovereign Bank and Colonial Bank each separately computes additions to its bad debt reserves, pursuant to the special preferential rules of Section 593 of the Internal Revenue Code of 1986, as amended (the "Code"), applicable only to certain savings banks, cooperative banks, and domestic building and loan associations (generically, sometimes referred to as either a "thrift" or a "savings institution"). Under certain circumstances, the separate bad debt reserve additions of Sovereign Bank and of Colonial Bank may be subject to adjustments upon consolidation. For purposes of computing the annual deductible addition to the bad debt reserve, Sovereign Bank and Colonial Bank each must separate its loans into "qualifying real property loans" (i.e., generally those loans secured by interests in real property - "qualifying loans") and all other loans ("nonqualifying loans"). The deduction with respect to "nonqualifying loans" must be computed under the experience method (using actual historical experience), which essentially approximates a deduction for Sovereign Bank's or Colonial Bank's actual charge-offs, as the case may be. A savings institution, which meets the qualifying assets test (as further described below), is able to compute its bad debt deduction with respect to "qualifying loans" using one of two methods (whichever results in the larger deduction): (i) experience method, or (ii) the "percentage of taxable income method" (less the amount deductible for the addition to the reserve for "nonqualifying loans"). The amount so determined is subject to limitation in certain cases. The sum of the additions to each reserve for Sovereign Bank and for Colonial Bank for each year is the annual consolidated bad debt deduction, subject to any consolidating adjustments referred to above. Sovereign Bank and Colonial Bank intend to elect to utilize whatever available method provides the maximum bad debt reserve additions. If Sovereign Bank or Colonial Bank distributes amounts to stockholders (i.e., to Sovereign) and the distribution is treated as being from accumulated bad debt reserves, the distribution will cause Sovereign Bank or Colonial Bank, as the case may be, to have additional taxable income. A distribution to stockholders is deemed to have been made from accumulated bad debt reserves to the extent that (a) the bad debt reserves exceed the amount that would have been accumulated on the basis of the experience method, and (b) the distribution is a "nondividend distribution." A distribution in respect of stock is a "nondividend distribution" to the extent that, for federal income tax purposes, (i) it is in redemption of shares, (ii) it is pursuant to a partial or complete liquidation of the institution or (iii) the distribution, together with all other such distributions during the taxable year, exceeds the distributing savings institution's current and post-1951 accumulated earnings and profits. The amount of additional taxable income resulting from a "nondividend distribution" is an amount that, when reduced by the tax attributable to such distribution, is equal to the amount of the distribution. The Code imposes a corporate alternative minimum tax ("AMT"). The corporate AMT only applies if such tax exceeds a corporation's regular tax liability. In general, the AMT is calculated by multiplying the corporate AMT rate of 20% by an amount equal to the excess of (i) the sum of (a) regular taxable income plus (b) certain adjustments and tax preference items ("alternative minimum taxable income" or "AMTI") over (ii) an exemption amount ($40,000 for a corporation, but such amount is reduced by 25% of the excess of AMTI over $150,000 and is completely eliminated when AMTI equals $310,000). The excess, if any, of the bad debt deduction using the "percentage of taxable income" method over the bad debt deduction calculated on the basis of actual experience method is treated as a preference item for determining AMTI. Although there are other applicable adjustment and preference items (e.g., the adjustment for depreciation) for determining AMTI of a savings institution, this particular preference item is significant in determining AMTI. If a savings institution is subject to AMT, then all or a portion of the amount of such preference will effectively be subject to a 20% surtax. Sovereign's consolidated federal income tax return, as well as certain prior year separate returns of Jersey Shore and Harmonia, for the tax years beginning after 1991 are open under the statute of limitations. State Taxation. Sovereign and its nonthrift Pennsylvania subsidiaries are subject to the Pennsylvania Corporate Net Income Tax and Capital Stock Tax. The Corporate Net Income Tax rate for 1995 and thereafter is 9.99% and is imposed on a corporate taxpayer's unconsolidated taxable income for federal purposes with certain adjustments. In general, the Capital Stock Tax is a property tax imposed on a corporate taxpayer's capital stock value apportionable to the Commonwealth of Pennsylvania, which is determined in accordance with a fixed formula based upon average book income and net worth. In the case of a holding company, an optional elective method permits the corporate taxpayer to be taxed on only 10% of such capital stock value. The Capital Stock Tax rate is presently 1.275%. Sovereign Bank is taxed under the Pennsylvania Mutual Thrift Institutions Tax Act (the "Mutual Tax Act"). The Mutual Tax Act exempts Sovereign Bank from all other corporate taxes imposed by the Commonwealth of Pennsylvania for Pennsylvania purposes and from all local taxation imposed by political subdivisions of Pennsylvania, except taxes on real estate and real estate transfers. The Mutual Tax Act is a tax upon net income apportioned to Pennsylvania, determined in accordance with generally accepted accounting principles ("GAAP"), with certain modifications. The Mutual Tax Act, in computing GAAP income, allows for the deduction of interest earned on Pennsylvania governmental and federal securities, while disallowing a percentage of a thrift's interest expense deduction in the proportion of the interest income from those securities to the overall interest income of the institution. Pursuant to the Mutual Tax Act, Sovereign Bank's tax rate is presently 11.5% of such net income. Sovereign Bank and Colonial Bank are also taxed under the New Jersey Savings Institution Tax. The Savings Institution Tax rate is 3% and is imposed on the portion of the taxpayer's modified federal taxable income (with certain adjustments) that is properly attributable to New Jersey. Effective September 29, 1995, Sovereign Bank is subject to a Delaware Franchise Tax that is imposed on federal savings banks not headquartered in Delaware. The tax, which is imposed on taxable income properly attributable to Delaware branches, varies from a rate of 8.7% on taxable income up to $20 million to a rate of 2.7% on taxable income over $30 million. Item 2. PROPERTIES. Sovereign Bank is the owner of a five-story office building in Wyomissing, Berks County, Pennsylvania. The building is used as Sovereign's and Sovereign Bank's executive offices and as Sovereign Bank's operations center. Colonial Bank leases its office building in Freehold, Monmouth County, New Jersey, from its wholly-owned subsidiary, CSB Building Corporation. The building is used as Colonial Bank's executive offices, retail banking office and operations center. Sovereign Bank has 120 branch offices, including 6 loan production and personalized banking offices. Sovereign owns 65 of these offices and leases 55. Branch office leases are generally long-term. Loan production and personalized banking office leases generally have terms of two years or less. Colonial Bank has no branch offices. Item 3. LEGAL PROCEEDINGS. Sovereign is not involved in any pending legal proceedings other than nonmaterial legal proceedings occurring in the ordinary course of business. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. Item 4A. EXECUTIVE OFFICERS OF THE REGISTRANT. Certain information, including principal occupation during the past five years, relating to the principal executive officers of Sovereign, as of March 4, 1996, is set forth below: Richard E. Mohn - Age 65. Mr. Mohn was elected the Chairman of the Board of Sovereign on April 24, 1995. Mr. Mohn became Chairman of the Board of Sovereign Bank in November, 1989. He is Chairman of Cloister Spring Water Company, Lancaster, Pennsylvania, a bottler and distributor of spring water. Jay S. Sidhu - Age 44. Mr. Sidhu has served as President and Chief Executive Officer of Sovereign since November 21, 1989. Prior thereto, Mr. Sidhu served as Treasurer and Chief Financial Officer of Sovereign. Mr. Sidhu is also President and Chief Executive Officer of Sovereign Bank and Colonial Bank. Prior to becoming President and Chief Executive Officer of Sovereign Bank on March 28, 1989, Mr. Sidhu served as Vice Chairman and Chief Operating Officer of Sovereign Bank. Lawrence M. Thompson, Jr. - Age 43. Mr. Thompson serves as Chief Administrative Officer and Secretary of Sovereign and Chief Administrative Officer and Secretary of Sovereign Bank. Upon Sovereign's acquisition of Colonial Bank on November 15, 1995, Mr. Thompson became Secretary of Colonial Bank. Mr. Thompson was hired as Sovereign Bank's General Counsel and Secretary in 1984. He was promoted to Vice President in 1985. In April 1986 he became Sovereign Bank's Senior Vice President for legal affairs and administration. In January, 1990, he became Group Executive Officer - Lending and in June, 1995, he became Chief Administrative Officer of Sovereign and Sovereign Bank. Karl D. Gerhart - Age 43. Mr. Gerhart was elected Chief Financial Officer and Treasurer of Sovereign on February 20, 1990. Mr. Gerhart is also Group Executive Officer, Treasurer and Chief Financial Officer of Sovereign Bank and Treasurer and Chief Financial Officer of Colonial Bank. Mr. Gerhart joined Sovereign Bank in 1975 and in 1986 was promoted to Vice President- Investments. In 1987, he became Sovereign Bank's Senior Vice President, Treasurer and Chief Investment Officer, responsible for managing Sovereign Bank's investment portfolio and interest rate risk. PART II Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Sovereign's common stock is traded in the over-the-counter market and is quoted on the National Association of Securities Dealers Automated Quotation System ("NASDAQ") National Market System under the symbol "SVRN." At March 4, 1996, the total number of holders of record of Sovereign's common stock was 8,452. The high and low bid prices reported on the NASDAQ National Market System for Sovereign's common stock for 1994, adjusted to reflect all stock dividends and splits, including a 5% stock dividend declared on December 20, 1995, were $11.000 and $7.000 and for 1995 were $10.375 and $7.000, respectively. During 1995, Sovereign paid a cash dividend of $.0209 per share in the first quarter, $.0209 per share in the second quarter, $.0209 per share in the third quarter and $.0210 per share in the fourth quarter. During 1994, Sovereign paid a cash dividend of $.0336 per share in the first quarter, $.0256 per share in the second quarter, $.0258 per share in the third quarter and $.0209 per share in the fourth quarter. During 1993, Sovereign paid a cash dividend of $0.0250 per share in the first quarter, $.0259 in the second quarter, $.0252 in the third quarter and $.0231 in the fourth quarter. These per share amounts have been adjusted to reflect all stock dividends and stock splits and acquisitions accounted for as pooling- of-interests. For certain limitations on the ability of Sovereign Bank and of Colonial Bank to pay dividends to Sovereign, see Note 10 to Sovereign's consolidated financial statements, incorporated by reference herein at Item 8 "Financial Statements and Supplementary Data" and Item 1 "Business--Supervision and Regulation--Restriction on Capital Distributions" hereof. Item 6. SELECTED FINANCIAL DATA. SELECTED FINANCIAL DATA(1) BALANCE SHEET DATA (IN THOUSANDS)
AT DECEMBER 31, -------------------------------------------------------------- 1995 1994 1993 1992(2) 1991 ---------- ---------- ---------- ---------- ---------- Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,078,287 $6,564,082 $4,877,166 $3,699,084 $2,274,702 Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,674,364 4,350,898 2,898,014 2,337,382 1,437,247 Allowance for possible loan losses . . . . . . . . . . . . . . . . 34,856 36,289 33,099 26,562 13,198 Investment and mortgage-backed securities available-for-sale . . . 889,509 87,128 -- -- -- Investment and mortgage-backed securities held-to-maturity . . . . 2,077,212 1,816,840 1,689,304 1,001,356 644,061 Deposits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,039,143 4,027,119 3,183,107 2,961,058 1,815,679 Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,530,656 2,162,587 1,367,100 427,591 285,059 Stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . 427,025 303,900 259,121 220,419 137,259 SUMMARY STATEMENT OF OPERATIONS (IN THOUSANDS) YEAR ENDED DECEMBER 31, -------------------------------------------------------------- 1995 1994 1993 1992(2) 1991 ---------- ---------- ---------- ---------- ---------- Total interest income . . . . . . . . . . . . . . . . . . . . . . $ 493,031 $ 354,141 $ 282,790 $ 199,431 $ 182,015 Total interest expense . . . . . . . . . . . . . . . . . . . . . 318,805 198,741 153,318 118,585 125,326 ---------- ---------- ---------- ---------- ---------- Net interest income . . . . . . . . . . . . . . . . . . . . . . . 174,226 155,400 129,472 80,846 56,689 Provision for possible loan losses . . . . . . . . . . . . . . . 1,000 4,100 8,650 10,080 6,796 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for possible loan losses. . . 173,226 151,300 120,822 70,766 49,893 ---------- ---------- ---------- ---------- ---------- Other income . . . . . . . . . . . . . . . . . . . . . . . . . . 25,829 14,554 15,167 10,965 5,083 Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . 113,108 90,989 77,377 47,036 33,460 ---------- ---------- ---------- ---------- ---------- Income before income taxes and cumulative effect of change in accounting principle . . . . . . . . . . . . . . . . . . . . 85,947 74,865 58,612 34,695 21,516 Income tax provision . . . . . . . . . . . . . . . . . . . . . . 29,539 28,467 22,998 15,057 9,534 ---------- ---------- ---------- ---------- ---------- Income before cumulative effect of change in accounting principle 56,408 46,398 35,614 19,638 11,982 Cumulative effect of change in accounting principle . . . . . . . -- -- 4,800 -- -- ---------- ---------- ---------- ---------- ---------- Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 56,408 $ 46,398 $ 40,414 $ 19,638 $ 11,982 ========== ========== ========== ========== ========== Net income applicable to common stock . . . . . . . . . . . . . . $ 51,719 $ 46,398 $ 40,414 $ 19,638 $ 11,982 ========== ========== ========== ========== ========== SHARE DATA(3) Common shares outstanding at end of period (in thousands) . . . . 45,465 45,567 41,357 40,682 23,898 Preferred shares outstanding at end of period (in thousands) . . . 2,000 -- -- -- -- Earnings per common and common equivalent share: Before cumulative effect of change in accounting principle. . $ 1.00 $ .90 $ .70 $ .51 $ .37 After cumulative effect of change in accounting principle . . 1.00 .90 .80 .51 .37 Book value per common and common equivalent share at end of period(4). . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.40 6.05 5.24 4.53 3.73 Common share price at end of period . . . . . . . . . . . . . . . 9 5/8 7 10 11/16 6 1/16 3 3/16 Dividends paid per common share . . . . . . . . . . . . . . . . . .084 .106 .099 .082 .058 Dividend payout ratio. . . . . . . . . . . . . . . . . . . . . . . 8.40% 11.78% 14.14% 16.08% 15.68%
(1) The acquisitions of Valley Federal and Charter were accounted for as pooling-of-interests and accordingly, the consolidated financial statements have been restated to include the accounts of Valley Federal and Charter for all periods presented. (2) The acquisition of Harmonia was accounted for as a purchase at the close of business on December 31, 1992. Sovereign's consolidated balance sheet at December 31, 1992, includes Harmonia. Sovereign's 1992 consolidated results of operations do not include Harmonia's results. (3) All per share data have been adjusted to reflect all stock dividends and stock splits. (4) Book value is calculated using equity divided by common shares and, if converted, preferred shares. Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. General. Sovereign and subsidiaries reported net income of $56.4 million for the year ended December 31, 1995. This represents an increase of 22% over net income of $46.4 million reported for 1994. Earnings per share were $1.00 for 1995 which represents an increase of 11% over 1994 earnings per share of $.90. Return on average equity and return on average assets were 14.95% and .78%, respectively, for 1995 compared to 16.47% and .84%, respectively, for 1994. Return on average risk-adjusted assets was 1.68% for 1995 compared to 1.77% for 1994. Sovereign's financial results include the following significant events: Interest Rate Environment. During 1995, the Board of Governors of the Federal Reserve System lowered short-term interest rates three times, resulting in a 1% reduction in short-term rates. Long-term interest rates responded dramatically to 1995's slowing economy and lower rate of inflation by decreasing more than 2% during the year. This tightening of interest rates resulted in a flat yield curve (a shrinking of the difference between short-term rates and long-term rates). The flat yield curve coupled with a low interest rate environment caused a contraction of Sovereign's interest rate spread (the difference between the yield on total assets and the cost of total liabilities and stockholders' equity) from 2.82% in 1994 to 2.42% in 1995. While the flat yield curve compressed Sovereign's interest rate spread, it did allow Sovereign the opportunity to extend the maturity and repricing of its liabilities and shorten the maturity and repricing of its assets. This repositioning shifted Sovereign's one year gap position (the ratio representing the difference between assets, liabilities and off-balance sheet positions which will mature or reprice within one year expressed as a percentage of average assets) from a negative 10.5% at December 31, 1994, to a negative .29% at December 31, 1995. Berkeley. On November 17, 1995, Sovereign acquired two branch offices and related deposits from Berkeley Federal Bank & Trust, FSB ("Berkeley"). Sovereign assumed approximately $111.7 million of deposit liabilities and received approximately $104.9 million of cash. Colonial. On November 15, 1995, Sovereign acquired Colonial Bank in a transaction accounted for as a purchase. Sovereign acquired $46.5 million of assets consisting principally of loans and investment securities. Sovereign also assumed approximately $42.0 million of deposit liabilities. Sovereign acquired Colonial Bank in exchange for $6.3 million in cash. Colonial Bank operates as a separate banking subsidiary of Sovereign. Colonial's results of operations from November 15, 1995, and thereafter, have been included in Sovereign's consolidated results of operations. Northwest Savings Bank and Union National Bank & Trust Company. On November 10, 1995, Sovereign completed the sale of its Pottsville, Pennsylvania branch office with related deposits totalling $23.9 million to Northwest Savings Bank ("Northwest") and the sale of its English Village branch office in North Wales, Pennsylvania with related deposits of $12.4 million to Union National Bank & Trust Company ("Union National"). As a result of these transactions, Sovereign recognized a pre-tax gain of $1.1 million and reduced goodwill by $568,000, respectively. Collective. On April 21, 1995, Sovereign completed the sale of seven southern New Jersey offices with related deposits totalling $106.7 million to Collective Bancorp, Inc. ("Collective"). Six of these offices had previously been purchased from Berkeley as part of a transaction which occurred on January 1, 1995. In addition, Sovereign acquired $7.0 million of deposits from Collective's Wilmington, Delaware branch office. As a result of this transaction, Sovereign recognized a pre-tax gain of $1.5 million and reduced its existing core deposit intangible by approximately $6.0 million. Berkeley. On January 1, 1995, Sovereign acquired 23 branch offices located in New Jersey and Delaware with $909.3 million of deposit liabilities from Berkeley. In exchange for assuming the deposits of the Berkeley offices, Sovereign acquired principally cash and fixed assets, net of a deposit premium of $66.6 million. Charter. On November 1, 1994, Sovereign acquired Charter FSB Bancorp, Inc. ("Charter"). At September 30, 1994, Charter had total assets, deposits and stockholders' equity of approximately $405.8 million, $341.4 million and $41.7 million, respectively. Sovereign exchanged a total of 7.0 million new shares (7.7 million shares as adjusted for all subsequent stock dividends) of Sovereign common stock with a value of $62.7 million for all of the outstanding shares of Charter common stock. The acquisition of Charter was accounted for as a pooling-of-interests and accordingly, the consolidated financial statements have been restated to include the accounts of Charter for all periods presented. Second National. On September 16, 1994, Sovereign acquired the Chadds Ford, Pennsylvania office and related deposits of Second National Federal Savings Association ("Second National") from the Resolution Trust Corporation ("RTC"), receiver for Second National. Sovereign assumed approximately $14.4 million of deposit liabilities and received approximately $13.7 million of cash. Shadow Lawn. On August 5, 1994, Sovereign acquired Shadow Lawn Savings Bank ("Shadow Lawn") in a transaction accounted for as a purchase. Sovereign acquired $787.5 million of assets consisting principally of investment and mortgage-backed securities and loans. Sovereign also assumed approximately $730.6 million of deposit liabilities. Sovereign acquired Shadow Lawn in exchange for $78.4 million of cash. Shadow Lawn's results of operations from August 5, 1994, and thereafter, have been included in Sovereign's consolidated results of operations. Valley Federal. On November 5, 1993, Sovereign acquired Valley Federal Savings and Loan Association ("Valley Federal"). At September 30, 1993, Valley Federal had total assets, deposits and stockholders' equity of $315.7 million, $256.4 million and $18.6 million, respectively. Sovereign exchanged a total of 2.9 million new shares (3.5 million shares as adjusted for all subsequent stock dividends) of Sovereign common stock with a value of $32.3 million for all of the outstanding shares of Valley Federal common stock. The acquisition of Valley Federal was accounted for as a pooling-of-interests and accordingly, the consolidated financial statements have been restated to include the accounts of Valley Federal for all periods presented. Home Unity. On August 27, 1993, Sovereign assumed $252.3 million of deposit liabilities and received $233.7 million of cash from the RTC as receiver of nine branch offices of Home Unity Federal Savings and Loan Association ("Home Unity"). Harmonia. On January 15, 1993, Sovereign formally acquired Harmonia Bancorp, Inc. ("Harmonia") in a transaction which was accounted for as a purchase. Pursuant to applicable accounting guidance for business combinations, the Harmonia acquisition was accounted for as having been completed at the close of business on December 31, 1992, because control of Harmonia had been transferred to Sovereign as of that date. Sovereign acquired total assets of $621.0 million consisting principally of cash and interest-earning deposits, federal funds sold, investment and mortgage-backed securities and performing loans. Sovereign assumed liabilities consisting principally of deposits. Sovereign acquired Harmonia in exchange for $19.6 million of cash and 9.6 million new shares (11.6 million shares as adjusted for all subsequent stock dividends) of Sovereign common stock which were issued at a value of $66.1 million. Since the Harmonia acquisition was accounted for at the close of business on December 31, 1992, Sovereign's consolidated balance sheet at December 31, 1992, includes Harmonia. Sovereign's consolidated results of operations include Harmonia's results of operations from January 1, 1993, and thereafter. Accounting Changes. In January 1994, Sovereign adopted Statement of Financial Accounting Standards ("SFAS") No. 115 "Accounting for Certain Investments in Debt and Equity Securities," which requires management to classify investments in equity securities that have readily determinable fair values and all investments in debt securities as either held-to-maturity and reported at amortized cost, available-for-sale and reported at fair value with unrealized gains and losses reported in a separate component of stockholders' equity, or trading securities and reported at fair value with unrealized gains and losses included in earnings. Effective January 1, 1994, Sovereign classified $1.29 billion of securities as held-to-maturity, $391.0 million of securities as available-for-sale and $6.5 million of securities as trading securities. The adoption of SFAS No. 115 resulted in an $836,000 increase to stockholders' equity accounted for as the cumulative effect of a change in accounting principle in 1994. On November 15, 1995, the Financial Accounting Standards Board ("FASB") issued a Special Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities". On December 7, 1995, in accordance with provisions in that Special Report, Sovereign reclassified $750.2 million of securities from held-to-maturity to available-for-sale. This reclassification resulted in a $1.7 million unrealized gain, net of tax, which is included in Sovereign's stockholders' equity at December 31, 1995. In October 1995, the FASB issued SFAS No. 123 "Accounting for Stock-Based Compensation" which provides companies with a choice either to expense the fair value of employee stock options over the vesting period (recognition method) or to continue the previous practice but disclose the pro forma effects on net income and earnings per share had the fair value method been used (disclosure only method). Companies electing the disclosure only method will be required to include the pro forma effects of all awards granted in fiscal years beginning after December 15, 1994. Sovereign plans to adopt the disclosure only method during 1996. Effective July 1, 1995, Sovereign prospectively adopted SFAS No. 122 "Accounting for Mortgage Servicing Rights". SFAS No. 122 requires that management recognize as separate assets, rights to service mortgage loans for others, however those servicing rights are acquired. Management allocates the total cost of mortgage loans, either purchased or originated, to the loans and the mortgage servicing rights based on their relative fair value. The Statement also requires that management assess its capitalized mortgage servicing rights for impairment based on the fair value of those rights, and that this impairment be recognized through a valuation allowance. The adoption of SFAS No. 122 will not have a material effect on Sovereign's operations. Sovereign adopted SFAS No. 109 in January 1993, and has applied the provisions of the statement without restating prior years' financial statements. The adoption of SFAS No. 109 resulted in a $4.8 million increase to net income ($.10 per share) that was accounted for as the cumulative effect of a change in accounting principle. Subordinated Debentures. On July 18, 1995, Sovereign issued $50.0 million of 6.75% non-amortizing subordinated debentures due July 1, 2000, receiving net proceeds of approximately $49.4 million. On September 1, 1993, Sovereign issued $50.0 million of 6.75% non-amortizing subordinated debentures due September 1, 2000, receiving net proceeds of approximately $49.2 million. On April 7, 1993, Sovereign issued $50.0 million of 8.00% non-amortizing subordinated debentures due March 15, 2003, receiving net proceeds of approximately $48.7 million. All of the subordinated debentures qualify as supplementary capital at Sovereign Bancorp. Approximately $100.0 million of the net proceeds of Sovereign's subordinated debentures has been contributed to the capital of Sovereign Bank and qualifies as primary capital at Sovereign Bank. Preferred Stock. On May 17, 1995, Sovereign completed the sale of 2.0 million shares of Convertible Preferred Stock, raising $96.7 million in capital. The 6 1/4%, non-voting, Cumulative Convertible Preferred Stock is convertible at the option of the holder at any time, unless previously redeemed, at a conversion rate of 4.989 shares of common stock for each share of preferred stock, equivalent to a conversion price of $10.022 per share of common stock. Stock Dividends. Sovereign declared a 5% stock dividend on December 20, 1995 and on February 22, 1995, and a 10% stock dividend on April 19, 1994. All per share information such as earnings, book value, share price and dividends have been restated to reflect all stock dividends and stock splits. See Item 8, at Note 1(c) to Sovereign Consolidated Financial Statements for a detailed discussion of Sovereign's stock dividends and stock splits. Federal Deposit Insurance Corporation. Sovereign Bank is insured by the SAIF of the FDIC and pays insurance fees equal to $.23 per $100.00 (23 basis points) of insured deposits annually, the lowest rate permitted. The average SAIF premium is 24 basis points. Colonial Bank is insured by the BIF of the FDIC. During recent years, the FDIC's BIF, which insures commercial banks and certain savings banks, has also charged an average premium to its members of 24 basis points, and a minimum assessment of 23 basis points. Effective September 30, 1995, the average BIF premium was reduced from 24 basis points to 4.4 basis points, with the minimum assessment being reduced from 23 basis points to 4 basis points. Subsequently, the minimum BIF assessment was reduced to 0 basis points effective January 1, 1996, subject to the minimum FDIC annual assessment of $1,000. The average and minimum SAIF premiums remain at 24 and 23 basis points, respectively, until the SAIF reserves reach $1.25 per $100.00 in insured deposits. In order to accelerate the recapitalization of the SAIF, it has been proposed that SAIF-insured institutions such as Sovereign Bank be assessed a one-time charge of between 85 and 90 basis points of their insured deposits as of March 31, 1995. If enacted, this assessment would result in a pre-tax charge to Sovereign Bank's earnings of approximately $36.0 million to $38.1 million. This charge would have a significant negative impact on earnings in the period enacted. In accordance with FASB guidance on this specific issue, no liability or charge for this assessment is included in the 1995 audited financial statements. While it cannot be determined at this time what the outcome of these events and proposals will be, Sovereign Bank has been placed at a significant competitive disadvantage which will remain until the BIF and SAIF insurance premiums are again made equal. RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994 Net Interest Income. Net interest income for 1995 was $174.2 million compared to $155.4 million in 1994. This represents an increase of 12% and is primarily due to an increase in the size of the balance sheet resulting from the recent acquisitions and internal growth, partially offset by a decline in Sovereign's interest rate spread. Interest and fees on loans were $327.5 million for 1995 compared to $248.7 million for 1994. The average balance of loans was $4.50 billion with an average yield of 7.29% for 1995 compared to an average balance of $3.58 billion with an average yield of 6.95% for 1994. The increase in average balance was primarily due to the origination of $1.06 billion of residential mortgage loans of which $808.8 million (principally discounted adjustable rate loans) were retained in Sovereign's loan portfolio. The increase in yield was the result of the upward repricing of discounted adjustable rate loans which Sovereign originated in 1994. Interest on investment and mortgage-backed securities available-for-sale was $10.1 million for 1995 compared to $6.2 million for 1994. The average balance of investment and mortgage-backed securities available-for-sale was $147.7 million with an average yield of 7.09% for 1995 compared to an average balance of $104.3 million with an average yield of 6.27% in 1994. The increase in average yield is the result of generally higher interest rates. Interest on investment and mortgage-backed securities held-to-maturity was $151.6 million for 1995 compared to $96.7 million for 1994. The average balance of investment and mortgage-backed securities held-to-maturity was $2.19 billion with an average yield of 6.92% for 1995 compared to an average balance of $1.55 billion with an average yield of 6.24% for 1994. Interest on interest-earning deposits was $3.8 million for 1995 compared to $2.5 million for 1994. The average balance of interest-earning deposits was $23.9 million with an average yield of 16.10% for 1995 compared to an average balance of $43.5 million with an average yield of 5.77% for 1994. Interest on total deposits was $210.3 million for 1995 compared to $121.8 million for 1994. The average balance of total deposits was $4.95 billion with an average cost of 4.25% for 1995 compared to an average balance of $3.58 billion with an average cost of 3.40% for 1994. The increase in average balance was primarily due to the Berkeley acquisition. The increase in the average cost of deposits was a result of a general rise in interest rates. Interest on total borrowings was $108.5 million for 1995 compared to $76.9 million for 1994. The average balance of total borrowings was $1.83 billion with an average cost of 5.92% for 1995 compared to an average balance of $1.59 billion with an average cost of 4.84% for 1994. The increase in average cost of borrowings is a result of the general rise in interest rates and the cost of the subordinated debentures issued during 1995. Table 1 presents a summary of Sovereign's average balances, the yields earned on average assets and the cost of average liabilities and stockholders' equity for the years ended December 31, 1995, 1994 and 1993 (in thousands): Table 1: Spread Analysis
YEAR ENDED DECEMBER 31, --------------------------------------------------------------- 1995 1994 --------------------------------------------------------------- AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST RATE BALANCE INTEREST RATE ---------- -------- ------ ---------- -------- ------ Interest-earning assets: Interest-earning deposits . . . . . . . . . . . . $ 23,868 $ 3,843 16.10% $ 43,503 $ 2,508 5.77% Investment and mortgage-backed securities available-for-sale(1) . . . . . . . . . . . . . 147,658 10,118 7.09 104,296 6,188 6.27 Investment and mortgage-backed securities held-to-maturity(2)(3) . . . . . . . . . . . . 2,191,395 151,620 6.92 1,549,999 96,729 6.24 Net loans(4)(5) . . . . . . . . . . . . . . . . 4,496,756 327,450 7.29 3,581,685 248,716 6.95 ---------- -------- ----- ---------- -------- ---- Total interest-earning assets . . . . . . . . . . 6,859,677 493,031 7.19 5,279,483 354,141 6.72 Non-interest-earning assets . . . . . . . . . . . 366,931 -- -- 250,836 -- -- ---------- -------- ----- ---------- -------- ---- Total assets . . . . . . . . . . . . . . . . . $7,226,608 493,031 6.83 $5,530,319 354,141 6.41 ========== -------- ----- ========== -------- ---- Interest-bearing liabilities: Deposits: Savings deposits . . . . . . . . . . . . . . . $2,017,194 53,059 2.63 $1,594,473 36,677 2.30 Certificates . . . . . . . . . . . . . . . . . 2,929,025 157,208 5.37 1,989,931 85,135 4.28 ---------- -------- ----- ---------- -------- ---- Total deposits . . . . . . . . . . . . . . . . 4,946,219 210,267 4.25 3,584,404 121,812 3.40 Total borrowings . . . . . . . . . . . . . . . . 1,832,446 108,538 5.92 1,588,560 76,929 4.84 ---------- -------- ----- ---------- -------- ---- Total interest-bearing liabilities 6,778,665 318,805 4.70 5,172,964 198,741 3.84 Non-interest-bearing liabilities 70,630 -- -- 75,694 -- -- ---------- -------- ----- ---------- -------- ---- Total liabilities . . . . . . . . . . . . . . 6,849,295 318,805 4.65 5,248,658 198,741 3.79 Stockholders' equity . . . . . . . . . . . . . . 377,313 -- -- 281,661 -- -- ---------- -------- ----- ---------- -------- ---- Total liabilities and stockholders' equity . . $7,226,608 318,805 4.41 $5,530,319 198,741 3.59 ========== -------- ----- ========== -------- ---- Interest rate spread(6) . . . . . . . . . . . . 2.42% 2.82% ===== ==== Net interest income/net yield on total interest-earning assets(7) $174,226 2.54% $155,400 2.96% ======== ===== ======== ==== Ratio of interest-earning assets to interest- bearing liabilities . . . . . . . . . . . . . . 1.01x 1.02x ===== ====
YEAR ENDED DECEMBER 31, ------------------------------ 1993 ------------------------------ AVERAGE YIELD/ BALANCE INTEREST RATE ---------- -------- ------ Interest-earning assets: Interest-earning deposits . . . . $ 82,980 $ 3,344 4.03% Investment and mortgage-backed securities available-for-sale(1) . . . . . -- -- -- Investment and mortgage-backed securities held-to-maturity(2)(3) . . . . 1,530,073 92,534 6.06 Net loans(4)(5) . . . . . . . . 2,547,943 186,912 7.34 ---------- -------- ----- Total interest-earning assets . 4,160,996 282,790 6.80 Non-interest-earning assets . . . 213,247 -- -- ---------- -------- ----- Total assets . . . . . . . . . $4,374,243 282,790 6.47 ========== -------- ----- Interest-bearing liabilities: Deposits: Savings deposits . . . . . . . $1,388,795 38,368 2.76 Certificates . . . . . . . . . 1,665,038 69,702 4.19 ---------- -------- ----- Total deposits . . . . . . . . 3,053,833 108,070 3.54 Total borrowings . . . . . . . . 1,001,793 45,248 4.52 ---------- -------- ----- Total interest-bearing liabilities 4,055,626 153,318 3.78 Non-interest-bearing liabilities 77,447 -- -- ---------- -------- ----- Total liabilities . . . . . . 4,133,073 153,318 3.71 Stockholders' equity . . . . . . 241,170 -- -- ---------- -------- ----- Total liabilities and stockholders' equity . . . . $4,374,243 153,318 3.51 ========== -------- ----- Interest rate spread(6) . . . . 2.96% ==== Net interest income/net yield on total interest-earning assets(7) $129,472 3.11% ======== ==== Ratio of interest-earning assets to interest- bearing liabilities . . . . . . 1.03x ====
(1) The tax equivalent adjustments for the years ended December 31, 1995 and 1994 were $344,000 and $346,000, respectively, and are based on a tax rate of 38% in 1995 and 35% in 1994. (2) The tax equivalent adjustment for the year ended December 31, 1993 was $145,000 and is based on a tax rate of 35%, (none in 1994 or 1995). (3) Amortization of fees of $52,000 pertaining to mortgage-backed securities is included in interest income for the year ended December 31, 1993, (none in 1994 or 1995). (4) Amortization of net fees of $2,574,000, $476,000 and $4,491,000 for the years ended December 31, 1995, 1994 and 1993, respectively, are included in interest income. Average loan balances include non-accrual loans and loans held for resale. (5) The tax equivalent adjustments for the years ended December 31, 1995, 1994 and 1993, were $144,000, $150,000 and $152,000, respectively, and are based on a tax rate of 38% in 1995 and 35% in 1994 and 1993. (6) Represents the difference between the yield on total assets and the cost of total liabilities and stockholders' equity. (7) Represents tax equivalent net interest income divided by interest-earning assets. Table 2 presents, prior to any tax equivalent adjustments, the relative contribution of changes in volumes and changes in rates to changes in net interest income for the periods indicated. The change in interest income and interest expense attributable to the combined impact of both volume and rate has been allocated proportionately to the change due to volume and the change due to rate (in thousands): Table 2: Volume/Rate Analysis
YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------------------- 1995 VS. 1994 1994 VS. 1993 INCREASE/(DECREASE) INCREASE/(DECREASE) ------------------------------------- -------------------------------------- VOLUME RATE TOTAL VOLUME RATE TOTAL ------- --------- -------- -------- -------- ------- Interest-earning assets: Interest-earning deposits . . . . $ (449) $ 1,784 $ 1,335 $ (8,809) $ 7,973 $ (836) Investment and mortgage-backed securities available-for-sale 2,863 1,067 3,930 6,188 -- 6,188 Investment and mortgage-backed securities held-to-maturity . 43,472 11,419 54,891 1,216 2,979 4,195 Net Loans(1) . . . . . . . . . . 66,140 12,594 78,734 72,255 (10,451) 61,804 ======= ======== -------- ======== ======== -------- Total interest-earning assets . . 138,890 71,351 -------- -------- Interest-bearing liabilities: Deposits . . . . . . . . . . . 53,273 35,182 88,455 18,169 (4,427) 13,742 Borrowings . . . . . . . . . . 12,885 18,724 31,609 28,205 3,476 31,681 ======= ======== -------- ======== ======== -------- Total interest-bearing liabilities 120,064 45,423 -------- -------- Net change in net interest income $42,395 $(23,569) $ 18,826 $ 32,183 $ (6,255) $25,928 ======= ======== ======== ======== ======== ========
(1) Includes non-accrual loans and loans held for resale. Provision for Possible Loan Losses. The provision for possible loan losses was $1.0 million for 1995 compared to $4.1 million for 1994. This decreased provision was the result of improved asset quality. See "Credit Quality" for a detailed discussion of Sovereign's asset quality. During 1995, Sovereign charged-off (net of recoveries) $2.9 million of loans compared to $5.6 million during 1994. The decreased level of charge-offs is primarily due to $2.4 million of charge-offs in 1994 that did not recur in 1995. The $2.4 million of charge-offs in 1994 were related to the disposition of $40.4 million of non-performing assets acquired in the Shadow Lawn acquisition. Sovereign also acquired a $485,000 allowance for possible loan losses in the Colonial acquisition. Table 3 presents the activity in the allowance for possible loan losses for the years indicated (in thousands): Table 3: Reconciliation of the Allowance for Possible Loan Losses
DECEMBER 31, ------------------------------------------------------------------------ 1995 1994 1993 1992 1991 ------- ------- ------- ------- ------- Allowance, beginning of year . . . . . . . . . . . . $36,289 $33,099 $26,562 $13,198 $ 8,823 Charge-offs: Residential . . . . . . . . . . . . . . . . . . . . 2,679 2,563 1,077 905 2,216 Commercial real estate . . . . . . . . . . . . . . 498 2,932 292 618 133 Commercial . . . . . . . . . . . . . . . . . . . . -- -- 1 1,853 104 Consumer (including home equity lines of credit) . 403 933 894 740 5 ------- ------- ------- ------- ------- Total charge-offs . . . . . . . . . . . . . . . 3,580 6,428 2,264 4,116 2,458 ------- ------- ------- ------- ------- Recoveries: Residential . . . . . . . . . . . . . . . . . . . 514 352 7 41 17 Commercial real estate . . . . . . . . . . . . . . 125 82 49 54 5 Commercial . . . . . . . . . . . . . . . . . . . . -- 75 45 3 12 Consumer (including home equity lines of credit) . 23 297 6 28 3 ------- ------- ------- ------- ------- Total recoveries . . . . . . . . . . . . . . . . 662 806 107 126 37 ------- ------- ------- ------- ------- Charge-offs, net of recoveries . . . . . . . . . . . 2,918 5,622 2,157 3,990 2,421 Provision for possible loan losses . . . . . . . . . 1,000 4,100 8,650 10,080 6,796 Acquired reserves and other additions . . . . . . . . 485 4,712 44 7,274 -- ------- ------- ------- ------- ------- Allowance, end of year . . . . . . . . . . . . . . . $34,856 $36,289 $33,099 $26,562 $13,198 ======= ======= ======= ======= ======= Charge-offs, net of recoveries to average loans . . . .064% .155% .084% .237% .179% ======= ======= ======= ======= =======
Other Income. Total other income was $25.8 million for 1995 compared to $14.6 million for 1994. Other loan fees and service charges were $4.4 million for 1995 compared to $5.0 million for 1994. This decrease was primarily due to a decrease in Sovereign's servicing portfolio. At December 31, 1995, Sovereign serviced $4.04 billion of its own loans and $947.1 million of loans for others. This compares to $3.90 billion of its own loans and $1.11 billion of loans for others at December 31, 1994. Deposit fees were $9.4 million for 1995 compared to $5.8 million for 1994. This increase was primarily the result of the Berkeley acquisition and the full year effect of the Shadow Lawn acquisition. The gain on loans and investment and mortgage-backed securities was $419,000 for 1995 compared to $494,000 for 1994. Mortgage banking gains were $6.1 million for 1995 compared to $1.5 million for 1994. The 1995 gain includes a $3.6 million gain recognized on the sale of $238.5 million of mortgage servicing rights. The 1994 gain includes a $1.1 million gain on the sale of servicing rights related to $111.4 million of residential mortgage loans. Miscellaneous income was $5.5 million for 1995 compared to $1.8 million for 1994. This increase includes a $2.6 million gain on the sale of $130.6 million of deposits sold during 1995. General and Administrative Expenses. Total general and administrative expenses were $100.3 million for 1995 compared to $84.4 million for 1994. The 19% increase in general and administrative expenses from 1994 to 1995 compares to a 31% increase in the average balance sheet over the same time period. The ratio of general and administrative expenses to average assets was 1.39% for 1995 compared to 1.53% for 1994. This decrease in the expense ratio is the result of efficiencies realized from recent acquisitions and an increase in average balances without a corresponding increase in operating expenses. Other operating expenses were $12.8 million for 1995 compared to $6.6 million for 1994. Included in other operating expenses was amortization of goodwill and other intangible assets of $12.2 million for 1995 compared to $6.5 million for 1994. This increase was primarily the result of the Berkeley acquisition and a full year of amortization of goodwill and core deposit intangibles resulting from the Shadow Lawn acquisition. Real estate owned ("REO") losses were $657,000 for 1995 compared to $91,000 for 1994. Income Tax Provision. The income tax provision was $29.5 million for 1995 compared to $28.5 million for 1994. The effective tax rate for 1995 was 34.4% compared to 38.0% for 1994. FINANCIAL CONDITION Loan Portfolio. Sovereign's primary loan products are variable rate mortgage loans on owner occupied residential real estate. Sovereign's focus on these products has resulted in 97.8% of Sovereign's total loan portfolio at December 31, 1995 being secured by residential real estate and $3.54 billion or 75.7% of the total loan portfolio being comprised of variable rate loans. However, as a result of Sovereign's use of interest rate swaps, $426.1 million of variable rate mortgage loans have been effectively converted to fixed rate mortgage loans. Also, $295.7 million of intermediate variable rate mortgage loans (loans with a five-year fixed rate period) have effectively been converted to a variable rate over the fixed rate period. At December 31, 1995, Sovereign's total loan portfolio of $4.67 billion included $4.00 billion of first mortgage loans secured primarily by liens on owner occupied one-to-four family residential properties and $456.9 million of outstanding home equity loans ($293.1 million of additional unused commitments for home equity lines of credit) secured primarily by second mortgages on owner occupied one-to-four family residential properties. At December 31, 1995, Sovereign's residential loan portfolio also included $75.2 million of multi-family loans. Table 4 presents the composition of Sovereign's loan portfolio by type of loan and by fixed and adjustable rates at the dates indicated (in thousands): Table 4: Composition of Loan Portfolio
AT DECEMBER 31, ----------------------------------------------------------------------------- 1995 1994 1993 ----------------------- ----------------------- ---------------------- BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT ---------- ------- ---------- -------- ---------- -------- Residential real estate loans: . . . . . . . . . . . . . $3,998,048 85.53% $3,710,150 85.27% $2,434,520 84.01% Real estate construction loans: Residential . . . . . . . . . . 38,151 .82 49,094 1.13 23,086 .80 Residential development . . . . 1,676 .04 3,226 .08 3,205 .11 Multi-family loans . . . . . . . . 75,218 1.61 95,216 2.19 117,257 4.04 Home equity loans . . . . . . . . . 456,922 9.77 413,037 9.49 270,471 9.33 ---------- ------ ---------- ----- --------- ------ Total Residential Loans . . . . . . . . . . . . . 4,570,015 97.77 4,270,723 98.16 2,848,539 98.29 Commercial real estate loans . . . . . . . . . . . . . . 47,177 1.01 39,717 .91 18,259 .63 Commercial loans . . . . . . . . . 15,831 .34 5,730 .13 8,351 .29 Consumer loans . . . . . . . . . . 41,341 .88 34,728 .80 22,865 .79 ---------- ------ ---------- ------ ---------- ------ Total Loans . . . . . . . . . . . $4,674,364 100.00% $4,350,898 100.00% $2,898,014 100.00% ========== ====== ========== ====== ========== ====== Total Loans with: Fixed rates . . . . . . . . . . . $1,134,542 24.27% $1,097,469 25.22% $905,320 31.24% Variable rates . . . . . . . . . 3,539,822 75.73 3,253,429 74.78 1,992,694 68.76 ---------- ------ ---------- ------ ---------- ------ Total Loans . . . . . . . . . . $4,674,364 100.00% $4,350,898 100.00% $2,898,014 100.00% ========== ====== ========== ====== ========== ======
AT DECEMBER 31, ------------------------------------------------- 1992 1991 ---------------------- ---------------------- BALANCE PERCENT BALANCE PERCENT ---------- ------- ---------- ------- Residential real estate loans: . . . . . . . . . . . . . $1,830,629 78.32% $1,113,224 77.46% Real estate construction loans: Residential . . . . . . . . . . 38,954 1.67 28,040 1.95 Residential development . . . . 2,029 .09 2,522 .18 Multi-family loans . . . . . . . . 125,443 5.37 6,748 .47 Home equity loans . . . . . . . . . 260,514 11.14 191,651 13.33 ---------- ----- ---------- ----- Total Residential Loans . . . . . . . . . . . . . 2,257,569 96.59 1,342,185 93.39 Commercial real estate loans . . . . . . . . . . . . . . 31,214 1.34 42,455 2.95 Commercial loans . . . . . . . . . 7,565 .32 7,878 .55 Consumer loans . . . . . . . . . . 41,034 1.75 44,729 3.11 ---------- ----- ---------- ----- Total Loans . . . . . . . . . . . $2,337,382 100.00% $1,437,247 100.00% ========== ====== ========== ====== Total Loans with: Fixed rates . . . . . . . . . . . $ 737,339 31.55% $ 420,151 29.23% Variable rates . . . . . . . . . 1,600,043 68.45 1,017,096 70.77 --------- ------ --------- ------ Total Loans . . . . . . . . . . $2,337,382 100.00% $1,437,247 100.00% ========== ====== ========== ======
Credit Quality. Since Sovereign's primary loan products are residential loans, Sovereign has instituted various controls specifically designed to improve the credit quality of residential loans. For instance, Sovereign utilizes underwriting standards which in some cases are more conservative than the Federal Home Loan Mortgage Corporation ("FHLMC") or the Federal National Mortgage Association ("FNMA"). Sovereign maintains an independent Loan Review Department which each month reviews a statistical sampling of all new originations for sound underwriting practices and reviews and rates all mortgage loan requests in excess of $300,000 with a loan-to-value ratio in excess of 75% and all applications for home equity lines of credit of $100,000 and over with a loan-to-value ratio in excess of 70%, prior to submission of the loan for underwriting. Results of these loan reviews are discussed at quarterly Loan Review meetings. Criticized loans and deficiencies in those loans are discussed and corrected. Sovereign also closely monitors delinquencies as a means of maintaining high asset quality. Collection efforts begin as early as 15 days after a loan payment is due. All borrowers whose loans are more than 30 days past due are contacted by a collection officer in an effort to correct the delinquency. Once a loan is more than 90 days past due, it is referred to the Asset Recovery and Liquidation Department and the process of liquidation begins. Sovereign monitors delinquency trends at 30, 60 and 90 days past due. These trends are discussed at the quarterly Loan Review and monthly Asset Review meetings, and with the Boards of Directors of Sovereign Bancorp and Sovereign Bank. At December 31, 1995, Sovereign's non-performing assets were $43.7 million compared to $40.5 million at December 31, 1994. Non-performing assets as a percentage of total assets were .54% at December 31, 1995 compared to .62% at December 31, 1994. At December 31, 1995, 84% of non-performing assets consisted of loans or REO related to one-to-four family residential real estate. Historically, losses on the disposition of non- performing residential real estate have been lower than non- performing commercial and commercial real estate loans. The remainder of Sovereign's non-performing assets consist principally of commercial, residential development and multi- family REO acquired in the Shadow Lawn acquisition. Non- performing assets at December 31, 1995, included $4.5 million of REO which is carried at lower of cost or estimated fair value minus estimated costs to sell. Sovereign places all loans 90 days or more delinquent (except loans guaranteed by the government) on non-performing status. Table 5 presents the composition of non-performing assets at the dates indicated (in thousands): Table 5: Non-performing Assets
AT DECEMBER 31, ------------------------------------------------ 1995 1994 1993 1992 1991 ------- ------- ------- ------- ------- Non-accrual loans: Past due 90 or more days as to interest or principal: Residential . . . . . . . . . . . . . . . . . . . $33,580 $25,379 $20,740 $20,465 $14,327 Other . . . . . . . . . . . . . . . . . . . . . . 3,902 2,892 1,795 835 762 Past due less than 90 days as to interest or principal: Residential . . . . . . . . . . . . . . . . . . . 644 2,980 1,056 -- -- Other . . . . . . . . . . . . . . . . . . . . . . 739 -- -- -- 81 ------- ------- ------- ------- ------- Total non-accrual loans . . . . . . . . . . . . . . . . . . 38,865 31,251 23,591 21,300 15,170 Restructured loans . . . . . . . . . . . . . . . . . . . . 296 99 372 1,183 30 ------- ------- ------- ------- ------- Total non-performing loans . . . . . . . . . . . . . . . . 39,161 31,350 23,963 22,483 15,200 Real estate owned: Residential . . . . . . . . . . . . . . . . . . . . . 2,437 6,104 4,510 7,655 10,079 Other . . . . . . . . . . . . . . . . . . . . . . . . 2,076 3,087 8,306 12,247 1,148 ------- ------- ------- ------- ------- Total real estate owned . . . . . . . . . . . . . . . . . . 4,513 9,191 12,816 19,902 11,227 ------- ------- ------- ------- ------- Total non-performing assets . . . . . . . . . . . . . . . . 43,674 40,541 36,779 42,385 26,427 Past due 90 days or more as to interest or principal and accruing interest . . . . . . . . . . . . . . . . -- -- 63 75 130 ------- ------- ------- ------- ------- Non-performing assets and loans past due 90 days or more and accruing . . . . . . . . . . . . . . . . . . . . $43,674 $40,541 $36,842 $42,460 $26,557 ======= ======= ======= ======= ======= Non-performing assets as a percentage of total assets . . . .54% .62% .75% 1.15% 1.16% Non-performing loans as a percentage of total loans . . . . .83 .72 .81 .94 1.03 Non-performing assets as a percentage of total loans and real estate owned . . . . . . . . . . . . . . . . .92 .93 1.24 1.75 1.78 Allowance for possible loan losses as a percentage of total non-performing assets . . . . . . . . . . . . . . . . 78.95 88.24 89.24 61.91 49.00 Allowance for possible loan losses as a percentage of total non-performing loans . . . . . . . . . . . . . . . . . 88.05 114.11 136.97 116.72 85.18
In May 1993, the FASB issued SFAS No. 114 "Accounting by Creditors for Impairment of a Loan." SFAS No. 114 requires that certain impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. In October 1994, the FASB issued SFAS No. 118 "Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures," that amends SFAS No. 114 and eliminates its provisions regarding how a creditor should report income on an impaired loan. Originally, SFAS No. 114 would have required creditors to apply one of two allowable methods. As a result of the amendment, creditors may now continue to use existing methods for recognizing income on impaired loans, including methods that are required by certain industry regulators. SFAS No. 118 also clarified SFAS No. 114's disclosure requirements. SFAS No. 114 and SFAS No. 118 were adopted by Sovereign beginning January 1, 1995. The effect of SFAS No. 114 and SFAS No. 118 on Sovereign was not significant. Potential problem loans (consisting of loans 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) were comprised of 17 loans which amounted to $5.7 million at December 31, 1995 and consisted principally of multi-family loans. At December 31, 1995, Sovereign serviced, with recourse, a total of $78.2 million of single-family residential loans. Substantially all of this recourse servicing was acquired in the Jersey Shore acquisition. These are seasoned loans and historical loss experience has been minimal. The adequacy of Sovereign's allowance for possible loan losses is constantly evaluated. Management's evaluation of the adequacy of the allowance to absorb potential future 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. Sovereign's loan delinquencies (all loans greater than 30 days delinquent) as a percentage of total loans was 1.32% at December 31, 1995, up slightly from 1994 delinquencies of 1.16% of total loans. These factors indicated to management that a provision for possible loan losses of $1.0 million was necessary to maintain the allowance for possible loan losses at a level which management conservatively estimates is necessary to absorb potential future losses in consideration of the factors noted above. Investment and Mortgage-backed Securities Available-For- Sale. Securities expected to be held for an indefinite period of time are classified as available-for-sale and are carried at fair value, with unrealized gains and losses reported as a separate component of stockholders' equity, net of estimated income taxes. Decisions to purchase or sell these securities are based on economic conditions including changes in interest rates, liquidity, and asset liability management strategies. Table 6 presents the amortized cost and estimated fair value of investment and mortgage-backed securities available-for-sale at the dates indicated (in thousands): Table 6: Investment and Mortgage-backed Securities Available-for-Sale
AT DECEMBER 31, ------------------------------------------------------------------ 1995 1994 1993 -------------------- ------------------- ------------------- AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE COST VALUE --------- ----- --------- ----- --------- ----- Investment Securities: U.S. Treasury and government agency securities . . . . . . . $150,242 $149,109 $ -- $ -- $ -- $ -- Equity Securities . . . . . . . . 135,494 136,571 88,583 87,128 -- -- Mortgage-backed Securities: . . . . FHLMC . . . . . . . . . . . . . . 156,123 155,529 -- -- -- -- FNMA . . . . . . . . . . . . . . 136,861 138,445 -- -- -- -- GNMA . . . . . . . . . . . . . . 59,215 61,912 -- -- -- -- Collateralized mortgage obligations 245,037 247,943 -- -- -- -- -------- -------- ------- ------- ------ ------ Total investment and mortgage-backed securities available-for-sale . . $882,972 $889,509 $88,583 $87,128 $ -- $ -- ======== ======== ======= ======= ====== ======
Investment and Mortgage-backed Securities Held-To-Maturity. Securities that Sovereign has the intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. This portfolio is primarily comprised of U.S. Treasury and government agency securities; corporate debt securities; mortgage-backed securities issued by FHLMC, FNMA, the Government National Mortgage Association ("GNMA"), the RTC and private issuers; and collateralized mortgage obligations. Table 7 presents the amortized cost and estimated fair value of investment and mortgage-backed securities held-to-maturity at the dates indicated (in thousands): Table 7: Investment and Mortgage-backed Securities Held-To-Maturity
AT DECEMBER 31, ---------------------------------------------------------------------- 1995 1994 1993 ----------------------- --------------------- ---------------------- AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE COST VALUE --------- ----- --------- ----- --------- ----- Investment Securities: U.S. Treasury and government agency securities . . . . . . . $ 4,993 $ 5,030 $ 159,353 $ 146,695 $ 125,077 $ 125,021 Corporate securities . . . . . . 1,010 1,070 4,025 3,982 14,070 14,332 Other securities . . . . . . . . 482 482 420 416 81,754 82,930 Mortgage-backed Securities: . . . . FHLMC . . . . . . . . . . . . . . 168,713 169,169 336,556 310,446 190,076 192,459 FNMA . . . . . . . . . . . . . . 221,046 220,260 316,968 290,595 243,688 246,417 GNMA . . . . . . . . . . . . . . 170,064 176,532 237,308 234,578 47,783 50,043 RTC . . . . . . . . . . . . . . . 28,954 24,498 33,976 28,749 44,744 44,757 Private issues . . . . . . . . . 284,640 282,636 272,833 252,341 361,826 361,346 Collateralized mortgage obligations 1,197,310 1,207,679 455,401 433,341 580,286 579,565 ---------- ---------- ---------- ---------- ---------- ---------- Total investment and mortgage- backed securities held-to-maturity $2,077,212 $2,087,356 $1,816,840 $1,701,143 $1,689,304 $1,696,870 ========== ========== ========== ========== ========== ==========
In January 1994, Sovereign adopted SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities," which requires management to classify investments in equity securities that have readily determinable fair values and all investments in debt securities as either held-to-maturity and reported at amortized cost, available-for-sale and reported at fair value with unrealized gains and losses reported in a separate component of stockholders' equity, or trading securities and reported at fair value with unrealized gains and losses included in earnings. Effective January 1, 1994, Sovereign adopted SFAS No. 115 and classified $1.29 billion of securities as held-to-maturity, $391.0 million of securities as available-for-sale and $6.5 million of securities as trading securities. The adoption of SFAS No. 115 resulted in an $836,000 increase to stockholders' equity accounted for as the cumulative effect of a change in accounting principle in 1994. On November 15, 1995, the FASB issued a Special Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities". On December 7, 1995, in accordance with provisions in that Special Report, Sovereign reclassified $750.2 million of securities from held-to-maturity to available-for-sale. This reclassification resulted in a $2.8 million unrealized gain which is included in Sovereign's stockholders' equity at December 31, 1995. Prior to the adoption of SFAS No. 115, management determined the appropriate classification of securities at the time of purchase. If Sovereign had the intent and the ability at the time of purchase to hold securities until maturity or on a long-term basis, they were classified as investments and carried at amortized historical cost. Securities to be held for indefinite periods of time and not intended to be held-to-maturity or on a long-term basis were classified as available-for-sale and carried at the lower of cost or estimated fair value. Securities held for indefinite periods of time included securities that management intended to use as part of its asset/liability management strategy and that may have been sold in response to changes in interest rates, resultant prepayment risk, and other factors related to interest rate and resultant prepayment risk changes. Other Assets. Other assets at December 31, 1995, were $26.3 million compared to $46.2 million at December 31, 1994. Premises and equipment at December 31, 1995, was $57.0 million compared to $48.1 million at December 31, 1994. The increase is primarily due to capital expenditures related to system conversions and the expansion of Sovereign's market. Goodwill and intangible assets at December 31, 1995, were $123.2 million compared to $64.6 million at December 31, 1994. The increase is primarily related to the Berkeley acquisition in January 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 December 31, 1995, were $5.04 billion compared to $4.03 billion at December 31, 1994. The increase was primarily the result of the acquisition of the Berkeley deposits which added $909.3 million of deposits. Table 8 presents the composition of Sovereign's deposits at the dates indicated (in thousands): Table 8: Deposit Portfolio Composition
AT DECEMBER 31, --------------------------------------------------------------------- 1995 1994 1993 ---------------------- --------------------- --------------------- % OF % OF % OF ACCOUNT TYPE BALANCE DEPOSITS BALANCE DEPOSITS BALANCE DEPOSITS ------------ ------- -------- ------- -------- ------- -------- Savings accounts . . . . . . . . . $ 925,842 18.37% $ 925,667 22.98% $ 779,016 24.48% NOW and money market accounts . . 1,101,472 21.86 696,781 17.30 557,465 17.51 Demand deposit accounts . . . . . 168,757 3.35 118,346 2.94 105,787 3.32 Retail certificates of deposit . . 2,731,009 54.20 2,207,531 54.82 1,637,721 51.45 ---------- ------ ---------- ------ ---------- ------ Total retail deposits . . . . . . 4,927,080 97.78 3,948,325 98.04 3,079,989 96.76 Jumbo certificates of deposit . . . 112,063 2.22 78,794 1.96 103,118 3.24 ---------- ------ ---------- ------ ---------- ------ Total deposits . . . . . . . . . $5,039,143 100.00% $4,027,119 100.00% $3,183,107 100.00% ========== ====== ========== ====== ========== ======
Borrowings. Sovereign utilizes 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 borrowings at December 31, 1995, were $2.53 billion of which $1.51 billion were short-term compared to total borrowings of $2.16 billion of which $1.72 billion were short-term at December 31, 1994. Table 9 presents information regarding borrowings at the dates indicated (in thousands): Table 9: Borrowings
AT DECEMBER 31, ------------------------------------------------------------------------------- 1995 1994 1993 ------------------------ ------------------------- ------------------------ WEIGHTED WEIGHTED WEIGHTED BALANCE AVERAGE RATE BALANCE AVERAGE RATE BALANCE AVERAGE RATE ------- ------------ ------- ------------ ------- ------------ Securities sold under repurchase agreements . . $ 382,279 6.38% $ 608,810 5.72% $ 315,616 3.40% FHLB advances . . . . . . . 1,979,551 5.75 1,434,081 5.25 929,106 4.39 Other borrowings . . . . . 168,826 7.49 119,696 7.71 122,378 7.84 ---------- ----- ---------- ----- ---------- ----- Total borrowings . . . . $2,530,656 5.96% $2,162,587 5.52% $1,367,100 4.47% ========== ===== ========== ===== ========== =====
Of the above advances, $280.0 million have been effectively converted to fixed rate obligations through the use of interest rate swaps. Of the other borrowings, $50.0 million of subordinated debentures have, through the use of an interest rate swap, been converted from a fixed rate obligation to a variable rate obligation. In addition, $996.0 million of borrowings have been protected from upward repricing through the use of interest rate caps. Stockholders' Equity. Total stockholders' equity at December 31, 1995, was $427.0 million compared to $303.9 million at December 31, 1994. The increase in stockholders' equity was primarily attributable to the retention of earnings of $56.4 million and the issuance of $100.0 million of preferred stock. LIQUIDITY AND CAPITAL RESOURCES Sovereign Bank is required under applicable federal regulations to maintain specified levels of "liquid" investments in cash and U.S. Treasury and other qualifying investments. Regulations currently in effect require Sovereign Bank to maintain liquid assets of not less than 5% of its net withdrawable accounts plus short-term borrowings, of which short-term liquid assets must consist of not less than 1%. These levels are changed from time to time by the OTS to reflect economic conditions. Sovereign Bank's liquidity ratio was 12.80% for December 1995. 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. During 1995, Sovereign increased its deposit base and market share when it acquired the Berkeley offices. At December 31, 1995, Sovereign had $2.37 billion in unpledged investment 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. The interest rate environment experienced in 1995 resulted in slower prepayments of mortgage-backed securities and loans than in prior years. Therefore, Sovereign obtained required funding in the form of borrowings and additional deposits. Cash and cash equivalents increased $8.4 million for 1995. Net cash provided by operating activities was $5.7 million for 1995. Net cash used by investing activities for 1995 was $1.33 billion consisting primarily of purchases of mortgage-backed securities which were classified as held-to-maturity. In the fourth quarter of 1995, $587.0 million of these mortgage-backed securities were transferred to the available-for-sale portfolio. The considerable flattening of the yield curve has diminished the market for originating adjustable rate mortgage loans. As a result, Sovereign has focused on the mortgage-backed security portfolio to provide earning assets. Net cash provided by financing activities for 1995 was $1.33 billion which includes the assumption of $818.9 million of deposits from recent acquisitions net of sales, and proceeds from long-term borrowings of $905.5 million which was partially offset by a decrease in short-term borrowings due to Sovereign's effort to extend borrowings to manage its interest rate risk. The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA") requires the OTS to prescribe uniformly applicable capital standards for all savings associations. These standards currently require institutions 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 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 incorporating an interest rate risk component into its risk-based capital requirements. Under the regulation, savings associations which are deemed to have an "above normal" level of interest rate risk must deduct a portion of that risk from total capital for regulatory capital purposes. Implementation of this interest rate risk capital deduction has been delayed by the OTS until further notification. 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 or adequately capitalized are subject to various restrictions regarding capital distributions, payment of management fees, acceptance of brokered deposits and other operating activities. At December 31, 1995, Sovereign Bank and Colonial Bank were classified as well capitalized and were in compliance with all capital requirements. The following table sets forth the capital ratios of Sovereign Bank, Colonial Bank and Sovereign Bancorp and the current regulatory requirements at December 31, 1995:
SOVEREIGN COLONIAL SOVEREIGN BANK BANK BANCORP(1) REQUIREMENT --------- -------- ---------- ----------- Tangible capital to tangible assets . . . . . . . 5.12% 6.26% 3.79% 1.50% Leverage (core) capital to tangible assets . . . 5.12 6.26 3.79 3.00 Leverage (core) capital to risk-adjusted assets . 11.80 9.23 8.53 4.00 Risk-based capital to risk-adjusted assets . . . 12.64 10.38 14.27 8.00
(1) OTS capital regulations do not apply to 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, 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 these factors on the estimated level of net interest income. There are a number of industry standards used to measure an institution's interest rate risk position. Most common among these is the one year gap which is the ratio representing the difference between assets, liabilities and off-balance sheet positions which will mature or reprice within one year expressed as a percentage of total assets. Using management's estimates of asset prepayments, core deposit decay and core deposit repricing in its computation, Sovereign estimates that its cumulative one year gap position was a negative .29% at December 31, 1995. 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. 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 rates 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 utilizes non-amortizing interest rate swaps to convert fixed rate liabilities to floating, and floating rate liabilities to fixed, 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 the 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 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 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. Table 10 presents the amounts of interest-earning assets and interest-bearing liabilities that are assumed to mature or reprice during the periods indicated at December 31, 1995, and their related average yields and costs. Adjustable and floating rate loans and securities are included in the period in which interest rates are next scheduled to adjust rather than the period in which they mature (in thousands). Table 10: Gap Analysis
2-3 3-5 OVER 5 1 YEAR YEARS YEARS YEARS TOTAL ------ ----- ----- ------ ----- Interest-earning assets: Loans(1) . . . . . . . . . . . . . $ 2,680,622 $ 1,400,761 $ 280,801 $ 347,836 $ 4,710,020 7.78% 7.02% 7.51% 8.41% 7.46% Investment and mortgage-backed securities(2)(3) . . . . . . . . 1,284,229 1,042,269 398,366 258,787 2,983,651 7.08% 6.48% 6.88% 6.94% 6.94% ----------- ------------ --------- ---------- ----------- Total interest-earning assets . . . . . 3,964,851 2,443,030 679,167 606,623 7,693,671 7.56% 6.79% 7.14% 7.79% 7.26% Non-interest-earning assets . . . . . . -- -- -- 384,616 384,616 ----------- ------------ --------- ---------- ----------- Total assets . . . . . . . . . . . . . $ 3,964,851 $ 2,443,030 $ 679,167 $ 991,239 $ 8,078,287 7.56% 6.79% 7.14% 4.76% 7.01% Interest-bearing liabilities: Deposits(4) . . . . . . . . . . . $ 3,243,138 $ 379,477 $ 723,052 $ 693,476 $ 5,039,143 5.05% 4.94% 2.28% 2.15% 4.24% Borrowings . . . . . . . . . . . 1,685,354 689,763 98,831 56,708 2,530,656 5.79% 5.95% 7.73% 9.32% 5.96% ----------- ------------ --------- ---------- ----------- Total interest-bearing liabilities . . 4,928,492 1,069,240 821,883 750,184 7,569,799 5.30% 5.59% 2.93% 2.69% 4.83% Non-interest-bearing liabilities . . . -- -- -- 81,463 81,463 Stockholders' equity . . . . . . . . . -- -- -- 427,025 427,025 ----------- ------------ --------- ---------- ----------- Total liabilities and stockholders' equity $ 4,928,492 $ 1,069,240 $ 821,883 $1,258,672 $ 8,078,287 5.30% 5.59% 2.93% 1.60% 4.55% ----------- ------------ --------- ---------- ----------- Excess assets (liabilities) before effect of off-balance sheet positions . . . $ (963,641) $ 1,373,790 $(142,716) $ (267,433) ----------- ------------ --------- ---------- To total assets . . . . . . . . . . (11.93)% 17.01% (1.77)% (3.31)% 2.46% =========== ============ ========= ========== =========== Cumulative excess assets (liabilities) before effect of off-balance sheet positions . . . . . . . . . . . . $ (963,641) $ 410,149 $ 267,433 $ -- =========== ============ ========= ========== To total assets . . . . . . . . . (11.93)% 5.08% 3.31% Effect of off-balance sheet positions on assets and liabilities . . . . . $ 940,262 $ (1,276,000) $ 254,948 $ 80,790 ----------- ------------ --------- ---------- Excess assets (liabilities) after effect of off-balance sheet positions . . . $ (23,379) $ 97,790 $ 112,232 $ (186,643) =========== ============ ========= ========== To total assets . . . . . . . . . (.29)% 1.21% 1.39% (2.31)% Cumulative excess assets (liabilities) after off-balance sheet positions $ (23,379) $ 74,411 $ 186,643 $ -- =========== ============ ========= ========== To total assets . . . . . . . . . (.29)% .92% 2.31%
(1) Loan balances include annual prepayment and repayment assumptions between 6% and 35% initially with gradual slowing thereafter. Loan balances are presented net of deferred loan fees and include loans held for resale and the allowance for loan losses. (2) Mortgage-backed securities include annual prepayment and repayment assumptions between 6% and 30% initially with gradual slowing thereafter. Balances on these securities are presented net of deferred loan fees. (3) Includes interest-earning deposits. (4) Savings, NOW, money market and demand deposit accounts have been assumed to decay at an annual rate of 20%. Table 11 presents selected quarterly consolidated financial data (in thousands, except per share data): Table 11: Selected Quarterly Consolidated Financial Data
THREE MONTHS ENDED -------------------------------------------------------------------------------------- DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31, 1995 1995 1995 1995 1994 1994 1994 1994 ---- ---- ---- ---- ---- ---- ---- ---- Total interest income . . . . . . . $ 136,575 $ 128,827 $ 116,220 $ 111,409 $ 102,367 $ 94,366 $ 80,715 $ 76,693 Total interest expense . . . . . . 90,137 85,150 74,845 68,673 60,881 53,871 43,657 40,332 --------- --------- --------- --------- --------- -------- --------- -------- Net interest income . . . . . . . . 46,438 43,677 41,375 42,736 41,486 40,495 37,058 36,361 Provision for possible loan losses . . . . . . . . . . . . . 250 250 250 250 600 950 1,013 1,537 --------- --------- --------- --------- --------- -------- --------- -------- Net interest income after provision . . . . . . . . . . . 46,188 43,427 41,125 42,486 40,886 39,545 36,045 34,824 Other income . . . . . . . . . . . 6,774 4,894 9,294 4,867 4,389 4,016 2,972 3,177 Other expenses . . . . . . . . . . 28,940 26,447 28,929 28,792 26,744 23,137 20,579 20,529 --------- --------- --------- --------- --------- -------- --------- -------- Income before income taxes . . . . 24,022 21,874 21,490 18,561 18,531 20,424 18,438 17,472 Income tax provision . . . . . . . 8,325 7,436 7,347 6,431 6,964 8,188 6,769 6,546 --------- --------- --------- --------- --------- -------- --------- -------- Net income . . . . . . . . . . . . $ 15,697 $ 14,438 $ 14,143 $ 12,130 $ 11,567 $ 12,236 $ 11,669 $ 10,926 ========= ========= ========= ========= ========= ======== ========= ======== Net income applicable to common stock . . . . . . . . . . . . . . $ 14,134 $ 12,875 $ 12,580 $ 12,130 $ 11,567 $ 12,236 $ 11,669 $ 10,926 ========= ========= ========= ========= ========= ======== ========= ======== Earnings per share:(1) . . . . . . $ .27 $ .24 $ .25 $ .24 $ .22 $ .24 $ .23 $ .21 Market Prices(1) High . . . . . . . . . . . . . . 10 3/8 10 1/4 9 3/16 8 13/16 9 1/16 10 3/16 10 7/16 11 Low . . . . . . . . . . . . . . 9 3/16 8 15/16 7 5/8 7 7 8 3/4 8 3/4 7 13/16 Dividends per share(1) . . . . . . .0210 .0209 .0209 .0209 .0209 .0258 .0256 .0336
(1) All per share data have been adjusted to reflect all stock dividends and stock splits. RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993 Net Income. Net income for the year ended December 31, 1994, was $46.4 million, a 30% increase over $35.6 million for the year ended December 31, 1993. On a per share basis, net income rose to $.90 in 1994 from $.70 in 1993. Return on average assets was .84% for 1994, compared to .81% for 1993. Return on average equity for 1994 was 16.47% compared to 14.77% for 1993. The 1993 results presented above exclude a $4.8 million increase to net income from the adoption of SFAS No. 109. Net Interest Income. Net interest income was $155.4 million for 1994 compared to $129.5 million for 1993. The increase was primarily due to an increase in the size of the balance sheet resulting from the Shadow Lawn acquisition and strong loan growth. Interest and fees on loans were $248.7 million in 1994 compared to $186.9 million in 1993. Loans averaged $3.58 billion with an average yield of 6.95% in 1994 compared to $2.55 billion with an average yield of 7.34% in 1993. The increase in average balance was primarily due to the Shadow Lawn acquisition and the origination of $1.66 billion of residential mortgage loans of which $1.44 billion were retained in Sovereign's loan portfolio. The decrease in yield was the result of discounted rates during the initial term on newly originated adjustable rate loans somewhat offset by generally higher interest rates. Interest on investment and mortgage-backed securities available-for-sale was $6.2 million with an average yield of 6.27% for 1994. There were no investment and mortgage-backed securities classified as available-for-sale in 1993. Interest on investment and mortgage-backed securities held-to-maturity was $96.7 million for 1995 compared to $92.5 million for 1993. The average balance of investment and mortgage-backed securities held-to-maturity was $1.55 billion with an average yield of 6.24% for 1994 compared to an average balance of $1.53 billion with an average yield of 6.06% for 1993. Interest on deposits was $121.8 million for 1994 compared to $108.1 million for 1993. Average deposits were $3.58 billion for 1994 compared to $3.05 billion for 1993. The increase in average balance was primarily due to the Shadow Lawn acquisition. The average rate paid on deposits was 3.40% for 1994 compared to 3.54% for 1993. The decrease in the average cost of deposits was a result of a change in deposit composition toward lower cost transaction accounts. Interest on borrowings was $76.9 million for 1994 compared to $45.2 million for 1993. During 1994, average outstanding borrowings were $1.59 billion with a cost of 4.84% compared to $1.00 billion for 1993 with a cost of 4.52%. The increase in average balance is the result of the significant loan growth being funded principally by borrowings. The increase in average cost of borrowings is a result of the general rise in interest rates and the full year effect of the cost of subordinated debentures issued during 1993. Provision for Possible Loan Losses. The provision for possible loan losses for 1994 was $4.1 million compared to $8.7 million in 1993. This decreased provision was the result of improved asset quality. Other Income. Other income was $14.6 million for 1994 compared to $15.2 million for 1993. Mortgage banking gains were $1.5 million for 1994 compared to $2.4 million for 1993. During 1994, Sovereign recognized a gain of $1.1 million on the sale of servicing rights related to $111.4 million of residential mortgage loans. Other loan fees and service charges were $5.0 million for 1994 compared to $4.4 million for 1993. This increase was primarily due to an increase in Sovereign's servicing portfolio. Deposit fee income was $5.8 million for 1994 compared to $4.4 million for 1993. This increase was the result of the Shadow Lawn acquisition. General and Administrative Expenses. Total general and administrative expenses were $84.4 million for 1994 compared to $73.3 million for 1993. The 15% increase in general and administrative expenses from 1993 to 1994 compares to a 26% increase in the average balance sheet over the same time period. Other operating expenses were $6.6 million for 1994 compared to $4.1 million for 1993. Amortization of goodwill and other intangible assets was $6.5 million for 1994 compared to $3.5 million for 1993. This increase was primarily the result of the Shadow Lawn acquisition and a full year of amortization of core deposit intangible resulting from the Home Unity acquisition. Net REO losses were $91,000 for 1994 compared to $603,000 for 1993. Income Tax Provision. The income tax provision was $28.5 million for 1994 compared to $23.0 million for 1993. The effective tax rate for 1994 was 38.0% compared to 39.2% for 1993. MARKET AND DIVIDEND INFORMATION Sovereign's common and preferred stock is traded and listed on the NASDAQ Stock market under the symbol "SVRN" and "SVRNP", respectively. Options on Sovereign common stock are traded on the Philadelphia Stock Exchange (PHLX) under the symbol "SVRN" or "SQV". At December 31, 1995, the total number of holders of record of Sovereign's common stock was 8,338. Holders of Sovereign's common stock are entitled to receive dividends when, as and if declared by Sovereign's Board of Directors, out of funds legally available therefor. The timing and amount of any future dividends will depend on earnings, capital requirements, federal and state laws, regulations and policies and other factors including the amounts of dividends payable to Sovereign by its subsidiaries. The current quarterly dividend is $.021 per share. Holders of Sovereign's preferred stock are entitled to receive, when and as declared by the Board of Directors, out of assets of the Corporation legally available for payment, cash dividends payable quarterly at the rate of 6-1/4% per annum. Dividends on the preferred stock, calculated as a percentage of the liquidation preference, are payable quarterly on February 15, May 15, August 15 and November 15 of each year. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders Sovereign Bancorp, Inc. We have audited the accompanying consolidated balance sheets of Sovereign Bancorp, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1993 financial statements of Charter FSB Bancorp, Inc., a company acquired on November 1, 1994 as more fully described in Note 2, which statements reflect net income constituting 12% of the related 1993 consolidated totals. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to data included for Charter FSB Bancorp, Inc., is based solely on the report of other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant assumptions made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and, for 1993, the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sovereign Bancorp, Inc. and subsidiaries at December 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. In 1995, the Company changed its method of accounting for mortgage servicing rights, as discussed in Note 1, to the consolidated financial statements. In 1994, the Company changed its method of accounting for investment and mortgage-backed securities, as discussed in Note 1 to the consolidated financial statements. In 1993, the Company changed its method of accounting for income taxes, as discussed in Note 13 to the consolidated financial statements. /s/ ERNST & YOUNG LLP January 17, 1996 Reading, Pennsylvania SOVEREIGN BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
AT DECEMBER 31, -------------------------- 1995 1994 ----------- ----------- ASSETS Cash and amounts due from depository institutions . . . . . . . . . . . . $ 130,841 $ 110,270 Interest-earning deposits . . . . . . . . . . . . . . . . . . . . . . . . . 16,930 29,131 Loans held for resale (approximate fair value of $71,297 and $7,666 at December 31, 1995 and 1994, respectively) . . . . . . . . . . . . . . 70,512 7,666 Investment and mortgage-backed securities available-for-sale . . . . . . . 889,509 87,128 Investment and mortgage-backed securities held-to-maturity (approximate fair value of $2,087,356 and $1,701,143 at December 31, 1995 and 1994, respectively) . . . . . . . . . . . . . . . 2,077,212 1,816,840 Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,674,364 4,350,898 Allowance for possible loan losses . . . . . . . . . . . . . . . . . . . . (34,856) (36,289) Premises and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . 56,951 48,096 Real estate owned . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,514 9,191 Accrued interest receivable . . . . . . . . . . . . . . . . . . . . . . . 42,785 30,369 Goodwill and other intangible assets . . . . . . . . . . . . . . . . . . . 123,243 64,553 Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,282 46,229 --------- --------- Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 8,078,287 $ 6,564,082 =========== =========== LIABILITIES Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,039,143 $ 4,027,119 Borrowings Short-term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,512,720 1,722,726 Long-term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,017,936 439,861 Advance payments by borrowers for taxes and insurance . . . . . . . . . . 22,117 25,893 Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59,346 44,583 ----------- ----------- Total Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,651,262 $ 6,260,182 =========== =========== STOCKHOLDERS' EQUITY Preferred stock; 7,500,000 shares authorized; 2,000,000 shares issued at December 31, 1995 . . . . . . . . . . . . . . . . . . . . . . . 96,446 -- Common stock; no par value; 100,000,000 shares authorized; 48,438,944 shares issued at December 31, 1995 and 45,566,971 shares issued at December 31, 1994 . . . . . . . . . . . . 248,875 224,958 Unallocated Common stock held by ESOP at cost; 2,974,346 shares at December 31, 1995 . . . . . . . . . . . . . . . . . . (28,772) -- Unrecognized gain (loss) on investment and mortgage-backed securities available-for-sale, net of tax . . . . . . . . . . . . . . . . . . . . . 3,988 (887) Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106,488 79,829 ----------- ----------- Total Stockholders' Equity . . . . . . . . . . . . . . . . . . . . . . . 427,025 303,900 ----------- ----------- Total Liabilities and Stockholders' Equity . . . . . . . . . . . . . . $ 8,078,287 $ 6,564,082 =========== =========== See accompanying notes to consolidated financial statements.
SOVEREIGN BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, --------------------------------------- 1995 1994 1993 ---- ---- ---- INTEREST INCOME: Interest and dividends on investment and mortgage-backed securities and other interest-earning deposits . . . . . . . . . . . . . $ 165,581 $ 105,425 $ 95,878 Interest and fees on loans . . . . . . . . . . . . . . . . . . . . . . . . . . 327,450 248,716 186,912 --------- --------- -------- Total interest income . . . . . . . . . . . . . . . . . . . . . . . 493,031 354,141 282,790 --------- --------- -------- INTEREST EXPENSE: Interest on deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210,267 121,812 108,070 Interest on borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108,538 76,929 45,248 --------- --------- -------- Total interest expense . . . . . . . . . . . . . . . . . . . . . . . 318,805 198,741 153,318 --------- --------- -------- Net Interest Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174,226 155,400 129,472 Provision for possible loan losses . . . . . . . . . . . . . . . . . . . . . . . . 1,000 4,100 8,650 --------- --------- -------- Net interest income after provision for possible loan losses . . . . . . . . . . . 173,226 151,300 120,822 --------- --------- -------- OTHER INCOME: Other loan fees and service charges . . . . . . . . . . . . . . . . . . . . . 4,445 5,018 4,431 Deposit fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,427 5,755 4,364 Gain on loans and investment and mortgage-backed securities . . . . . . . . . 419 494 2,173 Mortgage banking gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,079 1,486 2,367 Miscellaneous income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,459 1,801 1,832 --------- --------- -------- Total other income . . . . . . . . . . . . . . . . . . . . . . . . . 25,829 14,554 15,167 --------- --------- -------- GENERAL AND ADMINISTRATIVE EXPENSES: Salaries and employee benefits . . . . . . . . . . . . . . . . . . . . . . . . 41,158 33,896 32,414 Occupancy and equipment expenses . . . . . . . . . . . . . . . . . . . . . . . 19,286 15,908 12,543 Outside services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,890 7,627 6,360 Deposit insurance premiums . . . . . . . . . . . . . . . . . . . . . . . . . . 10,423 7,627 6,444 Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,602 4,013 3,356 Other administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . 13,908 15,319 12,195 --------- --------- -------- Total general and administrative expenses . . . . . . . . . . . . . 100,267 84,390 73,312 --------- --------- -------- OTHER OPERATING EXPENSES: Amortization of goodwill and other intangible assets . . . . . . . . . . . . . 12,184 6,508 3,462 Real estate owned losses . . . . . . . . . . . . . . . . . . . . . . . . . . . 657 91 603 --------- --------- -------- Total other operating expenses . . . . . . . . . . . . . . . . . . . 12,841 6,599 4,065 --------- --------- -------- Income before income taxes and cumulative effect of change in accounting principle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85,947 74,865 58,612 Income tax provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,539 28,467 22,998 --------- --------- -------- Income before cumulative effect of change in accounting principle . . . . . . . . . 56,408 46,398 35,614 Cumulative effect of change in accounting principle . . . . . . . . . . . . . . . . -- -- 4,800 --------- --------- -------- NET INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 56,408 $ 46,398 $ 40,414 ========= ========= ======== NET INCOME APPLICABLE TO COMMON STOCK . . . . . . . . . . . . . . . . . . . . . . . $ 51,719 $ 46,398 $ 40,414 ========= ========= ======== EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE:(1) Before cumulative effect of change in accounting principle . . . . . . . . . . $ 1.00 $ .90 $ .70 ========= ========= ======== After cumulative effect of change in accounting principle . . . . . . . . . . $ 1.00 $ .90 $ .80 ========= ========= ======== DIVIDENDS PER COMMON SHARE(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . $ .084 $ .106 $ .099 ========= ========= ========
(1) All per share data have been adjusted to reflect all stock dividends and stock splits. See accompanying notes to consolidated financial statements. SOVEREIGN BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
COMMON PREFERRED SHARES SHARES COMMON PREFERRED RETAINED TREASURY OUTSTANDING OUTSTANDING STOCK STOCK EARNINGS STOCK ----------- ----------- --------- -------- --------- -------- BALANCE, DECEMBER 31, 1992 . . . . . . . 40,682 -- $ 182,543 $ -- $ 39,834 $ (1,958) Net income . . . . . . . . . . . . . . . -- -- -- -- 40,414 -- Exercise of stock options . . . . . . . . 403 -- 727 -- -- -- Cash in lieu of fractional shares . . . . (4) -- (45) -- -- -- Sale of stock under Dividend Reinvestment Plan and Employee Stock Purchase Plan . . . . 229 -- 1,605 -- -- -- Dividends paid, $.0993 per share . . . . -- -- -- -- (4,570) -- Other . . . . . . . . . . . . . . . . . . 47 -- 56 -- 515 -- ---------- ---------- --------- -------- --------- -------- BALANCE, DECEMBER 31, 1993 . . . . . . . 41,357 -- 184,886 -- 76,193 (1,958) ---------- ---------- --------- -------- --------- -------- Net income . . . . . . . . . . . . . . . -- -- -- -- 46,398 -- Exercise of stock options . . . . . . . . 552 -- 1,318 -- -- -- Cash in lieu of fractional shares . . . . (1) -- (14) -- -- -- Sale of stock under Dividend Reinvestment Plan and Employee Stock Purchase Plan . . . . 191 -- 2,580 -- -- -- Stock Dividends . . . . . . . . . . . . . 3,468 -- 38,135 -- (38,135) -- Dividends paid, $.1059 per share . . . . -- -- -- -- (5,252) -- Treasury stock retired . . . . . . . . . -- -- (1,958) -- -- 1,958 Unrecognized loss on investment and mortgage-backed securities available-for-sale, net of tax . . . -- -- -- -- -- -- Other . . . . . . . . . . . . . . . . . . -- -- 11 -- 625 -- ---------- ---------- --------- -------- --------- -------- BALANCE, DECEMBER 31, 1994 . . . . . . . 45,567 -- 224,958 -- 79,829 -- ---------- ---------- --------- -------- --------- -------- Net Income . . . . . . . . . . . . . . . -- -- -- -- 56,408 -- Exercise of stock options . . . . . . . . 377 -- 840 -- -- -- Cash in lieu of fractional shares . . . . -- -- (2) -- -- -- Sale of stock under Dividend Reinvestment Plan and Employee Stock Purchase Plan . . . . 209 -- 1,963 -- -- -- Stock dividends . . . . . . . . . . . . . 2,286 -- 20,571 -- (20,571) -- Dividends paid on common stock, $.0837 per share . . . . . . . . . . -- -- -- -- (3,945) -- Preferred Stock offering . . . . . . . . -- 2,000 -- 96,446 -- -- Dividends paid on preferred stock, $2.34 per share . . . . . . . . . . -- -- -- -- (4,688) -- Unrecognized gain on investment and mortgage-backed securities available-for-sale, net of tax . . . -- -- -- -- -- -- Purchase of shares under Employee Stock Ownership Plan . . . . . . . . (3,131) -- -- -- -- -- Allocation of shares under Employee Stock Ownership Plan . . . . . . . . 157 -- -- -- -- -- Other . . . . . . . . . . . . . . . -- -- 545 -- (545) -- ---------- ---------- --------- -------- --------- -------- BALANCE, DECEMBER 31, 1995 . . . . . . . 45,465 2,000 $ 248,875 $ 96,446 $ 106,488 -- ========== ========== ========= ======== ========= ========
UNALLOCATED UNRECOGNIZED COMMON LOSS/GAIN ON STOCK AVAILABLE- TOTAL HELD BY FOR-SALE STOCKHOLDERS' ESOP PORTFOLIO EQUITY ----------- ----------- ------------ BALANCE, DECEMBER 31, 1992 . . . . . . . $ -- -- $ 220,419 Net income . . . . . . . . . . . . . . . -- -- 40,414 Exercise of stock options . . . . . . . . -- -- 727 Cash in lieu of fractional shares . . . . -- -- (45) Sale of stock under Dividend Reinvestment Plan and Employee Stock Purchase Plan . . . . -- -- 1,605 Dividends paid, $.0993 per share . . . . -- -- (4,570) Other . . . . . . . . . . . . . . . . . . -- -- 571 --------- ------- -------- BALANCE, DECEMBER 31, 1993 . . . . . . . -- -- 259,121 --------- ------- -------- Net income . . . . . . . . . . . . . . . -- -- 46,398 Exercise of stock options . . . . . . . . -- -- 1,318 Cash in lieu of fractional shares . . . . -- -- (14) Sale of stock under Dividend Reinvestment Plan and Employee Stock Purchase Plan . . . . -- -- 2,580 Stock Dividends . . . . . . . . . . . . . -- -- -- Dividends paid, $.1059 per share . . . . -- -- (5,252) Treasury stock retired . . . . . . . . . -- -- -- Unrecognized loss on investment and mortgage-backed securities available-for-sale, net of tax . . . -- (887) (887) Other . . . . . . . . . . . . . . . . . . -- -- 636 --------- ------- -------- BALANCE, DECEMBER 31, 1994 . . . . . . . -- (887) 303,900 --------- ------- -------- Net Income . . . . . . . . . . . . . . . -- -- 56,408 Exercise of stock options . . . . . . . . -- -- 840 Cash in lieu of fractional shares . . . . -- -- (2) Sale of stock under Dividend Reinvestment Plan and Employee Stock Purchase Plan . . . . -- -- 1,963 Stock dividends . . . . . . . . . . . . . -- -- -- Dividends paid on common stock, $.0837 per share . . . . . . . . . . -- -- (3,945) Preferred Stock offering . . . . . . . . -- -- 96,446 Dividends paid on preferred stock, $2.34 per share . . . . . . . . . . -- -- (4,688) Unrecognized gain on investment and mortgage-backed securities available-for-sale, net of tax . . . -- 4,875 4,875 Purchase of shares under Employee Stock Ownership Plan . . . . . . . . (30,286) -- (30,286) Allocation of shares under Employee Stock Ownership Plan . . . . . . . . 1,514 -- 1,514 Other . . . . . . . . . . . . . . . -- -- -- --------- ------- -------- BALANCE, DECEMBER 31, 1995 . . . . . . . $ (28,772) $ 3,988 $427,025 ========= ======= ========
See accompanying notes to consolidated financial statements. SOVEREIGN BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, --------------------------------------- 1995 1994 1993 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 56,408 $ 46,398 $ 40,414 Adjustments to reconcile net income to net cash provided by operating activities: Provision for possible loan losses and deferred taxes . . . . . . . . . . . . 5,269 9,837 8,452 Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,154 4,873 4,144 Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,162 (533) 3,626 Gain on loans, investment and mortgage-backed securities and real estate owned . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,538) (1,504) (1,570) Cumulative effect of change in accounting principle . . . . . . . . . . . . . -- -- (4,800) Net change in: Loans held for resale . . . . . . . . . . . . . . . . . . . . . . . . . . (62,846) 44,901 9,166 Official checks and other liabilities . . . . . . . . . . . . . . . . . . 14,647 (4,826) (19,350) Accrued interest receivable and other assets . . . . . . . . . . . . . . . (15,586) (79,698) (11,858) ---------- ----------- ----------- Net cash provided by operating activities . . . . . . . . . . . . . . . . . . . . . . . 5,670 19,448 28,224 ---------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of investment and mortgage-backed securities: Available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37,393 750,441 -- Held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- -- 45,366 Proceeds from repayments and maturities of investment and mortgage-backed securities: Available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 3,961 -- Held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 335,313 333,412 650,792 Purchases of investment and mortgage-backed securities: Available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (83,860) (337,046) -- Held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,322,625) (655,664) (1,387,913) Proceeds from sales of loans . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,307 6,515 19,423 Purchase of loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (305,794) (72,808) (49,075) Net change in loans other than purchases and sales . . . . . . . . . . . . . . . . (3,933) (1,012,243) (546,783) Proceeds from sales of premises and equipment . . . . . . . . . . . . . . . . . . 10,729 2,060 115 Purchases of premises and equipment . . . . . . . . . . . . . . . . . . . . . . . (18,551) (4,820) (5,726) Proceeds from sales of real estate owned . . . . . . . . . . . . . . . . . . . . . 6,972 12,556 6,940 Net cash received from business combinations . . . . . . . . . . . . . . . . . . . 5,569 46,659 -- Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- (4,395) 13,896 ---------- ----------- ----------- Net cash used by investing activities . . . . . . . . . . . . . . . . . . . . . . . . . (1,331,480) (931,372) (1,252,965) ---------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Assumption of deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 818,913 13,687 233,703 Net increase (decrease) in deposits . . . . . . . . . . . . . . . . . . . . . . . 88,085 101,535 (15,473) Net increase (decrease) in short-term borrowings . . . . . . . . . . . . . . . . . (535,669) 731,231 229,175 Proceeds from long-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . 905,499 75,000 714,000 Repayments of long-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . (714) (3,019) (1,540) Net increase (decrease) in advance payments by borrowers for taxes and insurance . (3,776) 3,992 (3,700) Proceeds from issuance of common stock . . . . . . . . . . . . . . . . . . . . . . 2,801 3,884 2,287 Proceeds from issuance of preferred stock . . . . . . . . . . . . . . . . . . . . 96,446 -- -- Allocation of ESOP shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,514 -- -- Advance to the ESOP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (30,286) -- -- Cash dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8,633) (5,252) (4,570) ---------- ----------- ----------- Net cash provided by financing activities . . . . . . . . . . . . . . . . . . . . . . . 1,334,180 921,058 1,153,882 ---------- ----------- ----------- Net change in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . 8,370 9,134 (70,859) Cash and cash equivalents at beginning of period . . . . . . . . . . . . . . . . . . . 139,401 130,267 201,126 ---------- ----------- ----------- Cash and cash equivalents at end of period . . . . . . . . . . . . . . . . . . . . . . $ 147,771 $ 139,401 $ 130,267 ========== =========== =========== RECONCILIATION OF CASH AND CASH EQUIVALENTS TO CONSOLIDATED BALANCE SHEETS: Cash and amounts due from depository institutions . . . . . . . . . . . . . . . . . . . $ 130,841 $ 110,270 $ 77,107 Interest-earning deposits and federal funds sold . . . . . . . . . . . . . . . . . . . 16,930 29,131 53,160 ---------- ----------- ----------- $ 147,771 $ 139,401 $ 130,267 ========== =========== ===========
SUPPLEMENTAL DISCLOSURES: Income tax payments totaled $20.6 million in 1995, $23.7 million in 1994 and $17.1 million in 1993. Interest payments totaled $303.6 million in 1995, $196.0 million in 1994 and $145.8 million in 1993. Noncash activity consisted of mortgage loan securitization of $200.9 million in 1995, $159.5 million in 1994 and $243.1 million in 1993; reclassification of long-term borrowings to short-term borrowings of $315.8 million in 1995, $159.5 million in 1994 and $190.0 million in 1993; and reclassification of mortgage loans to real estate owned of $4.5 million in 1995, $7.2 million in 1994 and $4.3 million in 1993. See accompanying notes to consolidated financial statements. SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The following is a description of the significant accounting policies of Sovereign Bancorp, Inc. and subsidiaries ("Sovereign"). Such accounting policies are in accordance with generally accepted accounting principles and have been followed on a consistent basis, except as separately noted herein. a. Principles of Consolidation -- The accompanying financial statements include the accounts of the parent company, Sovereign Bancorp, Inc. and its wholly-owned subsidiaries: Sovereign Bank, FSB ("Sovereign Bank") and its wholly-owned subsidiaries, Colonial Bank for Savings, FSB ("Colonial Bank") and its wholly-owned subsidiary and Sovereign Investment Company. All material intercompany balances and transactions have been eliminated in consolidation. b. Use of Estimates -- The preparation of 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. c. Per Share Information -- Earnings per share have been calculated based on the average common shares outstanding (including assumed conversion of preferred shares) for the respective periods. Stock options are considered common stock equivalents and are included in the computation of the number of outstanding shares using the treasury stock method, unless anti-dilutive. The number of shares used in the computation of fully diluted earnings per share for the years ended December 31, 1995, 1994, and 1993 were 56.6 million, 51.4 million and 50.9 million, respectively. All per share data have been restated to reflect the effect of the 5% stock dividends which were authorized on December 20, 1995 and February 22, 1995, with record dates of February 1, 1996 and March 31, 1995, respectively, the 10% stock dividend which was authorized on April 19, 1994, with a record date of April 29, 1994, the 20% stock splits which were authorized on October 19, 1993 and April 7, 1993, with record dates of November 15, 1993 and April 30, 1993, respectively, the 5% stock dividend which was authorized on December 22, 1992, with a record date of January 5, 1993, the 20% stock split which was authorized on October 13, 1992, with a record date of November 2, 1992, the 10% stock dividends which were authorized on July 21, 1992, April 21, 1992, and January 21, 1992, with record dates of August 4, 1992, April 30, 1992, and February 17, 1992, respectively, the 25% stock splits which were authorized on September 17, 1991, June 18, 1991, and April 16, 1991 with record dates of September 30, 1991, June 30, 1991, and April 30, 1991, respectively, the 20% stock dividend which was authorized on December 19, 1990, with a record date of January 31, 1991, and the 25% stock dividend which was authorized on October 17, 1989, with a record date of December 1, 1989. d. Interest-Earning Deposits -- Interest-earning deposits consist of deposit accounts with the Federal Home Loan Bank of Pittsburgh ("FHLB") and deposits with other financial institutions generally having maturities of three months or less. e. Investment and Mortgage-backed Securities -- Effective January 1, 1994, Sovereign adopted Statement of Financial Accounting Standard ("SFAS") No. 115 "Accounting for Certain Investments in Debt and Equity Securities." Under SFAS No. 115, debt securities that the company has the intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. Securities expected to be held for an indefinite period of time are classified as available-for-sale and are carried at fair value with unrealized gains and losses reported as a separate component of stockholders' equity, net of estimated income taxes. Securities that are bought and held principally for the purpose of selling are classified as trading and reported at fair value, with unrealized gains and losses included in earnings. Sovereign has no securities held for trading. Gains or losses on the sales of securities are recognized at trade date utilizing the specific identification method. In 1993 and prior periods, investment and mortgage-backed securities were intended to be held-to-maturity and were generally carried at cost, adjusted for amortization of premiums and accretion of discounts, because Sovereign had both the intent and ability to hold these securities to maturity or on a long-term basis. Marketable equity securities were carried at the lower of cost or estimated fair value on an aggregate basis. Trading securities were carried at fair value. f. Forward Commitments and Options -- Sovereign utilizes forward commitments and/or options to hedge interest rate risk associated with loans held for resale and/or, commitments to fund loans. Gains and losses on these transactions are included in the net gain or loss when the asset is sold. g. Mortgage Banking Activity -- Loans held for resale consist of residential mortgage loans and mortgage-backed securities originated or purchased by Sovereign. They are recorded at the lower of cost or estimated fair value on an aggregate basis. Gains and losses are included in the consolidated statements of operations. The fair value calculation includes consideration of all open positions, outstanding commitments and related fees paid. Excess servicing fees are computed as the present value of the difference between the estimated future net revenues and normal servicing net revenues as established by the federally sponsored secondary market makers. Resultant premiums are deferred and amortized over the estimated life of the related mortgages using the constant yield method. Effective July 1, 1995, Sovereign prospectively adopted SFAS No. 122 "Accounting for Mortgage Servicing Rights". SFAS No. 122 requires that management recognize as separate assets, rights to service mortgage loans for others, however these servicing rights are acquired. Management should allocate the total cost of mortgage loans, either purchased or originated, to the loans and the mortgage servicing rights based on their relative fair value. The Statement also requires that management assess its capitalized mortgage servicing rights for impairment based on the fair value of those rights, and that this impairment be recognized through a valuation allowance. The adoption of SFAS No. 122 will not have a material effect on Sovereign's operations. h. Allowance for Possible Loan Losses -- An allowance for possible loan losses is maintained at a level that management considers adequate to provide for potential losses based upon an evaluation of known and inherent risks in the loan portfolio. Management's evaluation 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. While management uses the best information available to make such evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. i. Interest on Loans -- Interest on loans is credited to income as it is earned. Interest income is not recognized for those loans when interest is 90 days or more delinquent (unless government guaranteed) or sooner if management feels the possibility for receiving interest payments in the future is doubtful. When a loan is placed on non-accrual, all uncollected interest is reversed. j. Loan Fees, Discounts and Premiums -- Loan origination fees and certain direct loan origination costs are deferred and recognized as interest income in the consolidated statement of operations over the contractual life of the loan utilizing the level yield method, except in the case of certain discounted loans in which a portion of the net deferred fee may be amortized over the discount period. Discounts and premiums on loans purchased are amortized into income utilizing methods which approximate the level yield method. k. Premises and Equipment -- Premises and equipment are carried at cost, less accumulated depreciation. Depreciation is calculated utilizing both accelerated and straight-line methods. Estimated useful lives are as follows: Office buildings . . . . . . . . . . . . . . . 15 to 50 years Leasehold improvements . . . . . . . . . . . . 5 to 10 years Furniture, fixtures and equipment . . . . . . 3 to 10 years Automobiles . . . . . . . . . . . . . . . . . 3 years Expenditures for maintenance and repairs are charged to expense as incurred. l. Real Estate Owned -- Real estate owned consists of properties acquired by or in lieu of foreclosure and properties that qualify for in-substance foreclosure. Real estate owned is stated at the lower of cost or estimated fair value minus estimated costs to sell. Write-downs of real estate owned which occur after the initial transfer from the loan portfolio are recorded as other operating expenses. Costs of holding foreclosed property are charged to expense in the current period, except for significant property improvements which are capitalized to the extent that carrying value does not exceed estimated fair value. m. Income Taxes -- Deferred income taxes are provided on temporary differences between amounts reported for financial statement and tax purposes in accordance with SFAS No. 109 "Accounting for Income Taxes". n. Interest Rate Exchange Agreements (Including Swaps, Caps, and Floors) -- Sovereign has entered into certain interest rate exchange agreements in connection with its asset/liability management program as hedges. Related fees are deferred and amortized on a straight line basis over the life of the interest rate exchange agreement. Net interest payments/receipts are accrued as an adjustment of interest expense/income on the hedged assets or liabilities. Gains or losses resulting from early termination of interest rate exchange agreements are deferred and amortized over the remaining term of the original exchange agreements. In the event the related asset/liability is disposed of, such deferred gains or losses are recognized as an adjustment to the respective gain or loss on disposition. Changes in the value of interest rate exchange agreements are not recorded in the financial statements because the interest rate exchange agreements are designated as hedges. o. General and Administrative Expenses -- General and administrative expenses are classified on a functional basis, except for salaries and employee benefits. Certain direct loan origination costs are deferred and are being amortized as a yield adjustment through net interest income (see note 1-j). p. Consolidated Statement of Cash Flows -- For purposes of reporting cash flows, cash and cash equivalents include cash and amounts due from depository institutions, interest-earning deposits, federal funds sold and securities purchased under resale agreements with an original maturity of three months or less. q. Reclassifications -- Certain amounts in the financial statements of prior periods have been reclassified to conform with the presentation used in these financial statements. These reclassifications have no effect on net income. r. Long-Lived Assets -- In March 1995, the Financial Accounting Standards Board ("FASB") issued SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of", which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. SFAS No. 121 also addresses the accounting for long-lived assets that are expected to be disposed of. Sovereign will adopt SFAS No. 121 in the first quarter of 1996, and based on current circumstances, Sovereign does not believe the effect of adoption will be material. s. Intangibles -- Core deposit intangibles are a measure of the value of consumer demand and savings deposits acquired in business combinations accounted for as purchases. Core deposit intangibles are being amortized on accelerated bases pursuant to core deposit studies and in accordance with SFAS No. 72 "Accounting for Certain Acquisitions of Banking or Thrift Institutions," over the estimated lives of the existing deposit relationships acquired, but not exceeding 15 years. Goodwill is the excess of the purchase price over the fair value of net assets of companies acquired through business combinations accounted for as purchases. Goodwill is being amortized using the straight line method over various periods not exceeding 20 years. The carrying amount of the goodwill is reviewed if facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as determined based on the loss of economic value, the carrying amount of the goodwill is reduced by the estimated loss of value. In addition, goodwill associated with impaired long-lived assets is included in the impairment evaluation which Sovereign assesses under the rules of SFAS No. 121. The carrying amount of the goodwill is reviewed if facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as determined based on the loss of economic value, the carrying amount of the goodwill is reduced by the estimated loss of value. (2) BUSINESS COMBINATIONS On November 17, 1995, Sovereign acquired two branch offices and related deposits of Berkeley Federal Bank & Trust, FSB ("Berkeley"). Sovereign assumed approximately $111.7 million of deposits for a premium of $5.5 million. Of this premium, $604,000 was recorded as a core deposit intangible and $4.9 million was recorded as goodwill. The balances of this core deposit intangible and goodwill at December 31, 1995 were $579,000 and $4.9 million, respectively. On November 15, 1995, Sovereign acquired Colonial State Bank ("Colonial") in a transaction accounted for as a purchase. Sovereign acquired $46.5 million of assets consisting principally of loans and investment securities. Sovereign also assumed approximately $42.0 million of deposit liabilities. Sovereign acquired Colonial in exchange for $6.3 million in cash. This transaction added goodwill of $3.3 million to Sovereign's balance sheet. The balance of the goodwill at December 31, 1995 was $3.3 million. Colonial will operate as a separate Banking subsidiary of Sovereign under the name Colonial Bank for Savings, FSB ("Colonial Bank"). On November 10, 1995, Sovereign completed the sale of its Pottsville, Pennsylvania branch office with related deposits totalling $23.9 million to Northwest Savings Bank ("Northwest") and the sale of its English Village branch office in North Wales, Pennsylvania with related deposits of $12.4 million to Union National Bank & Trust Company ("Union National"). As a result of these transactions, Sovereign recognized a pre-tax gain of $1.1 million and reduced goodwill by $568,000, respectively. On April 21, 1995, Sovereign completed its sale of seven southern New Jersey offices with related deposits totalling $106.7 million to Collective Bancorp, Inc. ("Collective"). Six of these offices had previously been purchased from Berkeley as part of a transaction which occurred on January 1, 1995. In addition, Sovereign acquired $7.0 million of deposits from Collective's Wilmington, Delaware branch office. As a result of this transaction, Sovereign recognized a pre-tax gain of $1.5 million and reduced its existing core deposit intangible by approximately $6.0 million. On January 1, 1995, Sovereign acquired 23 branch offices located in New Jersey and Delaware with $909.3 million of deposit liabilities from Berkeley. In exchange for assuming the deposits of the Berkeley offices, Sovereign acquired principally cash and fixed assets, net of a deposit premium of $66.6 million which was recorded as $7.6 million of core deposit intangible and $59.0 million of goodwill. The balances of this core deposit intangible and goodwill at December 31, 1995 were $4.5 million and $52.0 million, respectively. On November 1, 1994, Sovereign acquired Charter FSB Bancorp, Inc. ("Charter"). Sovereign exchanged a total of 7.0 million new shares (7.7 million shares as adjusted for all subsequent stock dividends) of Sovereign common stock for all of the outstanding shares of Charter common stock. The acquisition of Charter was accounted for as a pooling-of-interests and accordingly, the consolidated financial statements have been restated to include the accounts of Charter for all periods presented. Charter's fiscal year end was September 30, and accordingly, Sovereign's consolidated results of operations for the years ended December 31, 1993 and 1992 include Charter's results of operations for the twelve-month period ended September 30, 1993 and 1992, respectively. Sovereign's consolidated results of operations for the year ended December 31, 1994, include Charter's results of operations for the twelve-month period ended December 31, 1994. A net increase to Sovereign's stockholders' equity of $636,000 has been made to reflect Charter's activity for the three-month period ended December 31, 1993. That activity consisted of proceeds from the exercise of stock options of $11,000, net income of $1.0 million and dividends paid of $397,000. On September 16, 1994, Sovereign acquired the Chadds Ford, Pennsylvania office and related deposits of Second National Federal Savings Association ("Second National") from the Resolution Trust Corporation ("RTC"), receiver for Second National. Sovereign assumed approximately $14.4 million of deposits from the Chadds Ford office for a premium of $675,000 which was recorded as a core deposit intangible. The balance of this core deposit intangible was $472,000 at December 31, 1995. On August 5, 1994, Sovereign acquired Shadow Lawn Savings Bank ("Shadow Lawn") in a transaction accounted for as a purchase. Sovereign acquired $787.5 million of assets consisting principally of investment and mortgage-backed securities and loans. Sovereign also assumed approximately $730.6 million of deposit liabilities. Sovereign acquired Shadow Lawn in exchange for an estimated purchase price of $78.4 million of cash. This transaction added a core deposit intangible of $13.0 million and goodwill of $26.7 million to Sovereign's balance sheet. The balances of this core deposit intangible and goodwill at December 31, 1995 were $9.4 million and $25.7 million, respectively. On November 5, 1993, Sovereign acquired Valley Federal Savings and Loan Association ("Valley Federal"). At September 30, 1993, Valley Federal had total assets, deposits and stockholders' equity of $315.7 million, $256.4 million and $18.6 million, respectively. Sovereign exchanged a total of 2.9 million new shares (3.5 million shares as adjusted for all subsequent stock dividends) of Sovereign common stock with a value of $32.3 million for all of the outstanding shares of Valley Federal common stock. The acquisition of Valley Federal was accounted for as a pooling-of-interests and accordingly, the consolidated financial statements have been restated to include the accounts of Valley Federal for all periods presented. Valley Federal's fiscal year end was September 30, and accordingly, Sovereign's consolidated results of operations for the year ended December 31, 1992 include Valley Federal's results of operations for the twelve-month period ended September 30, 1992. Sovereign's consolidated results of operations for the year ended December 31, 1993 include Valley's Federal's results of operations for the twelve-month period ended December 31, 1993. A net increase to Sovereign's stockholders' equity of $571,000 has been made to reflect Valley Federal's activity for the three-month period ended December 31, 1992. That activity consisted of proceeds from the exercise of stock options of $56,000, net income of $603,000 and dividends paid of $88,000. On August 27, 1993, Sovereign assumed $252.3 million of deposit liabilities in exchange for $233.7 million in cash from the RTC as receiver for Home Unity Federal Savings and Loan Association ("Home Unity"). This transaction added a $5.0 million core deposit intangible and $13.5 million of goodwill to Sovereign's balance sheet. The balances of this core deposit intangible and goodwill at December 31, 1995 were $2.4 million and $10.6 million, respectively. On January 15, 1993, Sovereign formally acquired Harmonia Bancorp, Inc. ("Harmonia") in a transaction accounted for as a purchase. Pursuant to Accounting Principles Board ("APB") Opinion No. 16, the Harmonia acquisition was accounted for as having been completed at the close of business on December 31, 1992 because control of Harmonia had been transferred to Sovereign as of that date. Sovereign acquired total assets of $621.0 million representing the historical amount of Harmonia's assets, purchase accounting adjustments and the elimination of intercompany accounts. The total assets acquired consisted principally of cash and interest-earning deposits, federal funds sold, investment and mortgage-backed securities, and performing loans. Sovereign assumed liabilities consisting principally of deposits. Sovereign acquired Harmonia in exchange for $19.6 million in cash and 9.6 million new shares (11.6 million shares as adjusted for all subsequent stock dividends) of Sovereign common stock which were issued at a value of $66.1 million. The transaction added a core deposit intangible of $2.1 million to Sovereign's balance sheet. The balance of this core deposit intangible at December 31, 1995 was $756,000. Since the Harmonia acquisition was accounted for at the close of business on December 31, 1992, Sovereign's consolidated balance sheet at December 31, 1992 includes Harmonia. Sovereign's consolidated results of operations include Harmonia's results of operations from January 1, 1993 and thereafter. On September 11, 1992, Sovereign acquired Jersey Shore Savings and Loan Association ("Jersey Shore") in a transaction accounted for as a purchase and supervised by the Office of Thrift Supervision ("OTS"). Sovereign acquired total assets of $505.4 million consisting principally of cash and interest-earning deposits, investment and mortgage-backed securities and performing loans. Sovereign assumed liabilities consisting principally of deposits. Sovereign paid one thousand dollars for Jersey Shore and the transaction added a $7.2 million core deposit intangible to Sovereign's balance sheet. The balance of this core deposit intangible at December 31, 1995 was $3.3 million. Jersey Shore's results of operations from September 11, 1992 and thereafter have been included in Sovereign's consolidated results of operations. On August 23, 1991, Sovereign assumed $153.6 million of deposit liabilities from the RTC as receiver for Nassau Federal Savings and Loan Association, Princeton, New Jersey. On September 6, 1991, Sovereign assumed $169.7 million of deposit liabilities from the RTC as receiver for United Savings and Loan Association of Trenton, F.A., Lawrenceville, New Jersey. In connection with these transactions, Sovereign received assets of $320.2 million consisting almost entirely of cash. These transactions added a $3.3 million core deposit intangible and $135,000 of goodwill to Sovereign's balance sheet. The balances of this core deposit intangible and goodwill at December 31, 1995 were $1.2 million and $96,000, respectively. The pre-merger results of operations for Sovereign and Charter (which was acquired pursuant to a transaction accounted for as a pooling-of-interests) were as follows (in thousands):
SOVEREIGN CHARTER COMBINED --------- ------- -------- Year ended December 31, 1993 Net interest income . . . . . . . . . . . . . . . . . . . $ 115,396 $14,076 $129,472 Provision for possible loan losses . . . . . . . . . . . . 8,050 600 8,650 Other income . . . . . . . . . . . . . . . . . . . . . . . 14,456 711 15,167 Non-interest expense . . . . . . . . . . . . . . . . . . . 70,734 6,643 77,377 Income tax provision . . . . . . . . . . . . . . . . . . . 20,470 2,528 22,998 Cumulative effect of change in accounting principle . . . . 4,800 -- 4,800 --------- ------- -------- Net income . . . . . . . . . . . . . . . . . . . . . . . . $ 35,398 $ 5,016 $ 40,414 ========= ======= ========
Following are selected unaudited pro forma results of operations for 1995, 1994 and 1993 as if the Colonial, Shadow Lawn and Harmonia acquisitions (which were accounted for as purchases) had occurred at the beginning of 1993 (in thousands, except per share data):
YEAR ENDED DECEMBER 31, -------------------------------------- 1995 1994 1993 ---- ---- ---- Total interest and non-interest income . . . . . . . . . . . . $ 522,160 $ 403,772 $ 358,638 Net interest income . . . . . . . . . . . . . . . . . . . . . . 176,016 171,531 154,828 Net income before cumulative effect of change in accounting principle . . . . . . . . . . . . . . . . . . 56,602 47,313 39,783 Cumulative effect of change in accounting principle . . . . . -- -- 6,892 Net income after cumulative effect of change in accounting principle . . . . . . . . . . . . . . . . . . 56,602 47,313 46,675 Earnings per share: Before cumulative effect of change in accounting principle 1.00 .92 .78 After cumulative effect of change in accounting principle 1.00 .92 .92
On October 2, 1995, Sovereign executed an agreement to acquire West Jersey Bancshares, Inc. ("West Jersey"), a commercial bank headquartered in Fairfield, New Jersey. The transaction will be accounted for as a pooling-of-interests and is expected to close in the second quarter of 1996. Under the terms of the agreement, Sovereign would exchange $8.40 in Sovereign Common Stock (subject to adjustment) in exchange for each share of West Jersey Common Stock. The transaction is valued at approximately $17.2 million and Sovereign expects to issue about 1.6 million new shares. At December 31, 1995, West Jersey has assets, deposits and stockholders' equity of $101.6 million, $92.3 million and $8.5 million, respectively. (3) RESTRICTIONS ON CASH AND AMOUNTS DUE FROM DEPOSITORY INSTITUTIONS Sovereign Bank is required to maintain certain average reserve balances as established by the Federal Reserve Board. The amounts of those reserve balances for the reserve computation periods which included December 31, 1995 and 1994 were $50.8 million and $34.8 million, respectively. (4) INVESTMENT AND MORTGAGE-BACKED SECURITIES The amortized cost and estimated fair value of investment and mortgage-backed securities are as follows (in thousands):
AT DECEMBER 31, ---------------------------------------------------------------------------------------------- 1995 1994 ----------------------------------------------- --------------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR COST APPRECIATION DEPRECIATION VALUE COST APPRECIATION DEPRECIATION VALUE ---- ------------ ------------ ----- ---- ------------ ------------ ----- INVESTMENT AND MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY: Investment Securities: U.S. Treasury and government agency securities . . . . . . . . $ 4,993 $ 37 $ -- $ 5,030 $ 159,353 $ 17 $ 12,675 $ 146,695 Corporate securities . . . . 1,010 60 -- 1,070 4,025 -- 43 3,982 Other securities . . . . . . 482 -- -- 482 420 -- 4 416 Mortgage-backed Securities: FHLMC . . . . . . . . . . . . 168,713 1,730 1,274 169,169 336,556 396 26,506 310,446 FNMA . . . . . . . . . . . . 221,046 1,240 2,026 220,260 316,968 17 26,390 290,595 GNMA . . . . . . . . . . . . 170,064 6,548 80 176,532 237,308 147 2,877 234,578 RTC . . . . . . . . . . . . . 28,954 -- 4,456 24,498 33,976 -- 5,227 28,749 Private issues . . . . . . . 284,640 622 2,626 282,636 272,833 10 20,502 252,341 Collateralized mortgage obligations . . . . . . . 1,197,310 10,556 187 1,207,679 455,401 6,801 28,861 433,341 ---------- --------- -------- ----------- ---------- -------- --------- ----------- Total investment and mortgage-backed securities held-to-maturity . . . . . . $2,077,212 $ 20,793 $ 10,649 $ 2,087,356 $1,816,840 $ 7,388 $ 123,085 $ 1,701,143 ========== ========= ======== =========== ========== ======== ========= =========== INVESTMENT AND MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE: Investment Securities: U.S. Treasury and government agency securities . . . . . $ 150,242 $ 131 $ 1,264 $ 149,109 $ -- $ -- $ -- $ -- Equity Securities . . . . . . 135,494 1,166 89 136,571 88,583 366 1,821 87,128 Mortgage-backed Securities: FHLMC . . . . . . . . . . . . 156,123 763 1,357 155,529 -- -- -- -- FNMA . . . . . . . . . . . . 136,861 2,241 657 138,445 -- -- -- -- GNMA . . . . . . . . . . . . 59,215 2,697 -- 61,912 -- -- -- -- Collateralized mortgage obligations . . . . . . . 245,037 3,568 662 247,943 -- -- -- -- ---------- -------- -------- ----------- ---------- -------- --------- ----------- Total investment and mortgage-backed securities available-for-sale . . . . . $ 882,972 $ 10,566 $ 4,029 $ 889,509 $ 88,583 $ 366 $ 1,821 $ 87,128 ========== ======== ======== =========== ========== ======== ========= ===========
The amortized cost and estimated fair value of investment and mortgage-backed securities at December 31, 1995 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (in thousands):
AMORTIZED FAIR COST VALUE ---- ----- INVESTMENT AND MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY: Due in one year or less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,192 $ 5,194 Due after one year through five years . . . . . . . . . . . . . . . . . . . . . . . . . . . 87,174 88,689 Due after five years through ten years . . . . . . . . . . . . . . . . . . . . . . . . . . 39,180 39,622 Due after ten years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,945,666 1,953,851 ----------- ----------- Total investment and mortgage-backed securities held-to-maturity . . . . . . . . . . . . . $ 2,077,212 $ 2,087,356 =========== ===========
AMORTIZED FAIR COST VALUE ---- ----- INVESTMENT AND MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE: Due in one year or less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,001 $ 11,934 Due after one year through five years . . . . . . . . . . . . . . . . . . . . . . . . . . . 198,728 196,895 Due after five years through ten years . . . . . . . . . . . . . . . . . . . . . . . . . . 201,231 200,119 Due after ten years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 335,518 343,990 No stated Maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135,494 136,571 --------- --------- Total investment and mortgage-backed securities available-for-sale . . . . . . . . . . . . $ 882,972 $ 889,509 ========= =========
Proceeds from sales of investment and mortgage-backed securities and the realized gross gains and losses from those sales are as follows (in thousands):
HELD-TO-MATURITY AVAILABLE-FOR-SALE ------------------------------- --------------------------------------- YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, ------------------------------- --------------------------------------- 1995 1994 1993 1995 1994 1993 ---- ---- ---- ---- ---- ---- Proceeds from sales . . . . . . . . $ -- $ -- $ 45,366 $ 37,393 $ 750,441 $ -- ====== ======= ======== ======== ========= ====== Gross realized gains . . . . . . . . $ -- $ -- $ 231 $ 326 $ 2,377 $ -- Gross realized losses . . . . . . . . -- -- 16 7 840 -- ------ ------- -------- -------- --------- ------ Net realized gains . . . . . . . . . $ -- $ -- $ 215 $ 319 $ 1,537 $ -- ====== ======= ======== ======== ========= ======
Included in investment securities held-to-maturity at December 31, 1993 was a portfolio of $6.5 million of marketable equity securities which was carried at fair value. Sovereign recognized a gain of $1.6 million for the year ended December 31, 1993 from appreciation of this portfolio. Investment and mortgage-backed securities with an estimated fair value of $578.3 million and $707.9 million were pledged as collateral for borrowings, interest rate agreements and public deposits at December 31, 1995 and 1994, respectively. In May 1993, the FASB issued SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities." SFAS No. 115 requires management to classify investments in equity securities that have readily determinable fair values and all investments in debt securities as either held-to-maturity and reported at amortized cost, available-for-sale and reported at fair value with unrealized gains and losses reported in a separate component of stockholders' equity, or trading securities and reported at fair value with unrealized gains and losses included in earnings. Effective January 1, 1994, Sovereign adopted SFAS No. 115 and classified $1.29 billion of securities as held-to-maturity, $391.0 million of securities as available-for-sale and $6.5 million of securities as trading securities. The adoption of SFAS No. 115 resulted in an $836,000 increase to stockholders' equity accounted for as the cumulative effect of a change in accounting principle in 1994. On November 15, 1995, the FASB issued a Special Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities". On December 7, 1995, in accordance with provisions in that Special Report, Sovereign reclassified $750.2 million of securities from held-to-maturity to available-for-sale. This reclassification resulted in a $1.7 million unrealized gain, net of tax, which is included in Sovereign's stockholders' equity at December 31, 1995. (5) LOANS A summary of loans included in the consolidated balance sheets follows (in thousands):
AT DECEMBER 31, ---------------------------- 1995 1994 ---- ---- Residential real estate loans . . . . . . . . . . . . . . . . . . . . . . $ 3,998,048 $ 3,710,150 Real estate construction loans: Residential (net of loans in process of $23,365 and $33,095, respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,151 49,094 Residential development (net of loans in process of $736 and $1,382, respectively) . . . . . . . . . . . . . . . . . . . . . . . . 1,676 3,226 Multi-family loans . . . . . . . . . . . . . . . . . . . . . . . . . . . 75,218 95,216 Home equity loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . 456,922 413,037 ----------- ----------- Total Residential Loans . . . . . . . . . . . . . . . . . . . . . . . 4,570,015 4,270,723 Commercial real estate loans . . . . . . . . . . . . . . . . . . . . . . . 47,177 39,717 Commercial loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,831 5,730 Consumer loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41,341 34,728 ----------- ----------- Total Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,674,364 $ 4,350,898 ----------- ----------- Total Loans with: Fixed rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,134,542 $ 1,097,469 Adjustable rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,539,822 3,253,429 ----------- ----------- Total Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,674,364 $ 4,350,898 =========== ===========
As a result of Sovereign's use of interest rate swaps, $426.1 million of variable rate mortgage loans have been effectively converted to fixed rate mortgage loans. Also, $295.7 million of intermediate variable rate mortgage loans (loans with a five-year fixed rate period) have effectively been converted to a variable rate over the fixed rate period. The majority of all loans are located in Sovereign's marketplace (eastern Pennsylvania, New Jersey and northern Delaware). This is Sovereign's only significant geographic concentration. The total amount of loans being serviced for the benefit of others was $947.1 million and $1.11 billion at December 31, 1995 and 1994, respectively. During 1995, Sovereign recognized a gain of $3.6 million on the sale of servicing rights related to $238.5 million of residential mortgage loans. At December 31, 1995 and 1994, Sovereign had capitalized excess servicing assets of $2.3 million and $4.5 million, respectively and no purchased servicing assets. Effective July 1, 1995, Sovereign prospectively adopted SFAS No. 122 "Accounting for Mortgage Servicing Rights". SFAS No. 122 requires that management recognize as separate assets, rights to service mortgage loans for others, however those servicing rights are acquired. Management should allocate the total cost of mortgage loans, either purchased or originated, to the loans and the mortgage servicing rights based on their relative fair value. The Statement also requires that management assess its capitalized mortgage servicing rights for impairment based on the fair value of those rights, and that this impairment be recognized through a valuation allowance. The adoption of SFAS No. 122 will not have a material effect on Sovereign's operations. The activity in the allowance for possible loan losses is as follows (in thousands):
YEAR ENDED DECEMBER 31, ------------------------------------------ 1995 1994 1993 ---- ---- ---- Balance, beginning of period . . . . . . . . . . . . . . . $ 36,289 $ 33,099 $ 26,562 Acquired reserves and other additions . . . . . . . . . . 485 4,712 44 Provision for possible loan losses . . . . . . . . . . . . 1,000 4,100 8,650 Charge-offs . . . . . . . . . . . . . . . . . . . . . . . 3,580 6,428 2,264 Recoveries . . . . . . . . . . . . . . . . . . . . . . . 662 806 107 -------- -------- -------- Balance, end of period . . . . . . . . . . . . . . . . . . $ 34,856 $ 36,289 $ 33,099 ======== ======== ========
In May 1993, the FASB issued SFAS No. 114 "Accounting by Creditors for Impairment of a Loan." SFAS No. 114 requires that certain impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. In October 1994, the FASB issued SFAS No. 118 "Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures", that amends SFAS No. 114 and eliminates its provisions regarding how a creditor should report income on an impaired loan. Originally, SFAS No. 114 would have required creditors to apply one of two allowable methods. As a result of the amendment, creditors may now continue to use existing methods for recognizing income on impaired loans, including methods that are required by certain industry regulators. SFAS No. 118 also clarified SFAS No. 114's disclosure requirements. SFAS No. 114 and SFAS No. 118 were adopted by Sovereign beginning January 1, 1995. The effect of SFAS No. 114 and SFAS No. 118 on Sovereign was not significant. (6) PREMISES AND EQUIPMENT A summary of premises and equipment, less accumulated depreciation and amortization, follows (in thousands):
AT DECEMBER 31, --------------------------- 1995 1994 ---- ---- Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10,067 $ 9,934 Office buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,133 36,697 Furniture, fixtures, and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,681 36,995 Leasehold improvements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,937 3,161 Automobiles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 914 758 -------- -------- 100,732 87,545 Less accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (43,781) (39,449) -------- -------- $ 56,951 $ 48,096 ======== ========
Sovereign is committed under various non-cancelable operating leases relating to branch facilities having initial or remaining terms in excess of one year. The minimum annual rental commitments under these leases at December 31, 1995, are summarized as follows (in thousands):
1996 $ 2,340 1997 1,733 1998 1,496 1999 995 2000 756 Thereafter 3,473 -------- $ 10,793 ========
Total rental expense for all leases for the years ended December 31, 1995, 1994 and 1993 was $2.7 million, $2.1 million, and $1.6 million, respectively. (7) ACCRUED INTEREST RECEIVABLE Accrued interest receivable is summarized as follows (in thousands):
AT DECEMBER 31, --------------------------- 1995 1994 ---- ---- Accrued interest receivable on: Investment and mortgage-backed securities . . . . . . . . . . . . . . . . . $ 17,106 $ 10,721 Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,679 19,648 -------- -------- $ 42,785 $ 30,369 ======== ========
Accrued interest receivable is stated net of an allowance for potentially uncollected interest (for loans on non-accrual and for loans that have been restructured). If these non-accruing and restructured loans had been current in accordance with their original terms and had been outstanding throughout the period, gross interest income for the years ended December 31,1995, 1994 and 1993 would have increased by approximately $2.5 million, $1.7 million and $2.3 million, respectively. Interest income which was recorded on these loans for the years ended December 31, 1995, 1994 and 1993 was $1.1 million, $1.1 million and $545,000, respectively. (8) DEPOSITS Deposits are summarized as follows (in thousands):
AT DECEMBER 31, ------------------------------------------------------------------------------------ 1995 1994 ----------------------------------------- --------------------------------------- WEIGHTED WEIGHTED TYPE OF ACCOUNT BALANCE PERCENT AVERAGE RATE BALANCE PERCENT AVERAGE RATE --------------- ------- ------- ------------ ------- ------- ------------ Retail certificates . . . . . . . . . . $ 2,731,009 54% 5.48% $ 2,207,531 55% 4.75% Jumbo certificates . . . . . . . . . . . 112,063 2 5.70 78,794 2 4.86 Savings accounts . . . . . . . . . . . . 925,842 19 2.31 925,667 23 2.34 Demand deposit accounts . . . . . . . . . 168,757 3 -- 118,346 3 -- NOW accounts . . . . . . . . . . . . . . 380,475 8 1.26 308,202 8 1.82 Money market accounts . . . . . . . . . . 720,997 14 4.36 388,579 9 2.44 ----------- --- ---- ----------- --- ----- $ 5,039,143 100% 4.24% $ 4,027,119 100% 3.61% =========== === ==== =========== === =====
While certificate accounts frequently are renewed at maturity rather than paid out, they were scheduled to mature contractually at December 31, 1995 as follows (in thousands):
WITHIN SIX MOS. - ONE - THREE - FIVE - OVER SIX MOS. ONE YR. THREE YRS. FIVE YRS. TEN YRS. TEN YRS. TOTAL ----------- ---------- ---------- --------- -------- -------- ----- Certificate accounts by rate: 2.001 -- 4.000% . . . . . . . . $ 75,982 $ 9,532 $ 2,279 $ 948 $ 241 $ 13 $ 88,995 4.001 -- 6.000% . . . . . . . . 933,899 740,019 312,146 51,496 5,202 80 2,042,832 6.001 -- 8.000% . . . . . . . . 552,435 36,087 42,187 24,039 32,792 3,403 690,943 8.001 -- 10.000% . . . . . . . 5,990 1,146 4,706 2,914 741 747 16,244 Above 10.000% . . . . . . . . . 347 690 483 832 1,706 -- 4,058 ----------- -------- -------- ------- ------- ------ ---------- Total certificate accounts . . . . . . . . . . $ 1,568,643 $787,474 $361,801 $80,229 $40,682 $4,243 $2,843,072 =========== ======== ======== ======= ======= ====== ==========
Interest expense on deposits is summarized as follows (in thousands):
YEAR ENDED DECEMBER 31, ------------------------------------------- 1995 1994 1993 ---- ---- ---- Certificates of deposit . . . . . . . . . . . . . . . . . . . . $ 157,208 $ 85,135 $ 69,702 Savings accounts . . . . . . . . . . . . . . . . . . . . . . . . 23,158 24,267 24,209 NOW and money market accounts . . . . . . . . . . . . . . . . . . 29,901 12,410 14,159 --------- --------- -------- $ 210,267 $ 121,812 $108,070 ========= ========= ========
Sovereign Bank is insured by the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC") and pays insurance fees equal to $.23 per $100.00 (23 basis points) of insured deposits annually, the lowest rate permitted. The average SAIF premium is 24 basis points. Colonial Bank is insured by the Bank Insurance Fund ("BIF") of the FDIC. During recent years, the FDIC's BIF, which insures commercial banks and certain savings banks, has also charged an average premium to its members of 24 basis points, and a minimum assessment of 23 basis points. Effective September 30, 1995, the average BIF premium was reduced from 24 basis points to 4.4 basis points, with the minimum assessment being reduced from 23 basis points to 4 basis points. Subsequently, the minimum BIF assessment was reduced to 0 basis points effective January 1, 1996, subject to the minimum FDIC annual assessment of $1,000. The average and minimum SAIF premiums remain at 24 and 23 basis points, respectively, until the SAIF reserves reach $1.25 per $100.00 in insured deposits. In order to accelerate the recapitalization of the SAIF, it has been proposed that SAIF-insured institutions such as Sovereign Bank be assessed a one-time charge of between 85 and 90 basis points of their insured deposits as of March 31, 1995. If enacted, this assessment would result in a pre-tax charge to Sovereign Bank's earnings of approximately $36.0 million to $38.1 million. This charge would have a significant negative impact on earnings in the period enacted. In accordance with FASB guidance on this specific issue, no liability or charge for this assessment is included in the 1995 audited financial statements. While it cannot be determined at this time what the outcome of these events and proposals will be, Sovereign Bank has been placed at a significant competitive disadvantage which will remain until the BIF and SAIF insurance premiums are again made equal. (9) SHORT-TERM AND LONG-TERM BORROWINGS Short-term Borrowings. Short-term borrowings included in the consolidated balance sheets are as follows (in thousands):
AT DECEMBER 31, --------------------------- 1995 1994 ---- ---- Securities sold under repurchase agreements . . . . . . . . . . . . . . . . . . . . $ 382,279 $ 608,810 Federal Home Loan Bank advances . . . . . . . . . . . . . . . . . . . . . . . . . . 1,128,886 1,113,916 Amortizing loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,555 -- ----------- ----------- Total short-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,512,720 $ 1,722,726 =========== ===========
Included in short-term borrowings are sales of securities under repurchase agreements. Securities underlying these repurchase agreements consisted of mortgage-backed securities which had a book value of $387.2 million and $335.3 million and a market value of $392.6 million and $321.7 million at December 31, 1995 and 1994, respectively. At December 31, 1995, short-term borrowings include an 11.60% amortizing loan with principal of $714,000 which is collateralized by 15% of the outstanding shares of common stock of Sovereign Bank (all of the outstanding shares of Sovereign Bank are owned by Sovereign Bancorp). Qualifying repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as a liability in the balance sheet. The dollar amount of securities underlying the agreements remains in the asset accounts, although the securities underlying the agreements are delivered to the brokers who arranged the transactions. In certain instances, the broker may have sold, loaned, or disposed of the securities to other parties in the normal course of their operations, and have agreed to resell to Sovereign substantially similar securities at the maturity of the agreements. The broker/dealers who participate with Sovereign in these agreements are primary broker/dealers reporting to the Federal Reserve Bank of New York. The following table summarizes information regarding securities sold under repurchase agreements (in thousands): Securities Sold Under Repurchase Agreements
DECEMBER 31, ------------------------------------------ 1995 1994 1993 ---- ---- ---- Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 382,279 $ 608,810 $ 315,616 Weighted average interest rate . . . . . . . . . . . . . . . . . 6.38% 5.72% 3.40% Maximum amount outstanding at any month-end during the period . . . . . . . . . . . . . . . . . . . . . . . $ 630,077 $ 608,810 $ 315,616 Average amount outstanding during the period . . . . . . . . . . $ 477,195 $ 427,509 $ 140,968 Weighted average interest rate during the period . . . . . . . . 6.01% 4.49% 3.61%
The following table summarizes information regarding short-term FHLB advances (in thousands): Federal Home Loan Bank Advances
DECEMBER 31, --------------------------------------------- 1995 1994 1993 ---- ---- ---- Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,128,886 $ 1,113,916 $ 314,941 Weighted average interest rate . . . . . . . . . . . . . . . . . 5.65% 5.33% 4.16% Maximum amount outstanding at any month-end during the period . . . . . . . . . . . . . . . . . . . . . . . $ 1,128,886 $ 1,113,916 $ 434,901 Average amount outstanding during the period . . . . . . . . . . $ 792,450 $ 616,869 $ 350,866 Weighted average interest rate during the period . . . . . . . . 5.54% 4.57% 3.94%
Long-term Borrowings. Long-term FHLB advances had weighted average interest rates of 5.88% and 4.96% at December 31, 1995 and 1994, respectively. Long-term borrowings are as follows (in thousands):
AT DECEMBER 31, ---------------------------- 1995 1994 ---- ---- FHLB advances, maturing January 1997 to May 1998 . . . . . . . . . . . . . . $ 850,665 $ 320,165 Amortizing loan at 11.60%, maturing March 1996 . . . . . . . . . . . . . . . -- 2,143 6.75% subordinated debentures, due 2000 . . . . . . . . . . . . . . . . . . . 98,851 49,359 8.50% subordinated debentures, due 2002 . . . . . . . . . . . . . . . . . . . 19,471 19,392 8.00% subordinated debentures, due 2003 . . . . . . . . . . . . . . . . . . . 48,949 48,802 ----------- --------- $ 1,017,936 $ 439,861 =========== =========
The 6.75% debentures are non-amortizing and are not redeemable prior to maturity. The 6.75% debentures have, through the use of an interest rate swap, been effectively converted from a fixed rate obligation to a variable rate obligation tied to the 3-month LIBOR plus 140.5 basis points. The 8.50% debentures are non-amortizing and are redeemable at the option of Sovereign in whole or in part at any time on or after September 15, 1999. The 8.00% debentures are non-amortizing and are not redeemable prior to maturity. (10) STOCKHOLDERS' EQUITY In conformity with the OTS regulations, a "liquidation account" was established for Sovereign Bank and acquired banks at the time of their conversion to the stock form of ownership. In the unlikely event of a complete liquidation of Sovereign Bank, holders of savings accounts with qualifying deposits, who continue to maintain their savings accounts, would be entitled to a distribution from the "liquidation account" in an amount equal to their then current adjusted savings account balance before any liquidation distribution could be made with respect to capital stock. The balance in the "liquidation account" was $11.1 million at December 31, 1995, for Sovereign Bank. This amount may not be utilized for the payment of cash dividends to the holding company. The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA") requires institutions regulated by the OTS to have minimum regulatory tangible capital equal to 1.5% of total tangible assets, 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%. Sovereign Bank was in compliance with all of these capital requirements as of December 31, 1995. The following schedule summarizes the actual capital balances of Sovereign Bank and Colonial Bank at December 31, 1995 (in thousands):
RISK-BASED LEVERAGE CAPITAL TO CAPITAL TO TANGIBLE CAPITAL TO LEVERAGE CAPITAL TO RISK-ADJUSTED RISK-ADJUSTED SOVEREIGN BANK TANGIBLE ASSETS TANGIBLE ASSETS ASSETS ASSETS - -------------- ------------------- ------------------- -------------------- ------------- Regulatory capital . . . . . . . . . . . . . $ 404,470 $ 404,470 $ 404,470 $433,211 Minimum capital requirement . . . . . . . . . 118,586 237,172 137,075 274,151 --------- --------- --------- -------- Excess . . . . . . . . . . . . . . . . . . $ 285,884 $ 167,298 $ 267,395 $159,060 ========= ========= ========= ======== Capital ratio . . . . . . . . . . . . . . . . 5.12% 5.12% 11.80% 12.64% COLONIAL BANK - ------------- Regulatory capital . . . . . . . . . . . . . $ 2,855 $ 2,855 $ 2,855 $ 3,210 Minimum capital requirement . . . . . . . . . 684 1,369 1,237 2,474 --------- --------- --------- -------- Excess . . . . . . . . . . . . . . . . . . $ 2,171 $ 1,486 $ 1,618 $ 736 ========= ========= ========= ======== Capital ratio . . . . . . . . . . . . . . . . 6.26% 6.26% 9.23% 10.38%
OTS capital regulations do not apply to holding companies. The following schedule summarizes actual capital balances of Sovereign Bancorp as if those regulations did apply to Sovereign Bancorp (in thousands):
RISK-BASED LEVERAGE CAPITAL TO CAPITAL TO TANGIBLE CAPITAL TO LEVERAGE CAPITAL TO RISK-ADJUSTED RISK-ADJUSTED SOVEREIGN BANCORP TANGIBLE ASSETS TANGIBLE ASSETS ASSETS ASSETS - ----------------- ------------------- ------------------- ------------------- ------------- Regulatory capital . . . . . . . . . . . . . $295,397 $295,397 $295,397 $494,493 Minimum capital requirement . . . . . . . . . 116,989 233,979 138,600 277,200 -------- -------- -------- -------- Excess . . . . . . . . . . . . . . . . . . . $178,408 $ 61,418 $156,797 $217,293 ======== ======== ======== ======== Capital ratio . . . . . . . . . . . . . . . . 3.79% 3.79% 8.53% 14.27%
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 or adequately capitalized are subject to various restrictions regarding capital distributions, payment of management fees, acceptance of brokered deposits and other operating activities. At December 31, 1995, Sovereign Bank was classified as well capitalized. For income tax return purposes, Sovereign Bank is permitted a special bad debt deduction limited generally to a percentage of otherwise taxable income and subject to certain limitations based on aggregate loans and savings account balances at the end of the year. If these reserves, created from taxable deductions, are subsequently used for purposes other than to absorb loan losses, the amount used will be subject to federal income tax at the then prevailing corporate tax rate. It is not contemplated that the accumulated reserves will be used in a manner that will create income tax liabilities. Retained earnings at December 31, 1995 includes $47.9 million representing such bad debt deduction reserves, for which no provision for federal income taxes has been made. Sovereign maintains a Dividend Reinvestment and Stock Purchase Plan which permits holders of record of Sovereign common stock to purchase additional shares of common stock directly from Sovereign via reinvestment of cash dividends and optional cash purchases. At December 31, 1995, purchases of common stock with reinvested dividends are made at a 5% discount from current market price as defined and optional cash purchases are limited to a maximum of $5,000 per quarter. Sovereign maintains a Stockholder Rights Plan (the "Rights Plan"). The Rights Plan is designed to protect stockholders from attempts to acquire control of Sovereign at an inadequate price. Under the Rights Plan, Sovereign distributed a dividend of one right to purchase a unit of preferred stock on each outstanding share of Sovereign's common stock. The rights are not currently exercisable or transferable and no separate certificates evidencing such rights will be distributed, unless certain events occur. The rights attach to shares of common stock outstanding on October 2, 1989, and will expire on September 27, 2004 as stated in the amendment to the Rights Plan dated September 27, 1995. The rights will entitle the holders to purchase either Sovereign's common stock or the common stock of the potential acquirer at a substantially reduced price. On November 21, 1994, Sovereign's Board of Directors authorized an amendment to Sovereign's tax-qualified Employee Stock Ownership Plan ("ESOP") to add a leverage feature to purchase up to 4.2 million shares of Sovereign's outstanding common stock in the open market or in negotiated transactions. On May 17, 1995, Sovereign completed the sale of 2.0 million shares of Convertible Preferred Stock, raising $96.7 million in capital. The 6 1/4%, non-voting, Cumulative Convertible Preferred Stock is convertible at the option of the holder at any time, unless previously redeemed, at a conversion rate of 4.989 shares of common stock for each share of preferred stock, equivalent to a conversion price of $10.022 per share of common stock. The preferred stock may not be redeemed prior to May 15, 1998. Thereafter, the preferred stock is redeemable at the option of Sovereign, in whole or in part, at $52.188 per share during the twelve months beginning May 15, 1998, and thereafter at prices declining ratably to par on and after May 15, 2005. (11) STOCK OPTION PLANS Sovereign grants stock options for a fixed number of shares to key officers and directors with an exercise price equal to the fair value of the shares at the date of grant. Sovereign accounts for stock option grants in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees", and accordingly, recognizes no compensation expense for the stock option grants. There are 4.0 million shares of common stock reserved for issuance under the plans. These shares, along with the per share data in the following summary of option transactions, have been adjusted to reflect all stock dividends and stock splits.
1986 PLAN 1988 PLAN 1990 PLAN 1993 PLAN ------------ --------- --------- --------------------- OPTION PRICE $1.38-$10.00 $1.82 $1.87 $5.80 $6.30 TOTAL ------------ --------- --------- ------- ------- --------- Options outstanding December 31, 1993 . . . . . . 1,280,051 182,957 513,360 -- 630,433 2,606,801 ------------ ------- -------- ------- ------- --------- Granted . . . . . . . . . . . -- -- -- 184,616 -- 184,616 Exercised . . . . . . . . . . (292,591) (96,662) (150,878) (69,912) -- (610,043) Forfeited . . . . . . . . . . -- -- -- -- (29,688) (29,688) ------------ ------- -------- ------- ------- --------- Options outstanding December 31, 1994 . . . . . . 987,460 86,295 362,482 114,704 600,745 2,151,686 ------------ ------- -------- ------- ------- --------- Granted . . . . . . . . . . . 7,350 -- -- -- -- 7,350 Exercised . . . . . . . . . . (146,887) (86,295) (134,820) (34,298) -- (402,300) Forfeited . . . . . . . . . . -- -- -- (1,499) (96,050) (97,549) ------------ ------- -------- ------- ------- --------- Options outstanding December 31, 1995 . . . . . . 847,923 -- 227,662 78,907 504,695 1,659,187 ------------ ------- -------- ------- ------- --------- Options exercisable December 31, 1995 . . . . . . 840,573 -- 227,662 78,907 -- 1,147,142 ============ ======= ======== ======= ======= =========
In October 1995, the FASB issued SFAS No. 123 "Accounting for Stock-Based Compensation" which provides companies with a choice either to expense the fair value of employee stock options over the vesting period (recognition method) or to continue the previous practice but disclose the pro forma effects on net income and earnings per share had the fair value method been used (disclosure only method). Companies electing the disclosure only method will be required to include the pro forma effects of all awards granted in fiscal years beginning after December 15, 1994. Sovereign plans to adopt the disclosure only method during 1996. (12) EMPLOYEE BENEFIT PLANS Sovereign sponsors a non-contributory defined benefit pension plan which covers substantially all employees who have attained the age of 21 and completed one year of service. Benefits under the plan are based upon years of service and the employees' average compensation computed based upon the five consecutive plan years of highest pay during the ten years preceding retirement or termination. It is Sovereign's policy to fund the minimum contribution as determined by an actuarial valuation. The net periodic pension costs for this plan for 1995, 1994 and 1993 were $526,000, $929,000 and $841,000, respectively, and are comprised of the following components (in thousands):
1995 1994 1993 ---- ---- ---- Service cost benefits earned during the period . . . . . . . . . . . . . . . . . . . $ 851 $ 1,082 $ 1,111 Interest cost on projected benefit obligation . . . . . . . . . . . . . . . . . . . . 1,378 1,333 1,215 Actual return on plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,656) 181 (1,496) Amortization of unrecognized net assets and other deferred amounts, net . . . . . . . 2,953 (1,667) 11 ------- ------- ------- Net periodic pension expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 526 $ 929 $ 841 ======= ======= =======
The following table sets forth the pension plan's funded status at December 31, 1995 and 1994 (in thousands):
1995 1994 ---- ---- Fair value of plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 23,225 $ 18,613 ======== ======== Projected benefit obligation: Vested benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 19,800 $ 16,435 Non-vested benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 335 233 Effect of projected future salary increases . . . . . . . . . . . . . . . . . 1,701 2,165 -------- -------- Projected benefit obligation . . . . . . . . . . . . . . . . . . . . . . . . . . $ 21,836 $ 18,833 ======== ======== Plan assets in excess of (less than) the projected benefit obligation . . . . . . $ 1,389 $ (220) Unrecognized net (asset) liability existing at transition date . . . . . . . . . . (205) 34 Unrecognized net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,720 2,446 Unrecognized prior service cost . . . . . . . . . . . . . . . . . . . . . . . . (112) (103) -------- -------- Net pension asset included in balance sheet . . . . . . . . . . . . . . . . . . $ 2,792 $ 2,157 ======== ========
In determining the projected benefit obligation, the assumed discount rates at December 31, 1995, 1994 and 1993 were 7.00%, 8.00% and 7.00%, respectively. The weighted average rate of salary increase was 5.00% for 1995, 4.75% for 1994 and 5.00% for 1993. The expected long-term rate of return on assets used in determining net periodic pension expense was 9.00% for all three years. The pension plan's assets consist primarily of common stock, fixed income securities such as corporate bonds and U.S. Treasury securities and units of certain common trust funds. Sovereign also maintains a 401(k) savings plan. Substantially all employees of Sovereign are eligible to participate in the 401(k) savings plan on the January 1 and July 1 following their completion of one year of service and attaining age 21. Sovereign's contributions to this plan were $109,000, $111,000 and $114,000 during 1995, 1994 and 1993, respectively. Pursuant to this plan, employees can contribute up to 10% of their compensation to the plan. Sovereign contributes 50% of the employee contribution up to 6% of compensation in the form of Sovereign common stock. Sovereign maintains an ESOP. Substantially all employees of Sovereign are eligible to participate in the ESOP on the January 1 or July 1 following their completion of one year of service and attaining age 21. The ESOP is a deferred contribution plan which provides retirement benefits for participants and beneficiaries by purchasing Sovereign common stock in the open market. The amount of annual contributions to the ESOP by Sovereign is determined by the Board of Directors based upon the financial performance of Sovereign each year. Sovereign contributed and recognized as expense $1.5 million and $1.1 million to the ESOP during 1994 and 1993, respectively. On November 21, 1994, Sovereign's Board of Directors authorized an amendment to Sovereign's ESOP to add a leverage feature to purchase up to 4.2 million shares of Sovereign's outstanding common stock in the open market or in negotiated transactions. The ESOP is funded through direct loans from Sovereign totalling $30.0 million in 1995. The proceeds from these loans were used to purchase outstanding shares of Sovereign's common stock. As the debt on these loans is repaid, shares of Sovereign common stock are released and become eligible for allocation to employee accounts. In addition, dividends are paid on all shares of Sovereign common stock, including unallocated shares held by the ESOP. Dividends on the unallocated shares are allocated on a pro-rata basis when purchased shares are released. Compensation expense is recognized based on the fair value of the shares committed to be released to employees and the shares then become outstanding for earnings per share computations. Compensation expense of $1.6 million was recognized in 1995. Sovereign has committed to make contributions sufficient to provide for the ESOP debt requirements. At December 31, 1995, the ESOP held 3.1 million shares of which 157,000 shares are allocated to employee accounts. The outstanding loan balances of $28.8 million are presented as a reduction of stockholders' equity in the consolidated financial statements. At December 31, 1995, the fair value of the unallocated shares held by the ESOP was $30.1 million. Sovereign's Compensation Committee administers the ESOP. Under the ESOP, the trustees are directed to vote all shares held in the ESOP in accordance with the instructions of the participants to whom the shares have been allocated. In addition, the trustees shall vote in their discretion any shares in the unallocated suspense account. In 1992, Sovereign implemented the Employee Stock Purchase Plan which permits eligible employees to purchase Sovereign common stock directly from Sovereign. Purchases of common stock are limited to 15% of a participant's compensation. During 1995, 1994 and 1993, participants purchased Sovereign common stock at a price equal to 92.5% of the fair value of Sovereign common stock on the offering date. Compensation expense for this plan for the year ended December 31, 1995, 1994 and 1993 was $31,000, $31,000 and $21,000, respectively. (13) INCOME TAXES Effective January 1, 1993, Sovereign adopted SFAS No. 109 "Accounting for Income Taxes". SFAS 109 requires a change from the deferred method of accounting for income taxes to the asset and liability method which recognizes deferred tax assets and liabilities for the temporary differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases. Sovereign has reported the cumulative effect of that change in the method of accounting for income taxes in the 1993 consolidated statement of operations. The cumulative effect of this change of $4.8 million was determined as of January 1, 1993, and is reported separately in the consolidated statement of operations for the year ended December 31, 1993. The provision for income taxes in the consolidated statement of operations consists of the following components (in thousands):
YEAR ENDED DECEMBER 31, -------------------------------------- 1995 1994 1993 ---- ---- ---- Current: Federal . . . . . . . . . . . . . . . . . . . . . . $ 23,251 $ 12,986 $ 20,133 State . . . . . . . . . . . . . . . . . . . . . . . 2,931 3,155 3,063 -------- -------- -------- 26,182 16,141 23,196 Deferred . . . . . . . . . . . . . . . . . . . . . . . 3,357 12,326 (198) -------- -------- -------- Total income tax expense . . . . . . . . . . . . . . . $ 29,539 $ 28,467 $ 22,998 ======== ======== ========
The following is a reconciliation of the actual tax provisions with taxes computed at the federal statutory rate of 35% for 1995, 1994 and 1993:
YEAR ENDED DECEMBER 31, ------------------------------ 1995 1994 1993 ---- ---- ---- Federal income tax at statutory rate . . . . . . . . . . . . . . . . . . . . 35.0% 35.0% 35.0% Increase (decrease) in taxes resulting from: Tax-exempt interest . . . . . . . . . . . . . . . . . . . . . . . . . . . (.3) (.4) (.4) State income taxes, net of federal tax benefit . . . . . . . . . . . . . . 2.2 2.8 3.5 Amortization of intangible assets and other purchase accounting adjustments . . . . . . . . . . . . . . . . . . . . 2.4 1.7 1.5 Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4.9) (1.1) (.4) ----- ----- ---- 34.4% 38.0% 39.2% ===== ===== ====
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below (in thousands):
YEAR ENDED DECEMBER 31, --------------------------------- 1995 1994 1993 ---- ---- ---- Deferred tax assets: Allowance for possible loan losses . . . . . . . . . . . . . . . . . . . . $ 13,937 $ 14,106 $ 12,203 Merger related liabilities . . . . . . . . . . . . . . . . . . . . . . . . 785 392 163 Purchase accounting adjustments . . . . . . . . . . . . . . . . . . . . . . 3,538 7,846 6,229 Deferred loan fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- -- 411 Unrealized loss on available-for-sale portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 567 -- Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,003 1,374 479 --------- --------- -------- Total gross deferred tax assets . . . . . . . . . . . . . . . . . . . . . . 19,263 24,285 19,485 Less valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . (900) (900) (900) --------- --------- -------- Net deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . $ 18,363 $ 23,385 $ 18,585 --------- --------- -------- Deferred tax liabilities: Purchase accounting adjustments . . . . . . . . . . . . . . . . . . . . . . $ (8,559) $ (9,038) $ (1,581) Deferred loan fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,952) (2,088) -- Unrealized gain on available-for-sale portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,708) -- -- Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,684) (183) (491) --------- --------- -------- Total gross deferred tax liabilities . . . . . . . . . . . . . . . . . . . $ (19,903) $ (11,309) $ (2,072) --------- --------- -------- Net deferred tax (liability) asset . . . . . . . . . . . . . . . . . . . . $ (1,540) $ 12,076 $ 16,513 ========= ========= ========
The valuation for deferred tax assets is unchanged from the balance at January 1, 1993, and is primarily related to state deductible temporary differences resulting from the Harmonia acquisition. Sovereign has determined that it is not required to establish any additional valuation reserve for deferred tax assets since it is more likely than not that deferred tax assets (other than those for which the valuation allowance has been established) will be principally realized through carry back to taxable income in prior years. Sovereign's conclusion that it is "more likely than not" that the deferred tax assets will be realized is based on a history of growth in earnings and the prospects for continued growth including an analysis of potential uncertainties that may affect future operating results. Sovereign will continue to review the criteria related to the recognition of deferred tax assets on a quarterly basis. (14) COMMITMENTS AND CONTINGENCIES Financial Instruments Sovereign is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to manage its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit, loans sold with recourse, forward contracts and interest rate swaps, caps and floors. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The contract or notional amounts of these financial instruments reflect the extent of involvement Sovereign has in particular classes of financial instruments. Sovereign's exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and loans sold with recourse is represented by the contractual notional amount of those instruments. Sovereign uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. For interest rate swaps, caps and floors and forward contracts, the contract or notional amounts do not represent exposure to credit loss. Sovereign controls the credit risk of its interest rate swaps, caps and floors, and forward contracts through credit approvals, limits and monitoring procedures. Unless noted otherwise, Sovereign does not require and is not required to pledge collateral or other security to support financial instruments with credit risk. The following schedule summarizes Sovereign's off-balance sheet financial instruments (in thousands):
CONTRACT OR NOTIONAL AMOUNT AT DECEMBER 31, -------------------------- 1995 1994 ---- ---- Financial instruments whose contract amounts represent credit risk: Commitments to extend credit . . . . . . . . . . . . . . . . . . . . . . . . . . $ 420,763 $ 474,621 Standby letters of credit . . . . . . . . . . . . . . . . . . . . . . . . . . . 648 510 Loans sold with recourse . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78,193 73,880 Financial instruments whose notional or contract amounts exceed the amount of credit risk: Forward contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77,250 9,600 Interest rate swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,211,130 1,335,645 Interest rate caps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,446,000 450,000
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Sovereign evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management's credit evaluation of the counterparty. Collateral held usually consists of real estate but may include securities, accounts receivable, inventory and property, plant and equipment. Standby letters of credit are conditional commitments issued by Sovereign to guarantee the performance of a customer to a third party. The guarantees are primarily issued to support public and private borrowing arrangements. One guarantee for $17,000 expires in June 1996, one guarantee for $10,000 expires in August 1996, three guarantees totaling $79,000 expire in September 1996, one guarantee for $10,000 expires in October 1996, one guarantee for $75,000 expires in August 1997, and one guarantee for $457,000 expires in September 2000. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Sovereign holds various collateral to support the commitments. The extent of collateral held for the commitments at December 31, 1995 and December 31, 1994 varies from 100% to 120%; the average amount collateralized is 115%. Loans sold with recourse primarily represent residential loans that were originated and sold by Jersey Shore and acquired by Sovereign as part of the Jersey Shore acquisition. The forward contracts used by Sovereign in its mortgage banking activities are contracts for delayed delivery of securities in which Sovereign agrees to make delivery of a specified instrument, at a specified future date, at a specified price or yield. Risks arise from the possible inability of counterparties to meet the terms of their contracts and from movements in securities' values and interest rates. Interest rate swaps, caps and floors enable Sovereign to transfer, modify or reduce its interest rate risk and are used as part of asset and liability management. Sovereign may become a principal in the exchange of interest payments with another party and therefore, is exposed to loss should one of the other parties default. Sovereign minimizes this risk by performing credit reviews on counterparties. Notional principal amounts often are used to express the volume of these transactions, but the amounts potentially subject to credit risk are much smaller. Litigation At December 31, 1995, Sovereign was party to a number of lawsuits. While any litigation has an element of uncertainty, management, after reviewing these actions with legal counsel is of the opinion that the liability, if any, resulting from these actions will not have a material effect on the financial condition or results of operations of Sovereign. (15) FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents disclosures about fair value of financial instruments. These fair values are presented based upon subjective estimates of relevant market conditions at a specific point in time and information about each financial instrument. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. These techniques involve uncertainties resulting in variability in estimates affected by changes in assumptions and risks of the financial instruments at a certain point in time. Therefore, the derived fair value estimates cannot be substantiated by comparison to independent markets. In addition, the fair values do not reflect any premium or discount that could result from offering for sale at one time an entity's entire holdings of a particular financial instrument nor does it reflect potential taxes and the expenses that would be incurred in an actual sale or settlement. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of Sovereign (in thousands):
AT DECEMBER 31, ------------------------------------------------------ 1995 1994 ------------------------- ------------------------- CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE ---- ----- ----- ----- Financial Assets: Cash and amounts due from depository institutions . . . . $ 130,841 $ 130,841 $ 110,270 $ 110,270 Interest-earning deposits . . . . . . . . . . . . . . . 16,930 16,930 29,131 29,131 Loans held for resale . . . . . . . . . . . . . . . . . . 70,512 71,297 7,666 7,666 Investment and mortgage-backed securities available- for-sale . . . . . . . . . . . . . . . . . . . . . . 889,509 889,509 87,128 87,128 Investment and mortgage-backed securities held-to-maturity . . . . . . . . . . . . . . . . . . 2,077,212 2,087,356 1,816,840 1,701,143 Loans, net . . . . . . . . . . . . . . . . . . . . . . . 4,639,508 4,669,233 4,314,609 4,198,886 Excess servicing . . . . . . . . . . . . . . . . . . . . 2,328 7,330 4,459 8,678 Originated mortgage servicing rights . . . . . . . . . . 1,894 2,840 -- -- Financial Liabilities: Deposits . . . . . . . . . . . . . . . . . . . . . . . . 5,039,143 5,050,523 4,027,119 3,985,208 Borrowings(1) . . . . . . . . . . . . . . . . . . . . . . 2,542,465 2,557,990 2,162,587 2,131,250 Unrecognized Financial Instruments:(2) Commitments to extend credit . . . . . . . . . . . . . . 930 869 687 481 Standby letters of credit . . . . . . . . . . . . . . . . 4 6 4 5 Loans sold with recourse . . . . . . . . . . . . . . . . 391 156 369 236 Interest rate swaps, caps and floors . . . . . . . . . . 12,777 (9,873) 2,310 (77,685) - ----------------
(1) Borrowings are shown without unamortized cap premiums, as cap premiums are reflected separately below in "Interest rate swaps, caps and floors". (2) The amounts shown under "carrying value" represent accruals or deferred income (cost) arising from those unrecognized financial instruments. The following methods and assumptions were used to estimate the fair value of each class of financial instruments: Cash and amounts due from depository institutions and interest-earning deposits. For these short-term instruments, the carrying amount is a reasonable estimate of fair value. Loans held for resale. Fair values are estimated using quoted rates based upon secondary market sources for securities backed by similar loans. Fair value estimates include consideration of all open positions (including forward contracts), outstanding commitments and related fees paid. Investment and mortgage-backed securities available-for-sale. The fair value of investment and mortgage-backed securities available-for-sale are based on quoted market prices as of the balance sheet date. Investment and mortgage-backed securities held-to-maturity. The carrying amounts for short-term investment and mortgage-backed securities held-to-maturity approximate fair value because of the short maturity of these instruments and they do not present unanticipated credit concerns. The fair value of long-term investments and mortgage-backed securities held-to-maturity is estimated based upon bid quotations received from securities dealers and an independent pricing servicing bureau. Loans. Fair value is estimated by discounting cash flows using estimated market discount rates at which similar loans would be made to borrowers and reflect similar credit ratings and interest rate risk for the same remaining maturities. Excess servicing and originated mortgage servicing rights. The fair value of excess servicing is estimated using quoted rates based upon secondary market sources. The estimated fair value approximates the amount for which the servicing could currently be sold. Deposits. The fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, NOW accounts, savings accounts and certain money market accounts, is equal to the amount payable on demand as of December 31, 1995. The fair value of fixed-maturity certificates of deposit is estimated by discounting cash flows using currently offered rates for deposits of similar remaining maturities. Borrowings. Fair value is estimated by discounting cash flows using rates currently available to Sovereign for other borrowings with similar terms and remaining maturities. Commitments to extend credit. The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. Standby letters of credit. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. Loans sold with recourse. The fair value of loans sold with recourse is estimated based upon the cost to terminate Sovereign's obligations under the recourse provisions. Interest rate swaps, caps and floors. The fair value of interest rate swaps, caps and floors which represent the estimated amount Sovereign would receive or pay to terminate the contracts or agreements, taking into account current interest rates and when appropriate, the current creditworthiness of the counterparties are obtained from dealer quotes. (16) 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 (in thousands):
AT DECEMBER 31, 1995 AT DECEMBER 31, 1994 ----------------------------------------------- --------------------------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE NOTIONAL BOOK ESTIMATED MATURITY NOTIONAL BOOK ESTIMATED MATURITY AMOUNT VALUE FAIR VALUE IN YEARS AMOUNT VALUE FAIR VALUE IN YEARS ------ ----- ---------- -------- ------ ----- ---------- -------- Amortizing interest rate swaps: Pay variable-receive fixed(1) . . . . . . . . . . $ 585,429 $ -- $ (4,066) 4.2 $ 1,085,645 $ -- $ (84,349) 3.9 Pay fixed-receive variable(2) . . . . . . . . . 295,701 -- (3,653) 3.3 -- -- -- --- Non-amortizing interest rate swaps: Pay variable-receive fixed(3) . . . . . . . . . . . 50,000 -- (837) 4.6 250,000 -- (7,931) 1.5 Pay fixed-receive variable (4) . . . . . . . . . 280,000 -- (2,780) 1.8 -- -- -- --- Interest rate caps(5) . . . . . . . 1,446,000 12,777 1,463 1.6 450,000 2,310 14,595 1.6 --------- ------- -------- ----------- ------- --------- $2,657,130 $12,777 $ (9,873) $ 1,785,645 $ 2,310 $ (77,685) ========== ======= ======== =========== ======= =========
(1) The weighted average pay rate was 5.56% and 6.28% and the weighted average receive rate was 5.61% and 5.91% at December 31, 1995 and 1994, respectively. (2) The weighted average pay rate was 6.87% and the weighted average receive rate was 6.92%. (3) The weighted average pay rate was 7.28% and 6.59% and the weighted average receive rate was 6.75% and 5.73% at December 31, 1995 and 1994, respectively. (4) The weighted average pay rate was 5.91% and the weighted average receive rate was 5.89%. (5) The weighted average contract rate was 6.36% and 5.50% at December 31, 1995 and 1994, respectively. The following table summarizes by notional amounts the activity of Sovereign's interest rate exchange agreements (in thousands):
AMORTIZING INTEREST NON-AMORTIZING INTEREST INTEREST RATE RATE SWAPS RATE SWAPS CAPS ---------- ---------- ---- Balance, December 31, 1992 . . . . . . . . . . . . . . . $ -- $ -- $ 50,000 ---------- --------- ----------- Additions . . . . . . . . . . . . . . . . . . . . . 655,166 50,000 250,000 Maturities/Amortization . . . . . . . . . . . . . . 34,232 -- -- Terminations . . . . . . . . . . . . . . . . . . . -- -- -- ---------- --------- ----------- Balance, December 31, 1993 . . . . . . . . . . . . . . . 620,934 50,000 300,000 ---------- --------- ----------- Additions . . . . . . . . . . . . . . . . . . . . . 591,800 200,000 980,000 Maturities/Amortization . . . . . . . . . . . . . . 127,089 -- 50,000 Terminations . . . . . . . . . . . . . . . . . . . -- -- 780,000 ---------- --------- ----------- Balance, December 31, 1994 . . . . . . . . . . . . . . . 1,085,645 250,000 450,000 ---------- --------- ----------- Additions . . . . . . . . . . . . . . . . . . . . . 300,000 280,000 996,000 Maturities/Amortization . . . . . . . . . . . . . . 326,795 200,000 -- Terminations . . . . . . . . . . . . . . . . . . . 177,720 -- -- ---------- --------- ----------- Balance, December 31, 1995 . . . . . . . . . . . . . . . $ 881,130 $ 330,000 $ 1,446,000 ========== ========= ===========
At December 31, 1993, Sovereign's balance sheet included a net deferred gain of $132,000 related to interest rate exchange agreements terminated in November, 1994 and December, 1995 which were originally accounted for as hedges. Of this net deferred gain, $152,000 will amortize into interest income in 1996 and $20,000 will amortize into interest expense in 1997. Net interest income includes $(1.9) million in 1995, $8.0 million in 1994 and $2.0 million in 1993 of income (expense) resulting from interest rate exchange agreements. (17) PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for Sovereign Bancorp, Inc. is as follows (in thousands):
BALANCE SHEETS ------------------------------- AT DECEMBER 31, ------------------------------- 1995 1994 ---- ---- Assets Interest-earning deposits . . . . . . . . . . . . . . $ 280 $ 1,041 Investment securities . . . . . . . . . . . . . . . . . 9,129 9,634 Investment in subsidiaries . . . . . . . . . . . . . . 542,869 412,858 Other assets . . . . . . . . . . . . . . . . . . . . . 46,342 1,065 --------- --------- Total Assets . . . . . . . . . . . . . . . . . . . . . . . $ 598,620 $ 424,598 ========= ========= Liabilities and Stockholders' Equity Short-term borrowings . . . . . . . . . . . . . . . . . $ 714 $ -- Long-term borrowings . . . . . . . . . . . . . . . . . 167,271 119,696 Other liabilities . . . . . . . . . . . . . . . . . . . 3,610 1,002 Stockholders' equity . . . . . . . . . . . . . . . . . 427,025 303,900 --------- --------- Total Liabilities and Stockholders' Equity . . . . . . . . $ 598,620 $ 424,598 ========= =========
STATEMENTS OF OPERATIONS --------------------------------------------------- YEAR ENDED DECEMBER 31, --------------------------------------------------- 1995 1994 1993 ---- ---- ---- Interest income . . . . . . . . . . . . . . . . . . . . $ 4,308 $ 192 $ 1,426 Other income . . . . . . . . . . . . . . . . . . . . . 2,791 13,008 7,607 -------- -------- -------- Total income . . . . . . . . . . . . . . . . . . . . . 7,099 13,200 9,033 -------- -------- -------- Interest expense . . . . . . . . . . . . . . . . . . . 11,758 9,341 6,116 Other expense . . . . . . . . . . . . . . . . . . . . . 4,532 3,858 2,846 -------- -------- -------- Total expense . . . . . . . . . . . . . . . . . . . . . 16,290 13,199 8,962 -------- -------- -------- Income before taxes, dividends and equity in undistributed earnings of subsidiaries . . . . . . . (9,191) 1 71 Income taxes . . . . . . . . . . . . . . . . . . . . . (4,181) -- 64 -------- -------- -------- Income before earnings of subsidiaries . . . . . . . . (5,010) 1 7 Distributed earnings from subsidiaries . . . . . . . . 19,544 18,246 2,564 Undistributed earnings of subsidiaries . . . . . . . . 41,874 28,151 37,843 -------- -------- -------- Net Income . . . . . . . . . . . . . . . . . . . . . . $ 56,408 $ 46,398 $ 40,414 ======== ======== ========
STATEMENTS OF CASH FLOWS ---------------------------------------------- YEAR ENDED DECEMBER 31, ---------------------------------------------- 1995 1994 1993 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income . . . . . . . . . . . . . . . . . . . . . $ 56,408 $ 46,398 $ 40,414 Adjustments to reconcile net income to net cash provided by operating activities: Dividends received from subsidiaries . . . . . . 19,544 18,246 2,564 Earnings from subsidiaries . . . . . . . . . . . (61,418) (46,397) (40,407) Change in other assets . . . . . . . . . . . . . (45,277) 10,439 (8,629) Change in other liabilities . . . . . . . . . . . 2,608 (3,168) (16,906) -------- -------- -------- Net cash (used) provided by operating activities . . . (28,135) 25,518 (22,964) -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Investment in subsidiaries . . . . . . . . . . . . . (88,137) (17,140) (91,876) Maturity and repayments of investment securities . . . . . . . . . . . . . . . . . . . 505 5,319 3,567 Purchase of investment securities . . . . . . . . . -- (10,096) (4,857) Other, net . . . . . . . . . . . . . . . . . . . . . 4,875 (251) (635) -------- -------- -------- Net cash used by investing activities . . . . . . . . . (82,757) (22,168) (93,801) -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Cash dividends paid to stockholders . . . . . . . . (8,633) (5,252) (4,570) Net cash received from debt offering . . . . . . . . 49,379 -- 97,985 Net proceeds from issuance of common stock . . . . . 2,801 3,884 2,287 Net proceeds from issuance of preferred stock . . . 96,446 -- -- Purchase of ESOP shares . . . . . . . . . . . . . . (30,286) -- -- Allocation of ESOP shares . . . . . . . . . . . . . 1,514 -- -- Repayment of long-term debt borrowings . . . . . . . (376) (1,092) (1,429) Net change in short-term borrowings . . . . . . . . (714) -- -- -------- -------- -------- Net cash provided (used) by financing activities . . . 110,131 (2,460) 94,273 -------- -------- -------- Increase (decrease) in cash and cash equivalents . . . (761) 890 (22,492) Cash and cash equivalents at beginning of period . . . 1,041 151 22,643 -------- -------- -------- Cash and cash equivalents at end of period . . . . . . $ 280 $ 1,041 $ 151 ======== ======== ========
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information relating to executive officers of Sovereign is included under Item 4A in Part I hereof. The information required by this item relating to directors of Sovereign is incorporated herein by reference to (i) that portion of the section captioned "Election of Directors" located on pages 5 through 8 of the definitive Proxy Statement to be used in connection with Sovereign's 1996 Annual Meeting of Shareholders (the "Proxy Statement"). The information required by this item relating to compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated herein by reference to the section captioned "Additional Information Regarding Directors and Officers" on page 15 of the Proxy Statement. Item 11. EXECUTIVE COMPENSATION. The information required by this item is incorporated herein by reference to (i) the sections captioned "Compensation Paid to Directors" through "Indemnification" on pages 8 through 15 of the Proxy Statement and (ii) the section captioned "Performance Graph" on page 16 of the Proxy Statement. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this item is incorporated herein by reference to (i) the section captioned "Principal Shareholders" on page 17 of the Proxy Statement and (ii) that portion of the section captioned "Election of Directors" located on pages 5 through 8 of the Proxy Statement. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this item is incorporated herein by reference to the sections captioned "Indebtedness of Management" on page 15 of the Proxy Statement. PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) 1. Financial Statements. The following consolidated financial statements are included by reference in Part II, Item 8 hereof: Sovereign Bancorp, Inc. and Subsidiaries. Independent Auditors' Report Consolidated Balance Sheets. Consolidated Statements of Operations. Consolidated Statements of Stockholders' Equity. Consolidated Statements of Cash Flows. Notes to Consolidated Financial Statements. 2. Financial Statement Schedules. Financial statement schedules are omitted because the required information is either not applicable, not required or is shown in the respective financial statements or in the notes thereto. 3. Exhibits. (3.1) Articles of Incorporation, as amended and restated, of Sovereign Bancorp, Inc. (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 the fiscal year ended December 31, 1993.) (4.1) Sovereign Bancorp, Inc. has certain long-term debt outstanding. None of the instruments evidencing such debt authorizes an amount of securities in excess of 10% of the total assets of Sovereign Bancorp, Inc. and its subsidiaries on a consolidated basis; therefore, copies of such instruments are not included as exhibits to this Annual Report on Form 10-K. Sovereign Bancorp, Inc. agrees to furnish copies of such instruments to the Commission on request. (10.1) Sovereign Bancorp, Inc. Stock Option Plan. (Incorporated by reference to Exhibit 10.1 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 32 1994.) (10.2) Sovereign Bancorp, Inc. Employee Stock Purchase Plan. (Incorporated by reference to Exhibit 4.1 to Sovereign's Registration Statement No. 33-44108 on Form S-8.) (10.3) Agreement dated as of September 15, 1992, between Sovereign Bancorp, Inc., Sovereign Bank, a Federal Savings Bank, and Jay S. Sidhu. (Incorporated by reference to Exhibit 10.3 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.) (10.4) Agreement dated as of September 15, 1992, between Sovereign Bank, a Federal Savings Bank and Karl D. Gerhart. (Incorporated by reference to Exhibit 10.4 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.) (10.5) Agreement dated as of September 15, 1992, between Sovereign Bank, a Federal Savings Bank and Lawrence M. Thompson, Jr. (Incorporated by reference to Exhibit 10.5 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.) (10.6) Penn Savings Bank Senior Officer Incentive Plan. (Incorporated by reference to Exhibit 10.6 to Sovereign's Annual Report on Form 10-K for the year ended December 31, 1994.) (10.11) Rights Agreement dated September 19, 1989, between Sovereign Bancorp, Inc. and Harris Trust Company of New York. (Incorporated by reference to Exhibit 4.3 to Sovereign's Registration Statement No. 33-89586 on Form S-8). (10.12) Sovereign Bancorp, Inc. Non-Employee Director Incentive Compensation Plan. (Incorporated by reference to Exhibit 10.12 to Sovereign's Registration Statement No. 33-43195 on Form S-1). (10.14) 1993 Sovereign Bancorp, Inc. Stock Option Plan. (Incorporated by reference to Exhibit 10.23 to Sovereign's Annual Report on Form 10-K for the year ended December 31, 1992). (10.15) Indemnification Agreement dated December 21, 1993, between Sovereign Bank and Jay S. Sidhu. (Incorporated by reference to Exhibit 10.25 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.) (10.16) Agreement and Plan of Merger, dated June 16, 1994, by and between Sovereign Bancorp, Inc. and Charter FSB Bancorp, Inc. (Incorporated by reference to Exhibit 2.1 to Sovereign's Registration Statement No. 33-82846 on Form S-4.) (10.17) Branch Purchase and Deposit Assumption Agreement, dated September 19, 1994, between Berkeley Federal Bank & Trust FSB and Sovereign Bank, a Federal Savings Bank. (Incorporated by reference to Exhibit 2.1 to Sovereign's Current Report on Form 8-K dated September 16, 1994.) (10.18) Employment Agreement dated as of August 8, 1988, between Charter Federal Savings Bank and Patrick J. Petrone. (Incorporated by reference to Exhibit 10.23 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.) (10.19) Amendment to Employment Agreement between Patrick J. Petrone and Charter Federal Savings Bank, dated October 17, 1994. (Incorporated by reference to Exhibit 10.24 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.) (10.20) Charter One Bancorp, Inc. Stock Incentive Plan. (Incorporated by reference to Exhibit 4.1 to Registration Statement No. 33-36895 of Charter FSB Bancorp, Inc. on Form S-8). (10.21) Amendments to Charter FSB Bancorp, Inc. Stock Incentive Plan. (Incorporated herein by reference to Exhibit 4.2 to Registration Statement No. 33-36895 of Charter FSB Bancorp, Inc. on Form S-8.) (10.22) Charter One Bancorp, Inc. Stock Option Plan for Non-Employee Directors. (Incorporated by reference to Exhibit 4.1 to Registration Statement No. 33-36896 of Charter FSB Bancorp, Inc. Form S-8.) (10.23) Amendments to Charter FSB Bancorp, Inc. Stock Option Plan for Non-Employee Directors. (Incorporated herein by reference to Exhibit 4.2 to Registration Statement No. 33-36896 of Charter FSB Bancorp, Inc. on Form S-8). (10.24) Amendment to Rights Agreement, dated as of September 27, 1995, between Sovereign Bancorp, Inc. and Chemical Bank, as successor to Harris Trust Company of New York, as Rights Agent. (Incorporated by reference to Exhibit 2.2 of Amendment No. 1 of Sovereign's Registration Statement on Form 8-A.) (10.25) Agreement and Plan of Merger, dated March 23, 1995, by and between Sovereign Bancorp, Inc. and Colonial State Bank. (10.26) Agreement and Plan of Merger, dated September 29, 1995, between Sovereign Bancorp, Inc. and West Jersey Bancshares, Inc. (Incorporated by reference to Exhibit 2.1 to Sovereign's Registration Statement 33-64807 on Form S-4.) (11.1) Computation of Per Share Earnings. (21) Subsidiaries of the Registrant. (23.1) Consent of Ernst & Young LLP, Independent Auditors. (23.2) Consent of BDO Seidman, LLP, Independent Auditors. (27) Financial Data Schedule. (99.1) Report of BDO Seidman, LLP, Independent Auditors. (b) Reports on Form 8-K. 1. Report on Form 8-K, dated October 23, 1995 (date of earliest event reported - October 18, 1995) re: Sovereign's Press Release, dated October 18, 1995, announcing, among other things, earnings for the third quarter of 1995. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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) March 27, 1996 By /s/ Jay S. Sidhu Jay S. Sidhu, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated. Signature Title /s/ Howard D. Mackey Director March 27, 1996 Howard D. Mackey /s/ Richard E. Mohn Chairman of March 27, 1996 Richard E. Mohn Board and Director /s/ Rhoda S. Oberholtzer Director March 27, 1996 Rhoda S. Oberholtzer /s/ Patrick J. Petrone Director March 27, 1996 Patrick J. Petrone /s/ Daniel K. Rothermel Director March 27, 1996 Daniel K. Rothermel /s/ Jay S. Sidhu Director, March 27, 1996 Jay S. Sidhu President and Chief Executive Officer (Principal Executive Officer) /s/ G. Arthur Weaver Director March 27, 1996 G. Arthur Weaver /s/Samuel R. Willard, Jr. Director March 27, 1996 Samuel R. Willard, Jr. /s/ Theodore Ziaylek, Jr. Director March 27, 1996 Theodore Ziaylek, Jr. /s/ Karl D. Gerhart Chief Financial March 27, 1996 Karl D. Gerhart Officer (Principal Financial Officer and Principal Accounting Officer) EXHIBIT INDEX Page number in manually signed original (3.1) Articles of Incorporation, as amended and restated, of Sovereign Bancorp, Inc. (10.25) Agreement and Plan of Merger, dated March 23, 1995, by and between Sovereign Bancorp, Inc. and Colonial State Bank. (11.1) Computation of Per Share Earnings. (21) Subsidiaries of the Registrant. (23.1) Consent of Ernst & Young LLP, Independent Auditors. (23.2) Consent of BDO Seidman, LLP, Independent Auditors. (27) Financial Data Schedule. (99.1) Report of BDO Seidman, LLP, Independent Auditors. EX-3.1 2 RESTATED ARTICLES OF INCORPORATION OF SOVEREIGN BANCORP, INC. FIRST. The name of the Corporation is Sovereign Bancorp, Inc. SECOND. The location and post office address of the Corporation's registered office in this Commonwealth is 1130 Berkshire Boulevard, Wyomissing, Berks County, Pennsylvania 19610. THIRD. The Corporation was incorporated on March 24, 1987, under the provisions of the Business Corporation Law, the Act approved May 5, 1933, P.L. 364, as amended (the "Pennsylvania Business Corporation Law"). The purpose of the Corporation is and it shall have unlimited power to engage in and to do any lawful act concerning any or all lawful business for which corporations may be incorporated under such Law. FOURTH. The term of the Corporation's existence is perpetual. FIFTH. The aggregate number of shares of capital stock which the Corporation shall have authority to issue is 107,500,000 shares, divided into two classes consisting of 100,000,000 shares of common stock without par value ("Common Stock") and 7,500,000 shares of preferred stock, having such par value as the board of directors shall fix and determine, as provided in Article SIXTH below ("Preferred Stock"). SIXTH. The Preferred Stock may be issued from time to time as a class without series or, if so determined by the board of directors of the Corporation, either in whole or in part, in one or more series. There is hereby expressly granted to and vested in the board of directors of the Corporation authority to fix and determine (except as fixed and determined herein), by resolution, the par value, voting powers, full or limited, or no voting powers, and such designations, preferences and relative, participating, optional or other special rights, if any, and the qualifications, limitations or restrictions thereof, if any, including specifically, but not limited to, the dividend rights, conversion rights, redemption rights and liquidation preferences, if any, of any wholly unissued series of Preferred Stock (or the entire class of Preferred Stock if none of such shares have been issued), the number of shares constituting any such series and the terms and conditions of the issue thereof. Prior to the issuance of any shares of Preferred Stock, a statement setting forth a copy of each such resolution or resolutions and the number of shares of Preferred Stock of each such class or series shall be executed and filed in accordance with the Pennsylvania Business Corporation Law. Unless otherwise provided in any such resolution or resolutions, the number of shares of capital stock of any such class or series so set forth in such resolution or resolutions may thereafter be increased or decreased (but not below the number of shares then outstanding), by a statement likewise executed and filed setting forth a statement that a specified increase or decrease therein had been authorized and directed by a resolution or resolutions likewise adopted by the board of directors of the Corporation. In case the number of such shares shall be decreased, the number of shares so specified in the statement shall resume the status they had prior to the adoption of the first resolution or resolutions. SEVENTH. Each holder of record of Common Stock shall have the right to one vote for each share of Common Stock standing in such holder's name on the books of the Corporation. No shareholder shall be entitled to cumulate any votes for the election of directors. EIGHTH. The management, control and government of the Corporation shall be vested in a board of directors consisting of not less than six (6) nor more than twenty-five (25) members in number, as fixed by the board of directors of the Corporation from time to time. The directors of the Corporation shall be divided into three classes: Class I, Class II and Class III. Each Class shall be as nearly equal in number as possible. If the number of Class I, Class II or Class III directors is fixed for any term of office, it shall not be increased during that term, except by a majority vote of the board of directors. The term of office of each Class shall be three (3) years, so that the term of office of one class of directors shall expire each year when their respective successors have been duly elected by the shareholders and qualified. At each annual election by the shareholders of the Corporation, the directors chosen to succeed those whose terms then expire shall be identified as being of the same class as the directors they succeed. If, for any reason, a vacancy occurs on the board of directors of the Corporation, a majority of the remaining directors shall have the exclusive power to fill the vacancy by electing a director to hold office for the unexpired term in respect of which the vacancy occurred. No director of the Corporation shall be removed from office, as a director, by the vote of shareholders, unless the votes of shareholders cast in favor of the resolution for the removal of such director constitute at least a majority of the votes which all shareholders would be entitled to cast at an annual election of directors. NINTH. [Intentionally omitted.] TENTH. No holder of any class of capital stock of the Corporation shall have preemptive rights, and the Corporation shall have the right to issue and to sell to any person or persons any shares of its capital stock or any option, warrant or right to acquire capital stock, or any securities having conversion or option rights without first offering such shares, rights or securities to any holder of any class of capital stock of the Corporation. ELEVENTH. Except as set forth below, the affirmative vote of shareholders entitled to cast at least 80 percent (80%) of the votes which all shareholders of the Corporation are entitled to cast, and if any class of shares is entitled to vote as a separate class, the affirmative vote of shareholders entitled to cast at least a majority of the votes entitled to be cast by the outstanding shares of such class (or such greater amount as required by the provisions of these Articles of Incorporation establishing such class) shall be required to approve any of the following: (a) any merger or consolidation of the Corporation with or into any other corporation; (b) any share exchange in which a corporation, person or entity acquires the issued or outstanding shares of capital stock of the Corporation pursuant to a vote of shareholders; (c) any sale, lease, exchange or other transfer of all, or substantially all, of the assets of the Corporation to any other corporation, person or entity; or (d) any transaction similar to, or having similar effect as, any of the foregoing transactions, if, in any case, as of the record date for the determination of shareholders entitled to notice thereof and to vote thereon, such other corporation, person or entity is the beneficial owner, directly or indirectly, of shares of capital stock of the Corporation issued, outstanding and entitled to cast five percent (5%) or more of the votes which all shareholders of the Corporation are then entitled to cast. If any of the transactions identified above in this Article ELEVENTH is with a corporation, person or entity that is not the beneficial owner, directly or indirectly, of shares of capital stock of the Corporation issued, outstanding and entitled to cast five percent (5%) or more of the votes which all shareholders of the Corporation are then entitled to cast, then the affirmative vote of shareholders entitled to cast at least a majority of the votes which all shareholders are entitled to cast shall be required to approve any such transaction. An affirmative vote as provided in the foregoing provisions shall, to the extent permitted by law, be in lieu of the vote of the shareholders otherwise required by law. The board of directors of the Corporation shall have the power and duty to determine, for purposes of this Article ELEVENTH, on the basis of information known to the board, if and when such other corporation, person or entity is the beneficial owner, directly or indirectly, of shares of capital stock of the Corporation issued, outstanding and entitled to cast five percent (5%) or more of the votes which all shareholders of the Corporation are then entitled to cast, and/or if any transaction is similar to, or has an effect similar to, any of the transactions identified above in this Article ELEVENTH. Any such determination shall be conclusive and binding for all purposes of this Article ELEVENTH. The Corporation may voluntarily completely liquidate and/or dissolve only in accordance with all applicable laws and only if the proposed liquidation and/or dissolution is approved by the affirmative vote of shareholders entitled to cast at least 80 percent (80%) of the votes which all shareholders are entitled to cast. The provisions of this Article ELEVENTH shall not apply to any transaction which is approved in advance by 66-2/3 percent (66-2/3%) of the members of the board of directors of the Corporation, at a meeting duly called and held. TWELFTH. [Intentionally omitted.] THIRTEENTH. No action required to be taken or which may be taken at any annual or special meeting of shareholders of the Corporation may be taken without a meeting, and the power of the shareholders of the Corporation to consent in writing to action without a meeting is specifically denied. The presence, in person or by proxy, of shareholders entitled to cast at least a majority of the votes which all shareholders are entitled to cast shall constitute a quorum of shareholders at any annual or special meeting of shareholders of the Corporation. FOURTEENTH. The authority to make, amend, alter, change or repeal the By-Laws of the Corporation is hereby expressly and solely granted to and vested in the board of directors of the Corporation, subject always to the power of the shareholders to change such action by the affirmative vote of shareholders of the Corporation entitled to cast at least 66-2/3 percent (66-2/3%) of the votes which all shareholders are entitled to cast, except that Article Eight of the By-Laws of the Corporation relating to limitations on directors' liabilities and indemnification of directors, officers and others may not be amended to increase the exposure to liability for directors or to decrease the indemnification of directors, officers and others except by the affirmative vote of 66-2/3 percent (66-2/3%) of the entire board of directors or by the affirmative vote of shareholders of the Corporation entitled to cast at least 80 percent (80%) of the votes which all shareholders are entitled to cast. FIFTEENTH. The board of directors of the Corporation, when evaluating any offer of another party to (a) make a tender or exchange offer for any equity security of the Corporation, (b) merge or consolidate the Corporation with another corporation, (c) purchase or otherwise acquire all or substantially all of the properties and assets of the Corporation, or (d) engage in any transaction similar to, or having similar effects as, any of the foregoing transactions, shall, in connection with the exercise of its judgment in determining what is in the best interests of the Corporation and its shareholders, give due consideration to all relevant factors, including without limitation the social and economic effects of the proposed transaction on the depositors, employees, suppliers, customers and other constituents of the Corporation and its subsidiaries and on the communities in which the Corporation and its subsidiaries operate or are located, the business reputation of the other party, and the board of directors' evaluation of the then value of the Corporation in a freely negotiated sale and of the future prospects of the Corporation as an independent entity. SIXTEENTH. If any corporation, person, entity, or group becomes the beneficial owner, directly or indirectly, of shares of capital stock of the Corporation having the right to cast in the aggregate 25 percent (25%) or more of all votes entitled to be cast by all issued and outstanding shares of capital stock of the Corporation entitled to vote, such corporation, person, entity or group shall within thirty (30) days thereafter offer to purchase all shares of capital stock of the Corporation issued, outstanding and entitled to vote. Such offer to purchase shall be at a price per share equal to the highest price paid for shares of the respective class or series of capital stock of the Corporation purchased by such corporation, person, entity or group within the preceding twelve months. If such corporation, person, entity or group did not purchase any shares of a particular class or series of capital stock of the Corporation within the preceding twelve months, such offer to purchase shall be at a price per share equal to the fair market value of such class or series of capital stock on the date on which such corporation, person, entity or group becomes the beneficial owner, directly or indirectly, of shares of capital stock of the Corporation having the right to cast in the aggregate 25 percent (25%) or more of all votes entitled to be cast by all issued and outstanding capital stock of the Corporation. Such offer shall provide that the purchase price for such shares shall be payable in cash. The provisions of this Article SIXTEENTH shall not apply if 80 percent (80%) or more of the members of the board of directors of the Corporation approve in advance the acquisition of beneficial ownership by such corporation, person, entity or group, of shares of capital stock of the Corporation having the right to cast in the aggregate 25 percent (25%) or more of all votes entitled to be cast by all issued and outstanding shares of capital stock of the Corporation. The provisions of this Article SIXTEENTH shall be in addition to and not in lieu of any rights granted under Section 910 of the Pennsylvania Business Corporation Law and any amendment or restatement of such section ("Section 910"); provided, however, that if the provisions of this Article SIXTEENTH and Section 910 are both applicable in any given instance, the price per share to be paid for shares of capital stock of the Corporation issued, outstanding and entitled to vote shall be the higher of the price per share determined in accordance with this Article SIXTEENTH or the price per share determined in accordance with the provisions of Section 910. SEVENTEENTH. The Corporation reserves the right to amend, alter, change or repeal any provision contained in its Articles of Incorporation in the manner now or hereafter prescribed by statute and all rights conferred upon shareholders and directors herein are hereby granted subject to this reservation; provided, however, that the provisions set forth in Articles SEVENTH, EIGHTH, ELEVENTH and THIRTEENTH through FIFTEENTH, inclusive, of these Articles of Incorporation may not be repealed, altered or amended, in any respect whatsoever, unless such repeal, alteration or amendment is approved by either (a) the affirmative vote of shareholders of the Corporation entitled to cast at least 80 percent (80%) of the votes which all shareholders of the Corporation are then entitled to cast or (b) the affirmative vote of 80 percent (80%) of the members of the board of directors of the Corporation and the affirmative vote of shareholders of the Corporation entitled to cast at least a majority of the votes which all shareholders of the Corporation are then entitled to cast. APPENDIX I SOVEREIGN BANCORP, INC. RESOLUTION OF THE BOARD OF DIRECTORS ADOPTED ON SEPTEMBER 19, 1989, AND FILED WITH THE SECRETARY OF THE COMMONWEALTH OF PENNSYLVANIA DEPARTMENT OF STATE ON OCTOBER 16, 1989 TERMS OF SERIES A JUNIOR PARTICIPATING PREFERRED STOCK RESOLVED that, pursuant to the authority vested in the Board of Directors of the Corporation by the Articles of Incorporation, the Board of Directors does hereby provide for the issue of a series of Preferred Stock, without par value, of the Corporation, to be designated "Series A Junior Participating Preferred Stock" (hereinafter referred to as the "Series A Preferred Stock" or "this Series"), initially consisting of 25,000 shares, and to the extent that the designations, powers, preferences and relative and other special rights and the qualifications, limitations and restrictions of the Series A Preferred Stock are not stated and expressed in the Articles of Incorporation, does hereby fix and herein state and express such designations, powers, preferences and relative and other special rights and the qualifications, limitations and restrictions thereof, as follows (all terms used herein which are defined in the Articles of Incorporation shall be deemed to have the meanings provided therein): 1. Designation and Amount. The designation of the series of Preferred Stock created by this resolution shall be "Series A Junior Participating Preferred Stock" and the number of shares constituting such Series is Twenty-Five Thousand (25,000). Such number of shares may be increased or decreased by resolution of the Board of Directors; provided, that no decrease shall reduce the number of shares of Series A Preferred Stock to a number less than the number of shares then outstanding plus the number of shares reserved for issuance upon the exercise of outstanding options, rights or warrants or upon the conversion of any outstanding securities of the Corporation convertible into shares of this Series. 2. Dividends. (A) Subject to the prior and superior rights of the holders of any shares of any series of Preferred Stock ranking prior and superior to the shares of this Series with respect to dividends, the holders of shares of this Series shall be entitled to receive, when and as declared by the Board of Directors out of funds legally available for the purpose, quarterly dividends payable in cash on April 1, July 1, October 1, and January 1 of each year (each such date being referred to herein as a "Quarterly Dividend Payment Date"), commencing on the first Quarterly Dividend Payment Date after the first issuance of a share or fraction of a share of this Series, in an amount per share (rounded to the nearest cent) equal to the greater of (a) $10.00 or (b) subject to the provision for adjustment hereinafter set forth, 100 times the aggregate per share amount of all cash dividends, and 100 times the aggregate per share amount (payable in kind) of all non-cash dividends or other distributions other than a dividend payable in Common Stock or a subdivision of the outstanding Common Stock (by reclassification or otherwise), declared on the Common Stock since the immediately preceding Quarterly Dividend Payment Date, or, with respect to the first Quarterly Dividend Payment Date, since the first issuance of any share or fraction of a share of this Series. In the event the Company shall at any time after September 19, 1989 (the "Rights Declaration Date") declare any dividend on the Common Stock payable in Common Stock, subdivide the outstanding Common Stock, or combine the outstanding Common Stock into a smaller number of shares, then in each such case the amount to which holders of shares of this Series were entitled immediately prior to such event under clause (b) of the preceding sentence shall be adjusted by multiplying such amount by a fraction the numerator of which is the number of Common Stock outstanding immediately after such event and the denominator of which is the number of Common Stock that were outstanding immediately prior to such event. (B) The Corporation shall declare a dividend or distribution on the Series A Preferred Stock as provided in paragraph (A) of this Section immediately after it declares a dividend or distribution on the Common Stock (other than a dividend payable in Common Stock); provided that, in the event no dividend or distribution shall have been declared on the Common Stock during the period between any Quarterly Dividend Payment Date and the next subsequent Quarterly Dividend Payment Date, a dividend of $10.00 per share on Series A Preferred Stock shall nevertheless be payable on such subsequent Quarterly Dividend Payment Date. (C) Dividends shall begin to accrue and be cumulative on outstanding shares of Series A Preferred Stock from the Quarterly Dividend Payment Date next preceding the date of issue of such shares of this Series, unless the date of issue of such shares is prior to the record date for the first Quarterly Dividend Payment Date in which case dividends on such shares shall begin to accrue from the date of issue of such shares, or unless the date of issue is a Quarterly Dividend Payment Date or is a date after the record date for the determination of holders of shares of this Series entitled to receive a quarterly dividend and before such Quarterly Dividend Payment Date, in either of which events such dividends shall begin to accrue and be cumulative from such Quarterly Dividend Payment Date. Accrued but unpaid dividends shall not bear interest. Dividends paid on the shares of this Series in an amount less than the total amount of such dividends at the time accrued and payable on such shares shall be allocated pro rata on a share-by-share basis among all such shares at the time outstanding. The Board of Directors may fix a record date for the determination of holders of shares of this Series entitled to receive payment of a dividend or distribution declared thereon, which record date shall be no more than days prior to the date fixed for the payment thereof. 3. Voting Rights. The holders of shares of Series A Preferred Stock shall have the following voting rights: (A) Subject to the provision for adjustment hereinafter set forth, each share of Series A Preferred Stock shall entitle the holder thereof to 100 votes on all matters submitted to a vote of the shareholders of the Corporation. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in Common Stock, or effect a subdivision or combination or consolidation of the outstanding Common Stock (by reclassification or otherwise than by payment of a dividend in Common Stock) into a greater or lesser number of Common Stock, then in each such case the number of votes per share to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event shall be adjusted by multiplying such number by a fraction, the numerator of which is the number of Common Stock outstanding immediately after such event and the denominator of which is the number of Common Stock that were outstanding immediately prior to such event. (B) Except as otherwise provided herein, in any other resolutions creating a series of Preferred Stock or any similar stock, or by law, the holders of shares of Series A Preferred Stock and the holders of Common Stock and any other capital stock of the Corporation having general voting rights shall vote together as one class on all matters submitted to a vote of stockholders of the Corporation. (C) Except as set forth herein, or as otherwise provided by law, holders of Series A Preferred Stock shall have no special voting rights and their consent shall not be required (except to the extent they are entitled to vote with holders of Common Stock as set forth herein) for taking any corporate action. 4. Certain Restrictions. (A) Whenever quarterly dividends or other dividends or distributions payable on the Series A Preferred Stock as provided in Section 2 are in arrears, thereafter and until all accrued and unpaid dividends and distributions, whether or not declared, on shares of Series A Preferred Stock outstanding shall have been paid in full, the Corporation shall not: (i) declare or pay dividends, or make any other distributions, on any shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock; (ii) declare or pay dividends, or make any other distributions, on any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except dividends paid ratably on the Series A Preferred Stock and all such parity stock on which dividends are payable or in arrears in proportion to the total amounts to which the holders of all such shares are then entitled; (iii) redeem or purchase or otherwise acquire for consideration shares of any stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock, provided that the Corporation may at any time redeem, purchase or otherwise acquire shares of any such junior stock in exchange for shares of any stock of the Corporation ranking junior (either as to dividends or upon dissolution, liquidation or winding up) to the Series A Preferred Stock; or (iv) redeem or purchase or otherwise acquire for consideration any shares of Series A Preferred stock, or any shares of stock ranking on a parity with the Series A Preferred Stock, except in accordance with a purchase offer made in writing or by publication (as determined by the Board of Directors) to all holders of such shares upon such terms as the Board of Directors, after consideration of the respective annual dividend rates and other relative rights and preferences of the respective series and classes, shall determine in good faith will result in fair and equitable treatment among the respective series or classes. (B) The Corporation shall not permit any subsidiary of the Corporation to purchase or otherwise acquire for consideration any shares of stock of the Corporation unless the Corporation could, under paragraph (A) of this Section 4, purchase or otherwise acquire such shares at such time and in such manner. 5. Reacquired Shares. Any shares of Series A Preferred Stock purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and cancelled promptly after the acquisition thereof. All such shares shall upon their cancellation become authorized but unissued shares of Preferred Sock and may be reissued as part of a new series of Preferred Stock subject to the conditions and restrictions on issuance set forth herein, in the Articles of Incorporation, or in any other resolutions creating a series of Preferred Stock or any similar stock or as otherwise required by law. 6. Liquidation, Dissolution or Winding Up. Upon any liquidation, dissolution or winding up of the Corporation, no distribution shall be made (A) to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock unless, prior thereto, the holders of shares of Series A Preferred Stock shall have received $100.00 per share, plus an amount equal to accrued and unpaid dividends and distributions thereon, whether or not declared, to the date of such payment, provided that the holders of shares of Series A Preferred stock shall be entitled to receive an aggregate amount per share, subject to the provision for adjustment hereinafter set forth, equal to 100 times the aggregate amount to be distributed per share to holders of Common Stock, or (B) to the holders of shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except distributions made ratably on the Series A Preferred Stock and all such parity stock in proportion to the total amounts to which the holders of all such shares are entitled upon such liquidation, dissolution or winding up. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in Common Stock, or effect a subdivision or combination or consolidation of the outstanding Common Stock (by reclassification or otherwise than by payment of a dividend in Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the aggregate amount to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event under the proviso in clause (A) of the preceding sentence shall be adjusted by multiplying such amount by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. 7. Consolidation, Merger, Etc. In case the Corporation shall enter into any consolidation, merger, combination or other transaction in which the Common Shares are exchanged for or changed into other stock or securities, cash and/or any other property, then in any such case each share of Series A Preferred Stock shall at the same time be similarly exchanged or changed into an amount per share, subject to the provision for adjustment hereinafter set forth, equal to 100 times the aggregate amount of stock, securities, cash and/or any other property (payable in kind), as the case may be, into which or for which each Common Stock is changed or exchanged. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in Common Stock, or effect a subdivision or combination or consolidation of the outstanding Common Stock (by reclassification or otherwise than by payment of a dividend in Common Stock) into a greater or lesser number of shares of Common Stock then in each such case the amount set forth in the preceding sentence with respect to the exchange or change of shares of Series A Preferred Stock shall be adjusted by multiplying such amount by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. 8. No Redemption. The shares of Series A Preferred Stock shall not be redeemable. 9. Rank. The Series A Preferred Stock shall rank, with respect to the payment of dividends and the distribution of assets, junior to all series of any other class of the Corporation's Preferred Stock. 10. Amendment. The Articles of Incorporation of the Corporation shall not be amended in any manner which would materially alter or change the powers, preferences or special rights of the Series A Preferred Stock so as to affect them adversely without the affirmative vote of the holders of at least two-thirds of the outstanding shares of Series A Preferred Stock, voting together as a single class. APPENDIX II SOVEREIGN BANCORP, INC. RESOLUTION OF THE BOARD OF DIRECTORS ADOPTED ON MAY 9, 1995, AND FILED WITH THE SECRETARY OF THE COMMONWEALTH OF PENNSYLVANIA, DEPARTMENT OF STATE ON MAY 15, 1995 TERMS OF 6-1/4% CUMULATIVE CONVERTIBLE PREFERRED STOCK, SERIES B RESOLVED that, pursuant to the authority vested in the Board of Directors of the Corporation by the Articles of Incorporation, the Board of Directors does hereby provide for the issue of a series of Preferred Stock, without par value, of the Corporation, to be designated "6-1/4% Cumulative Convertible Preferred Stock, Series B" (hereinafter referred to as the "Series B Preferred Stock" or "this Series"), initially consisting of 2,000,000 shares, and to the extent that the designations, powers, preferences and relative and other special rights and the qualifications, limitations and restrictions of the Series B Preferred Stock are not stated and expressed in the Articles of Incorporation, does hereby fix and herein state and express such designations, powers, preferences and relative and other special rights and the qualifications, limitations and restrictions thereof, as follows (all terms used herein which are defined in the Articles of Incorporation shall be deemed to have the meanings provided therein): 1. Designation and Amount. The designation of the series of Preferred Stock created by this resolution shall be "6-1/4% Cumulative Convertible Preferred Stock, Series B" and the number of shares constituting such Series is Two Million (2,000,000). Such number of shares may be increased or decreased by resolution of the Board of Directors; provided, that no decrease shall reduce the number of shares of Series B Preferred Stock to a number less than the number of shares then outstanding. 2. Dividends. (a) The holders of record of Series B Preferred Stock shall be entitled to receive, as and if declared by the Board of Directors of the Corporation, out of any funds legally available for the purpose, cumulative cash dividends on each share of Series B Preferred Stock in the amount of 6-1/4% per annum (calculated as a percentage of the liquidation preference applicable to the Series B Preferred Stock as provided herein). Dividends shall accrue from the date of original issuance and shall be payable, as and if declared by the Board of Directors, on February 15, May 15, August 15, and November 15 of each year, commencing August 15, 1995. Each such dividend shall be paid to the holders of record of shares of Series B Preferred Stock as they appear on the stock register of the Corporation on the applicable record date, which shall be a date not more than 30 days nor less than 10 days preceding the dividend payment date, as shall be fixed by the Board of Directors of the Corporation. (b) If there shall be outstanding shares of any other series of Preferred Stock ranking on a parity as to dividends with the Series B Preferred Stock, the Corporation, in making any dividend payment on account of arrears on the Series B Preferred Stock or such other series of Preferred Stock, shall make payments ratably upon all outstanding shares of Series B Preferred Stock and such other series of Preferred Stock in proportion to the respective amounts of dividends in arrears upon all such outstanding shares of Series B Preferred Stock and such other series of Preferred Stock to the date of such dividend payment. (c) No interest, or sum of money in lieu of interest, shall be payable in respect of any dividend payment or payments which may be in arrears. (d) Dividends payable on the Series B Preferred Stock for any period less than a full quarterly dividend period, and for any portion of the initial dividend period occurring prior to August 15, 1995, shall be computed on the basis of a 360-day year of four 90-day quarters and the actual number of days elapsed in the period for which payable. 3. Redemption. (a) The Corporation, at its option, may redeem shares of the Series B Preferred Stock, in whole or in part, at any time or from time to time, at a redemption price as set forth below, plus accrued and unpaid dividends thereon to the date fixed for redemption: If Redeemed During the Twelve Months Redemption Beginning May 15, Price 1998 ............................................. $52.188 1999 ............................................. 51.075 2000 ............................................. 51.563 2001 ............................................. 51.250 2002 ............................................. 50.938 2003 ............................................. 50.625 2004 ............................................. 50.313 2005 and thereafter............................... 50.000 Notwithstanding the foregoing, no shares of Series B Preferred Stock shall be redeemed hereunder prior to May 15, 1998. If the Corporation shall redeem shares of Series B Preferred Stock pursuant to this subparagraph (a), notice of such redemption shall be mailed by first-class mail, postage prepaid, not less than 30 nor more than 60 days prior to the redemption date, to each holder of record of the shares to be redeemed, at such holder's address as the same appears on the stock register of the Corporation. Each such notice shall state: (a) the redemption date; (b) the number of shares of Series B Preferred Stock to be redeemed and, if less than all the shares held by such holder are to be redeemed, the number of such shares to be redeemed from such holder; (c) the redemption price; (d) the place or places where certificates for such shares are to be surrendered for payment of the redemption price; and (e) that dividends on the shares to be redeemed will cease to accrue on such redemption date. Notice having been mailed as aforesaid, from and after the redemption date (unless default shall be made by the Corporation in providing money for the payment of the redemption price) dividends on the shares of the Series B Preferred Stock so called for redemption shall cease to accrue, and said shares shall no longer be deemed to be outstanding, and all rights of the holders thereof as shareholders of the Corporation (except the right to receive from the Corporation the redemption price) shall cease. Upon surrender in accordance with said notice of the certificates for any shares so redeemed (properly endorsed or assigned for transfer, if the Board of Directors of the Corporation shall so require and the notice shall so state), such shares shall be redeemed by the Corporation at the redemption price aforesaid. If less than all the outstanding shares of Series B Preferred Stock are to be redeemed, shares to be redeemed shall be selected by the Corporation from outstanding shares of Series B Preferred Stock are to be deemed, shares to be redeemed shall be selected by the Corporation from outstanding shares of Series B Preferred Stock not previously called for redemption by lot or pro rata (as nearly as may be) in any method determined by the Corporation in its sole discretion to be equitable. (b) In no event shall the Corporation redeem or purchase any shares of Series B Preferred Stock pursuant to this Section 4 unless full cumulative dividends shall have been paid or declared and set apart for payment upon all outstanding shares of Series B Preferred Stock, or any other series of Preferred Stock then outstanding ranking on a parity with or prior to the Series B Preferred Stock as to dividends, for all past dividend periods, and unless all matured obligations of the Corporation with respect to all sinking funds, retirement funds or purchase funds for all series of Preferred Stock then outstanding have been met. (c) All shares of Series B Preferred Stock redeemed by the Corporation shall be restored to the status of authorized but unissued shares of Preferred Stock, without designation as to series, and may thereafter be reissued by the Corporation as shares of one or more series of Preferred Stock other than Series B Preferred Stock. 4. Conversion Rights. (a) The holder of any share or shares of Series B Preferred Stock shall have the right, at any time, to convert any shares of Series B Preferred Stock (except any share of Series B Preferred Stock which shall have been called for redemption pursuant to the provisions hereof, the conversion right with respect thereto shall terminate on the close of business of the date fixed for redemption) into fully paid and non-assessable shares of the Common Stock of the Corporation, at a conversion rate of 4.752 shares of Common Stock for each share of Series B Preferred Stock, subject to adjustment as hereinafter provided. The conversion right herein granted shall be exercised by the surrender of a certificate or certificates for Series B Preferred Stock to be so converted at the office of any transfer agent for the Series B Preferred Stock, at any time during its usual business hours, together with written notice that the holder elects to convert the same, or a stated number of shares thereof, which notice shall state the name or names (with addresses) in which the certificate or certificates of Common Stock shall be issued. Every such notice of election to convert shall constitute a contract between the holder of such Series B Preferred Stock and the Corporation, whereby such holder shall be deemed to subscribe for the amount of Common Stock which he will be entitled to receive upon such conversion and, in payment and satisfaction of such subscription (and any cash adjustment to which he may be entitled), to surrender such Series B Preferred Stock and to release the Corporation from all obligation on the shares to be converted and whereby the Corporation shall be deemed to agree that the surrender of such shares and the extinguishment of obligation thereon shall constitute full payment for the Common Stock so subscribed for and to be issued upon such conversion. (b) As promptly as practicable after the conversion of any Series B Preferred Stock and the payment in cash of any amount required by paragraph (h) of this Section 4, the Corporation shall deliver or cause to be delivered to or upon the written order of the holder of such Series B Preferred Stock certificates representing the number of shares of Common Stock issuable upon such conversion, issued in such name or names as such holder shall have directed, together with cash in respect of any fractional interest in a share of Common Stock issuable upon such conversion and, if only a part of such Series B Preferred Stock is converted, a certificate or certificates for the unconverted shares of Series B Preferred Stock. Such conversion shall be deemed to have been made at the close of business on the day of surrender of the Series B Preferred Stock for conversion, and the rights of the holder of such stock as a Series B Preferred Shareholder, in respect of the stock surrendered for conversion, shall cease at such time and the person or persons in whose name or names the certificates for such shares are to be issued shall be treated for all purposes as having become the record holder or holders of Common Stock at such time and such conversion shall be at the conversion rate in effect at such time; provided, however, that no such surrender on any date when the stock transfer books of the Corporation shall be closed shall be effective to constitute the person or persons entitled to receive the shares of Common Stock upon such conversion as the record holder or holders of such shares on such date, but such surrender shall be effective to constitute the person or persons entitled to receive such shares of Common Stock as the record holder or holders thereof for all purposes at the opening of business on the next succeeding day on which such stock transfer books are open and such conversion shall be at the conversion rate in effect at the opening of business on such next succeeding day. If the last day for the exercise of the conversion is a legal holiday in the city in which the transfer agent to which shares are presented for conversion is located, then such conversion right may be exercised (at the conversion rate in effect on such last day) upon the next succeeding day not in such city a legal holiday. (c) No payment or adjustment shall be made upon any conversion in respect of dividends accrued and unpaid on the Series B Preferred Stock to the date of conversion or in respect of any dividends on the Common Stock issued upon such conversion. (d) The conversion rate shall be subject to adjustment from time to time as follows: (i) In case the Corporation shall at any time (A) pay a dividend or make a distribution on shares of its Common Stock in shares of its capital stock (whether shares of Common Stock or of capital stock of any other class), (B) subdivide or reclassify its outstanding shares of Common Stock into a greater number of securities (including shares of Common Stock), or (C) combine or reclassify its outstanding shares of Common Stock into a smaller number of shares (including shares of Common Stock), the conversion rate in effect immediately prior thereto shall be adjusted so that the holder of record of any shares of Series B Preferred Stock thereafter surrendered for conversion shall be entitled to receive the number of shares of the Corporation which he would have owned or have been entitled to receive after the happening of any of the events described above had such shares of Series B Preferred Stock been converted immediately prior to the happening of such event. An adjustment made pursuant to this subparagraph (i) shall become effective immediately after the record date in the case of a dividend and shall become effective immediately after the effective date in the case of a subdivision or combination; provided, however, that in the event no record date is specified for any dividend, such adjustment shall become effective on the payment date for such dividend. If, as a result of an adjustment made pursuant to this subparagraph (i), the holder of any Series B Preferred Stock thereafter converted shall become entitled to receive shares of two or more classes of capital stock of the Corporation, the Board of Directors of the Corporation (whose determination shall be conclusive) shall determine the allocation of the adjusted conversion rate between or among shares of such classes of capital stock. In the event that any time, as a result of an adjustment made to this subparagraph (i), the holder of any Series B Preferred Stock thereafter converted shall become entitled to receive any shares or other securities of the Corporation other than shares of Common Stock, thereafter the number of such other shares so received upon conversion of any Series B Preferred Stock shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the shares of Common Stock contained in this paragraph 4(d), and other provisions of this Section 4 with respect to the shares of Common Stock shall apply on like term to any such other shares or other securities. (ii) In case the Corporation shall fix a record date for the issuance of rights or warrants to all holders of its Common Stock (or securities convertible into Common Stock) entitling them (for a period expiring within 45 days after such record date) to subscribe for or purchase Common Stock at a price per share (or a conversion price per share) less than the current market price per share of Common Stock (as defined in subparagraph (iv) below) at such record date, the conversion rate in effect immediately prior thereto shall be adjusted so that the same shall equal the rate determined by multiplying the conversion rate in effect immediately prior to such record date by a fraction of which the numerator shall be the number of shares of Common Stock outstanding on such record date plus the number of additional shares of Common Stock offered for subscription or purchase (or into which the convertible securities so offered are initially convertible), and of which the denominator shall be the number of shares of Common Stock outstanding on such record date plus the number of shares which the aggregate offering price of the total number of shares so offered (or the aggregate initial conversion price of the convertible securities so offered) would purchase at such current market price. Such adjustment shall be made successively whenever such a record date is fixed, and become effective immediately after such record date; provided, however, that, in the event no record date is fixed, such adjustment shall be made successively and shall become effective on the distribution date. In determining whether any rights or warrants entitle the holders to subscribe for or purchase shares of Common Stock at less than such current market price, and in determining the aggregate offering price of such shares, there shall be taken into account any consideration received by the Corporation for such rights or warrants, the value of such consideration, if other than cash, to be determined by the Board of Directors of the Corporation. Common Stock owned by or held for the account of the Corporation or any majority owned subsidiary shall not be deemed outstanding for the purpose of any adjustment required under this subparagraph (ii). (iii) In case the Corporation shall fix a record date for making a distribution to all holders of its Common Stock evidences of its indebtedness or assets (excluding regular quarterly or other periodic or recurring cash dividends or distributions and cash dividends or distributions paid from retained earnings or referred to in subparagraph (i) above) or rights or warrants to subscribe or purchase (excluding those referred to in subparagraph (ii) above), then in each such case the conversion rate shall be adjusted so that the same shall equal the rate determined by multiplying the conversion rate in effect immediately prior to such record date by a fraction of which the numerator shall be the current market price (as defined in subparagraph (iv) below) per share of the Common Stock on such record date, and the denominator of which shall be such current market price per share of Common Stock, less the then fair market value (as determined in good faith by the Board of Directors, whose determination shall be conclusive) of the portion of the assets or evidences of indebtedness so distributed or of such rights or warrants applicable to one share of Common Stock. Such adjustment shall be made successively whenever such a record date is fixed and shall become effective immediately after such record date. Notwithstanding the foregoing, in the event that the Corporation shall distribute any rights or warrants to acquire capital stock ("Rights") pursuant to this subparagraph (iii), the distribution of separate certificates representing such Rights subsequent to their initial distribution (whether or not such distribution shall have occurred prior to the date of the issuance of such Series B Preferred Stock) shall be deemed to be the distribution of such Rights for purposes of this subparagraph (iii); provided that the Corporation may, in lieu of making any adjustment pursuant to this subparagraph (iii) upon a distribution of separate certificates representing such Rights, make proper provision so that each holder of such Series B Preferred Stock who converts such Series B Preferred Stock (or any portion thereof) (A) before the record date for such distribution of separate certificates shall be entitled to receive upon such conversion shares of Common Stock issued with Rights and (B) after such record date and prior to the expiration, redemption or termination of such Rights shall be entitled to receive upon such conversion, in addition to the shares of Common Stock issuable upon such conversion, the same number of such rights as would a holder of the number of shares of Common Stock that such Series B Preferred Stock so converted would have entitled the holder thereof to purchase in accordance with the terms and provisions of and applicable to the Rights if such Series B Preferred Stock were converted immediately prior to the record date for such distribution; provided, however, that, in the event no record date is fixed, such adjustment shall be made successively and shall become effective on the distribution date. Common Stock owned by or held for the account of the Corporation or any majority owned subsidiary shall not be deemed outstanding for the purpose of any adjustment required under this subparagraph (iii). (iv) For the purpose of any computation under subparagraph (ii) and (iii) above, the current market price per share of Common Stock at any date shall be deemed to be the average of the daily closing prices for the thirty consecutive business days commencing forty-five business days before the day in question. The closing price for any day shall be (A) if the Common Stock is listed or admitted for trading on any national securities exchange, the last sale price (regular way), or the average of the closing bid and ask prices, if no sale occurred, of Common Stock on the principal securities exchange on which the Common Stock is listed, (B) if not listed as described in (A) but if quoted on the Nasdaq Stock Market (formerly the National Market System of the National Association of Securities Dealers, Inc. Automated Quotation System) the last sale price, or the average of the closing bid and ask prices, if no sale occurred, of Common Stock on the Nasdaq Stock Market, (C) if not quoted as described in clause (B), the mean between the closing high bid and low asked quotations of Common Stock on the National Association of Securities Dealers, Inc. Automated Quotation System, or any similar system or automated dissemination of quotations of securities prices then in common use, if so quoted, or (D) if not quoted as described in clauses (B) or (C), the mean between the high bid and low asked quotations for Common Stock as reported by the National Quotation Bureau Incorporated if at least two securities dealers have inserted both bid and asked quotations for common stock on at least 5 of the 10 preceding days. If none of the conditions set forth above is met, the closing price of Common Stock on any day or the average of such closing prices for any period shall be the fair market value of Common Stock as determined by a member firm of the New York Stock Exchange, Inc. selected by the Corporation. (v) A. Nothing contained herein shall be construed to require an adjustment in the conversion rate as a result of the issuance of Common Stock pursuant to, or the granting or exercise of any rights under, the Corporation's Dividend Reinvestment and Stock Purchase Plan, the Corporation's Employee Stock Purchase Plan, the Corporation's Stock Option Plan or any successor or similar plans providing for the purchase of shares of Common Stock by the Corporation's shareholders or employees at a price not less than 90% of the "average market price" during the "pricing period" as such terms, or equivalent terms, are defined in, and as calculated pursuant to, such plans from time to time. B. In addition, no adjustment in the conversion rate shall be required unless such adjustment would require an increase or decrease of at least 1% in such rate; provided, however, that any adjustments which by reason of this subparagraph (v)(B) are not required to be made shall be carried forward and taken into account in any subsequent adjustment; further provided, however, that any adjustments which by reason of this subparagraph (v)(B) are not otherwise required to be made shall be made no later than 3 years after the date on which occurs an event that requires an adjustment to be made or carried forward. C. All calculations under this Section 4 shall be made to the nearest cent or to the nearest one-hundredth of a share, as the case may be. Anything in this Section 4 to the contrary notwithstanding, the Corporation shall be entitled to make such increases in the conversion rate, in addition to those required by this paragraph (d), as it in its discretion shall determine to be advisable in order that any stock dividends, subdivision of shares, distribution of rights to purchase stock or securities, or distribution of securities convertible into or exchangeable for stock hereafter made by the Corporation to its shareholders shall not be taxable. (vi) In any case in which this paragraph (d) provides that an adjustment shall become effective after a record date for an event, the Corporation may defer until the occurrence of such event (A) delivering to the holder of any Series B Preferred Stock converted after such record date and before the occurrence of such event the additional shares of stock deliverable upon such conversion by reason of the adjustment required by such event over and above the Common Stock deliverable upon such conversion before giving effect to such adjustment and (B) paying to such holder any amount in cash in lieu of any fraction pursuant to paragraph (a), provided, however, that the Corporation shall deliver to such holder a due bill or other appropriate instrument evidencing such holder's rights to receive such additional shares, and such cash, upon the occurrence of the event requiring such adjustment. If such event does not occur, no adjustments shall be made pursuant to this paragraph (d). (e) No fractional shares of stock shall be issued upon the conversion of any Series B Preferred Stock. If more than one share of Series B Preferred Stock shall be surrendered for conversion at one time by the same holder, the number of full shares of stock which shall be issuable upon conversion thereof shall be computed on the basis of the aggregate number of shares of Series B Preferred Stock so surrendered. Instead of any fractional share of stock which would otherwise be issuable upon conversion of any Series B Preferred Stock, the Corporation shall pay a cash adjustment in respect of such fraction in an amount equal to the same fraction of the closing price per share of Common Stock on the business day which immediately precedes the day of conversion. The closing price for such business day shall be (A) if the Common Stock is listed or admitted for trading on any national securities exchange, the last sale price (regular way), or the average of the closing bid and ask prices, if no sale occurred, of Common Stock on the principal securities exchange on which the Common Stock is listed, (B) if not listed as described in (A) but if quoted on the Nasdaq Stock Market (formerly the National Market System of the National Association of Securities Dealers, Inc. Automated Quotation System) the last sale price, or the average of the closing bid and ask prices, if no sale occurred, of Common Stock on the Nasdaq Stock Market, (C) if not quoted as described in clause (B), the mean between the closing high bid and low asked quotations of Common Stock on the National Association of Securities Dealers, Inc. Automated Quotation System, or any similar system or automated dissemination of quotations of securities prices then in common use, if so quoted, or (D) if not quoted as described in clauses (B) or (C), the mean between the high bid and low asked quotations for Common Stock as reported by the National Quotation Bureau Incorporated if at least two securities dealers have inserted both bid and asked quotations for common stock on at least 5 of the 10 preceding days. If none of the conditions set forth above is met, the closing price of Common Stock on any day or the average of such closing prices for any period shall be the fair market value of Common Stock as determined by a member firm of the New York Stock Exchange, Inc. selected by the Corporation. (f) In case of any of the following shall occur while any Series B Preferred Stock is outstanding: (i) any reclassification or change of the outstanding shares of Common Stock deliverable upon conversion of the Series B Preferred Stock (other than a change in par value, or from par value to no par value, or from no par value to par value, or as a result of a subdivision or combination, but including any change in the shares of Common Stock into two or more classes or series of securities); or (ii) any consolidation or merger to which the Corporation is a party (other than a consolidation or a merger in which the Corporation is the continuing corporation and which does not result in any reclassification of, or change other than a change in par value, or from par value to no par value, or from no par value to par value, or as a result of a subdivision or combination in, the outstanding shares of Common Stock issuable upon conversion of the Series B Preferred Stock); or (iii) any sale or conveyance to another corporation of the properties and assets of the Corporation as an entirety or substantially as an entirety; then the Corporation, or such successor or purchasing corporation, as the case may be, shall make appropriate provision in its charter or otherwise so that the holders of the Series B Preferred Stock then outstanding shall have the right at any time thereafter to convert such Series B Preferred Stock into the kind and amount of shares of stock and other securities and property receivable upon such reclassification, change, consolidation, merger, sale or conveyance by a holder of the number of shares of Common Stock issuable upon conversion of such Series B Preferred Stock immediately prior to such reclassification, change, consolidation, merger, sale or conveyance. Such provision shall provide for adjustments which shall be as nearly equivalent as may be practicable to the adjustments provided for in this Section 4. The above provisions of this paragraph (f) shall similarly apply to successive reclassifications, changes, consolidations, mergers, sales or conveyances. (g) The Corporation will at all times reserve and keep available out of its authorized but unissued or treasury stock, solely for the purpose of issue upon conversion of the Series D Preferred Stock as provided in this Section 4, such number of shares of Common Stock as shall from time to time be sufficient to effect the conversion of all outstanding Series B Preferred Stock. (h) The issuance of certificates for shares of Common Stock upon conversion of Series B Preferred Stock shall be made without charge to the converting shareholder for such certificates or for any tax in respect of the issuance of such certificates, and such certificates shall be issued in the name of, or in such name or names as may be directed by, the holder of the Series B Preferred Stock converted. However, if any such certificate is to be issued in a name other than that of the holder of the converted Series B Preferred Stock, the Corporation shall not be required to issue or deliver any stock certificate or certificates unless and until the holder has paid to the Corporation the amount of any tax which may be payable in respect of any transfer involved in such issuance or shall establish to the satisfaction of the Corporation that such tax has been paid. 678 Whenever the conversion rate then in effect is adjusted as herein provided, the Corporation shall mail to each holder of the Series B Preferred Stock at such holder's address as it shall appear on the books of the Corporation a statement setting forth the adjusted conversion rate, then and thereafter effective under the provisions hereof together with the facts, in reasonable detail, upon which such adjustment is based. (j) In case any of the following shall occur while any Series B Preferred Stock is outstanding: (i) the Corporation shall declare a dividend (or any other distribution) on its Common Stock other than in cash out of its current or retained earnings; or (ii) other than pursuant to the shareholder or employee plans, or any successor plans, in accordance with paragraph (d)(v)(A) above, the Corporation shall authorize the granting to the holders of its Common Stock of rights or warrants to subscribe for or purchase any shares of capital stock of any class or of any other rights or warrants; or (iii) any reclassification or change of the outstanding shares of Common Stock deliverable upon conversion of the Series B Preferred Stock (other than a change in par value, or from par value to no par value, or from no par value to par value, or as a result of a subdivision or combination, but including any changes in the shares of Common Stock into two or more classes or series of securities); or any consolidation or merger to which the Corporation is a party (other than a consolidation or a merger in which the Corporation is the continuing corporation and which does not result in any reclassification of, or change other than a change in par value, or from par value to no par value, or from no par value to par value, or as a result of a subdivision or combination in, the outstanding shares of Common Stock issuable upon conversion of the Series B Preferred Stock); or (iv) any sale or conveyance to another corporation of the properties and assets of the Corporation as an entirety or substantially as an entirety; or (v) of the voluntary or involuntary dissolution, liquidation or winding up of the Corporation; then the Corporation shall mail to each holder of Series B Preferred Stock at such holder's address as it shall appear on the books of the Corporation, at least fifteen days prior to the applicable record date hereinafter specified, a notice stating (x) the record date for such dividend, distribution or rights, or, if a record is not to be taken, the date as of which the holders of Common Stock of record to be entitled to such dividend, distribution or rights are to be determined, or (y) the date on which such reclassification, consolidation, merger, dissolution, liquidation or winding up is expected to become effective, and the date as of which it is expected that holders of Common Stock of record shall be entitled to exchange their shares of Common Stock for securities or other property deliverable upon such reclassification, consolidation, merger, dissolution, liquidation or winding up. No failure to mail such notice or any defect therein or in the mailing thereof shall affect the legality or validity of any such transaction or any adjustment in the conversion rate or conversion price required by this Section 4. 5. Voting. (a) Except as hereinafter in this Section 5 expressly provided or as otherwise required by law, the Series B Preferred Stock shall have no voting power. (b) Whenever and as often as dividends payable on any share or shares of the Preferred Stock of the Corporation at the time outstanding shall be accumulated and unpaid in an amount equivalent to or exceeding six quarterly dividends (whether or not declared and whether or not consecutive), the number of directors constituting the full Board of Directors shall be increased by two in the manner prescribed by law and the Articles of Incorporation and Bylaws of the Corporation and the holders of record of the Preferred Stock of all series shall thereafter have the right, voting noncumulatively separately as a single class, to elect two directors to the Board of Directors. In any election of directors, the holders of Series B Preferred Stock shall be entitled to cast one vote per share. (c) At any time when the right of holders of Series Stock to elect two additional directors shall have so vested, the Corporation may, and upon the written request of the holders of record of not less than 10% of the Series B Preferred Stock then outstanding (or 10% of all Preferred Stock having the right to vote for such directors in case holders of shares of other series of Preferred Stock shall also have the right to elect directors in such circumstances) shall, call a special meeting of holders of such Series B Preferred Stock (and other series of Preferred Stock, if applicable) for the election of directors. In the case of such a written request, such special meeting shall be held within 60 days after the delivery of such request, and, in either case, at the place and upon the notice provided by law and in the Bylaws of the Corporation; except that the Corporation shall not be required to call such a special meeting if the request is received less than 120 days before the date fixed for the next ensuing annual meeting of shareholders of the Corporation. At all meetings of shareholders at which holders of Preferred Stock shall be entitled to vote for directors as a single class, the holders of a majority of the outstanding shares of each class or series of capital stock of the Corporation having the right to vote as a single class shall be necessary to constitute a quorum, whether present in person or by proxy, for the election by that class or series of its designated directors. Directors to be elected by shareholders voting as a class shall be elected by the vote of at least a plurality of votes cast by such shareholders present in person or proxy at the meeting. (d) The two directors elected as provided in this subsection shall serve until the next annual meeting of shareholders of the Corporation at which directors of the class in which such directors are serving are to be elected and until their respective successors shall be elected and qualified or the earlier expiration of their terms as provided in this subsection. No such director may be removed without the vote or consent of holders of a majority of the shares of Series B Preferred Stock (or holders of a majority of shares of Preferred Stock having the right to vote in the election of such director in case holders of shares of other series of Preferred Stock shall also have the right to elect such director). In case any vacancy shall occur among the directors elected by such shareholders voting as a class, such vacancy may be filled by the remaining director so elected, or his successor then in office, and the director so elected to fill such vacancy shall serve for the unexpired term of the director for which the vacancy is being filled. (e) Such voting rights of the holders of Preferred Stock as a single class, once effective, shall continue only until all arrears in dividends (whether or not declared) on the Preferred Stock shall have been paid or declared and set apart for payment at which time the right of the Preferred Stock to vote as a single class for the election of directors, as herein set forth, shall terminate. (f) The consent of the holders of at least two-thirds of the number of shares of Preferred Stock at the time outstanding, given in person or by proxy, either in writing or at a meeting of stockholders at which the holders of the Preferred Stock shall vote separately as a class without regard to series, the holders of shares of Series B Preferred Stock being entitled to cast one vote per share thereon, shall be necessary for effecting or validating: (i) any change in the Articles of Incorporation or Bylaws of the Corporation which would materially and adversely alter or change the preferences, privileges, rights or powers given to the holders of the Preferred Stock, provided, that if one or more but not all series of Preferred Stock at the time outstanding are so affected, only the consent of the holders of at least two-thirds of each series so affected, voting separately as a class, shall be required; or (ii) the issuance of any shares of any other class of stock of the Corporation ranking prior to the Preferred Stock. The term "ranking prior to the Preferred Stock" shall mean and include all shares of stock of the Corporation in respect of which the rights of the holders thereof as to the payment of dividends or as to distributions in the event of a voluntary or an involuntary liquidation, dissolution or winding up of the corporation, are given preference over the rights of the holders of the Preferred Stock. 6. Liquidation Rights. (a) In the event of any liquidation, dissolution or winding up of the Corporation, voluntary or involuntary, the holders of all shares of Series B Preferred Stock shall be entitled to be paid in full out of the assets of the Corporation available for distribution to shareholders, before any distribution of assets shall be made to the holders of Common Stock or of any other shares of stock of the Corporation ranking as to any such distribution junior to the Series B Preferred Stock, an amount equal to $50 per share plus an amount equal to any accrued and unpaid dividends thereon to the date fixed for payment of such distribution. If, upon any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, the amounts payable with respect to the Series B Preferred Stock and any other shares of stock of the Corporation ranking as to any such distribution on a parity with the Series B Preferred Stock are not paid in full, the holders of the Series B Preferred Stock and of such other shares shall share ratably in any such distribution of assets of the Corporation in proportion to the full respective preferential amounts to which they are entitled. After payment to the holders of the Series B Preferred Stock of the full preferential amounts provided for in this Section 6, the holders of the Series B Preferred Stock shall be entitled to no further participation in any distribution of assets by the Corporation. (b) None of the following shall be considered a liquidation, dissolution or winding up of the Corporation within the meaning of this section: (i) a consolidation or merger of the Corporation with or into any other corporation; (ii) a merger of any other corporation into the Corporation; (iii) a reorganization of the Corporation; (iv) the purchase or redemption of all or part of the outstanding shares of any class or classes of the Corporation; (v) a sale or transfer of all or any part of its assets; :\DM a share exchange to which the Corporation is a party; or (vii) a division of the Corporation. 7. Limitation on Dividends on Junior Stock. So long as any Series B Preferred Stock shall be outstanding, the Corporation shall not declare any dividends on the Common Stock of the Corporation or any other stock of the Corporation ranking as to dividends or distribution of assets junior to the Series B Preferred Stock (the Common Stock and any such other stock being herein referred to as "Junior Stock"), or make any payment on account of, or set apart money for, a sinking or other analogous fund for the purchase, redemption or other retirement of any shares of Junior Stock, or make any distribution in respect thereof, whether in cash or property or in obligations or stock of the Corporation, other than Junior Stock (such dividends, payments, setting apart and distributions being herein called "Junior Stock Payments"), unless all of the conditions set forth in the following subsections A and B shall exist at the date of such declaration in the case of any such dividend, or the date of such setting apart in that case of any such fund, or the date of such payment or distribution in the case of any other Junior Stock Payment: A. Full cumulative dividends shall have been paid or declared and set apart for payment upon all outstanding shares of Preferred Stock other than Junior Stock. B. The Corporation shall not be in default or in arrears with respect to any sinking or other analogous fund or any call for tenders, obligation or other agreement for the purchase, redemption or other retirement of any shares of Preferred Stock other than Junior Stock. EX-10.25 3 AGREEMENT AND PLAN OF MERGER between SOVEREIGN BANCORP, INC. and COLONIAL STATE BANK March 23, 1995 TABLE OF CONTENTS Page ARTICLE I PLAN OF MERGER, CLOSING AND EFFECTIVE DATE.................. 2 Section 1.1 Plan of Merger.......................... 2 Section 1.2 Closing................................. 2 Section 1.3 Effective Date.......................... 2 ARTICLE II REPRESENTATIONS AND WARRANTIES OF COLONIAL.................. 2 Section 2.1 Organization and Standing................. 2 Section 2.2 Authority................................. 2 Section 2.3 No Violation.............................. 3 Section 2.4 Subsidiaries.............................. 3 Section 2.5 Capitalization............................ 4 Section 2.6 Certificate of Incorporation, Bylaws and Minute Books.............................. 4 Section 2.7 Financial Statements...................... 4 Section 2.8 Absence of Changes........................ 6 Section 2.9 Dividends, Distributions and Stock Purchases................................. 6 Section 2.10 Taxes..................................... 6 Section 2.11 Title To and Condition of Assets.......... 6 Section 2.12 Loan Portfolio; Portfolio Management...... 7 Section 2.13 Investment Securities..................... 8 Section 2.14 Contracts and Required Consents........... 8 Section 2.15 Litigation................................ 9 Section 2.16 Compliance with Laws; Governmental Authorizations............................ 9 Section 2.17 Regulatory Reports of Examination......... 10 Section 2.18 Insurance................................. 10 Section 2.19 Fidelity Bonds............................ 10 Section 2.20 Labor Relations........................... 11 Section 2.21 Employee Benefit Plans.................... 11 Section 2.22 Related Party Transactions................ 12 Section 2.23 No Finder................................. 12 Section 2.24 Significant Customers..................... 12 Section 2.25 Environmental Matters..................... 12 Section 2.26 Allowance for Loan Losses................. 13 Section 2.27 Deleted................................... 13 Section 2.28 Complete and Accurate Disclosure.......... 13 ARTICLE III REPRESENTATIONS AND WARRANTIES OF SOVEREIGN................. 14 Section 3.1 Organization and Standing................. 14 Section 3.2 Authority................................. 14 Section 3.3 No Violation.............................. 14 Section 3.4 Financial Statements...................... 15 Section 3.5 Absence of Changes........................ 15 Section 3.6 Liquidity................................. 15 Section 3.7 No Finder................................. 15 ARTICLE IV COVENANTS OF COLONIAL....................................... 16 Section 4.01 Conduct of Business....................... 16 Section 4.02 Best Efforts.............................. 19 Section 4.03 Access and Confidentiality................ 19 Section 4.04 Subsequent Financial Statements and Regulatory Reports........................ 20 Section 4.05 Update of Schedule I and Notice........... 20 Section 4.06 Consents.................................. 20 Section 4.07 Deleted................................... 20 Section 4.08 Regulatory Applications................... 20 Section 4.09 Shareholder Approval...................... 21 Section 4.10 Fairness of Opinion....................... 21 Section 4.11 Reserves and Accruals..................... 21 Section 4.12 Financial Statement Review................ 21 Section 4.13 No Other Bids............................. 21 Section 4.14 Park Avenue Real Estate................... 22 Section 4.15 Miscellaneous............................. 23 Section 4.16 Colonial D&O Insurance.................... 23 ARTICLE V COVENANTS OF SOVEREIGN...................................... 24 Section 5.01 Best Efforts.............................. 24 Section 5.02 Interim Banks............................. 24 Section 5.03 Regulatory Notices and Applications....... 24 Section 5.04 Management Following the Merger........... 24 Section 5.05 Employees and Employee Benefits........... 25 ARTICLE VI CONDITIONS PRECEDENT........................................ 26 Section 6.01 Conditions to Colonial's Obligations under this Agreement...................... 26 Section 6.02 Conditions to Sovereign's Obligations under this Agreement...................... 27 ARTICLE VII TERMINATION................................................. 29 Section 7.01 Termination............................... 29 Section 7.02 Effect of Termination..................... 31 ARTICLE VIII MISCELLANEOUS............................................... 32 Section 8.01 Expenses.................................. 32 Section 8.02 Non-Survival of Representations and Warranties................................ 32 Section 8.03 Amendment, Extension and Waiver........... 32 Section 8.04 Public Announcements...................... 33 Section 8.05 Entire Agreement.......................... 33 Section 8.06 No Assignment............................. 33 Section 8.07 Notices................................... 33 Section 8.08 Captions.................................. 34 Section 8.09 Counterparts.............................. 34 Section 8.10 Severability.............................. 35 Section 8.11 Governing Law............................. 35 Exhibits.................................................... 35 AGREEMENT AND PLAN OF MERGER MADE this 23rd day of March 1995, by and between SOVEREIGN BANCORP, INC., a Pennsylvania business corporation having its administrative headquarters at 1130 Berkshire Boulevard, P.O. Box 37, Reading, Pennsylvania 19603 ("Sovereign") and COLONIAL STATE BANK, a New Jersey commercial bank having its administrative headquarters at 521 Park Avenue, Freehold, New Jersey 07728 ("Colonial"). Background: Sovereign is a savings and loan holding company. Colonial is a New Jersey commercial bank. Sovereign wishes to acquire all of the outstanding $5.00 par value common stock of Colonial (the "Colonial Common Stock") and Colonial wishes to affiliate itself with and to become a subsidiary of Sovereign. Subject to the terms and conditions of this Agreement, the acquisition by Sovereign of all of the outstanding Colonial Common Stock will be accomplished by means of a reverse triangular merger under which: (i) Sovereign will organize as a wholly-owned subsidiary Sovereign Interim Bank, a non-operating phantom federal savings bank ("Interim Bank"), (ii) Interim Bank will be merged with and into Colonial (the "Merger"), (iii) Colonial will survive the Merger as a wholly-owned subsidiary of Sovereign, (iv) each outstanding share of Colonial Common Stock will in consideration of the Merger be converted into the right to receive $11.60 in cash from Sovereign, (v) Sovereign will organize as a wholly-owned subsidiary Sovereign Interim Bank II, a non-operating phantom Pennsylvania-chartered savings bank ("Second Interim Bank"), (vi) Second Interim Bank will convert from a Pennsylvania-chartered savings bank to a federal savings bank (the "Charter Conversion"), (vii) immediately following the Merger, Colonial will be merged with and into Second Interim Bank (the "Second Merger"), and (viii) Second Interim Bank will change its name to a name which includes the term "Sovereign" and will survive the merger as a federal savings bank and wholly-owned subsidiary of Sovereign. Prior to or contemporaneously with the execution and delivery of this Agreement and as a condition and inducement to Sovereign's execution of this Agreement: (i) all of the directors and certain of the officers and shareholders of Colonial executed in favor of Sovereign a Letter Agreement dated the date of this Agreement in the form attached hereto as Exhibit E pursuant to which each such person has agreed, among other things, to vote for and otherwise support the consummation of the transactions contemplated in this Agreement, and (ii) Colonial granted to Sovereign an option to acquire up to 19.9% of Colonial's common stock pursuant to the terms of a Stock Option Agreement between Sovereign and Colonial dated the date of this Agreement (the "Sovereign Option Agreement"). WITNESSETH: NOW, THEREFORE, in consideration of the mutual covenants hereinafter set forth and intending to be legally bound hereby, the parties agree as follows: ARTICLE I PLAN OF MERGER, CLOSING AND EFFECTIVE DATE Section 1.1 Plan of Merger. Subject to the terms and conditions of this Agreement, Interim Bank shall merge with and into Colonial in accordance with the Plan of Merger attached hereto as Exhibit A and Colonial shall survive such merger (the "Merger"). Section 1.2 Closing. Provided that all conditions precedent set forth in Article VI above shall have been satisfied or waived, the parties shall hold a closing (the "Closing") following the receipt of all required regulatory approvals and the expiration of all applicable waiting periods on a date and at a place to be agreed upon by the parties, at which time the parties shall execute and deliver all such documents and instruments as may be necessary or appropriate to effectuate the purposes of this Agreement. Section 1.3 Effective Date. The Merger shall be effective on the date on which all filings with government agencies as may be required under all applicable laws and regulations for the Merger to become effective are made and accepted by such agencies or, if later, on the date specified in such filings (the "Effective Date"). ARTICLE II REPRESENTATIONS AND WARRANTIES OF COLONIAL Colonial represents and warrants to Sovereign, as of the date of this Agreement and as of the date of the Closing, as follows: Section 2.1 Organization and Standing. Colonial is a New Jersey commercial bank duly organized, validly existing and in good standing under the laws of the State of New Jersey. Colonial is an insured bank under the provisions of the Federal Deposit Insurance Act and is not a member of the Federal Reserve System. Colonial has full power and lawful authority to own and hold its properties and to carry on its present business. Section 2.2 Authority. Colonial has full corporate power and authority to execute and deliver this Agreement and, subject to the receipt of shareholder and required regulatory approvals (and compliance with any conditions contained therein), to consummate the transactions contemplated herein. The execution and delivery of this Agreement and the consummation of the transactions contemplated herein have been authorized and unanimously approved by the Board of Directors of Colonial and, subject to the approval of this Agreement by its shareholders, no other corporate action on its part is necessary to authorize this Agreement or the consummation of the transactions contemplated herein. This Agreement has been duly executed and delivered by and, assuming due authorization, execution and delivery by Sovereign, constitutes a valid and binding obligation of Colonial, enforceable against Colonial in accordance with its terms, subject to applicable bankruptcy, insolvency, conservatorship, receivership and similar laws affecting creditors' rights generally and subject to the application of equitable principles. Section 2.3 No Violation. Subject to the receipt of shareholder and required regulatory approvals (and compliance with any conditions contained therein), the execution, delivery and performance of this Agreement and the consummation of the transactions contemplated herein will not: (i) violate or conflict with any provision of the Certificate of Incorporation or bylaws of Colonial; (ii) violate any statute, rule, regulation, ordinance, judgment, order or decree applicable to Colonial or by which Colonial or any of its properties is bound; or (iii) violate, conflict with, or constitute a default (or be an event which, with or without due notice or lapse of time, or both, would constitute such a default) under, or cause or permit the acceleration or termination of, any contract, note, bond, mortgage, indenture, license, lease or other instrument, agreement or commitment to which Colonial is a party or by which Colonial or any of its properties are bound, except in the case of clause (iii) for such violations, defaults, conflicts, accelerations, and terminations as would not, individually or in the aggregate, materially adversely affect the assets, liabilities, business, financial condition or results of operations of Colonial, or its ability to perform its obligations under this Agreement. Section 2.4 Subsidiaries. Colonial owns no subsidiaries, either directly or indirectly, other than CSB Building Corporation (the "Colonial Subsidiary"), which was organized on February 21, 1995 for purposes of acquiring title to the real estate located at 521 Park Avenue, Freehold, New Jersey pursuant to the transaction described in Section 4.14 below. The Colonial Subsidiary is a corporation duly organized, validly existing and in good standing under the laws of the State of New Jersey and has the corporate power and authority to carry on its business and operations as now being conducted (and as proposed to be conducted in connection with the transaction referred to in Section 4.14 below) and to operate the properties and assets now owned (or to be acquired pursuant to the transaction referred to in Section 4.14 below) by it. Colonial owns all of the outstanding shares of capital stock of the Colonial Subsidiary, free and clear of all liens, security interests, restrictions, options, claims, charges, pledges and/or encumbrances of any kind whatsoever. There are no outstanding agreements, subscriptions, obligations, options or rights of any kind relating to the issuance of or entitling others to acquire shares of capital stock of the Colonial Subsidiary and there are no outstanding securities or other instruments of any kind convertible into shares of capital stock of the Colonial Subsidiary. Section 2.5 Capitalization. (a) General. The authorized capital of Colonial consists exclusively of 2,550,000 shares of common stock of $5.00 par value per share (the "Colonial Common Stock"), of which 538,911 shares are validly issued and outstanding and are fully paid and non-assessable, none of which are held as treasury shares. There are no outstanding agreements, subscriptions, obligations, options or rights of any kind relating to the issuance of or entitling others to acquire shares of Colonial Common Stock and there are no outstanding securities or other instruments of any kind convertible into shares of Colonial Common Stock. (b) Number of Shareholders and Ownership by Management. As of December 31, 1994, Colonial had 276 shareholders of record. The Colonial Common Stock is not required to be registered with the Securities and Exchange Commission (the "SEC") under the provisions of Section 12 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Colonial is not required to file periodic reports with the SEC pursuant to Section 15(d) of the Exchange Act. Except as disclosed in Schedule I, to the knowledge of Colonial, no person or "group" (as that term is defined in Section 13(d)(3) of the Exchange Act) is the beneficial owner of 5% or more of the outstanding shares of Colonial Common Stock. Schedule I sets forth the name and number of shares of Colonial Common Stock beneficially owned by each such person and each such group as of the date of this Agreement. Schedule I also sets forth the name of each director and officer of Colonial and the number of shares of Colonial Common Stock owned beneficially by him as of the date of this Agreement. Section 2.6 Certificate of Incorporation, Bylaws and Minute Books. The copies of the Certificate of Incorporation, as amended, and of the bylaws, as amended, of Colonial which have been delivered to Sovereign are true, complete and accurate in all respects. The minute books of Colonial which have been or will be made available to Sovereign for inspection are true, complete and accurate in all respects. Section 2.7 Financial Statements. (a) Colonial Regulatory Reports. For purposes of this Agreement, the term "Colonial Regulatory Reports" shall mean the call reports, consolidated reports of condition and income, and accompanying schedules filed, or to be filed, by Colonial with the Federal Deposit Insurance Corporation (the "FDIC") and/or with the NJDOB for each calendar quarter, beginning with the quarter ended March 31, 1992 through the date of the Closing. Colonial has previously delivered (and in the case of subsequently prepared reports, will deliver) to Sovereign the Colonial Regulatory Reports. The Colonial Regulatory Reports have been (and in the case of subsequently prepared reports, will be) prepared in accordance with applicable regulatory accounting principles and practices applied on a consistent basis throughout the periods covered by such statements and fairly present (and in the case of subsequently prepared reports, will fairly present) the financial condition, results of operations and changes in shareholder's equity of Colonial at their respective dates and for the respective periods then ended in accordance with applicable regulatory accounting principles applied on a consistent basis. (b) Financial Statements. For purposes of this Agreement, the term "Colonial Financial Statements" shall mean the financial statements of Colonial at and for the years ended December 31, 1992, 1993 and 1994 as certified by KPMG Peat Marwick. Colonial has previously delivered to Sovereign the Colonial Financial Statements. The Colonial Financial Statements have been prepared in accordance with generally accepted accounting principles consistently applied during the periods involved and fairly present the financial condition, results of operations, cash flows and changes in shareholders' equity of Colonial at their respective dates and for the respective periods then ended in accordance with generally accepted accounting principles consistently applied. (c) Absence of Undisclosed Liabilities. As of the date of each balance sheet included in the Colonial Regulatory Reports or in the Colonial Financial Statements, Colonial did not have (and in the case of subsequently prepared Colonial Regulatory Reports, will not have) any liabilities (whether accrued, absolute, contingent or otherwise) which are required to be reflected, noted or reserved against therein under generally accepted accounting principles or which are in any case or in the aggregate material, except as reflected, noted or adequately reserved against therein. Except with respect to the real estate transaction referred to in Section 4.14 below, since December 31, 1994, Colonial has not incurred and will not incur any such liability, other than liabilities of the same nature as those set forth in the balance sheet included in the Colonial Financial Statement, at and for the year ended December 31, 1994, all of which have been reasonably incurred in the ordinary course of business consistent with past practice. (dStatements of Financial Accounting Standard Nos. 114 and 118, effective January 1, 1995, and the adoption of such Statements will not have a material adverse impact upon the financial condition or results of operations of Colonial. Section 2.8 Absence of Changes. Since December 31, 1994, Colonial has conducted its business in the regular and ordinary course (except with respect to the real estate transaction referred to in Section 4.14 below) and has not undergone any change in condition (financial or otherwise), assets, liabilities, business or operations, other than changes in the ordinary course of business consistent with past practice which have not been, either in any case or in the aggregate, materially adverse, except that the operation of its business was affected by the terms and conditions of, and the restrictions imposed by, the Memorandum of Understanding referred to in Section 2.16 below during the period March 2, 1993 through November 21, 1994. Section 2.9 Dividends, Distributions and Stock Purchases. Since December 31, 1994, Colonial has not: (i) declared, set aside, made or paid any dividend or other distribution in respect of Colonial Common Stock, or (ii) purchased, issued or sold any shares of Colonial Common Stock. Section 2.10 Taxes. Colonial has duly filed, and will duly file, all federal, state, county, municipal and foreign tax returns, reports, information returns and declarations which are required to be filed by it (which returns, reports and declarations are (and, in the case of subsequently filed returns, will be complete, accurate and correct in all material respects and free of any material omission, deficiency, error, misstatement or misrepresentation) and has duly paid (and, in the case of returns, reports and declarations to be filed by it after the date of this Agreement, will duly pay) all taxes, penalties and interest which have become due pursuant thereto or which became due pursuant to assessments. Colonial has not received any notice of deficiency or assessment of additional taxes and no tax audits are in process. Colonial has not granted any waiver of any statute of limitation with respect to any extension of a period for the assessment of any federal, state, county, municipal or foreign income tax. The accruals and reserves for taxes reflected in the balance sheet included in the Colonial Financial Statements and in the Colonial Regulatory Reports at and for the 12 months ended December 31, 1994 are adequate to cover all taxes (including interest and penalties, if any, thereon) payable or accrued as a result of its operations for all periods prior thereto. Section 2.11 Title To and Condition of Assets. Colonial is the legal, equitable, beneficial and record owner of and has good and marketable title to all real and personal properties and assets, both tangible and intangible, reflected (and in the case of subsequently prepared financial statements, to be reflected) in the balance sheets set forth in the Colonial Financial Statements and in the Colonial Regulatory Reports, or acquired subsequent to December 31, 1994 (other than property and assets disposed of for fair value in the ordinary course of business), free and clear of all liens, security interests, restrictions, options, claims, charges, pledges and/or encumbrances of any kind whatsoever other than: (i) as reflected in such balance sheets; (ii) liens of current taxes not yet due; and (iii) such imperfections of title, encumbrances and easements, if any, as are not substantial in character, amount or extent and do not materially detract from the value, or materially interfere with the present use, of the properties and assets subject thereto. Without limitation of the foregoing, Colonial has (or the Colonial Subsidiary organized in connection with the transaction referred to in Section 4.14 below, will have) good and marketable title to the real property located at 521 Park Avenue, Freehold, New Jersey, which property is insurable at ordinary rates by any nationally recognized title company (including Fidelity Land Title Insurance Company and Chicago Title Insurance Company, which are represented by Alliance Title Agency), free and clear of all liens, restrictions, options, claims, charges, pledges and encumbrances, other than as described in clauses (i) through (iii) of the preceding sentence or as described in Schedule I. The structures and other improvements to real estate, furniture, fixtures and equipment reflected in the balance sheets included in the Colonial Financial Statements and in the Colonial Regulatory Reports or acquired subsequent to December 31, 1994, are in good operating condition and repair, are fit for the purposes for which they are used, and conform in all material respects with all applicable laws, ordinances and regulations, including without limitation, all building, zoning and other similar laws. Colonial owns, has a valid leasehold interest in or otherwise has the right to use all real and personal properties and assets necessary to the conduct of its business as now conducted. Section 2.12 Loan Portfolio; Portfolio Management. All evidences of indebtedness reflected as assets in the balance sheets included in the Colonial Financial Statements and/or the Colonial Regulatory Reports are and in the case of any such assets reflected in subsequently prepared Colonial Regulatory Reports, will be, (except with respect to those assets which have been or will be disposed of for fair value in the ordinary course of business) binding obligations of the respective obligors named therein, except as enforcement may be limited by bankruptcy, insolvency or other similar laws affecting the enforcement of creditors' rights generally, and except that the availability of equitable remedies, including specific performance, is subject to the discretion of the court before which any proceeding may be brought, and the payment of no amount thereof is subject to any defenses which have been threatened or asserted against Colonial. All such indebtedness which is secured by an interest in real property is secured by a valid and perfected mortgage lien having the priority specified in the latest title report included with the loan documents theretofore made available to Sovereign. Colonial warrants that all loans originated by it were at the time entered into and have been at all times since in compliance in all material respects with all applicable laws and regulations. All loans purchased by Colonial: (i) were, at the time entered into in compliance in all material respects with all applicable laws and regulations, and (ii) at all times since such loans were purchased have been in compliance in all material respects with all applicable laws and regulations. Colonial administers its loan and investment portfolios in all material respects in accordance with all applicable laws and regulations. The records of Colonial regarding all loans outstanding on its books are accurate in all material respects and the risk classification system has been established in accordance with the requirements of the FDIC. Schedule I discloses all loans which, as of December 31, 1994, have been classified by Colonial or by any regulatory examiner as "Other Loans Specifically Mentioned," "Substandard," "Doubtful," or "Loss." Section 2.13 Investment Securities. All securities reflected as assets in the balance sheets included in the Colonial Financial Statements and/or the Colonial Regulatory Reports are (and in the case of securities reflected in subsequently prepared financial statements and reports, will be) owned legally, beneficially, equitably and of record by Colonial free and clear of all mortgages, liens, security interests, pledges, encumbrances and other restrictions, whether contractual or statutory, which would impair the ability of Colonial freely to dispose of any such security at any time. With respect to all repurchase agreements to which Colonial is, or will be, a party, Colonial has, or will have, a valid, perfected first lien or security interest in the government securities or other collateral securing the repurchase agreement, and the value of the collateral securing each such repurchase agreement equals or exceeds, or will equal or exceed, the amount of the debt secured by such collateral under such repurchase agreement. Section 2.14 Contracts and Required Consents. (a) Contracts. Colonial has identified on Schedule I: (i) all written or oral contracts (other than contracts with customers reasonably entered into by Colonial in the ordinary course of business consistent with past practice) which involve the payment or the receipt of consideration in excess of $10,000 per year, including, without limitation, all employment contracts, agreements, leases, licenses, and other commitments to which Colonial is a party or by which Colonial or any of its properties are bound, and (ii) all employment, consulting, retirement, severance, bonus, deferred compensation or similar agreements, whether written or oral, entered into by Colonial with any past or present officer, director, employee or shareholder of Colonial. Except as disclosed in Schedule I, all such contracts, agreements, leases, licenses and other commitments are valid and in full force and effect and all parties thereto have in all material respects performed all obligations required to be performed by them to date and are not in default in any material respect. (b) Consents. Schedule I identifies all such contracts, agreements, leases, licenses and other commitments which require the consent, approval or waiver of any third party to avoid a violation, the occurrence of an event of default or the exercise of a right of termination by reason of the execution and delivery of this Agreement or the consummation of the transactions contemplated herein. Section 2.15 Litigation. There is no litigation, investigation or proceeding pending, or to the knowledge of Colonial, threatened involving Colonial or its properties which, if determined adversely to Colonial, would materially adversely affect the condition (financial or otherwise), assets, liabilities, business or operations of Colonial or which challenge the validity or propriety of the transactions contemplated under this Agreement. There are no outstanding orders, writs, injunctions or decrees of any court, governmental agency or arbitration tribunal against Colonial which materially adversely affect the condition (financial or otherwise), assets, liabilities, business or operations of Colonial, its right to conduct its business as presently conducted or its ability to perform its obligations under this Agreement. Colonial is not aware of any fact or condition presently existing which might give rise to any litigation, investigation or proceeding which, if determined adversely to Colonial, would materially adversely affect the condition (financial or otherwise), assets, liabilities, business or operations of Colonial. Section 2.16 Compliance with Laws; Governmental Authorizations. (a) General Compliance. Colonial is in compliance in all material respects with all statutes, laws, ordinances, rules, regulations, judgments, orders, decrees, permits, concessions, grants, franchises, licenses and other governmental authorizations or approvals applicable to it or to any of its properties. All permits, concessions, grants, franchises, licenses and other governmental authorizations and approvals necessary for the lawful conduct of Colonial's business have been duly obtained and are in full force and effect and there are no proceedings pending or, to the knowledge of Colonial, threatened which may result in the revocation, cancellation, suspension or materially adverse modification of any of them. (b) Regulatory Compliance. Except: (i) as directly related to the Memorandum of Understanding referred to in the next sentence, (ii) for matters relating to the failure by Colonial to comply in certain respects with the requirements of the Community Reinvestment Act and with certain regulations relating to consumer compliance (the complete facts and circumstances of such non-compliance having in each case been fully disclosed by Colonial to Sovereign), and (iii) for matters relating to the fact that Colonial's investment in bank premises exceeded applicable regulatory limits, Colonial has not received any notification or communication from any regulatory authority: (A) asserting that Colonial is not in substantial compliance with any of the statutes, regulations or ordinances which such regulatory authority enforces; (B) threatening to revoke any license, franchise, permit or governmental authorization which is material to Colonial; (C) requiring or threatening to require Colonial, or indicating that Colonial may be required, to enter into a cease and desist order, agreement or memorandum of understanding or any other agreement restricting or limiting, or purporting to restrict or limit, in any manner the operations of Colonial, including without limitation, any restriction on the payment of dividends; or (D) directing, restricting or limiting, or purporting to direct, restrict or limit, in any manner the operations of Colonial, including without limitation any restriction on the payment of dividends (any such notice, communication, memorandum, agreement or order described in this sentence herein referred to as a "Regulatory Agreement"). Colonial has never consented to or entered into any Regulatory Agreement, except for a Memorandum of Understanding dated March 2, 1993 (the "MOU") entered into by Colonial with the FDIC and the New Jersey Department of Banking (the "NJDOB"). Colonial has delivered to Sovereign a true, complete and accurate copy of the MOU, including all amendments thereto. The MOU was terminated on November 21, 1994 and Colonial has not since that time received any notification or communication from any regulatory authority of the kind contemplated under clauses (A) through (D) of the first sentence of this Section. Section 2.17 Regulatory Reports of Examination. Colonial will make available to Sovereign for inspection true, complete and accurate copies of: (i) all reports of examination prepared by the FDIC and/or by the NJDOB from the date of its organization through the date of the Closing, (ii) all correspondence relating to the foregoing reports of examination and to the MOU, and (iii) all agreements, memoranda of understanding and other arrangements and understandings between Colonial and the FDIC and/or the NJDOB entered into as a result of matters raised in such reports of examination and correspondence. Section 2.18 Insurance. All policies of insurance, including all policies of title insurance and fidelity bonds, held by or on behalf of Colonial are listed on Schedule I. All such policies of insurance are in full force and effect and no notices of cancellation have been received in connection therewith. Section 2.19 Fidelity Bonds. Colonial has continuously since the date of its organization maintained in full force and effect a fidelity bond insuring it against acts of dishonesty by each of its employees in such amounts as are disclosed on Schedule I. No claim has been made under any such bond and Colonial is not aware of any fact or condition presently existing which might form the basis of a claim under any such bond. Colonial has no reason to believe that its present fidelity bond will not be renewed by its carrier on substantially the same terms as those now in effect. Section 2.20 Labor Relations. Colonial is not a party to or bound by any collective bargaining agreement. Colonial enjoys good working relationships with its employees and there are no labor disputes pending or to the knowledge of Colonial, threatened which might materially adversely affect the condition (financial or otherwise), assets, liabilities, business or operations of Colonial. Section 2.21 Employee Benefit Plans. (a) Plans and Plan Documents. All employee benefit plans, contracts or arrangements to which Colonial is a party or by which it is bound which Colonial maintains for the benefit of employees or former employees (including retired employees), including, without limitation, all pension, retirement, deferred compensation, incentive, bonus, profit sharing, stock purchase, stock option, life insurance, death or survivor's benefit, health insurance, sickness, disability, medical, surgical, hospital, severance, layoff and vacation plans, contracts or arrangements are identified in Schedule I. Colonial has delivered to Sovereign true, complete and accurate copies of all plans identified on Schedule I. Colonial has no pension plan or other employee benefit plan which constitutes a "qualified plan" under IRC Section 401(a) of the Internal Revenue Code of 1986, as amended (the "IRC"). (b) Compliance. All "employee benefit plans," as defined in Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), comply in all material respects with ERISA. As of December 31, 1994 Colonial had no material liability under any such plan which is not reflected, reserved against or accrued in the unaudited financial statements of Colonial at and for the year ended December 31, 1994 previously delivered to Sovereign (or disclosed in the notes thereto), including any liability under SFAS No. 106. No prohibited transaction (which shall mean any transaction prohibited by ERISA Section 406 and not exempt under ERISA Section 408) has occurred with respect to any employee benefit plan maintained by Colonial which would result in the imposition, directly or indirectly, of a material excise tax under IRC Section 4975. Colonial provides continuation coverage under group health plans for separating employees in accordance with the provisions of IRC Section 4980B(f). Such group health plans are in compliance with Section 1862(b)(1) of the Social Security Act. There have been no breaches of fiduciary duty by any fiduciary under and with respect to any employee benefit plan to which Colonial is a party or by which it is bound and no claim is pending or threatened with respect to any such plan, other than claims for benefits made in the ordinary course. Section 2.22 Related Party Transactions. Except as disclosed in Schedule I: (i) no present or former officer or director of Colonial, (ii) no spouse of any present or former officer or director of Colonial, (iii) no shareholder owning five percent or more of the outstanding Colonial Common Stock, (iv) no child, parent, or sibling of any of the foregoing Persons, and (v) no Person with respect to which any of the foregoing Persons is an officer, director, partner, trustee or direct or indirect beneficial owner of 10 percent or more of its equity interest, is a party to (or has an interest in any property which is the subject of) any contract, business arrangement or relationship of any kind whatsoever with Colonial. For purposes of this Agreement: (a) the term "Person" shall mean any individual, corporation, partnership, association, joint venture, limited liability company, trust or other organization or entity, and (b) the term "Colonial Affiliate" shall mean the Persons identified in clauses (i) through (v) of the preceding sentence. All extensions of credit to Colonial Affiliates conform with all applicable laws and regulations and no such extension of credit is in default or has been in default, restructured, modified or extended during the three year period preceding the date of this Agreement, except for: (i) a loan to Directors Limited identified in Schedule I, and (ii) a loan to Robert J. Belon in the principal amount of approximately $106,000, the details of which have been fully disclosed to Sovereign. Section 2.23 No Finder. Except with respect to its engagement of Ryan, Beck & Co., Colonial has not paid or become obligated to pay any fee or commission of any kind whatsoever to any investment banker, broker, finder or other intermediary for, on account of or in connection with the transactions contemplated in this Agreement. A true, complete and accurate copy of the engagement letter entered into by Colonial with Ryan, Beck & Co. (including all amendments thereto) has been delivered to Sovereign. Section 2.24 Significant Customers. All significant customers of Colonial are identified in Schedule I. For purposes of this Agreement, a "significant customer" shall mean any customer which as of February 28, 1995 had in the aggregate: (i) outstanding loans in the amount of $250,000 or more, or (ii) deposits in the amount of $200,000 or more. There has been no material change in the identity of the significant customers of Colonial or in the composition of these loans and/or, to the best of Colonial's knowledge, deposits since February 28, 1995. Section 2.25 Environmental Matters. For purposes of this Agreement, the term "Environmental Laws" shall mean any federal, state, local or foreign law, statute, ordinance, rule, regulation, code, license, permit, authorization, approval, consent, order, judgment, decree, injunction or agreement with any Regulatory Authority relating to: (i) the protection, preservation or restoration of the environment (including, without limitation, air, water vapor, surface water, groundwater, drinking water supply, surface soil, subsurface soil, plant and animal life or any other natural resource), and/or (ii) the use, storage, recycling, treatment, generation, transportation, processing, handling, labeling, production, release or disposal of any substance presently listed, defined, designated or classified as hazardous, toxic, radioactive or dangerous, or otherwise regulated, whether by type or by quantity, including any material containing any such substance as a component. To the knowledge of Colonial, neither Colonial nor any property owned or operated by Colonial (including other real estate owned) or any property which serves as collateral for any loan held by Colonial has been or is in violation of or liable under any Environmental Law, except for such violations or liabilities that, individually or in the aggregate, would not have a material adverse effect on the assets, business, financial condition or results of operation of Colonial. There are no actions, suits or proceedings, or demands, claims, notices or investigations (including without limitation notices, demand letters or requests for information from any environmental agency) instituted or pending, or, to the knowledge of Colonial, threatened relating to the liability of any property owned or operated by Colonial (including other real estate owned) or any property which serves as collateral for any loan held by Colonial under any Environmental Law. Section 2.26 Allowance for Loan Losses. The allowance for loan losses reflected in the Colonial Regulatory Reports and shown on the balance sheets included in the Colonial Financial Statements are (and in the case of allowances reflected in subsequently prepared reports and financial statements, will be) adequate, in accordance with the requirements of generally accepted accounting principles and all applicable regulatory criteria. No regulatory authority has requested Colonial to increase the allowance for loan losses since January 1, 1995. Section 2.27 Deleted. Section 2.28 Complete and Accurate Disclosure. Neither this Agreement nor any financial statement, schedule (including, without limitation, Schedule I), certificate, or other statement or document delivered (or to be delivered) by Colonial to Sovereign in connection herewith contains (or will contain) any untrue statement of a material fact or omits (or will omit) to state a material fact necessary to make the statements contained herein or therein (considered as a whole) not misleading. As of the date of this Agreement, there are no material facts known to Colonial which materially adversely affect, or which may in the future materially adversely affect, the assets, liabilities, business, financial condition, results of operations or future prospects of Colonial which have not been previously disclosed by Colonial to Sovereign in writing. ARTICLE III REPRESENTATIONS AND WARRANTIES OF SOVEREIGN Sovereign represents and warrants to Colonial, as of the date of this Agreement and as of the date of the Closing, as follows: Section 3.1 Organization and Standing. Sovereign is a Pennsylvania corporation duly organized, validly existing and in good standing under the laws of the Commonwealth of Pennsylvania. Sovereign is duly registered as a savings and loan holding company under the Home Owners Loan Act of 1933, as amended. Sovereign has full power and lawful authority to own and hold its properties and to carry on its present business. Section 3.2 Authority. Sovereign has full corporate power and authority to execute and deliver this Agreement and, subject to the receipt of all required regulatory approvals (and compliance with any conditions contained therein), to consummate the transactions contemplated herein. The execution and delivery of this Agreement and the consummation of the transactions contemplated herein have been authorized and approved by the Board of Directors of Sovereign and no other corporate action on its part is necessary to authorize this Agreement or the consummation of the transactions contemplated herein. This Agreement has been duly executed and delivered by and, assuming due authorization, execution and delivery by Colonial, constitutes a valid and binding obligation of Sovereign, enforceable against Sovereign in accordance with its terms, subject to applicable bankruptcy, insolvency, conservatorship, receivership and similar laws affecting creditors' rights generally and subject to the application of equitable principles. Section 3.3 No Violation. Subject to the receipt of all required regulatory approvals (and compliance with any conditions contained therein), the execution, delivery and performance of this Agreement and the consummation of the transactions contemplated herein will not: (i) violate or conflict with any provision of the Articles of Incorporation or bylaws of Sovereign, (ii) violate, conflict with, or constitute a default, however defined (or be an event which, with or without due notice or lapse of time, or both, would constitute such a default) under, or cause or permit the acceleration of any contract, note, bond, mortgage, indenture, license, lease or other instrument, agreement or commitment to which Sovereign is a party or by which Sovereign or any of its properties are bound, or (iii) violate any statute, rule, regulation, ordinance, judgment, order or decree applicable to Sovereign or by which Sovereign or any of its properties is bound; except, however, in the case of clauses (ii) and (iii) for such violations, defaults, conflicts, accelerations, and terminations as would not, individually or in the aggregate, materially adversely affect the financial condition of Sovereign or its ability to perform its obligations under this Agreement. Section 3.4 Financial Statements. (a) Financial Statements. For purposes of this Agreement, the term "Sovereign Financial Statements" shall mean: (i) the financial statements of Sovereign at and for the year ended December 31, 1994 as certified by Ernst & Young, and (ii) the unaudited financial statements of Sovereign for each calendar quarter following the date of this Agreement included in the Quarterly Reports on Form 10-Q to be filed by Sovereign with the SEC. Sovereign has previously delivered, or will deliver, to Colonial the Sovereign Financial Statements. The Sovereign Financial Statements have been (and in the case of subsequently prepared financial statements, will be) prepared in accordance with generally accepted accounting principles consistently applied during the periods involved and fairly present (and in the case of subsequently prepared financial statements will fairly present) the financial condition, results of operations, cash flows and changes in shareholder's equity of Sovereign at their respective dates and for the respective periods then ended in accordance with generally accepted accounting principles consistently applied. (b) Absence of Undisclosed Liabilities. As of the date of each balance sheet included in the Sovereign Financial Statements, Sovereign did not have (and in the case of subsequently prepared financial statements, will not have) any liabilities (whether accrued, absolute, contingent or otherwise) which are required to be reflected, noted or reserved against therein under generally accepted accounting principles or which are in any case or in the aggregate material, except as reflected, noted or adequately reserved against therein. Section 3.5 Absence of Changes. Since December 31, 1994, Sovereign has conducted its business in the regular and ordinary course and has not undergone any change in condition (financial or otherwise), assets, liabilities, business or operations, other than changes in the ordinary course of business consistent with past practice which have not been, either in any case or in the aggregate, materially adverse. Section 3.6 Liquidity. Sovereign will on the date of the Closing have adequate liquidity to perform its obligations under Sections 7.2 and 7.3 of the Plan of Merger attached hereto as Exhibit A. Section 3.7 No Finder. Sovereign has not paid or become obligated to pay any fee or commission of any kind whatsoever to any investment banker, broker, finder or other intermediary for, on account of or in connection with the transactions contemplated in this Agreement. ARTICLE IV COVENANTS OF COLONIAL From the date of this Agreement until the earlier of the Effective Date or the termination of this Agreement in accordance with the terms of Section 7.01 below, Colonial agrees to do the following: Section 4.01 Conduct of Business. (a) Ordinary Course. From the date of this Agreement to the date of the Closing, Colonial will conduct its business and engage in transactions only in the ordinary course and consistent with past practice, except as otherwise required by this Agreement or with the written consent of Sovereign. Colonial will use its reasonable best efforts to: (i) preserve its business organization intact, (ii) maintain good relationships with its employees, and (iii) preserve the goodwill of its customers and others with whom business relationships exist. (b) Certain Negative Covenants. Without limitation of the covenants set forth in Section 4.01(a) above, from the date hereof to the date of the Closing, except as otherwise consented to or approved by Sovereign in writing or as permitted or required by this Agreement, Colonial will not: (i) change any provision of its Articles of Incorporation or bylaws; (ii) change the number of authorized or issued shares of its capital stock or issue or grant any option, warrant, call commitment, subscription, right or agreement of any kind relating to its authorized or issued capital stock or any securities convertible into shares of such stock, combine or reclassify any shares of capital stock, or declare, set aside or pay any dividend or other distribution in respect of capital stock, or redeem or otherwise acquire any shares of capital stock; (iii) grant any severance or termination pay to, or enter into or amend any employment agreement with, any employee, officer or director of Colonial, or increase the rate of compensation of any officer, director or employee of Colonial; (iv) merge or consolidate Colonial with any other entity; sell or lease all or any substantial portion of the assets or business of Colonial; make any acquisition of all or any substantial portion of the business or assets of any other person, firm, association, corporation or business organization other than in connection with the collection of a loan or credit arrangement; enter into a purchase and assumption transaction with respect to its deposits and liabilities; revoke or surrender any certificate of authority to maintain, or file an application for the relocation of, any existing branch office, or file an application for a certificate of authority to establish a new branch office; (v) sell or otherwise dispose of any asset, other than in the ordinary course of business consistent with past practice; subject any asset of Colonial to a lien, pledge, security interest or other encumbrance, other than in the ordinary course of its banking business consistent with past practice; modify in any material respect the manner in which Colonial has heretofore conducted its business or enter into any new line of business; incur any indebtedness for borrowed money (or guarantee any indebtedness for borrowed money), except in the ordinary course of its banking business consistent with past practice; (vi) take any action which would result in any of the representations and warranties of Colonial set forth in this Agreement becoming untrue after the date hereof or any of the conditions set forth in Article V hereof not being satisfied; (vii) change any method, practice or principle of accounting; or change any assumption underlying, or any method of calculation of, depreciation of any type of asset or establishment of any reserve, except at the request of Sovereign pursuant to Section 4.14 below and except as may be required by any change in generally accepted accounting principles; (viii) waive, release, grant or transfer any rights of value or modify or change in any material respect any existing agreement to which Colonial is a party, other than in the ordinary course of business consistent with past practice; (ix) establish any new pension, retirement, profit sharing, bonus, welfare benefit or similar plan or arrangement or amend any such existing plan or arrangement, except for such amendments as may be required by law; (x) make any new loan or other credit facility commitment (including, without limitation, lines of credit and letters of credit) to: (A) any borrower or group of affiliated borrowers in excess of $250,000 in the aggregate, or (B) any Colonial Affiliate; (xi) compromise, extend or restructure any loan with an unpaid principal balance exceeding $250,000, provided, however, that Sovereign agrees that it may withhold its consent to any such compromise, extension or restructuring only for reasons relating to credit considerations specifically applicable to the loan involved; (xii) sell, exchange or otherwise dispose of any investment securities or loans held for sale in an amount in excess of $100,000; (xiii) purchase any security for its investment portfolio not rated "A" or higher by both Standard & Poor's Corporation or Moody's Investor Services, Inc.; (xiv) offer, issue any commitment for, or approve any loan or other credit facility, except in the ordinary course of business and at rates and on terms and conditions which are consistent with past practice; (xv) originate deposits, except in the ordinary course of business and at rates and on other terms and conditions which are consistent with past practice; (xvi) make any loan or other credit facility commitment (including without limitation, lines of credit and letters of credit) to any Colonial Affiliate or compromise, extend, renew (other than the renewal of a home equity line of credit which is secured by a first mortgage lien and which has a loan to value ratio of not more than 50%) or modify any such existing loan or commitment; provided, however, that Sovereign shall not unreasonably withhold its consent; (xvii) enter into, renew, extend or modify any other transaction with any Colonial Affiliate; (xviii) enter into or assume any material contract or commitment, except in the ordinary course of business consistent with past practice; (xix) take any action which would adversely affect the ability of Sovereign or Colonial to obtain any regulatory approval required in order to consummate the transactions contemplated in this Agreement; (xx) make any capital expenditure of $10,000 or more; (xxi) enter into any contract or commitment (other than in the ordinary course of extending credit to customers as part of its banking business) involving an unbudgeted expense of $10,000 or more or involving a material financial commitment which extends beyond six months from the date hereof; (xxii) elect or appoint any person to its Board of Directors who is not a director on the date of this Agreement; or (xxiii) agree to do any of the foregoing. (c) Certain Affirmative Covenants. Without limitation of the covenants set forth in Section 4.01(a) above, from the date hereof to the date of the Closing, except as otherwise consented to or approved by Sovereign in writing or as permitted or required by this Agreement, Colonial will: (i) maintain all furniture, fixtures, equipment and improvements to real estate in good condition and repair, except for ordinary wear and tear and damage by unavoidable casualty; (ii) maintain all insurance policies in effect; (iii) perform all of its obligations under all material agreements, contracts and other commitments to which it is a party or by which it or any of its assets are bound; \DMS maintain its books of accounts and other records in the ordinary course consistent with past practice; and (v) comply with all statutes, laws, ordinances, rules and regulations applicable to it and/or to the conduct of its business. Section 4.02 Best Efforts. Colonial shall cooperate with Sovereign and shall use its reasonable best efforts to do or cause to be done all things necessary or appropriate on its part in order to consummate the transactions contemplated by this Agreement. Section 4.03 Access and Confidentiality. (a) Access. From the date of this Agreement through the date of the Closing, Colonial shall afford to Sovereign and its authorized agents and representatives reasonable access during normal business hours to its properties, books and records and personnel and Colonial shall make available to Sovereign and its authorized agents and representatives all such financial and operating data and other information relating to Colonial and its business, properties, assets, liabilities and personnel as they may from time to time reasonably request. (b) Confidentiality. In the event of the termination of this Agreement, Sovereign shall return or destroy (and deliver to Colonial an affidavit of destruction) all documents and records obtained by it from Colonial and will maintain the confidentiality of all information relating to Colonial obtained by it pursuant to this Agreement, except to the extent that such information becomes public through no fault of Sovereign and except to the extent that disclosure of any such information is legally required. Section 4.0Regulatory Reports. Colonial shall promptly deliver to Sovereign all Colonial Financial Statements and all Colonial Regulatory Reports required to be prepared by it subsequent to the date of this Agreement. In addition, Colonial agrees to deliver to Sovereign all such other reports and other documents normally prepared by Colonial which relate to its assets, liabilities or otherwise to the conduct of its business as Sovereign may from time to time reasonably request. Section 4.05 Update of Schedule I and Notice. (a) Update of Schedule I. Colonial shall update Schedule I as promptly as possible after the occurrence of any event or fact which, if such event or fact had occurred prior to the date of this Agreement, would have been disclosed on Schedule I. The delivery of any update to Schedule I by Colonial shall not relieve Colonial from liability for any breach or violation of this Agreement. (b) Notice. Without limitation of the foregoing, Colonial shall promptly notify Sovereign in writing of any action, claim, investigation or other development which, if pending or in existence on the date of this Agreement, would have been required to be disclosed to Sovereign to assure the accuracy of the representations and warranties set forth in this Agreement or which otherwise materially affects the assets, liabilities, business, financial condition or results of operation of Colonial or its ability to perform its obligations under this Agreement. Section 4.06 Consents. Colonial shall obtain in writing all such consents, waivers and other documents contemplated under Section 2.14(b) from third parties that may be required in order to consummate the transactions contemplated in this Agreement. Section 4.07 Deleted. Section 4.08 Regulatory Applications. Colonial shall, with the cooperation and assistance of Sovereign, promptly prepare and file with the NJDOB, with the FDIC and with all other relevant regulatory authorities all notices and applications necessary in order to secure (and use its best efforts to secure as promptly as possible) all regulatory approvals and consents required to be obtained or filed by it in order to consummate the transactions contemplated in this Agreement. All such notices and applications shall be subject to review by and the approval of Sovereign prior to filing, which approval shall not be unreasonably withheld or delayed. Section 4.09 Shareholder Approval. Colonial agrees to hold a special meeting of its shareholders (the "Special Meeting") as soon as practicable in order to obtain shareholder approval of the Merger. Colonial agrees to cause its Board of Directors to recommend to the shareholders that the Merger be approved. Colonial further agrees to prepare and distribute to its shareholders a proxy statement (the "Proxy Statement") in connection with the Special Meeting in accordance with all applicable laws and regulations, which proxy statement shall not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements contained therein, in light of the circumstances under which made, not misleading. Section 4.10 Fairness of Opinion. Colonial shall use its reasonable best efforts to obtain a written opinion from Ryan Beck & Co. (or, in the event that Ryan Beck & Co. is for any reason unable or unwilling to deliver the required opinion, from another reputable investment banking firm engaged on terms and conditions reasonably satisfactory to Sovereign) as to the fairness of the Merger to the shareholders of Colonial from a financial point of view, which opinion shall be dated a date not more than ten (10) business days and not less than five (5) business days prior to the date of mailing of the Proxy Statement and shall be included in the Proxy Statement. Section 4.11 Reserves and Accruals. Immediately prior to the Closing, Colonial shall establish such additional accruals and reserves as Sovereign may request in order to conform Colonial's accounting reserve practices and methods (including credit loss practices and methods) to those of Sovereign and its subsidiaries and otherwise to reflect the expenses and costs incurred by Colonial in connection with the consummation of this Agreement. Section 4.12 Financial Statement Review. If requested to do so by Sovereign, Colonial shall at Sovereign's expense cause KPMG Peat Marwick to perform a review of Colonial's unaudited financial statements as of the end of a calendar quarter designated by Sovereign in accordance with Statement of Auditing Standards No. 36 and to issue their report hereon as soon as practicable thereafter. Section 4.13 No Other Bids. Colonial shall not, nor shall it permit any officer, director, or employee of Colonial, or any investment banker, attorney, accountant or other representative retained by Colonial to, directly or indirectly, solicit, encourage, initiate or engage in discussions or negotiations with, or respond to requests for information, inquiries, or other communications from, any person other than Sovereign concerning the fact of, or the terms and conditions of, this Agreement, or concerning any acquisition of Colonial, or any assets or business of Colonial (except that Colonial's officers may respond to inquiries from regulatory authorities and holders of Colonial Common Stock in the ordinary course of business). Colonial shall notify Sovereign immediately if any such discussions or negotiations are sought to be initiated with Colonial by any person other than Sovereign or if by such requests for information, inquiries, proposals or communications are received from any person other than Sovereign. Notwithstanding the foregoing, Colonial, after written notice to Sovereign, may respond to unsolicited inquiries from third parties and/or engage in discussions with third parties if, in each case Colonial shall have received a written opinion, from Independent Counsel, to be selected by Colonial and approved by Sovereign, to the effect that consummation of the Merger constitutes a clear breach or failure on the part of the Board of Directors of Colonial to perform the duties of their office, and that such breach constitutes actionable misconduct for which a majority of such directors are liable under New Jersey law. For purposes of this Agreement, the term "Independent Counsel" shall mean a law firm which is experienced in matters involving the fiduciary duties of directors and which has not within the preceding five years been engaged to represent Colonial or any director or officer of Colonial. Section 4.14 Park Avenue Real Estate. (a) Background. Sovereign acknowledges that Colonial has sought regulatory approval from the NJDOB for a transaction (the "Real Estate Transaction") under which it will cause the Colonial Subsidiary to purchase: (i) from Colonial the fee interest in the real estate located at 521 Park Avenue, Freehold, New Jersey, and (ii) from Directors Limited, a joint venture, the improvements thereon erected. Colonial has provided to Sovereign a true, complete and accurate copy of the regulatory application filed with the NJDOB in connection with the Real Estate Transaction and all correspondence relating thereto (the "Application"). The Application completely and accurately describes the terms of the Real Estate Transaction and includes true, complete and accurate copies of all agreements, loan commitments, appraisals and other documents and instruments (including all amendments thereto) relating to the Real Estate Transaction. (b) Consents and Approvals. Colonial shall not consummate the Real Estate Transaction: (i) without the prior written consent of Sovereign, (ii) without the written approval of the NJDOB, and (iii) except in strict compliance with the terms and conditions of the approval of the NJDOB. Sovereign agrees that it will consent to the Real Estate Transaction, provided that: (i) the Real Estate Transaction is approved by the NJDOB and such approval contains no terms or conditions which Sovereign reasonably determines in the exercise of its sole discretion to be burdensome or otherwise unacceptable, and (ii) the financial and other terms of the Real Estate Transaction are not amended, waived or otherwise changed in any material respect from those set forth in the Application, and (iii) the agreements of sale, mortgage, mortgage note, title policy, lease and other documents pursuant to which the Real Estate Transaction is consummated are in form and substance usual, reasonable and customary for a transaction of that kind. (c) No Violation of Other Covenants. No action taken by Colonial for purposes of consummating the Real Estate Transaction in accordance with the terms of and as contemplated by this Section 4.14 shall constitute a breach of any covenant set forth in any other Section of this Article IV. Section 4.15 Miscellaneous. (a) Environmental Audit. Colonial agrees to permit Sovereign, at Sovereign's expense and if Sovereign elects to do so, to cause a Phase I and/or a Phase II environmental audit to be performed at any real property owned or occupied by Colonial (including other real estate owned) and at any property which serves as collateral for any loan held by Colonial. Sovereign agrees to deliver to Colonial a copy of any report it may receive in connection with any such environmental audit. (b) Board of Director Meetings. Colonial agrees that a representative of Sovereign shall be permitted to attend: (i) all meetings of the Board of Directors of Colonial, (ii) all meetings of the executive committee of the Board of Directors of Colonial, and (iii) all senior management level meetings of Colonial involving policy matters or significant business decisions; provided, however, that Sovereign acknowledges that its representative will be asked to leave any meeting during any discussion of matters relating to this Agreement. Colonial agrees to provide Sovereign with at least 48 hour's advance written or oral notice of any such meeting, except that in the case of an emergency meeting, Colonial shall provide the same notice to Sovereign as it provides to its own directors and/or officers. Section 4.16 Colonial D&O Insurance. Colonial has advised Sovereign that it has the ability to purchase a six year policy of director and officer liability "tail" coverage insurance on terms and conditions previously disclosed to Sovereign at an aggregate cost which does not exceed $65,000. Colonial shall take all such steps as may be necessary or appropriate to purchase such policy of "tail" coverage insurance immediately before the Effective Date, provided that the cost of such policy does not exceed $65,000. ARTICLE V COVENANTS OF SOVEREIGN From the date of this Agreement until the earlier of the Effective Date or the termination of this Agreement in accordance with the terms of Section 7.01 below, Sovereign covenants and agrees to do the following: Section 5.01 Best Efforts. Sovereign shall cooperate with Colonial and shall use its reasonable best efforts to do or cause to be done all things necessary or appropriate on its part in order to consummate the transactions contemplated in this Agreement. Section 5.02 Interim Banks. Sovereign shall promptly take all steps necessary or appropriate in order to organize Interim Bank and Interim Bank II and shall cause Interim Bank and Interim Bank II to take all actions which are necessary or appropriate in order to effectuate the purposes of this Agreement, including, without limitation, the Merger, the Charter Conversion and the Second Merger. Section 5.03 Regulatory Notices and Applications. Sovereign shall promptly prepare and file all required notices and applications required to be filed by it and by Interim Bank and Interim Bank II for regulatory approval of the transactions contemplated by this Agreement (which notices and applications Sovereign will endeavor to file not later than April 30, 1995) and shall use its reasonable best efforts to obtain such approvals as promptly as possible. Section 5.04 Management Following the Merger. (a) Board of Directors. The Board of Directors of Colonial following the Merger shall consist of: (i) those persons who are members of Colonial's Board of Directors immediately prior to the Merger, each of whom shall serve after the Merger at the pleasure of Sovereign and until his successor is elected and has qualified, and (ii) such additional persons as Sovereign in its discretion may cause to be elected or appointed to the Board of Directors. Notwithstanding the foregoing, Sovereign agrees that each of the persons identified below shall serve as a member of the Board of Directors of Colonial following the Effective Date for the period indicated below opposite his name, unless he resigns, dies or is removed from office for cause: Period of Service After Name of Director the Effective Date Charles P. Kaempffer 3 Years Eli Kramer 3 Years David I. Weiner 3 Years Robert J. Belon 2 Years Anthony R. Coppola 2 Years Robert L. Coutts 2 Years H. Daniel Harris 1 Year Robert M. Kaye 1 Year Charles R. Miller 1 Year Each person identified above shall be free to resign as a director at any time. (b) Laine Employment Contract and Amendment. Colonial has provided to Sovereign a true, complete and accurate copy of an Employment Contract dated November 16, 1993, including all amendments thereto (the "Employment Contract"), entered into by and between Colonial and Stephen S. Laine ("Laine") under the terms of which Colonial engaged Laine to serve as its President and Chief Executive Officer for a three year period expiring on November 15, 1996, subject, among other things, to the right of Colonial to terminate such employment at any time, with or without cause. Colonial has in all material respects performed all obligations required to be performed by it under the Employment Contract and is not in default in any material respect under the Employment Contract. Colonial has also provided to Sovereign a true, complete and accurate copy of an Agreement dated March 20, 1995, including all amendments thereto (the "Agreement"), entered into by and between Colonial and Laine which, among other things, becomes effective on the Effective Date and, upon becoming effective, supersedes the Employment Contract in its entirety. The execution and delivery of the Agreement and the consummation of the transactions contemplated therein have been authorized and unanimously approved by the Board of Directors of Colonial. The Agreement has been duly executed and delivered by Colonial and by Laine and constitutes a valid and binding obligation of Laine, enforceable against Laine in accordance with its terms. Section 5.05 Employees and Employee Benefits. It is Sovereign's present intention to retain substantially all of the officers and employees of Colonial following the Merger, with appropriate changes in title so as to be consistent with Sovereign's management and employee structure. It is Sovereign's present intention to provide to the employees of Colonial following the Merger the standard employee benefits package which Sovereign then makes available to its employees and to the employees of its subsidiaries. Employees of Colonial following the Merger shall be entitled to full credit for each year of service with Colonial for purposes of the eligibility and vesting provisions of Sovereign's employee benefit plans, but not for purposes of benefit accrual. Sovereign agrees that Colonial's existing severance policy (as reflected in the minutes of the November 17, 1994 meeting of the Board of Directors of Colonial) will be applicable to any Colonial employee whose employment is terminated (or who resigns because he is required to work at a location which is more than 20 miles from Freehold, New Jersey or because his annual salary or hourly rate of pay is reduced) within six months following the Merger, provided that such employee is otherwise entitled to receive benefits under that policy in accordance with its terms. Nothing herein shall be construed to limit in any way or prohibit the right of Sovereign following the Merger to cause Colonial to amend or terminate any Colonial employee benefit plan, except that Sovereign agrees that it will honor Colonial's existing severance policy as and to the extent contemplated in the fourth sentence of this Section. ARTICLE VI CONDITIONS PRECEDENT Section 6.01 Conditions to Colonial's Obligations under this Agreement. The obligations of Colonial hereunder shall be subject to satisfaction at or prior to the Closing of each of the following conditions, unless waived by Colonial pursuant to Section 8.03 hereof: (a) Corporate Proceedings. All actions required to be taken by, or on the part of, Sovereign and Interim Bank to authorize the execution, delivery and performance of this Agreement and the consummation of the transactions contemplated hereby, shall have been duly and validly taken and Colonial shall have received certified copies of the resolutions evidencing such authorizations; (b) Covenants and Representations. The obligations of Sovereign required by this Agreement to be performed by Sovereign at or prior to the Closing shall have been duly performed and complied with in all material respects and the representations and warranties of Sovereign set forth in this Agreement shall be true and correct in all material respects, as of the date of this Agreement and as of the Closing, as though made on and as of the Closing, except: (i) as to any representation or warranty which specifically relates to an earlier date, or (ii) where the facts which cause the failure of any representation or warranty to be so true and correct would not, either individually or in the aggregate, constitute a material adverse change in the assets, liabilities, business, financial condition or results of operations of Sovereign and its subsidiaries taken as a whole; (c) Approvals of Regulatory Authorities. The approval or authorization of each federal and state regulatory authority required in connection with the transactions contemplated hereby, including without limitation the approval of the OTS and the NJDOB, shall have been obtained, and all notice and waiting periods required thereunder shall have expired or been terminated; (d) No Injunction. There shall not be in effect any order, decree or injunction of a court or agency of competent jurisdiction which enjoins or prohibits consummation of the transactions contemplated hereby; (e) No Material Adverse Change. Since December 31, 1994, there shall not have occurred any material adverse change in the consolidated assets, consolidated financial condition or consolidated results of operations of Sovereign and its subsidiaries taken as a whole; (f) Officer's Certificate. Sovereign shall have delivered to Colonial a certificate, dated the date of the Closing and signed, without personal liability, by its president or by a vice president, to the effect that the conditions set forth in Subsections (a) through (e) of this Section 6.01 have been satisfied, to the best knowledge of the officer executing the same; (g) Opinion of Sovereign's Counsel. Colonial shall have received an opinion of Stevens & Lee, counsel to Sovereign, dated the date of the Closing, in form and substance reasonably satisfactory to Colonial and its counsel to the effect set forth on Exhibit B attached hereto; and (h) Approval of Colonial's Shareholders. This Agreement (including the Plan of Merger) shall have been approved by the shareholders of Colonial by such vote as is required under New Jersey law and by Colonial's Articles of Incorporation and bylaws. Section 6.02 Conditions to Sovereign's Obligations under this Agreement. The obligations of Sovereign hereunder shall be subject to satisfaction at or prior to the Closing of each of the following conditions, unless waived by Sovereign pursuant to Section 8.01 hereof: (a) Corporate Proceedings. All action required to be taken by, or on the part of, Colonial to authorize the execution, delivery and performance of this Agreement and the consummation of the transactions contemplated hereby, shall have been duly and validly taken by Colonial and Sovereign shall have received certified copies of the resolutions evidencing such authorizations; (b) Covenants; Representations. The obligations of Colonial required by this Agreement to be performed by it at or prior to the Closing shall have been duly performed and complied with in all material respects and the representations and warranties of Colonial set forth in this Agreement shall be true and correct in all material respects, as of the date of this Agreement and as of the Closing, as though made on and as of the Closing, except: (i) as to any representation or warranty which specifically relates to an earlier date, or (ii) where the facts which cause the failure of any representation or warranty to be so true and correct would not, either individually or in the aggregate, constitute a material adverse change in the assets, liabilities, business, financial condition or results of operations of Colonial. (c) Approvals of Regulatory Authorities. The approval or authorization of each federal and state regulatory authority required in connection with the transactions contemplated hereby, including without limitation the approvals of the OTS and the NJDOB, shall have been obtained without the imposition of any term or condition that Sovereign determines in good faith and in the exercise of its reasonable discretion to be unacceptable, and all notice and waiting periods required thereunder shall have expired or been terminated; (d) No Litigation. There shall not be in effect any order, decree or injunction of a court or agency of competent jurisdiction which enjoins or prohibits consummation of the transactions contemplated hereby and there shall be no material suit, action, or other proceeding threatened or pending before any court or governmental agency seeking monetary damages or other relief against Colonial in connection with this Agreement or otherwise; (e) No Material Adverse Change. Since December 31, 1994, there shall not have occurred any material adverse change in the assets, liabilities, business, financial condition or results of operations of Colonial (For purposes of this Subsection (e), no "material adverse change" shall be deemed to have occurred solely by reason of any increase by Colonial in its allowance for loan losses, to the extent that such increase is effected at the request of Sovereign pursuant to Section 4.11 of this Agreement.); (f) Approval of Colonial's Shareholders. This Agreement (including the Plan of Merger) shall have been approved by the shareholders of Colonial by such vote as is required under New Jersey law and by Colonial's Articles of Incorporation and bylaws; (g) Officer's Certificate. Colonial shall have delivered to Sovereign a certificate, dated the date of the Closing and signed, without personal liability, by its chairman of the board or president, to the effect that the conditions set forth in Subsections (a) through (f) of this Section 6.02 have been satisfied, to the best knowledge of the officer executing the same; (h) Interim Bank II, Charter Conversion and Second Merger. Interim Bank II shall have been duly organized, all regulatory approvals shall have been obtained, and all other actions shall have been taken which are required in order to effect the Charter Conversion and the Second Merger immediately following the Merger. (i) Tax Opinion. Sovereign shall have received an opinion of Stevens & Lee, counsel to Sovereign, substantially to the effect set forth on Exhibit C attached hereto; (j) Opinion of Colonial's Counsel. Sovereign shall have received an opinion of counsel to Colonial dated the date of the Closing in form and substance reasonably satisfactory to Sovereign and its counsel to the effect set forth on Exhibit D attached hereto; (k) Comfort Letter. If requested by Sovereign, Sovereign shall have received, at Sovereign's expense, a "comfort" letter from KPMG Peat Marwick dated shortly prior to the Effective Date, covering such matters as are usual and customary for transactions of the type contemplated by this Agreement, which letter shall be reasonably satisfactory in form and substance to Sovereign; (l) Dissenters' Rights. The holders of fewer than 26,945 shares of Colonial Common Stock shall have timely served written notice of dissent upon Colonial. ARTICLE VII TERMINATION Section 7.01 Termination. This Agreement may be terminated on or at any time prior to the Closing, as follows: (a) Mutual Consent. This Agreement may be terminated at any time by the mutual written consent of the parties hereto. (b) Unilateral Action by Sovereign. This Agreement may be terminated unilaterally by Sovereign upon written notice given to Colonial: (i) Material Breach. At any time if there shall have been any material breach of this Agreement by Colonial and such breach cannot be, or shall not have been, remedied within 30 days after receipt by Colonial of notice in writing specifying the nature of such breach and requesting that it be remedied; (ii) Environmental Matters. At any time prior to the expiration of 60 days after the date of this Agreement if Sovereign reasonably determines in its sole discretion that the results of any environmental audit(s) performed by it pursuant to Section 4.15(a) above reflect so adversely upon the assets, liabilities, business, financial condition or results of operations of Colonial that Sovereign concludes that it would be inadvisable for Sovereign to consummate this Agreement; (iii) Adverse Determination. At any time if Sovereign reasonably determines in its sole discretion that any change or development in state or federal law or regulatory policy so adversely affects the legal, regulatory, business and/or financial assumptions underlying the transactions contemplated by this Agreement that Sovereign concludes that it would be inadvisable for Sovereign to consummate this Agreement; (iv) Regulatory Disapproval. At any time if either party has been informed in writing by a regulatory authority whose approval or consent is required that such approval or consent is unlikely to be granted, unless the failure of such occurrence shall be due to the failure of Sovereign to perform or observe its agreements set forth herein required to be performed or observed by it on or before the Closing; or (v) Failure to Close. At any time if the Closing shall not have occurred prior to November 15, 1995, unless the failure of such occurrence shall be due to the failure of Sovereign to perform or observe its agreements set forth in this Agreement required to be performed or observed by it on or before the Closing. (c) Unilateral Action by Colonial. This Agreement may be terminated unilaterally by Colonial upon written notice given to Sovereign: (i) Material Breach. At any time if there shall have been any material breach of this Agreement by Sovereign and such breach cannot be, or shall not have been, remedied within 30 days after receipt by Sovereign of notice in writing specifying the nature of such breach and requesting that it be remedied; (ii) Regulatory Disapproval. At any time if either party has been informed in writing by a regulatory authority whose approval or consent is required that such approval or consent is unlikely to be granted, unless the failure of such occurrence shall be due to the failure of Colonial to perform or observe its agreements set forth herein required to be performed or observed by it on or before the Closing; or (iii) Failure to Close. At any time if the Closing shall not have occurred prior to November 15, 1995, unless the failure of such occurrence shall be due to the failure of Colonial to perform or observe its agreements set forth in this Agreement required to be performed or observed by it on or before the Closing. Section 7.02 Effect of Termination. (a) General. If this Agreement is terminated pursuant to Section 7.01 hereof, this Agreement shall forthwith become void (other than Section 4.03(b), Section 7.02(b), Section 7.02(c), and Section 8.01 hereof, each of which shall remain in full force and effect), and there shall be no further liability on the part of Sovereign or Colonial to the other, except for any liability of Sovereign or Colonial under Section 4.03(b), Section 7.02(b), Section 7.02(c) and Section 8.01 hereof and except for any liability arising out of a breach of any covenant or other agreement contained in this Agreement. (b) Colonial Fee. If, within 18 months following the date of termination of this Agreement by Sovereign pursuant to Section 7.01(b)(i) on account of an unremedied material breach by Colonial, a Person other than Sovereign or a subsidiary of Sovereign, enters into a letter of intent or agreement with Colonial pursuant to which such Person would: (i) merge or consolidate, or enter into any similar transaction, with Colonial, (ii) acquire all or substantially all of the assets of Colonial, or (iii) acquire beneficial ownership of securities representing, or the right to acquire beneficial ownership or to vote securities representing, 25% or more of the then outstanding shares of Colonial Common Stock, and at such time, for any reason, Sovereign is prohibited by a court or any government authority from exercising the Sovereign Option or causing Colonial to repurchase the Sovereign Option or Sovereign in its sole discretion reasonably determines that it is otherwise unable to exercise the Sovereign Option or cause Colonial to repurchase the Sovereign Option, then Colonial shall immediately pay to Sovereign a fee of $500,000, which fee shall constitute reimbursement to Sovereign for its costs and expenses, including legal fees and expenses, incurred in connection with this Agreement and the transactions contemplated hereby. Nothing in this Section 7.02(b) shall constitute a waiver or limitation, in whole or in part, of any legal or equitable rights which Sovereign may possess against Colonial relating to any breach by Colonial of its obligations under this Agreement or under the Sovereign Option Agreement or against any other Person relating to this Agreement or to the Sovereign Option Agreement, or relating to Sovereign's relationship with Colonial or for any act or omission of any such Person, including any tortious interference with this Agreement or with the Sovereign Option Agreement or for otherwise wrongfully inducing or causing any breach of any such agreement. (c) Sovereign Fees. (i) Breach by Sovereign. If this Agreement is terminated by Colonial pursuant to Section 7.01(c)(i) on account of an unremedied material breach by Sovereign, then Sovereign shall immediately pay to Colonial a fee of $500,000, which fee shall constitute reimbursement to Colonial for its costs and expenses, including legal fees and expenses, incurred in connection with this Agreement and the transactions contemplated hereby. Nothing in this Section 7.02(c)(i) shall constitute a waiver or limitation, in whole or in part, of any legal or equitable rights which Colonial may possess against Sovereign relating to any breach by Sovereign of its obligations under this Agreement. (ii) Adverse Determination by Sovereign. If this Agreement is terminated by Sovereign pursuant to Section 7.01(b)(iii), then Sovereign shall immediately pay to Colonial a fee of $500,000. Upon payment of such fee, Sovereign shall have no further obligations or liabilities of any kind whatsoever to Colonial relating to this Agreement or the transactions contemplated hereby, except for any liability of Sovereign under Section 4.03(b) and Section 8.01 hereof, and Colonial hereby covenants not to sue Sovereign or any Person which is an affiliate of Sovereign for any cause of action or claim of any kind whatsoever relating to this Agreement or the transactions contemplated hereby, whether such cause of action or claim is at law or in equity and whether it involves an alleged breach of contract, tort or otherwise. ARTICLE VIII MISCELLANEOUS Section 8.01 Expenses. Each party hereto shall bear and pay all costs and expenses incurred by it in connection with the transactions contemplated hereby, including fees and expenses of its own financial consultants, accountants and counsel, except as provided in Section 4.12 and except that Sovereign shall pay: (i) one-half of the cost of printing and mailing the Proxy Statement, up to $2,000, and (ii) the additional regulatory application filing fees and legal and accounting fees, if any, reasonably incurred by Colonial by reason of or relating to the Charter Conversion and/or the Second Merger. Section 8.02 Non-Survival of Representations and Warranties. All representations, warranties and, except to the extent specifically provided otherwise herein, agreements and covenants shall terminate on the Effective Date. Section 8.03 Amendment, Extension and Waiver. Subject to applicable law, at any time prior to the Effective Date, the parties may: (i) amend this Agreement, (ii) extend the time for the performance of any of the obligations or other acts of either party hereto, (iii) waive any inaccuracies in the representations and warranties contained herein or in any document delivered pursuant hereto, or (iv) waive compliance with any of the agreements or conditions contained herein. This Agreement may not be amended except by an instrument in writing signed, by duly authorized officers, on behalf of the parties hereto. Any agreement on the part of a party hereto to any extension or waiver shall be valid only if set forth in an instrument in writing signed by a duly authorized officer on behalf of such party, but such waiver or failure to insist on strict compliance with such obligation, covenant, agreement or condition shall not operate as a waiver of, or estoppel with respect to, any subsequent or other failure. Section 8.04 Public Announcements. The parties shall agree upon the form and substance of any press release related to this Agreement and the transactions contemplated hereby, and upon the form and substance of other public disclosures related thereto, including without limitation communications to Colonial shareholders, Colonial internal announcements and customer disclosures, but nothing contained herein shall prohibit either party from making any disclosure which its counsel deems necessary. Section 8.05 Entire Agreement. This Agreement, including the documents and other writings referred to herein or delivered pursuant thereto, contains the entire agreement and understanding of the parties with respect to its subject matter. This Agreement supersedes all prior arrangements and understandings between the parties, both written and oral with respect to its subject matter. This Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective successors; provided, however, that nothing in this Agreement, express or implied, is intended to confer upon any party, other than the parties hereto and their respective successors, any rights, remedies, obligations or liabilities of any kind and no such person (including, without limitation, any officer, director, employee or shareholder of Colonial) shall have any right to initiate or maintain any suit or other action for any breach or alleged breach of this Agreement or to enforce any provision set forth herein. Section 8.06 No Assignment. Neither party hereto may assign any of its rights or obligations hereunder to any other person, without the prior written consent of the other party hereto. Section 8.07 Notices. All notices or other communications hereunder shall be in writing and shall be deemed given if delivered personally, mailed by prepaid registered or certified mail (return receipt requested), or sent by telecopy, addressed as follows: (a) If to Sovereign, to: Sovereign Bancorp, Inc. 1130 Berkshire Boulevard P.O. Box 37 Reading, Pennsylvania 19603 Attention: Richard A. Elko, Corporate Controller and Development Officer Telecopy No.: (610) 320-8448 with a copy to: Stevens & Lee 607 Washington Street Reading, Pennsylvania 19601 Attention: Joseph M. Harenza, Esquire and Clinton W. Kemp, Esquire Telecopy No.: (610) 376-5610 (b) If to Colonial to: Colonial State Bank 521 Park Avenue Freehold, New Jersey 07728 Attention: Eli Kramer, Chairman of the Board Telecopy No.: (908) 780-4948 with a copy to: Wilentz, Goldman & Spitzer 90 Woodbridge Center Drive Woodbridge, New Jersey 07095 Attention: Norman Peer, Esquire Telecopy No.: (908) 855-6117 Section 8.08 Captions. The captions contained in this Agreement are for reference purposes only and are not part of this Agreement. Section 8.09 Counterparts. This Agreement may be executed in any number of counterparts, and each such counterpart shall be deemed to be an original instrument, but all such counterparts together shall constitute but one agreement. Section 8.10 Severability. If any provision of this Agreement or the application thereof to any person or circumstance shall be invalid or unenforceable to any extent, the remainder of this Agreement and the application of such provisions to other persons or circumstances shall not be affected thereby and shall be enforced to the greatest extent permitted by law. Section 8.11 Governing Law. This Agreement shall be governed by and construed in accordance with the domestic internal law (without reference to its law of conflicts of law) of the Commonwealth of Pennsylvania, except to the extent that matters relating to the Merger may be governed by the laws of the United States of America or, in the absence of controlling federal law, by the domestic internal law (without reference to its law of conflicts of law) of the State of New Jersey. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their duly authorized officers as of the day and year first above written. SOVEREIGN BANCORP, INC. (CORPORATE SEAL) By: /s/ Jay S. Sidhu Jay S. Sidhu, President Attest:/s/ Lawrence M. Thompson, Jr. Lawrence M. Thompson, Jr., Secretary COLONIAL STATE BANK (CORPORATE SEAL) By: /s/ Eli Kramer Eli Kramer, Chairman of the Board Attest: /s/ Robert S. Vuono Robert S. Vuono, Secretary Exhibits Exhibit A - Plan of Merger Exhibit B - Form of Opinion of Sovereign's Counsel Exhibit C - Form of Tax Opinion Exhibit D - Form of Opinion of Colonial's Counsel Exhibit E - Form of Affiliate Letter Agreement Schedule I EXHIBIT A PLAN OF MERGER SOVEREIGN INTERIM BANK With and Into COLONIAL STATE BANK The following is the Plan of Merger adopted pursuant to the terms of an Agreement and Plan of Merger (the "Agreement") dated as of March 23, 1995 by and between Sovereign Bancorp, Inc. and Colonial State Bank, under the terms of which, among other things: (i) Sovereign Interim Bank will be merged with and into Colonial State Bank, (ii) Colonial State Bank will survive the merger as a wholly-owned subsidiary of Sovereign Bancorp, Inc., and (iii) each outstanding share of the $5.00 par value common stock of Colonial State Bank (the "Colonial Common Stock"), other than shares of such stock, if any, held by Sovereign Bancorp, Inc. or by shareholders who duly elect to exercise and perfect dissenters' rights, will be converted into the right to receive $11.60 in cash from Sovereign Bancorp, Inc. ARTICLE I PARTIES AND LOCATION OF OFFICES The parties to this Plan of Merger are Sovereign Interim Bank and Colonial State Bank. The location of the principal office and each branch office of Sovereign Interim Bank and Colonial State Bank are as follows: Sovereign Interim Bank Colonial State Bank 521 Park Avenue 521 Park Avenue Freehold, New Jersey 07728 Freehold, New Jersey 07728 ARTICLE II MERGER Subject to the terms and conditions of the Agreement and this Plan of Merger, and in accordance with the applicable laws and regulations of the United States of America and the State of New Jersey, Sovereign Interim Bank shall, on the Effective Date (as defined in Article IX of this Plan of Merger) merge with and into Colonial State Bank, whereupon the separate existence of Sovereign Interim Bank shall cease and Colonial State Bank shall be the surviving institution. The foregoing merger is sometimes hereinafter referred to as the "Merger" and Colonial State Bank is sometimes hereinafter referred to as the "Surviving Bank". ARTICLE III NAME The name of the Surviving Bank shall be Colonial State Bank. ARTICLE IV CERTIFICATE OF INCORPORATION AND BYLAWS As of the Effective Date, the Certificate of Incorporation and the bylaws of the Surviving Bank shall be the Certificate of Incorporation and bylaws of Colonial State Bank as then in effect. ARTICLE V BOARD OF DIRECTORS AND OFFICERS Section 5.1 Board of Directors. As of the Effective Date, the directors of the Surviving Bank shall be: (i) certain directors of Colonial State Bank duly elected and then in office, and (ii) _____ additional persons, each of whom shall serve at the pleasure of Sovereign Bancorp, Inc. and until such time as his successor is elected and has qualified and each of whom is identified below: Robert J. Belon Robert M. Kaye Anthony R. Coppola Eli Kramer Robert L. Coutts Charles R. Miller H. Daniel Harris David I. Weiner Charles P. Kaempffer ____________________ ____________________ ____________________ ____________________ ____________________ ____________________ ____________________ ____________________ ____________________ Section 5.2 Officers. On and after the Effective Date, the officers of the Surviving Institution shall be the officers of Colonial State Bank duly elected and then in office (each of whom is identified below), together with such other officers as may be subsequently elected or appointed, each of whom shall serve at the pleasure of Sovereign Bancorp, Inc. and until such time as his successor is elected and has qualified: Name of Officer Office Held Stephen S. Laine President and Chief Executive Officer Robert S. Vuono Executive Vice President, Secretary and Treasurer Frederick M. Wells Senior Vice President and Senior Loan Officer Michael J. Salerno Senior Vice President and Mortgage Officer ARTICLE VI PRINCIPAL OFFICE AND BRANCH OFFICE As of the Effective Date, the principal office and the only branch office of the Surviving Bank shall be as follows: 521 Park Avenue Freehold, New Jersey 07728 ARTICLE VII CONVERSION OF SHARES Section 7.1 Stock of Sovereign Interim Bank. Each share of Sovereign Interim Bank common stock issued and outstanding immediately before the Effective Date shall, on the Effective Date, be converted into and become, without any action on the part of the holder thereof, such number of shares of the $5.00 par value common stock of Colonial State Bank as shall be equal to: (i) 538,911, divided by (ii) the number of shares of Sovereign Interim Bank common stock issued and outstanding immediately before the Effective Date. Immediately following the Merger, the authorized capital stock of Colonial State Bank shall consist of 2,550,000 shares of $5.00 par value common stock, of which 538,911 shares shall be issued and outstanding. Immediately following the Merger, the surplus of Colonial State Bank shall be not less than $500,000. Section 7.2 Stock of Colonial State Bank. (a) General. Subject to the provisions of Section 7.2(b) below relating to dissenting shares, each share of Colonial Common Stock issued and outstanding immediately before the Effective Date (other than shares, if any, then owned by Sovereign Bancorp, Inc. and shares, if any, held in the treasury of Colonial State Bank) shall, on the Effective Date, be converted into and become without any action on the part of the holder thereof, the right to receive $11.60 in cash from Sovereign Bancorp, Inc. Each share of Colonial Common Stock, if any, owned by Sovereign Bancorp, Inc. on the Effective Date and each share of Colonial Common Stock, if any, held in the treasury of Colonial on the Effective Date shall be cancelled and no cash or other consideration shall be delivered in exchange therefor. (b) Dissenting Shareholders of Colonial. Shares of Colonial Common Stock with respect to which dissenters' rights shall have been duly exercised and perfected: (i) shall not be converted into the right to receive cash from Sovereign Bancorp, Inc. pursuant to Section 7.2(a) above and the holders thereof shall be entitled only to such rights as are granted by law to dissenting shareholders, and (ii) shall be deemed to have been retired and cancelled immediately prior to the Merger. Section 7.0 Surrender and Exchange of Colonial Stock Certificates. (a) Letter of Instruction. On or promptly after the Effective Date, Sovereign Bancorp, Inc. shall mail or cause to be mailed to each former shareholder of Colonial State Bank at his address as it appears on the records of Colonial State Bank a letter of instruction specifying the procedures to be followed in surrendering his Colonial Common Stock certificates. (b) Surrender and Exchange Procedure. As promptly as possible after receipt of the foregoing letter of instruction, each former shareholder of Colonial State Bank shall surrender to Sovereign Bancorp, Inc. his Colonial Common Stock certificates and Sovereign Bancorp, Inc. shall upon such surrender mail to him in exchange therefore a check payable to the order of the registered holder of such shares in an amount equal to: (i) the number of shares surrendered, multiplied by (ii) $11.60. Following the Effective Date and until surrender, each Colonial Common Stock certificate shall be deemed for all purposes to evidence solely the right to receive cash in exchange therefore pursuant to the Agreement and this Plan of Merger. Notwithstanding the foregoing, neither Sovereign Bancorp, Inc. nor any party to this Plan of Merger will be liable to any holder of Colonial Common Stock for any amount paid in good faith to a public official or agency pursuant to any applicable abandoned property, escheat or similar law. (c) Closing of Stock Transfer Books. The stock transfer books of Colonial State Bank will be closed on and after the Effective Date and no further transfers of shares of Colonial Common Stock will thereafter be made or recognized. ARTICLE VIII EFFECT OF THE MERGER Section 8.: Separate Existence. On the Effective Date, the separate existence of Colonial State Bank shall cease and all of the property (real, personal and mixed), rights, powers, duties and obligations of Sovereign Interim Bank and Colonial State Bank shall be taken and deemed to be transferred to and vested in the Surviving Bank, without further act or deed, as provided by applicable laws and regulations. Section 8.2 Savings Accounts. After the Effective Date, the Surviving Bank will continue to issue savings accounts on the same basis as immediately prior to the Effective Date. ARTICLE IX EFFECTIVE DATE The Merger shall be effective on the date on which all filings with government agencies as may be required under all applicable laws and regulations for the Merger to become effective are made and accepted by such agencies or, if later, on the date specified in such filings (the "Effective Date"). ARTICLE X CONDITIONS PRECEDENT The obligations of Sovereign Bancorp, Inc., Sovereign Interim Bank and Colonial State Bank to effect the Merger shall be subject to the satisfaction, unless duly waived by the party entitled to the benefit thereof, of the conditions precedent set forth in the Agreement. ARTICLE XI TERMINATION This Plan of Merger shall terminate upon any termination of the Agreement in accordance with its terms; provided, however, that neither Sovereign Bancorp, Inc. nor any party hereto shall by reason of such termination be relieved from liability on account of a breach by it of any of the terms of this Plan of Merger or of the Agreement. ARTICLE XII AMENDMENT Subject to applicable law, this Plan of Merger may be amended at any time prior to consummation of the Merger, but only by means of an instrument in writing signed by duly authorized officers on behalf of the parties hereto. ARTICLE XIII MISCELLANEOUS Section 13.1 Extensions; Waivers. Each party, by a written instrument signed by a duly authorized officer, may extend the time for the performance of any of the obligations or other acts of the other party hereto and may waive compliance with any of the covenants, or performance of any of the obligations, of the other party contained in this Plan of Merger. Section 13.2 Notices. Any notice or other communication required or permitted under this Plan of Merger shall be given, and shall be effective, in accordance with the provisions of Section 8.07 of the Agreement. Section 13.3 Captions. The headings of the several Articles and Sections herein are inserted for convenience of reference only and are not intended to be part of, or to affect the meaning or interpretation of, this Plan of Merger. Section 13.4 Counterparts. For the convenience of the parties hereto, this Plan of Merger may be executed in several counterparts, each of which shall be deemed the original, but all of which together shall constitute one and the same instrument. Section 13.5 Governing Law. This Plan of Merger shall be governed by and construed in accordance with the domestic internal law (without reference to its law of conflicts of law) of the Commonwealth of Pennsylvania, except to the extent that matters relating to the Merger may be governed by the laws of the United States of America or, in the absence of controlling federal law, by the domestic internal law (without reference to its law of conflicts of law) of the State of New Jersey. IN WITNESS WHEREOF, Sovereign Interim Bank and Colonial State Bank have caused this Plan of Merger to be executed by their duly authorized officers and their corporate seals to be hereunto affixed as of this ________ day of ____________________, 1995. SOVEREIGN INTERIM BANK, F.S.B. By:________________________________ Jay S. Sidhu, President (CORPORATE SEAL) Attest:____________________________ Lawrence M. Thompson, Jr. Secretary COLONIAL STATE BANK By:________________________________ Eli Kramer, Chairman of the Board (CORPORATE SEAL) Attest:____________________________ Robert S. Vuono, Executive Vice President, Treasurer and Secretary EXHIBIT B FORM OF OPINION OF COUNSEL TO SOVEREIGN Colonial shall have received from Stevens & Lee an opinion, dated as of the Closing Date, substantially to the effect that, subject to customary exceptions and qualifications: (1) Sovereign and Interim Bank have full corporate power to carry out the transactions contemplated in the Agreement. The execution and delivery of the Agreement and the completion of the transactions contemplated thereunder have been duly and validly authorized by all necessary corporate action on the part of Sovereign and Interim Bank, as the case may be, and the Agreement constitutes a valid and legally binding obligation of Sovereign, enforceable in accordance with its terms, except as may be limited by bankruptcy, insolvency, reorganization, moratorium, receivership, conservatorship, and other laws affecting creditors' rights generally and as may be limited by the exercise of judicial discretion in applying principles of equity. Subject to satisfaction of the conditions set forth in the Agreement, neither the transactions contemplated in the Agreement, nor compliance by Sovereign and Interim Bank with any of the provisions thereof, will (i) conflict with or result in a breach or default under (A) the Articles of Incorporation or bylaws of Sovereign or the charter or bylaws of Interim Bank, or, (B) based upon certificates of officers and without independent verification, to the actual knowledge of such counsel, any note, bond, mortgage, indenture, license, agreement or other material instrument or obligation to which Sovereign or Interim Bank is a party; or (ii) violate in any material respect any order, writ, injunction or decree actually known to such counsel, or any federal or Pennsylvania statute, rule or regulation applicable to Sovereign or Interim Bank. (2) Interim Bank is a validly existing, nonoperating, federally-chartered savings bank organized and in good standing under the laws of the United States of America. (3) There is, to the actual knowledge of such counsel, no legal, administrative, arbitration or governmental proceeding or investigation pending or threatened to which Sovereign or any of its subsidiaries is a party which states a claim to restrain or prohibit the transactions contemplated by the Agreement. (4) No consent, approval, authorization or order of any federal or state court or federal or state governmental agency or body is required for the completion by Sovereign or Interim Bank of the transactions contemplated by the Agreement, except for such consents, approvals, authorizations or orders as have been obtained. (5) Assuming the receipt by Colonial of all required regulatory approvals upon the filing and effectiveness of the Articles of Merger with the NJDOB in accordance with the Agreement, the merger of Interim Bank and Colonial contemplated by the Agreement will have been effected in compliance in all material respects with all applicable federal laws, rules and regulations. EXHIBIT C FORM OF TAX OPINION OF STEVENS & LEE Sovereign shall have received an opinion of Stevens & Lee dated as of the date of Closing and subject to customary exceptions and qualifications substantially to the effect that, under the provisions of the IRC: 1. The formation of Interim and its merger with and into Colonial ("Merger #1") will be disregarded. The transaction will be treated as a sale by Colonial's stockholders of all of the outstanding Colonial Common Stock to Sovereign in exchange for cash. 2. Sovereign's purchase of all of the outstanding Colonial Common Stock will constitute a qualified stock purchase within the meaning of IRC Section 338(d)(3). 3. No gain or loss will be recognized by Sovereign, Interim, or Colonial as a result of Merger #1. 4. Gain or loss, as determined under IRC Section 1001, will be recognized by each Colonial stockholder in an amount measured by the difference between: (i) the sum of the amount of cash received, and (ii) the adjusted basis (as determined under IRC Section 1011) in the Colonial Common Stock surrendered in exchange therefor. 5. Provided that IRC Section 341 is not applicable and that the Colonial Common Stock is a capital asset in the hands of a Colonial stockholder, any gain or loss realized by such stockholder will be capital gain or loss, subject to the provisions and limitations of Chapter 1P of the IRC. 6. The basis in the hands of Sovereign of the Colonial Common Stock acquired will, under IRC Section 1012, be equal to the sum of: (i) the cash paid to the Colonial stockholders, and (ii) the amount of any expenses of the transaction which are properly chargeable to a capital account. 7. The merger of Colonial, as the surviving institution following Merger #1, with and into Second Interim Bank will qualify as a reorganization under IRC Section 368(a)(1). EXHIBIT D FORM OF OPINION OF COUNSEL TO COLONIAL Sovereign shall have received from counsel to Colonial, an opinion, dated as of the Closing Date, substantially to the effect that, subject to customary exceptions and qualifications: (1) Colonial has full corporate power to carry out the transactions contemplated in the Agreement. The execution and delivery of the Agreement and the completion of the transactions contemplated thereunder have been duly and validly authorized by all necessary corporate action on the part of Colonial, and the Agreement constitutes a valid and legally binding obligation of Colonial, enforceable in accordance with its terms, except as may be limited by bankruptcy, insolvency, reorganization, moratorium, receivership, conservatorship, and other laws affecting creditors' rights generally and institutions the deposits of which are insured by the FDIC, and as may be limited by the exercise of judicial discretion in applying principles of equity. Subject to satisfaction of the conditions set forth in the Agreement, neither the transactions contemplated in the Agreement, nor compliance by Colonial with any of the respective provisions thereof, will: (i) conflict with or result in a breach or default under (A) the Certificate of Incorporation or bylaws of Colonial, or (B) based on certificates of officers and without independent verification, to the actual knowledge of such counsel, any note, bond, mortgage, indenture, license, agreement or other instrument or obligation to which Colonial is a party; or (ii) to the actual knowledge of such counsel, result in the creation or imposition of any material lien, instrument or encumbrance upon the property of Colonial, except such material lien, instrument or obligation that has been disclosed to Sovereign pursuant to the Agreement, or (iii) violate in any material respect any order, writ, injunction, or decree actually known to such counsel, or any statute, rule or regulation applicable to Colonial. (2) Colonial is a validly existing New Jersey- chartered commercial bank organized and in good standing under the laws of the State of New Jersey. The deposits of Colonial are insured to the maximum extent provided by law by the Federal Deposit Insurance Corporation. (3) There is, to the actual knowledge of such counsel, no legal, administrative, arbitration or governmental proceeding or investigation pending or threatened to which Colonial is a party which would, if determined adversely to Colonial, have a material adverse effect on the business, properties, results of operations, or condition, financial or otherwise, of Colonial or which states a claim to restrain or prohibit the transactions contemplated by the Agreement. (4) No consent, approval, authorization, or order of any federal or state court or federal or state governmental agency or body, or of any third party, is required for the consummation of the Merger by Colonial, except for such consents, approvals, authorizations or orders as have been obtained. (5) Assuming the receipt by Interim of all required regulatory approvals, upon the filing and effectiveness of the Articles of Merger with the NJDOB in accordance with the Agreement, the merger of Interim Bank and Colonial contemplated by the Agreement will have been effected in compliance in all material respects with the Banking Act and all other applicable New Jersey laws, rules and regulations. EXHIBIT E March 23, 1995 Sovereign Bancorp, Inc. 1130 Berkshire Boulevard Wyomissing, Pennsylvania 19610 Ladies and Gentlemen: Sovereign Bancorp, Inc. ("Sovereign") and Colonial State Bank ("Colonial") desire to enter into an agreement (the "Agreement") pursuant to which and subject to the terms and conditions set forth therein: (a) Colonial will merge with a to- be-formed nonoperating phantom federal savings bank subsidiary of Sovereign, with Colonial surviving the merger, and (b) shareholders of Colonial will receive cash in exchange for common stock of Colonial outstanding on the closing date (the foregoing, collectively, referred to herein as the "Merger"). Sovereign has required, as a condition to its execution and delivery to Colonial of the Agreement, that the undersigned, being directors (or former directors) and/or executive officers of Colonial, execute and deliver to Sovereign this Letter Agreement. Each of the undersigned, intending to be legally bound and in order to induce Sovereign to execute and deliver to Colonial the Agreement, for himself and not for any other person who signs this Letter Agreement, hereby irrevocably: (1) Agrees to be present (in person or by proxy) at all meetings of shareholders of Colonial called to vote for approval of the Merger so that all shares of common stock of Colonial then owned by him will be counted for the purpose of determining the presence of a quorum at such meetings and to vote all such shares: (i) in favor of approval and adoption of the Agreement and the transactions contemplated thereby (including any amendments or modifications of the terms thereof approved by Colonial's Board of Directors), and (ii) against approval or adoption of any other merger, business combination, recapitalization, partial liquidation or similar transaction involving Colonial, provided, however, that these obligations shall terminate concurrently with any termination of the Agreement in accordance with its terms; (2) Agrees not to vote or execute any written consent to rescind or amend in any manner any prior vote or written consent, as a shareholder of Colonial, to approve or adopt the Agreement and the transactions contemplated thereby; (3) Agrees to use his reasonable best efforts to cause the Merger to be completed; (4) Agrees not to sell, transfer or otherwise dispose of any common stock of Colonial on or prior to the date of the meeting of Colonial shareholders to vote on the Merger; (5) Agrees not to solicit, initiate or, except as permitted by Section 4.13 of the Agreement, engage in any negotiations or discussions with any party other than Sovereign with respect to any offer, sale, transfer or other disposition of, any shares of common stock of Colonial now or hereafter owned by him or her, or to support any such offer, sale, transfer, or other disposition; (6) Waives the right to assert dissenters' rights under applicable law; (7) Agrees to disclose and to permit Sovereign and colonial to disclose that he has entered into this Letter Agreement and that he supports the Merger and recommends that shareholders of Colonial vote in favor of the Merger; and (8) Represents that he has the capacity to enter into this Letter Agreement and that it is a valid and binding obligation enforceable against him in accordance with its terms. ________________________ This Letter Agreement may be executed in two or more counterparts, each of which shall be deemed to constitute an original, but all of which together shall constitute one and the same Letter Agreement. ________________________ This Letter Agreement shall be effective upon execution by one or more persons listed below, and its validity and enforceability shall not be affected by the lack of its execution by any person listed below. ________________________ This Letter Agreement shall terminate concurrently with any termination of the Agreement in accordance with its terms. ________________________ The undersigned intend to be legally bound hereby. Sincerely, __________________________________ Robert J. Belon __________________________________ Anthony R. Coppola __________________________________ Robert L. Couts __________________________________ H. Daniel Harris __________________________________ Charles P. Kaempffer __________________________________ Robert M. Kaye __________________________________ Eli Kramer __________________________________ Stephen S. Laine __________________________________ Charles R. Miller __________________________________ Allan J. Sockol __________________________________ Robert S. Vuono __________________________________ David I. Weiner AGREEMENT AND PLAN OF MERGER PROPOSED TO BE ENTERED BY AND BETWEEN SOVEREIGN BANCORP, INC. AND COLONIAL STATE BANK SCHEDULE I Section 2.5(b): A.) Beneficial Owners of 5% or more of outstanding shares of Colonial State Bank Common Stock: Percentage of Total Shares Number of Shares Outstanding As of Beneficial Owner Beneficially Owned 03/15/95 ---------------- ------------------ ----------------- Anthony R. Coppola 87,954 (1) 16.32% Robert M. Kaye 30,079 5.58% Eli Kramer 32,730 (2) 6.07% David I. Weiner 29,906 (3) 5.55% Note: (1) Includes 2,547 shares owned by Mr. Coppola's wife and 315 shares owned by Mr. Coppola's children. (2) Includes 32,630 shares owned by PEK Realty Associates of which Mr. Kramer is a principal. (3) Includes 13,500 shares owned by the Weiner Family Trust. B.) Director and Officer Beneficial Holdings: Number of Shares Director Beneficially Owned -------- ------------------ Robert J. Belon 472 Anthony R. Coppola 87,954 (1) Robert Lloyd Coutts 4,475 (2) H. Daniel Harris 150 Charles P. Kaempffer 8,771 Robert M. Kaye 30,079 Eli Kramer 32,730 (3) Stephen S. Laine 100 Charles R. Miller 5,122 David I. Weiner 29,906 (4) Number of Shares Officer Beneficially owned ------- ------------------ Stephen S. Laine (See Director Listing Above) President & CEO Kenneth A. Ney 100 Assistant Treasurer Robert S. Vuono 562 (5) Executive Vice President Note: (1) Includes 2,547 shares owned by Mr. Coppola's wife and 315 shares owned by Mr. Coppola's children. (2) Includes 1,237 shares owned by Mr. Coutts' wife. (3) Includes 32,630 shares owned by PEK Realty Associates of which Mr. Kramer is a principal. (4) Includes 13,500 shares owned by the Weiner Family Trust. (5) Includes 300 shares owned jointly with his wife. Section 2.11: In connection with the real estate transaction referred to in Section 4.14 of the Agreement, the Colonial subsidiary will grant a mortgage to a bank in an amount not to exceed $850,000. Section 2.12: See Attached December 31, 1994 Watch List. Section 2.14(a): A. Contracts with payments in excess of $10,000 per year: Contract With Purpose ------------- ------- AT&T Global Information Services Data Processing AT&T Credit Lease of DP Equipment Systematics, Inc. Item Processing Directors Limited Lease of Main Office KPMG Peat Marwick Audit of Financial Statements Contracts with receipts in excess of $10,000 per year: Contract With Purpose ------------- ------- Director's Limited Land Lease B. Employment Contract with President & CEO Stephen S. Laine Severance Policy for Colonial State Bank staff. C. All of the foregoing contracts are in full force and effect and none are in default in any material respects. Section 2. 14 (b): None. Section 2.18: Insurance policies maintained by Colonial State Bank: Kidnap & Ransom Director's & Officers and IRA/Keough Financial Institution Bond Commercial Excess Policy Special Multi-Peril Policy Worker's Compensation Key Man Insurance on President (See Employment Contract) Section 2.19: Coverage Type & Limit of Liability Coverage Director Financial Excess Period Carrier & Officer Institution Dishonesty -------- ------- --------- ----------- ---------- 8/29/88 to Progressive 8/29/89 Cas. Ins. Co. $1,000,000 $1,000,000 $1,000,000 8/29/89 to Progressive 8/29/90 Cas. Ins. Co. $1,000,000 $1,000,000 $1,000,000 8/29/90 to Progressive 8/29/91 Cas. Ins. Co. $1,000,000 $1,000,000 $1,000,000 8/29/91 to Reliance 8/29/92 Insurance Co. $ 500,000 $1,000,000 N/A 8/29/92 to Continental 9/13/93 Insurance Co. $1,000,000 $1,050,000 N/A 9/13/93 to Continental 9/27/94 Insurance Co. $1,000,000 $1,050,000 N/A 9/27/94 to 9/27/95 AETNA $1,000,000 $1,050,000 N/A Section 2.21(a): COLONIAL STATE BANK EMPLOYEE BENEFITS JANUARY 31, 1995 Employee Benefits provided are as follows: Group Life Insurance - Two times annual salary to $100,000 maximum coverage plus $25,000 Cost: 2X's salary: .465 per $1,000 (Sixteen employees) $25,000: $10.25 per month (Sixteen employees) Medical/Hospitalization - Coverage for employee and dependents. Cost: Employees: $190.11 per month (Fourteen employees) Dependents: 339.83 per month (Seven employees) Prescription Drug Plan - Coverage for employee and dependents. Cost: Employees: $26.45 per month (Sixteen employees) Dependents: 37.98 per month (Eight employees) Dental Plan - Coverage for employee and dependents. Cost: Employees: $30.06 per month (Sixteen employees) Dependents: 53.68 per month (Eight employees) Long Term Disability - Coverage for employee. Cost: .600 Per $100 in monthly salary (49,910 @01/31/95) Note: Employees contribute on a monthly basis for coverage taken: Single coverage - $10.00 monthly Husband/Wife - $25.00 monthly Family - $50.00 monthly Employment contract of President Laine calls for additional life insurance coverage in excess of standard coverage. Section 2.22: Loans with Directors & officers (present and former): Borrower Type Amount -------- ---- ------ R. Belon (Director) Commercial Mtg. $106,868.73 A. Coppola (Director) Secured Loan 100,000.00 R. Kaye (Director) Secured Loan 250,000.00 E. & C. Kramer (Director) Auto Loan 15,440.99 Home Equity 61,192.67 C. Miller (Director) Commercial Mtg. 16,000.00 Home Equity 78,505.98 W.J.D. Ltd (D. Weiner-Director) Construct Mtg. 186,000.00 D. Hearn (Former Officer) Personal Loan 200.00 J. Peavley (officer) Personal Cr Line 1,480.32 Installment Loan 199.20 Installment Loan 7,652.57 D. Staples (Former Officer) Personal Cr Line 381.62 Contracts with Directors & Officers (present and former): Lease arrangement with four present and one former Director for the sale and subsequent leaseback of Colonial's only office - Director's Limited, A Joint Venture. In addition, land lease by Director's Limited of land owned by Colonial State. Planned Residential communities services thirteen mortgages purchased from PRC. Total outstanding balances as of February 1, 1995 - $646,015.83. Director Robert M. Kaye is owner of PRC. Business Arrangements with Directors & Officers (Present and former): Colonial's Loan Policy includes Mid-Atlantic Appraisal, Inc. as one of seven authorized appraisers for the Bank. Director Robert J. Belon is owner of Mid-Atlantic. Section 2.24: Customers with aggregate outstanding loans in the amount of $250,000 or more as of February 28, 1995: Customer Name Aggregate Outstanding Balance ------------- ----------------------------- Harlayne Roberts $405,270.65 Marilyn Loh Collado 317,241.18 Roy Carmen 460,807.36 William Schwartz 250,000.00 Eugene Cheslock 314,956.68 Howard Schoor 250,000.00 Donald Steel 456,751.62 Richard Eknoian 293,395.08 Sirb Construction 700,000.00 (350,000.00 Partic.) George Fahoury 260,707.08 James Vaccaro 294,115.48 Samuel Carotenuto 457,813.68 John P. Tsakiris 276,649.32 Domenico Procopio 378,960.66 Martin Barger 328,734.66 Marvin Harris 271,492.95 Summerton Group 437,920.00 Frank Hawk 338,438.09 Jennie Nicol 350,000.00 Timothy Sullivan 333,450.01 Richard Sambol 250,000.00 Brian Boyle 460,807.09 Conover Holding Corp. 319,079.51 Joseph Lenczyk 333,450.01 Robert M. Kaye 250,000.00 Jewish Community Center 368,000.00 East of Eden 391,089.95 Rivers Edge Mall 296,000.00 Vizzoni Bros. Const. 268,287.78 Cong. Sons of Israel 250,562.50 Miller & McTigue 331,197.37 RC&C Sin Assoc. 275,000.00 S.R. Whelan Dev. 259,999.60 AMV GEN-3 Part. 385,808.50 Group Const. of Marlboro 300,000.00 V.S.K Inc. 353,246.45 Philip Kramer 250,000.00 Section 2.24 (Continued): Customers with aggregate deposit balances in the amount of $200,000 or more as of February 28, 1995: Customer Name Aggregate Deposit Balances - ------------- -------------------------- Freehold Township $1,099,887.30 * Freehold Township Escrow Accts 541,669.89 John Riehl 208,222.99 Freehold Chrysler Plymouth 275,339.72 Coltsbrook, Inc. 363,142.04 Beta Lambda Instruments 234,605.72 Planned Residential Communities 200,000.00 Reussille Law Firm Estate Accounts and Partner Deposits 618,260.37 Charlene M. Schmitt 200,707.25 ** * Adjusted Balance ** Account Added
TOTAL DUE DATE BORROWER CREDIT PMT/NOTE COLLATERAL VALUE TYPE -------- ------ -------- ---------------- ---- MARTIN BARGER $ 175,000 current 2ND MTG I/L MARTIN BARGER $ 156,679 11-24-94 UNSECURED COMML ROBERT BELON $ 107,085 current LAND PARCEL COMML LAVERNE FINE $ 35,194 10-1-94 1ST MTG R/E LAVERNE FINE $ 28,365 current 1ST MTG R/E FIRST UNITED INVEST. $ 100,000 current 1ST MTG COMML GREENBROW ASSOC. $ 182,250 current UNSECURED COMML CARL GROSS $ 72,000 current UNSECURED COMML HERBERT GEORGE ASSOC. $ 57,600 current A/R COMML ALSON HODDER $ 12,564 12-10-93 2ND MTG I/L KIRSCH HOLDINGS $ 220,229 current ASSIGN MTG COMML E. LEVINSON $ 28,349 current 1ST MTG R/E MARLBORO FEED $ 11,455 7-28-94 A/R, INV COMML JENNIE NICOL $ 89,000 1-13-94 UNSECURED COMML OMNI TEMPS $ 85,000 current A/R COMML GERALD RICHTER $ 100,156 current UNSECURED COMML RIVERS EDGE $ 298,000 current 2NTG STRP MALL ## COMML VERDON'S LANDSCAPING $ 17,121 10-1-94 EQUIPMENT VIZZONI BROTHERS $ 9,030 9-24-94 UNSECURED COMML VIZZONI BROTHERS $ 269,500 11-1-94 UNSECURED COMML ---------- $2,054,577 ==========
SPECIAL ACTION TAKEN TO BORROWER MENTION SUBSTND. DOUBTFUL N.I.A. IMPROVE BANK'S POS. -------- ------- -------- -------- ------ ------------------- MARTIN BARGER $ 175,000 Bal 173,943 due 1/1/95 MARTIN BARGER $ 156,679 N/D 11/24/94 ROBERT BELON $107,085 CURRENT LAVERNE FINE $ 35,194 PRC servicing. CSB not LAVERNE FINE $ 28,365 told this mtg. mat. 11/1/9 FIRST UNITED INVEST. $100,000 Int. N/D 12/17/94 GREENBROW ASSOC $ 182,250 CURRENT CARL GROSS $ 72,000 N/D 12/15/94 HERBERT GEORGE ASSOC. $ 57,600 CURRENT ALSON HODDER $ 12,564 Chpt. 13 BK 12/27/94 KIRSCH HOLDINGS $ 220,229 E. LEVINSON $ 28,349 CURRENT MARLBORO FEED $ 11,455 Y N/D 7/28/94 JENNIE NICOL $89,000 Y Stock MV 247M bal. 350M OMNI TEMPS $ 85,000 CURRENT GERALD RICHTER $ 100,156 RENEWED TO 1/20/95 RIVERS EDGE $ 298,000 Paying $1M/mo + Int. VERDON'S LANDSCAPING $ 17,121 N/D 10/1/94; following VIZZONI BROTHERS $ 9,030 VIZZONI BROTHERS $269,500 1 pmt. promised -------- ---------- ------- $628,215 $1,337,362 $89,000 TOTAL $2,054,57 ======== ========== ======= =========
COMMERCIAL N.CLASS $16,767,049 1.25% $209,588 COMMERCIAL CLASS. OLEM $ 628,215 2.00% $ 18,564 SUBS $ 1,040,769 10.00% $ 74,077 DOUBT $ 89,000 50.00% $ 44,500 LOSS $ 0 100.00% $ 0 INSTALLMENT N.CLASS $ 6,073,771 1.00% $ 60,738 INSTALLMENT CLASS OLEM $ 0 2.00% $ 0 SUBS $ 187,564 5.00% $ 9,378 DOUBT $ 0 50.00% $ 0 LOSS $ 0 100.00% $ 0 REAL ESTATE N.CLASS $ 8,516,989 .50% $ 42,585 REAL ESTATE CLASS OLEM $ 0 2.00% $ 0 SUBS $ 81,908 5.00% $ 4,595 DOUBT $ 0 50.00% $ 0 LOSS $ 0 100.00% $ 0 UNUSED COMM. AND LC'S . . . . . $ 3,933,887 .50% $ 19,669 TOTAL PER FORMULA . . . . . . . . . . . . . . . . . . . $483,695 RESERVE PER G.L. . . . . . . . . . . . . . . . . . . . $494,496 OVERAGE/(DEFICIT) . . . . . . . . . . . . . . . . . . . $ 10,801
EX-11.1 4 EXHIBIT 27 COMPUTATION OF EARNINGS PER SHARE
Year Ended December 31, 1995 1994 1993 1992 1991 (in thousands, except per share data) Net Income (1) $56,408 $46,398 $35,614 $19,638 $11,982 Average Common Share outstanding (2) 55,364 49,751 49,101 36,903 30,949 Stock options considered to be common stock equivalents, net of shares assumed to be repurchased under the treasury stock method (2) 1,204 1,643 1,805 1,596 1,092 Total stock/stock equivalents (2) 56,568 51,394 50,906 38,499 32,041 ======= ======= ======= ======= ======= Net income per share before cumulative effect of accounting change (2) $ 1.00 $ .90 $ .70 $ .51 $ .37 ======= ======= ======= ======= ====== Net income per share after cumulative effect of accounting change (2) $ 1.00 $ .90 $ .80 $ .51 $ .37 ======= ======= ======= ======= ====== (1) The 1993 results do not include a $4.8 million cumulative effect of a change in accounting principle resulting from the adoption of Statement of Financial Accounting Standards No. 109 in 1993. (2) All per share date have been adjusted to reflect all stock dividends and stock splits.
EX-21 5 EXHIBIT 21 Subsidiaries of Sovereign Bancorp, Inc. Subsidiary State or other jurisdiction of Incorporation Sovereign Bank, a Federal Savings Bank United States of America d/b/a Charter Federal Savings Bank Division d/b/a Sovereign Bank of Delaware Valley Division d/b/a Sovereign Bank, Valley Federal Division d/b/a Sovereign Bank of New Jersey Division d/b/a Bank of Princeton FS Division of Sovereign Bank Colonial Bank for Savings, a United States of Federal Savings Bank America Sovereign Investment Corporation Delaware First Lancaster Financial Corp. Pennsylvania 201 Associates, Inc. Delaware Sovereign Annuity Corp., Inc. New Jersey Sovereign Agency, Inc. New Jersey CSB Building Corporation New Jersey March 28, 1996 EX-23.1 6 EXHIBIT 23.1 Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statements (Form S-8 No. 33-20186, Form S-8 No. 33-29038, Form S-8 No. 33-39453, Form S-8 No. 33-44108, Form S-8 No. 33-89586 and Form S-8 No. 33-89592) of Sovereign Bancorp, Inc. of our report dated January 17, 1996, with respect to the consolidated financial statements of Sovereign Bancorp, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 1995. Reading, Pennsylvania /s/ Ernst & Young LLP March 25, 1996 EX-23.2 7 EXHIBIT 23.2 Consent of Independent Certified Public Accountants To the Board of Directors Sovereign Bancorp, Inc. We hereby consent to the incorporation by reference in Registration Statement No. 33-20186 on Form S-8, Registration Statement No. 33-29038 on Form S-8, Registration Statement No. 33-39453 on Form S-8, Registration Statement No. 33-44108 on Form S-8, Registration Statement No. 33-89586 on Form S-8 and Registration Statement No. 33-89592 on Form S-8 of Sovereign Bancorp, Inc. and subsidiaries of our report dated November 24, 1994 with respect to the consolidated financial statements of Charter FSB Bancorp, Inc. and subsidiary, which report appears in the Annual Report on Form 10-K of Sovereign Bancorp, Inc. for the year ended December 31, 1995. /s/ BDO Seidman, LLP BDO SEIDMAN, LLP Woodridge, New Jersey March 27, 1996 EX-27 8
5 0000811830 SOVEREIGN BANCORP, INC. 1,000 DOLLARS 12-MOS DEC-31-1995 JAN-01-1995 DEC-31-1995 1 147,771 2,966,721 4,744,876 (34,856) 0 196,824 100,732 (43,781) 8,078,287 7,651,262 0 0 96,446 220,103 110,476 8,078,287 0 518,860 0 100,267 12,841 1,000 318,805 85,947 29,539 0 0 0 0 56,408 1.00 1.00
EX-99.1 9 EXHIBIT 99.1 Report of Independent Certified Public Accountants To the Board of Directors Charter FSB Bancorp, Inc. We have audited the accompanying consolidated statements (not presented) of financial condition of Charter FSB Bancorp, Inc. and subsidiary as of September 30, 1994 and 1993, and the related consolidated statements (not presented) of income, stockholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We have conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements (not presented) referred to above present fairly, in all material respects, the financial position of Charter FSB Bancorp, Inc. and subsidiary at September 30, 1994 and 1993, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. Woodbridge, NJ November 23, 1994 /s/ BDO Seidman, LLP -----END PRIVACY-ENHANCED MESSAGE-----