-----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, QhuDKYgsBy2rDiHupgNfroXp0VQig7+vioQuV2IOdgh9OvXG0MzBLMdFPczk86uM SURPlrGwFy2TZPZkHeFuUA== 0000950115-00-000452.txt : 20000331 0000950115-00-000452.hdr.sgml : 20000331 ACCESSION NUMBER: 0000950115-00-000452 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 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: SEC FILE NUMBER: 000-16533 FILM NUMBER: 588447 BUSINESS ADDRESS: STREET 1: 2000 MARKET ST CITY: PHILADELPHIA STATE: PA ZIP: 19103 BUSINESS PHONE: 2155574630 MAIL ADDRESS: STREET 1: PO BOX 12646 CITY: READING STATE: PA ZIP: 19612 10-K 1 ANNUAL REPORT ================================================================================ 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, 1999, 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 incorporation or (I.R.S. Employer organization) Identification No.) 1130 BERKSHIRE BOULEVARD, WYOMISSING, PENNSYLVANIA 19610 - ------------------------------------------------------------ ---------- (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER: (610) 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 $1,635,601,921 at March 29, 2000. As of March 29, 2000, the Registrant had 225,600,265 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE The Registrant's definitive Proxy Statement to be used in connection with its 2000 Annual Meeting of Shareholders is incorporated herein by reference in response to Part III hereof. ================================================================================ FORWARD-LOOKING STATEMENTS Sovereign Bancorp, Inc. ("Sovereign") may from time to time make "forward-looking statements," including statements contained in Sovereign's filings with the Securities and Exchange Commission (including this Annual Report on Form 10-K and the Exhibits thereto), in its reports to shareholders (including its 1999 Annual Report) and in other communications by Sovereign, which are made in good faith by Sovereign, pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements with respect to Sovereign's vision, mission, strategies, goals, beliefs, plans, objectives, expectations, anticipations, estimates, intentions, financial condition, results of operations, future performance and business of Sovereign, including: (i) statements relating to Sovereign's expectations and goals with respect to (a) growth in earnings per share; (b) return on equity; (c) return on assets; (d) efficiency ratio; (e) tier 1 leverage ratio; (f) annualized net charge-offs and other asset quality measures; (g) fee income as a percentage of total revenue; (h) tangible equity to assets; (i) book value and tangible book value per share; (j) loan and deposit portfolio compositions, (ii) statements preceded by, followed by or that include the words "may," "could," "should," "pro forma," "looking forward," "would," "believe," "expect," "anticipate," "estimate," " intend," "plan," or similar expressions, and (iii) statements relating to some or all of the foregoing which assume the successful completion of the three staggered closings with respect to its FleetBoston acquisition, the successful conversion of FleetBoston operating systems, and the retention of former FleetBoston employees and customers. Although we believe that the expectations reflected in our forward-looking statements are reasonable, these forward-looking statements involve risks and uncertainties which are subject to change based on various important factors (some of which, in whole or in part, are beyond Sovereign's control). The following factors, among others, could cause Sovereign's financial performance to differ materially from the goals, plans, objectives, intentions and expectations forecasts and projections (and underlying assumptions) expressed in such forward-looking statements: (1) the strength of the United States economy in general and the strength of the regional and local economies in which Sovereign conducts operations; (2) the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; (3) inflation, interest rate, market and monetary fluctuations; (4) the timely development of competitive new products and services by Sovereign and the acceptance of such products and services by customers; (5) the willingness of customers to substitute competitors' products and services and vice versa; (6) the success of Sovereign in meeting the conditions for regulatory approval for each of its three staggered closings with respect to its FleetBoston acquisition; (7) the impact of changes in financial services' laws and regulations and the application of such laws and regulations (including laws concerning taxes, capital, liquidity, proper accounting treatment, securities and insurance); (8) technological changes; (9) changes in consumer spending and savings habits; (10) the impact of the FleetBoston acquisition and other acquisitions of Sovereign, including the success of Sovereign in fully realizing, within the expected time frame, earnings enhancements from such pending or completed acquisitions, including, without limitation, the earnings enhancements expected from the acquisition of approximately $12.0 billion in deposits, $9.1 billion in loans, and 285 branches from FleetBoston; (11) Sovereign's ability to complete the FleetBoston acquisition and related systems conversions, and Sovereign's ability to retain FleetBoston customers and employees; (12) changes in the amount, mix, yield, quality, and other characteristics of the deposits and loans Sovereign expects to assume and acquire from FleetBoston; (13) changes in the timing and structure of the FleetBoston acquisition and related transactions and other changed facts and circumstances resulting from the passage of time; (14) unanticipated regulatory or judicial proceedings; (15) unanticipated changes in asset quality; and (16) the success of Sovereign at managing the risks involved in the foregoing. Sovereign cautions that the foregoing list of important factors is not exclusive, and neither such list nor any such forward-looking statement takes into account the impact that any future acquisition may have on Sovereign and any such forward-looking statement. Sovereign does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of Sovereign. 1 PART I ITEM 1. BUSINESS. GENERAL Sovereign Bancorp, Inc. ("Sovereign") is a Pennsylvania business corporation and is the holding company for Sovereign Bank. Sovereign is headquartered in Philadelphia, Pennsylvania and Sovereign Bank is headquartered in Wyomissing, Pennsylvania, a suburb of Reading, Pennsylvania. 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. Since then, Sovereign has completed 24 acquisitions with assets totaling approximately $15 billion through December 31, 1999, and expanded its markets throughout eastern Pennsylvania, central New Jersey and northern Delaware. Sovereign also serves customers throughout New York and several New England states. At December 31, 1999, Sovereign had consolidated assets, deposits and stockholders' equity of approximately $26.6 billion, $11.7 billion and $1.8 billion, respectively and 306 community banking offices. Based on assets at December 31, 1999, Sovereign is the largest thrift holding company and the third largest bank headquartered in Pennsylvania. On June 30, 1999, Sovereign acquired Peoples Bancorp, Inc. ("Peoples"), a $1.4 billion bank holding company headquartered in Lawrenceville, New Jersey whose principal operating subsidiary operated 14 community banking offices in Mercer, Burlington and Ocean counties, New Jersey. This transaction was accounted for as a purchase. On June 15, 1999, Sovereign acquired The Network Companies ("Network"), a $50 million privately held specialty leasing company headquartered in Commack, New York. Network provides financing for the purchase or lease of equipment and specialty vehicles plus other specialty products for businesses throughout the United States. This acquisition was accounted for as a purchase. On September 3, 1999, Sovereign entered into a purchase and assumption agreement with FleetBoston Financial to acquire branch banking offices located in Connecticut, Massachusetts, New Hampshire and Rhode Island, and related deposit liabilities, loans and other assets associated with the business of those branches. On February 28, 2000, Sovereign and FleetBoston Financial agreed to restructure certain terms of the agreement. Sovereign will purchase approximately $12 billion of deposits, $9 billion of loans and 285 community banking offices. The acquisition, which results in the creation of Sovereign Bank New England, the third largest bank in New England, includes the following: the former Fleet Bank community banking franchise in eastern Massachusetts; the entire former BankBoston community banking franchise in Rhode Island; and select community banking offices of Fleet Bank in southern New Hampshire and BankBoston in Connecticut. In addition, Sovereign is acquiring a substantial portion of the middle market and small business-lending groups from Fleet Bank in Massachusetts and New Hampshire, and from BankBoston in Rhode Island and Connecticut. The acquisition includes the purchase of fully functioning business units, with the necessary management, relationship officers, support staffs, and other infrastructure for the acquired loans and deposits to be fully serviced. For additional information with respect to the Sovereign Bank New England Acquisition see part II, Item 7 "Management Discussion and Analysis of Financial Condition and Results of Operations" hereof. Sovereign's primary business consists of attracting deposits from its network of community banking offices, located throughout eastern and northcentral Pennsylvania, New Jersey and northern Delaware, and originating commercial, consumer and residential mortgage loans in those communities. Sovereign also serves customers throughout New York and several New England States. 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 II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" hereof. SUBSIDIARIES Sovereign has six wholly-owned subsidiaries: Sovereign Bank, Sovereign Delaware Investment Corporation, Sovereign Delaware Escrow Company, Sovereign Capital Trust I, Sovereign Capital Trust II, and ML Capital Trust I. Sovereign Delaware Investment Corporation is a Delaware corporation whose 2 primary purpose is to purchase and hold certain investment securities. Sovereign Delaware Escrow Company is a Delaware corporation created expressly for holding in escrow the proceeds of the debt and equity issuances to finance the Sovereign Bank New England transaction. Sovereign Capital Trust I and Sovereign Capital Trust II are special-purpose statutory trusts, created expressly for the issuance of preferred capital securities, which solely holds subordinated debentures of Sovereign. ML Capital Trust I is a special-purpose statutory trust created expressly for the issuance of preferred capital securities. Sovereign Bank has the following wholly-owned subsidiaries: Main Line Abstract Corporation, 1130 Abstract, Inc., 201 Associates, Inc., First Lancaster Financial Corp., Sovereign Trust Company, and Sovereign REIT Holdings, Inc. Main Line Abstract Corporation and 1130 Abstract Inc. are Pennsylvania corporations whose primary functions are to act as title insurance agencies and abstract companies. 201 Associates, Inc. is a Delaware corporation whose primary purpose is to hold certain investment securities. First Lancaster Financial Corp. is a Pennsylvania corporation whose primary function is to act as a holding company for Sovereign Annuity Corp. and The Sovereign Agency, Inc. Sovereign Annuity Corp. is a New Jersey corporation whose primary purpose is to market investment securities, mutual funds and insurance annuities. The Sovereign Agency, Inc. is a New Jersey corporation whose primary purpose is to market insurance products. The Sovereign Trust Company is a New Jersey corporation whose primary function is to perform trust services. Sovereign REIT Holdings, Inc. is a Delaware corporation whose primary purpose is to act as a holding company for Sovereign Real Estate Investment Trust ("REIT"). Sovereign REIT is a Delaware business trust whose primary purpose is to invest in and manage certain real estate assets. 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, 1999, Sovereign Bank was authorized to have a maximum investment of approximately $507.0 million in such subsidiaries, pursuant to applicable federal regulations. As of such date, Sovereign Bank had a total investment of $46.7 million in subsidiary service corporations, which excludes 201 Associates, Inc., Sovereign Trust Company, and Sovereign REIT Holdings, Inc., as they are considered to be operating subsidiaries for purposes of this test. EMPLOYEES At December 31, 1999, Sovereign had 3,923 full-time and 573 part-time employees. None of these employees are 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 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 3 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. 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 Federal Deposit Insurance Corporation ("FDIC"). The FDIC manages two funds: the Savings Association Insurance Fund ("SAIF") and the Bank Insurance Fund ("BIF"). These funds are required to be separately maintained and not combined. The majority of Sovereign Bank's deposits are subject to the FDIC's SAIF deposit insurance assessment rate; however, certain deposits which Sovereign acquired from other institutions are subject to the FDIC's BIF deposit insurance assessment rate. See "Insurance of Deposit Accounts" below. Sovereign Bank is required to file reports with the OTS describing its activities and financial condition and is periodically examined to test compliance with various regulatory requirements. Sovereign Bank is 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 or Sovereign 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. Sovereign Bank is 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. 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. As of December 31, 1999, no individual corporation or other entity owned more than 10% of Sovereign's capital stock. Regulatory Capital Requirements. OTS regulations require savings associations to maintain a minimum tangible capital ratio of not less than 2.0%, 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 4 of interest rate risk, concentration of credit risk and risks of non-traditional 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 may 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 5 account of a savings association. At December 31, 1999, Sovereign Bank 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. The implementation or enforcement of these guidelines has not had a material adverse effect on Sovereign's results of operations. Insurance of Accounts and Regulation by the FDIC. Sovereign Bank is a member of the Savings Association Insurance Fund, which is administered by the FDIC. Deposits are insured up to the applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the Savings Association Insurance Fund or Bank Insurance Fund. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the Office of Thrift Supervision an opportunity to take such action, and may terminate an institution's deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition. The FDIC's deposit insurance premiums are assessed through a risk-based system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their level of capital and supervisory evaluation. Under the system, institutions classified as well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier I or core capital to risk-weighted assets ("Tier 1 risk-based capital") of at least 6% and a risk-based capital ratio of at least 10%) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (i.e., core or Tier I risk-based capital ratios of less than 4% of a risk-based capital ratio of less than 8%) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period. The FDIC is authorized to increase assessment rates, on a semi-annual basis, if it determines that the reserve ratio of the Savings Association Insurance Fund will be less than the designated reserve ratio of 1.25% of Savings Association Insurance Fund insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. The FDIC may also impose special assessments on Savings Association Insurance Fund members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC. The current premium schedule for Savings Association Insurance Fund insured institutions ranges from 0 to 27 basis points per $100 of deposits. Sovereign Bank is in the category of institutions that pay no deposit insurance premiums. However, all insured institutions are required to pay a Financing Corporation assessment, in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. The current rate for Savings Association Insurance Fund insured institutions is 5.9 basis points for each $100 in domestic deposits, while Bank Insurance Fund insured institutions pay an assessment equal to 1.2 basis points for each $100 in domestic deposits. After January 1, 2000, the Financing Corporation assessments for Savings Association Insurance Fund and Bank Insurance Fund insured institutions will be the same. These assessments, which may be revised based upon the level of Bank Insurance Fund and Savings Association Insurance Fund deposits, will continue until the bonds mature in the year 2017. New Legislation. Landmark legislation in the financial services area was signed into law by the President on November 12, 1999. The Gramm-Leach-Bliley Act dramatically changes certain banking laws that have been in effect since the early part of the 20th century. The most radical changes are that the separation between banking and the securities businesses mandated by the Glass-Steagall Act has now been removed, and the provisions of any state law that prohibits affiliation between banking and insurance entities have been preempted. Accordingly, the new legislation now permits firms engaged in underwriting and dealing in securities, and insurance companies, to own banking entities, and permits bank holding companies (and in some cases, banks) to own securities firms and insurance companies. As Sovereign is a savings and loan holding company, many of the provisions of the new legislation do not apply to it. The new law does change the status of Sovereign, however, in that Sovereign can no longer become part of a non-financial group of companies, as it could under prior law. Sovereign is still permitted to acquire non-financial companies, however. 6 The new legislation also makes a number of additions and revisions to numerous federal laws that affect the business of banking. For example, there is now a federal law on privacy with respect to customer information held by banks. The federal banking regulators are authorized to adopt rules regarding privacy for customer information. Banks must establish a disclosure policy for non-public customer information, disclose the policy to their customers, and give their customers the opportunity to object to non-public information being disclosed to a third party. The new law also requires any CRA agreement entered into between a bank and a community group to be disclosed, with both the bank and the group receiving any grants from the bank detailing the amount of funding provided and what it was used for. The new law also requires a bank's policy on fees for transactions at ATM machines by non-customers to be conspicuously posted on the ATM. A number of other provisions affecting other general regulatory requirements for banking institutions were also adopted. 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 Bank's executive offices and operations center. Sovereign Bank has 315 branch and loan production offices. Sovereign owns 162 of these offices and leases 153. Sovereign Bank also leases several other facilities throughout its market area to support its various administrative functions. ITEM 3. LEGAL PROCEEDINGS. Sovereign is not involved in any pending legal proceedings other than non-material 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 29, 2000, is set forth below: Richard E. Mohn--Age 68. 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 the retired Chairman of Cloister Spring Water Company, Lancaster, Pennsylvania, a bottler and distributor of spring water. Jay S. Sidhu--Age 48. 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. 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 47. Mr. Thompson serves as Chief Administrative Officer and Secretary of Sovereign and Chief Operating Officer and Secretary of Sovereign 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. Mr. Thompson became Chief Operating Officer of Sovereign Bank in November 1996. Dennis S. Marlo--Age 57. Mr. Marlo was appointed Chief Financial Officer and Treasurer of Sovereign on May 19, 1998. Mr. Marlo joined Sovereign in February 1998 as the President of the Pennsylvania Division of Sovereign Bank. Prior thereto, Mr. Marlo served as President and Chief Executive Officer of ML Bancorp, a predecessor company of Sovereign. 7 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 29, 2000, the total number of holders of Sovereign's common stock was 17,098. The high and low bid prices reported on the NASDAQ National Market system for Sovereign's common stock for 1999, adjusted to reflect all stock dividends and splits, were $26.250 and $7.000 and for 1998 were $22.188 and $9.000, respectively. During 1999, Sovereign paid a cash dividend of $.021 per share in the first quarter, $.026 per share in the second quarter, $.027 per share in the third quarter and $.024 per share in the fourth quarter. During 1998, Sovereign paid a cash dividend of $.020 per share in the first quarter, $.023 per share in the second quarter, $.020 per share in the third quarter and $.021 per share in the fourth quarter. During 1997, Sovereign paid a cash dividend of $.037 per share in the first quarter, $.038 in the second quarter, $.036 in the third quarter and $.017 in the fourth quarter. These per share amounts have been adjusted to reflect all stock dividends and stock splits. For certain limitations on the ability of Sovereign Bank to pay dividends to Sovereign, see part I, Item 1 "Business--Supervision and Regulation--Regulatory Capital Requirements" and Note 12 at Item 8 "Financial Statements and Supplementary Data" hereof. 8 ITEM 6. SELECTED FINANCIAL DATA.
SELECTED FINANCIAL DATA(1) AT OR FOR THE YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 ----------- ----------- ----------- ----------- ----------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Balance Sheet Data Total assets................................ $26,607,112 $21,913,873 $17,655,455 $15,298,690 $13,082,579 Loans....................................... 14,226,540 11,285,840 11,324,122 9,595,495 7,591,107 Allowance for loan losses................... (132,986) (133,802) (116,823) (73,847) (67,515) Investment securities....................... 10,392,263 8,502,082 5,372,713 5,012,118 4,695,805 Deposits.................................... 11,719,646 12,322,716 9,515,294 8,660,684 8,548,888 Borrowings.................................. 12,663,138 7,902,239 6,863,643 5,599,109 3,566,857 Stockholders' equity........................ 1,821,495 1,204,068 1,047,795 889,751 843,733 Summary Statement of Operations Total interest income....................... $ 1,607,329 $ 1,355,371 $ 1,178,777 $ 1,016,826 $ 838,261 Total interest expense...................... 992,673 861,759 746,695 629,860 518,483 ----------- ----------- ----------- ----------- ----------- Net interest income......................... 614,656 493,612 432,082 386,966 319,778 Provision for loan losses................... 30,000 27,961 41,125 22,685 13,119 ----------- ----------- ----------- ----------- ----------- Net interest income after provision for loan losses.................................... 584,656 465,651 390,957 364,281 306,659 Other income................................ 130,342 105,181 48,688 63,379 42,908 Other expenses(2)........................... 446,384 359,626 269,783 289,773 199,647 ----------- ----------- ----------- ----------- ----------- Income before income taxes.................. 268,614 211,206 169,862 137,887 149,920 Income tax provision........................ 89,315 74,751 67,324 47,509 51,051 ----------- ----------- ----------- ----------- ----------- Net income.................................. $ 179,299 $ 136,455 $ 102,538 $ 90,378 $ 98,869 =========== =========== =========== =========== =========== Share Data(3) Common shares outstanding at end of period (in thousands)............................ 225,470 159,727 141,218 134,000 130,762 Preferred shares outstanding at end of period (in thousands)..................... -- -- 1,996 2,000 2,000 Basic earnings per share(4)................. $ 1.02 $ .88 $ .70 $ .63 $ .68 Diluted earnings per share(4)............... $ 1.01 $ .85 $ .66 $ .59 $ .66 Book value per share at end of period(5).... $ 8.08 $ 7.54 $ 7.42 $ 6.64 $ 6.45 Common share price at end of period......... $ 7 29/64 $ 14 1/4 $ 1 75/16 $ 9 1/8 $ 6 11/16 Dividends per common share(6)............... $ 0.098 $ .084 $ .114 $ .140 $ .119 Selected Financial Ratios Dividend payout ratio(7).................... 9.7% 9.9% 17.3% 23.7% 18.0% Return on average assets.................... .75% .70% .63% .63% .83% Return on average equity.................... 13.20% 12.42% 10.92% 10.34% 12.60% Equity to assets............................ 6.85% 5.49% 5.93% 5.82% 6.45%
- ------------------ (1) All selected financial data has been restated to reflect those acquisitions which have been accounted for under the pooling-of-interests method of accounting. (2) Other expenses for the year ended December 31, 1999 include special charges related to merger and other integration expenses of $30.8 million. See Reconciliation of Net Income to Operating Earnings in Part II, Item 7 "Management's Discussion and Analysis" hereof. (3) All per share data have been adjusted to reflect all stock dividends and stock splits. (4) The 1998 and 1997 results include the merger-related charges of $33.5 million (after-tax) and $36.7 million (after-tax), respectively, resulting from Sovereign's acquisitons during 1998 and 1997. Excluding the merger-related charges, basic earnings per share and diluted earnings per share were $1.10 and $1.06, respectively, for 1998 and $.97 and $.89, respectively, for 1997. The 1996 results include the non-recurring SAIF assessment of $24.9 million (after-tax). Excluding the non-recurring SAIF assessment, basic earnings per share and diluted earnings per share for 1996 were $.81 and $.76, respectively. (5) Book value is calculated using equity divided by common shares. (6) The higher dividend rate in prior periods is the result of acquisitions which were accounted for as a pooling-of-interests. (7) The dividend payout ratio is calculated using dividends per common share divided by diluted earnings per share. 9 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General. Sovereign reported cash earnings for 1999 of $231 million, or $1.34 per share, up from $188 million and $1.17 per share in 1998. This represents an increase in cash earnings of 23% and a 15% increase in cash earnings per share. Operating earnings for 1999 were $202 million, an increase of 19% from 1998 operating earnings of $170 million. Operating earnings per share for 1999 was $1.18, an increase of 11% over 1998 operating earnings per share of $1.06. Net income for 1999 was $179 million or $1.01 per share. Net income for 1998 was $136 million or $.85 per share. On an operating basis, return on average equity and return on average assets were 15.51% and .85%, respectively, for 1999 compared to 15.47% and .87%, respectively, for 1998. Operating earnings exclude the following special charges for 1999 and 1998: merger-related and integration charges related to acquisitions, as well as the impact on net interest income and shares outstanding from the early issuance of certain debt and equity instruments issued to finance Sovereign's pending New England retail banking and middle market lending acquisition from FleetBoston ("Sovereign Bank New England"). Special charges were $23.0 million after tax for the year ended December 31, 1999 and $33.5 million after tax for the year ended 1998. Cash earnings are operating earnings excluding amortization of intangible assets and ESOP-related expense. A reconciliation of net income to operating earnings is presented below: RECONCILIATION OF NET INCOME TO OPERATING EARNINGS (Dollars in thousands, except per share data -- all amounts are after tax)
YEAR-ENDED DECEMBER 31, ----------------------------------- TOTAL PER SHARE ------------------- ------------- 1999 1998 1999 1998 -------- -------- ----- ----- Net income as reported.................................... $179,299 $136,455 $1.01 $0.85 Net negative carry on escrowed bond proceeds(1)........... 3,123 -- 0.02 -- Merger-related and integration costs recorded during the period.................................................. 20,576 33,533 0.12 0.21 Expense on convertible trust preferred securities ("PIERS")(1)............................................ 2,125 -- 0.01 -- Assumed income from reinvestment of net proceeds of common equity and PIERS(1)..................................... (2,827) -- (0.02) -- Impact of additional shares outstanding for 1999 common and PIERS securities offerings(2)....................... -- -- 0.04 -- -------- -------- ----- ----- Operating earnings(2)..................................... $202,296 $169,988 $1.18 $1.06 ======== ======== ===== ===== Cash earnings(2).......................................... $231,467 $188,177 $1.34 $1.17 ======== ======== ===== =====
- ------------------ (1) As part of the agreement to purchase Sovereign Bank New England, Sovereign was required to raise $1.8 billion of debt or equity capital by December 15, 1999. Substantially all of the funds were required to be escrowed with limited ability to reinvest the proceeds between the closing of the financing and the assumption of the FleetBoston branches. Consequently, the excess of interest expense and trust preferred expense over income earned on the raised capital has resulted in a net reduction in net income of $3.7 million ($2.4 million after-tax) for the year ended December 31, 1999, comprised of the following components: a) a net negative impact of $4.7 million ($3.1 million after-tax) to net interest income; b) $3.1 million ($2.1 million after-tax) of expense associated with PIERS issued in November, 1999; c) an assumed $4.4 million ($2.8 million after-tax) of income from the re-investment of the proceeds of the Trust Preferred Securities and the common stock offerings in November, 1999. (2) Operating earnings per share and cash earnings per share are calculated using weighted average shares of 172 million, which excludes the average effect of the 43.8 million shares issued in the November, 1999 offering. 10 All per share amounts presented in Management's Discussion and Analysis of Financial Condition and Results of Operations have been adjusted to reflect all stock dividends and stock splits. Acquisitions. Sovereign's financial results for 1999 include the following significant events: (For additional information with respect to Sovereign's 1999 acquisition activity, see Note 2 in the "Notes to Consolidated Financial Statements" hereof). Network. On June 15, 1999, Sovereign acquired The Network Companies ("Network"), a privately held specialty leasing company headquartered in Commack, New York. The acquisition was accounted for as a purchase and had total assets of approximately $50 million. Peoples. On June 30, 1999, Sovereign acquired Peoples Bancorp, Inc. ("Peoples"), a $1.4 billion bank holding company headquartered in Lawrenceville, New Jersey whose principal operating subsidiary operated 14 community banking offices in Mercer, Burlington and Ocean counties, New Jersey. The transaction added loans, deposits, and equity to Sovereign of approximately $503 million, $515 million, and $291 million, respectively. Sovereign Bank New England. On September 3, 1999, Sovereign entered into a purchase and assumption agreement with FleetBoston Financial to acquire branch banking offices located in Connecticut, Massachusetts, New Hampshire and Rhode Island, and related deposit liabilities, loans and other assets associated with the business of those branches. On February 28, 2000, Sovereign and FleetBoston Financial agreed to restructure certain terms of the agreement. Sovereign will purchase approximately $12 billion of deposits, $9 billion of loans and 285 community banking offices. The acquisition, which results in the creation of Sovereign Bank New England, the third largest bank in New England, includes the following: the former Fleet Bank community banking franchise in eastern Massachusetts; the entire former BankBoston community banking franchise in Rhode Island; and select community banking offices of Fleet Bank in southern New Hampshire and BankBoston in Connecticut. In addition, Sovereign is acquiring a substantial portion of the middle market and small business-lending groups from Fleet in Massachusetts and New Hampshire, and from BankBoston in Rhode Island and Connecticut. The acquisition includes the purchase of fully functioning business units, with the necessary management, relationship officers, support staffs, and other infrastructure for the acquired loans and deposits to be fully serviced. ACQUISITION TIMETABLE
DATE DIVESTED UNITS DEPOSITS BRANCHES LOANS ---- -------------- ------------ -------- ------------ March 24, 2000......... Rhode Island, Connecticut (BankBoston) $4.0 billion 90 $3.2 billion June 16, 2000.......... Eastern Mass (Fleet) $4.0 billion 86 $3.5 billion July 21, 2000.......... Central Mass, New Hampshire (Fleet) $4.0 billion 109 $2.4 billion
In February, 2000, Sovereign received approval from the Office of Thrift Supervision for the transaction subject to certain conditions at each acquisition date. Total potential consideration for the consumer and banking franchise is 12% of acquired deposits, or approximately $1.4 billion. Sovereign will pay approximately $1.1 billion as the purchases are completed according to the above schedule. Sovereign will pay the remaining $340 million in periodic installments between January 2001 and October 2001 if FleetBoston complies with its non-compete obligations under the agreement. Sovereign paid a non-refundable deposit of $200 million to FleetBoston in connection with the acquisition, and their obligation to close each of the acquisitions is unconditional. Sovereign raised approximately $1.8 billion of debt and equity in November and December, 1999, to finance the acquisition. See Liquidity and Capital Resources for a more complete description of these financings. 11 RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998 Net Interest Income. Net interest income for 1999 was $615 million compared to $494 million for 1998. This growth represents an increase of 24% and was primarily due to an internal commercial and consumer loan growth, recent acquisitions, an increase in average balances in investment securities available for sale and growth in core deposits. Net interest margin -- operating basis (net interest income adjusted to eliminate the negative impact from escrowed financing proceeds relating to the pending acquisition of Sovereign Bank New England, divided by average interest-earning assets -- see Reconciliation of Net Income to Operating Earnings) was 2.88% for 1999 compared to 2.79% for 1998. Interest on interest-earning deposits was $4.7 million for 1999 compared to $7.4 million for 1998. The average balance of interest-earning deposits was $15.2 million with an average yield of 31.12%for 1999 compared to an average balance of $56.4 million with an average yield of 13.12%for 1998. The high yields on interest-earning deposits were the result of a contractual arrangement whereby a third-party vendor performed check processing and reconcilement functions for Sovereign's disbursement accounts. Under the agreement, the vendor is required to pay Sovereign interest on disbursed funds during the two to three day float period, effectively producing interest income with no corresponding asset balance. This agreement will continue to favorably impact the yield on Sovereign's interest-earning deposits in future years. Interest on investment securities available-for-sale was $544 million for 1999 compared to $284 million for 1998. The average balance of investment securities available-for-sale was $8.1 billion with an average yield of 6.85%for 1999 compared to an average balance of $4.3 billion with an average yield of 6.75% for 1998. The increase in the average balance of investment securities available-for-sale was due to Sovereign's realignment of its investment portfolio, and an active decision by management to increase balance sheet flexibility by placing more investments into available-for-sale. Interest on investment securities held-to-maturity was $99.8 million for 1999 compared to $182 million for 1998. The average balance of investment securities held-to-maturity was $1.4 billion with an average yield of 6.94% for 1999 compared to an average balance of $2.5 billion with an average yield of 7.22% for 1998. The decrease in the yield at year end, and the majority of the year-end balance, is associated with the escrowed proceeds from the November offerings related to the FleetBoston acquisition. Interest and fees on loans were $959 million for 1999 compared to $881 million for 1998. The average balance of net loans was $12.4 billion with an average yield of 7.77% for 1999 compared to an average balance of $11.1 billion with an average yield of 7.94% for 1998. The increases in average loan volume were primarily the result of Sovereign's significant progress during the year in increasing its emphasis in commercial and consumer lending. The increases in volume were offset slightly by an overall decrease in rates. Interest on total deposits was $428 million for 1999 compared to $440 million for 1998. The average balance of total deposits was $12.0 billion with an average cost of 3.57% for 1999 compared to an average balance of $10.7 billion with an average cost of 4.11% for 1998. The increase in the average balance and the decrease in the average cost of deposits was primarily the result of Sovereign's emphasis on attracting lower-cost core deposits from small and medium size corporations, governmental units and consumers, and the CoreStates branch acquisition in September 1998. 12 Interest on total borrowings was $565 million for 1999 compared to $421 million for 1998. The average balance of total borrowings was $10.3 billion with an average cost of 5.47% for 1999 compared to an average balance of $7.4 billion with an average cost of 5.69% for 1998. The increase in the average balance was the result of both balance sheet growth and funding requirements needed in anticipation of the pending acquisition of assets and liabilities from FleetBoston. The decrease in the average cost of borrowings was due to a higher proportion of short-term borrowings in the current year versus prior year, and a slight overall decrease in interest rates. 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 indicated (in thousands): TABLE 1: NET INTEREST MARGIN
YEAR ENDED DECEMBER 31, --------------------------------------------------------------------- 1999 1998 --------------------------------- --------------------------------- AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST RATE BALANCE INTEREST RATE ----------- ---------- ------ ----------- ---------- ------ Interest-earning assets: Interest-earning deposits.... $ 15,170 $ 4,721 31.12% $ 56,389 $ 7,397 13.12% Investment securities available-for-sale(1)...... 8,079,731 543,631 6.85 4,336,872 284,392 6.75 Investment securities held-to-maturity........... 1,440,894 99,813 6.94 2,530,143 182,499 7.22 Net loans(2)(3).............. 12,379,295 959,164 7.77 11,105,400 881,083 7.94 ----------- ---------- ----- ----------- ---------- ----- Total interest-earning assets..................... 21,915,090 1,607,329 7.39 18,028,804 1,355,371 7.57 Non-interest-earning assets..................... 2,027,003 -- -- 1,589,937 -- -- ----------- ---------- ----- ----------- ---------- ----- Total assets............. $23,942,093 $1,607,329 6.76% $19,618,741 1,355,371 6.96 =========== ---------- ----- =========== ---------- ----- Interest-bearing liabilities: Deposits: Demand deposit and NOW accounts................. $ 2,607,000 $ 21,851 .84 $ 1,712,730 $ 16,387 .96 Savings accounts........... 2,246,127 58,333 2.60 2,126,149 62,694 2.95 Money market accounts...... 1,288,581 50,246 3.90 1,173,889 45,055 3.84 Certificates of deposit.... 5,836,785 297,625 5.10 5,688,568 316,164 5.56 ----------- ---------- ----- ----------- ---------- ----- Total deposits........... 11,978,493 428,055 3.57 10,701,336 440,300 4.11 Total borrowings............. 10,330,125 564,618 5.47 7,404,186 421,459 5.69 ----------- ---------- ----- ----------- ---------- ----- Total interest-bearing liabilities . . 22,308,618 992,673 4.45 18,105,522 861,759 4.76 Non-interest-bearing liabilities................ 274,858 -- -- 414,719 -- -- ----------- ---------- ----- ----------- ---------- ----- Total liabilities........ 22,583,476 992,673 4.40 18,520,241 861,759 4.65 Stockholders' equity......... 1,358,617 -- -- 1,098,500 -- -- ----------- ---------- ----- =========== ---------- ----- Total liabilities and stockholders' equity... $23,942,093 $ 992,673 4.15 $19,618,741 $ 861,759 4.39 =========== ---------- ----- =========== ---------- ----- Net interest net spread(4)... 2.62% 2.56% ===== ===== Net interest income/net interest margin(5)......... $ 614,656 2.86% $ 493,612 2.79% ========== ===== ========== ===== Net interest margin-operating basis(6)................... 2.88% 2.79% ----- ----- Ratio of interest-earning assets to interest-bearing liabilities................ .98x 1.00x ===== ===== YEAR ENDED DECEMBER 31, --------------------------------- 1997 --------------------------------- AVERAGE YIELD/ BALANCE INTEREST RATE ----------- ---------- ------ Interest-earning assets: Interest-earning deposits.... $ 32,261 $ 5,392 16.71% Investment securities available-for-sale(1)...... 1,566,975 102,123 6.77 Investment securities held-to-maturity........... 3,902,940 279,900 7.18 Net loans(2)(3).............. 10,138,964 791,362 7.82 ----------- ---------- ----- Total interest-earning assets..................... 15,641,140 1,178,777 7.57 Non-interest-earning assets..................... 689,618 -- -- ----------- ---------- ----- Total assets............. $16,330,758 $1,178,777 7.25 =========== ---------- ----- Interest-bearing liabilities: Deposits: Demand deposit and NOW accounts................. $ 1,157,372 $ 7,967 .69 Savings accounts........... 1,946,404 58,974 3.03 Money market accounts...... 834,933 33,719 4.04 Certificates of deposit.... 5,069,113 278,153 5.49 ----------- ---------- ----- Total deposits........... 9,007,822 378,813 4.21 Total borrowings............. 6,164,004 367,882 5.97 ----------- ---------- ----- Total interest-bearing liabilities . . 15,171,826 746,695 4.92 Non-interest-bearing liabilities................ 220,047 -- -- ----------- ---------- ----- Total liabilities........ 15,391,873 746,695 4.85 Stockholders' equity......... 938,885 -- -- =========== ---------- ----- Total liabilities and stockholders' equity... $16,330,758 $ 746,695 4.57 =========== ---------- ----- Net interest net spread(4)... 2.68% ===== Net interest income/net interest margin(5)......... $ 432,082 2.79% ========== ===== Net interest margin-operating basis(6)................... 2.79% ----- Ratio of interest-earning assets to interest-bearing liabilities................ 1.03x =====
- ------------------ (1) The tax equivalent adjustments for the years ended December 31, 1999, 1998 and 1997 were $9.7 million, $8.1 million and $3.9 million, respectively, and are based on an effective tax rate of 35%. (2) Amortization of net fees of $10.4 million, $2.6 million and $4.8 million for the years ended December 31, 1999, 1998 and 1997, respectively, are included in interest income. Average loan balances include non-accrual loans and loans held for sale. (3) The tax equivalent adjustments for the years ended December 31, 1999, 1998 and 1997, were $2.5 million, $1.1 million and $1.0 million, respectively, and are based on an effective tax rate of 35%. (4) Represents the difference between the yield on total assets and the cost of total liabilities and stockholders' equity. (5) Represents tax equivalent net interest income divided by average interest-earning assets. (6) Represents net interest margin adjusted to eliminate the negative impact from escrowed financing proceeds relating to the pending acquisition of Sovereign Bank New England. Sovereign was required to raise $1.8 billion of debt and equity capital by December 15, 1999. Substantially all of the proceeds were required to be escrowed with limited ability to reinvest between closing of the financings and the assumption of the FleetBoston branches. 13 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, --------------------------------------------------------------- 1999 VS. 1998 1998 VS. 1997 INCREASE/(DECREASE) INCREASE/(DECREASE) ------------------------------ ------------------------------ VOLUME RATE TOTAL VOLUME RATE TOTAL -------- -------- -------- -------- -------- -------- Interest-earning assets: Interest-earning deposits.............. $ (5,407) $ 2,731 $ (2,676) $ 4,033 $ (2,028) $ 2,005 Investment securities available-for-sale................... 245,439 13,800 259,239 180,520 1,749 182,269 Investment securities held-to-maturity..................... (78,567) (4,119) (82,686) (98,450) 1,049 (97,401) Net loans(1)........................... 101,069 (22,988) 78,081 75,432 14,289 89,721 -------- -------- Total interest-earning assets............ 251,958 176,594 -------- -------- Interest-bearing liabilities: Deposits............................... 52,548 (64,793) (12,245) 71,219 (9,732) 61,487 Borrowings............................. 166,549 (23,390) 143,159 74,017 (20,440) 53,577 -------- -------- Total interest-bearing liabilities....... 130,914 115,064 -------- -------- Net change in net interest income........ $ 43,437 $ 77,607 $121,044 $ 16,299 $ 45,231 $ 61,530 ======== ======== ======== ======== ======== ========
- ------------------ (1) Includes non-accrual loans and loans held for sale. Provision for Loan Losses. The provision for loan loss expense is based upon credit loss experience and on estimation of losses inherent in the current loan portfolio. The provision for loan losses for 1999 was $30.0 million compared to $28.0 million for 1998. Over the last few years, through several strategic acquisitions and internal restructuring initiatives, Sovereign has diversified its lending efforts and increased its emphasis on providing its customers with small business loans and an expanded line of commercial and consumer products, such as asset-based lending and automobile loans. As a result of the increased risk inherent in these loan products, and as Sovereign continues to place emphasis on commercial and consumer lending in future years, management will regularly evaluate its loan portfolio and record additional loan loss allowance as is necessary. Historically, Sovereign's additions to its loan loss allowance (through income statement charges and acquisition accounting) have been sufficient to absorb the incremental credit risk in its loan portfolio. During 1998, Sovereign established an initial loan loss allowance of $20.5 million related to $725 million of loans acquired in connection with its CoreStates branch acquisition. Excluding charge-offs of $7.0 million incurred as part of an accelerated disposition of non-performing residential loans during the second and fourth quarters of 1999, as shown in Table 3 on the next page, the 1999 loan loss provision is in excess of net charge-offs. Sovereign's net charge-offs for 1999 were $35.6 million and consisted of charge-offs of $55.0 million and recoveries of $19.4 million. This compares to 1998 net charge-offs of $33.6 million consisting of charge-offs of $46.3 million and recoveries of $12.7 million. The ratio of net loan charge-offs to average loans, including loans held for sale, was .29% for 1999, compared to .30% for 1998 and .18% for 1997. Commercial loan net charge-offs as a percentage of average commercial loans were .11% for 1999, compared to .14% for 1998 and .14% for 1997. Consumer loan net charge-offs as a percentage of average consumer loans were .48% for 1999, compared to .80% for 1998 and .55% for 1997. Residential real estate mortgage loan net charge-offs as a percentage of average residential mortgage loans, including loans held for sale, were .23% for 1999, .08% for 1998, and .11% for 1997. Sovereign's increased level of consumer and commercial loan charge-offs in 1998 was primarily related to Sovereign's acquisition activity during the two preceding years and principally the result of higher indirect automobile loan charge-offs, substantially all of which are related to Sovereign's acquisition of Fleet Financial Group, Inc.'s ("Fleet") Auto Finance Division ("Fleet Auto") during 1997. The increased level of residential mortgage loan net charge-offs were the result of the $7.0 million accelerated net charge-offs previously described. In Sovereign's experience, a strategy that involves the accelerated resolution of certain problem assets is more appropriate than a long-term workout approach. 14 Table 3 presents the activity in the allowance for loan losses for the years indicated (in thousands): TABLE 3: RECONCILIATION OF THE ALLOWANCE FOR LOAN LOSSES
DECEMBER 31, -------------------------------------------------------------- 1999 1998 1997 1996 1995 -------- -------- -------- ------- ------- Allowance, beginning of year.................... $133,802 $116,823 $ 73,847 $67,515 $64,611 Charge-offs: Residential(1)................................ 14,038 6,223 8,869 11,016 9,546 Commercial.................................... 4,659 3,220 3,687 5,846 2,563 Consumer...................................... 36,326 36,887 11,628 2,079 962 -------- -------- -------- ------- ------- Total charge-offs........................... 55,023 46,330 24,184 18,941 13,071 -------- -------- -------- ------- ------- Recoveries: Residential................................... 1,629 1,134 1,040 1,376 923 Commercial.................................... 1,429 839 2,264 133 201 Consumer...................................... 16,350 10,715 2,079 363 227 -------- -------- -------- ------- ------- Total recoveries............................ 19,408 12,688 5,383 1,872 1,351 -------- -------- -------- ------- ------- Charge-offs, net of recoveries.................. 35,615 33,642 18,801 17,069 11,720 Provision for loan losses....................... 30,000 27,961 41,125 22,685 13,119 Acquired allowance and other additions(2)....... 4,799 22,660 20,652 716 1,505 -------- -------- -------- ------- ------- Allowance, end of year.......................... $132,986 $133,802 $116,823 $73,847 $67,515 ======== ======== ======== ======= ======= Charge-offs, net of recoveries to average total loans......................................... .285% .300% .184% .193% .159% ======== ======== ======== ======= =======
- ------------------ (1) The 1999 residential charge-offs include $7.0 million of charge-offs incurred as part of accelerated dispositions of non-performing residential loans sold during the second and fourth quarters of 1999. (2) For 1999, acquired allowance relate entirely to Sovereign's June 1999 acquisition of Peoples Bancorp, Inc. For 1998, acquired allowance and other additions include $20.5 million of loan loss allowance established in connection with the CoreStates branch acquisition. For 1997, acquired allowance and other additions represent $22.0 million of loan loss allowance established as part of the Fleet Auto acquisition, partially off-set by net charge-offs of $2.7 million related to First State for the three-month period ended December 31, 1996 resulting from the differing fiscal year end of First State. Sovereign's policy for charging off loans varies with respect to the category of loans and specific circumstances surrounding each loan under consideration. Consumer loans are generally charged off when deemed to be uncollectible or 120 days past due, whichever comes first. Charge-offs of commercial loans and residential real estate mortgage loans are made on the basis of management's ongoing evaluation of non-performing loans. Other Income. Total other income was $130 million for 1999 compared to $105 million for 1998. Several factors contributed to the increase in other income as discussed below. Retail banking fees were $49.2 million for 1999 compared to $31.1 million for 1998. This increase was primarily due to an increase in the number of Sovereign's transaction accounts and active fee collection efforts due in part to customer relationships acquired in the CoreStates and Peoples' acquisitions. Mortgage banking revenues were $29.9 million for 1999 compared to $28.2 million for 1998. At December 31, 1999, Sovereign serviced $10.2 billion of its own loans and $5.7 billion of loans for others. This compares to $9.2 billion of its own loans and $6.7 billion of loans for others at December 31, 1998. Loan fees and service charges were $8.9 million for 1999 compared to $7.1 million for 1998. Loan fees and service charges relate primarily to Sovereign's non-residential loan portfolios, and the growth period to period is the result of growth in the commercial and consumer loan portfolios due to internal growth and acquisitions. 15 Net gains on sales of loans and investment securities were $4.3 million for 1999 compared to $19.8 million for 1998, which included net investment security gains of $3.7 million and $15.8 million, and net gains on sales of loans of $0.6 million and $4.0 million in 1999 and 1998, respectively. This decrease was in part due to a net gain of $2.8 million resulting from the sale of Sovereign's credit card portfolio during the second quarter of 1998, and gains on sales of investment securities available-for-sale during 1998. Income from bank-owned life insurance ("BOLI") was $22.8 million for 1999 compared to $12.6 million for 1998. This increase was primarily due to an additional investment in BOLI, which was made during the first quarter of 1999. General and Administrative Expenses. Total general and administrative expenses were $393 million for 1999 compared to $327 million. Included in 1998 total general and administrative expenses were $49.9 million of merger-related charges. The increase in general and administrative expenses for 1999 was primarily due to Sovereign's overall franchise growth (including the full year impact of the CoreStates branch acquisition completed September 4, 1998, and inclusion of the Peoples acquisition from June 30, 1999), $30.8 million of merger, integration and other charges related to Sovereign's recent and pending acquisitions, and start-up costs related to the formation of Sovereign's Capital Markets Group and 1stwebbankdirect.com during the fourth quarter of 1999. The remaining increase in expenses are related to Sovereign's Year 2000 and other technology initiatives, and expansion in its corporate banking business line during the year. Included in 1998 total general and administrative expenses were $49.9 million of merger-related charges. Sovereign's efficiency ratio (all operating general and administrative expenses as a percentage of net interest income and recurring non-interest income) for 1999 was 48.6% compared to 46.6% for 1998. Other Operating Expenses. Total other operating expenses were $53.5 million for 1999 compared to $32.3 million for 1998. Other operating expenses included amortization of goodwill and other intangible assets of $38.0 million for 1999 compared to $20.6 million for 1998, Trust Preferred Securities expense of $15.4 million for 1999 compared to $12.5 million for 1998, and other net real estate owned ("OREO") losses of $95,000 for 1999 compared to net OREO gains of $804,000 for 1998. This increase in amortization expense for goodwill and other intangible assets is due to Sovereign's September 1998 CoreStates branch acquisition. Trust Preferred Securities expense increased due to the issuance of additional securities in November. Income Tax Provision. The income tax provision was $89.3 million for 1999 compared to $74.8 million for 1998. The effective tax rate for 1999 was 33.2% compared to 35.4% for 1998. The effective tax rate for 1999 includes the effect of Sovereign's increased investment in BOLI during the first quarter of 1999. For additional information with respect to Sovereign's income taxes, see Note 15 in the "Notes to Consolidated Financial Statements" hereof. FINANCIAL CONDITION Loan Portfolio. Sovereign's loan portfolio at December 31, 1999 was $14.2 billion compared to $11.3 billion at December 31, 1998. Sovereign's loan portfolio has increased as a result of strong originations during the year. With its increased focus on non-residential lending and Sovereign's acquisition activity over the past few years, at December 31, 1999, Sovereign's total loan portfolio included $4.1 billion of commercial loans and $4.5 billion of consumer loans, including $2.0 billion of outstanding home equity loans secured primarily by second mortgages on owner-occupied one-to-four family residential properties and $1.9 billion of auto loans. This compares to $2.3 billion of commercial loans and $3.8 billion of consumer loans, including $1.8 billion of outstanding home equity loans and $1.5 billion of auto loans, at December 31, 1998. Additionally, at December 31, 1999, Sovereign has extended $1.0 billion and $572 million of unused commitments for commercial loans and home equity lines of credit, respectively. At December 31, 1999, Sovereign's total loan portfolio included $5.6 billion of first mortgage loans secured primarily by liens on owner-occupied one-to-four family residential properties compared to $5.1 billion at December 31, 1998. Over the past few years, Sovereign has increased its emphasis on commercial and consumer loan originations evidenced by $3.2 billion of commercial loans closed during 1999, compared to $1.3 billion of 16 commercial loans closed during 1998. This increase was due to strong business loan demand in Sovereign's market area resulting from a strong regional economy, recent bank mergers affecting the region, significant staffing increases in Sovereign's commercial banking unit, and Sovereign's recent acquisitions. Sovereign closed $2.3 billion of consumer loans during 1999 compared to $2.0 billion of consumer loans for 1998. This increase was primarily the result of home equity loan originations of approximately $492 million and indirect auto loan originations of approximately $735 million during 1999. Total production of first mortgage loans was $2.9 billion in 1999 of which $1.6 billion were fixed rate and sold in the secondary market. This compares to first mortgage loan closings of $2.1 billion and $1.9 billion of fixed rate loans sold for 1998. Table 4 presents the composition of Sovereign's loan portfolio by type of loan and by fixed and variable rates at the dates indicated (in thousands): TABLE 4: COMPOSITION OF LOAN PORTFOLIO
AT DECEMBER 31, -------------------------------------------------------------------------------------------- 1999 1998 1997 1996 --------------------- --------------------- --------------------- -------------------- BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT ----------- ------- ----------- ------- ----------- ------- ---------- ------- Residential real estate loans........ $ 5,623,295 39.5% $ 5,113,537 45.3% $ 6,634,271 58.6% $7,381,820 76.9% Residential construction loans............... 59,264 .4 62,536 .6 137,367 1.2 136,436 1.4 ----------- ----- ----------- ----- ----------- ----- ---------- ----- Total Residential Loans............. 5,682,559 39.9 5,176,073 45.9 6,771,638 59.8 7,518,256 78.3 ----------- ----- ----------- ----- ----------- ----- ---------- ----- Commercial real estate loans........ 1,516,953 10.7 887,938 7.9 664,943 5.9 511,071 5.3 Commercial loans..... 1,690,744 11.8 717,440 6.4 356,517 3.1 262,840 2.7 Automotive floor plan loans............... 730,623 5.2 578,147 5.1 279,757 2.5 -- -- Multi-family loans... 137,019 1.0 115,195 1.0 115,570 1.0 109,774 1.2 ----------- ----- ----------- ----- ----------- ----- ---------- ----- Total Commercial Loans............. 4,075,339 28.7 2,298,720 20.4 1,416,787 12.5 883,685 9.2 ----------- ----- ----------- ----- ----------- ----- ---------- ----- Home equity loans.... 1,957,945 13.8 1,750,883 15.5 1,050,304 9.3 800,559 8.3 Auto loans........... 1,936,980 13.6 1,510,676 13.4 1,553,318 13.7 73,393 .8 Loans to automotive lessors............. 288,636 2.0 252,856 2.2 267,033 2.3 -- -- Student loans........ 249,279 1.8 256,744 2.3 190,440 1.7 211,358 2.2 Credit cards......... -- -- -- -- 54,887 .5 82,798 .9 Other................ 35,802 .2 39,888 .3 19,715 .2 25,446 .3 ----------- ----- ----------- ----- ----------- ----- ---------- ----- Total Consumer Loans............. 4,468,642 31.4 3,811,047 33.7 3,135,697 27.7 1,193,554 12.5 ----------- ----- ----------- ----- ----------- ----- ---------- ----- Total Loans......... $14,226,540 100.0% $11,285,840 100.0% $11,324,122 100.0% $9,595,495 100.0% =========== ===== =========== ===== =========== ===== ========== ===== Total Loans with:(1) Fixed rates......... $ 8,707,951 61.2 $ 5,798,158 51.4% $ 4,548,951 40.2% $2,180,356 22.7% Variable rates...... 5,518,589 38.8 5,487,682 48.6 6,775,171 59.8 7,415,139 77.3 ----------- ----- ----------- ----- ----------- ----- ---------- ----- Total Loans....... $14,226,540 100.0% $11,285,840 100.0% $11,324,122 100.0% $9,595,495 100.0% =========== ===== =========== ===== =========== ===== ========== ===== AT DECEMBER 31, -------------------- 1995 -------------------- BALANCE PERCENT ---------- ------- Residential real estate loans........ $6,059,064 79.8% Residential construction loans............... 116,110 1.6 ---------- ----- Total Residential Loans............. 6,175,174 81.4 ---------- ----- Commercial real estate loans........ 358,334 4.7 Commercial loans..... 166,712 2.2 Automotive floor plan loans............... -- -- Multi-family loans... 130,819 1.7 ---------- ----- Total Commercial Loans............. 655,865 8.6 ---------- ----- Home equity loans.... 648,033 8.5 Auto loans........... 14,267 .2 Loans to automotive lessors............. -- -- Student loans........ 14,232 .2 Credit cards......... 32,274 .4 Other................ 51,262 .7 ---------- ----- Total Consumer Loans............. 760,068 10.0 ---------- ----- Total Loans......... $7,591,107 100.0% ========== ===== Total Loans with:(1) Fixed rates......... $1,896,384 25.0% Variable rates...... 5,694,723 75.0 ---------- ----- Total Loans....... $7,591,107 100.0% ========== =====
- ------------------ (1) Loan totals do not reflect the impact of off-balance sheet interest rate swaps used for interest rate risk management as discussed in "Management's Discussion and Analysis--Asset and Liability Management." 17 Table 5 presents the contractual maturity of Sovereign's commercial loans at December 31, 1999 (in thousands): TABLE 5: LOAN MATURITY SCHEDULE
AT DECEMBER 31, 1999, MATURING ------------------------------------------------------ IN ONE YEAR AFTER ONE YEAR AFTER OR LESS FIVE YEARS FIVE YEARS TOTAL ----------- -------------- ---------- ---------- Commercial real estate loans................ $164,561 $ 491,530 $ 860,862 $1,516,953 Commercial loans............................ 656,954 582,022 451,768 1,690,744 Automotive floor plans loans................ 129,596 509,191 91,836 730,623 Multi-family loans.......................... 1,571 35,345 100,103 137,019 -------- ---------- ---------- ---------- Total..................................... $952,682 $1,618,088 $1,504,569 $4,075,339 ======== ========== ========== ========== Loans with: Fixed rates............................... $327,493 $ 880,465 $ 935,920 $2,143,878 Variable rates............................ 625,189 737,623 568,649 1,931,461 -------- ---------- ---------- ---------- Total.................................. $952,682 $1,618,088 $1,504,569 $4,075,339 ======== ========== ========== ==========
Sovereign's recent strategic acquisitions, coupled with expanded origination capacity, accelerated Sovereign's transition in becoming a Super Community Bank by increasing consumer and commercial loans to 60% of total loans in 1999, up from 54% in 1998. Commercial loan credit quality remains strong and the commercial loan division's growing portfolio is regularly examined for quality by an experienced internal credit review team. Larger commercial loans are allocated loan loss allowance based upon individual asset risk assessments. Credit Risk Management. Extending credit exposes Sovereign to credit risk, which is the risk that the principal balance of a loan and any related interest will not be collected due to the inability of the borrower to repay the loan. Sovereign manages credit risk in the loan portfolio through adherence to consistent standards, guidelines and limitations established by the Board of Directors. Written loan policies establish underwriting standards, lending limits and other standards or limits as deemed necessary and prudent. Various approval levels, based on the amount of the loan and whether the loan is secured or unsecured, have also been established. Loan approval authority ranges from the individual loan officer to the Board of Directors' Loan Committee. The Loan Review group conducts ongoing, independent reviews of the lending process to ensure adherence to established policies and procedures, monitors compliance with applicable laws and regulations, provides objective measurement of the risk inherent in the loan portfolio, and ensures that proper documentation exists. The results of these periodic reviews are reported to the Asset Review Committee, and to the Board of Directors of both Sovereign and Sovereign Bank. In response to Sovereign's increased emphasis on commercial and consumer lending, Sovereign has added to its loan review group by hiring loan review officers with significant commercial and consumer experience. Sovereign also maintains a watch list for certain loans identified as requiring a higher level of monitoring by management because of one or more factors, such as economic conditions, industry trends, nature of collateral, collateral margin, payment history, or other factors. The following discussion summarizes the underwriting policies and procedures for the major categories within the loan portfolio and address Sovereign's strategies for managing the related credit risk. Commercial Loans. Credit risk associated with commercial loans is primarily influenced by prevailing and expected economic conditions and the level of underwriting risk Sovereign is willing to assume. To manage credit risk when extending commercial credit, Sovereign focuses on both assessing the borrower's ability to repay and on obtaining sufficient collateral. Commercial and industrial loans are generally secured by the borrower's assets and by personal guarantees. Commercial Real Estate loans are originated primarily within the Pennsylvania, New Jersey, and New England market areas and are secured by developed real 18 estate at conservative loan-to-values and often by a guarantee of the borrower. Management closely monitors the composition and quality of the total commercial loan portfolio to ensure that significant credit concentrations by borrower or industry do not exist. Consumer Loans. Credit risk in the direct consumer loan portfolio is controlled by strict adherence to conservative underwriting standards that consider debt to income levels and the creditworthiness of the borrower and, if secured, collateral values. In the home equity loan portfolio, combined loan-to-value ratios are generally limited to 80% or credit insurance is purchased to limit exposure. Other credit considerations may warrant higher combined loan-to-value ratios for approved loans. The portion of the consumer portfolio which is secured by real estate, vehicles, deposit accounts or government guarantees comprises 93% of the entire portfolio. Residential Loans. Sovereign originates fixed rate and adjustable rate residential mortgage loans which are secured by the underlying 1-4 family residential property. At December 31, 1999 and 1998, residential loans accounted for 40% and 46% respectively, of the total loan portfolio. This decrease was the outcome of Sovereign's increased emphasis on commercial and consumer lending. Credit risk exposure in this area of lending is minimized by the evaluation of the creditworthiness of the borrower, including debt-to-equity ratios, credit scores, and adherence to underwriting policies that emphasize conservative loan-to-value ratios of generally no more than 80%. Residential mortgage loans granted in excess of the 80% loan-to-value ratio criterion are generally insured by private mortgage insurance, unless otherwise guaranteed or insured by the Federal, state or local government. Sovereign also utilizes underwriting standards which comply with those of the Federal Home Loan Mortgage Corporation ("FHLMC") or the Federal National Mortgage Association ("FNMA"). Credit risk is further reduced since a portion of Sovereign's fixed rate mortgage loan production and all of its sub-prime mortgage loan production is sold to investors in the secondary market without recourse. Collections. Sovereign closely monitors delinquencies as another means of maintaining high asset quality. Collection efforts begin within 15 days after a loan payment is missed by attempting to contact all borrowers and to offer a variety of loss mitigation alternatives. If these attempts fail, Sovereign will proceed to gain control of any and all collateral in a timely manner in order to minimize losses. While liquidation and recovery efforts continue, officers continue to work with the borrowers, if appropriate, to recover all monies owed to Sovereign. Sovereign monitors delinquency trends at 30, 60, and 90 days past due. These trends are discussed at the monthly Committee meetings. Minutes from these meetings are submitted to the Board of Directors of Sovereign Bank. Approximately $168 million, or 1.18%, of the loans in the loan portfolio at December 31, 1999, were 30 to 89 days delinquent, compared to $231 million, or 2.05% of portfolio loans, at December 31, 1998. Sovereign also maintains a watch list for loans identified as requiring a higher level of monitoring by management because of one or more factors, such as economic conditions, industry trends, nature of collateral, collateral margin, payment history or other factors. Non-Performing Assets. At December 31, 1999, Sovereign's non-performing assets were $84 million compared to $116 million at December 31, 1998. Non-performing assets as a percentage of total assets was .32% at December 31, 1999 compared to .53% at December 31, 1998. This decrease, both in dollars and as a percent of total assets, is a result in part of the aforementioned non-performing asset sales in the second and fourth quarters of 1999 and an active non-performing loan management program. At December 31, 1999, 47% of non-performing assets consisted of loans related to real estate or OREO. Another 4% of non-performing assets consist of indirect auto loans and other repossessed assets. Indirect auto loans delinquent in excess of 120 days carry an allowance allocation of 100%. Repossessed autos carry an allowance allocation of 50%. The remainder of Sovereign's non-performing assets consist principally of consumer loans, many of which are secured by collateral. Sovereign places all loans 90 days or more delinquent (except auto loans and loans guaranteed by the government or secured by deposit accounts) on non-performing status. Sovereign's auto loans continue to accrue interest until they are 120 days delinquent, at which time they are placed on non-accrual status and a 100% allowance allocation is assigned. 19 Table 6 presents the composition of non-performing assets at the dates indicated (in thousands): TABLE 6: NON-PERFORMING ASSETS
AT DECEMBER 31, --------------------------------------------------- 1999 1998 1997 1996 1995 ------- -------- -------- -------- -------- Non-accrual loans: Past due 90 days or more as to interest or principal: Real estate related............................. $36,510 $ 63,258 $ 65,930 $ 78,715 $81,571 Other........................................... 36,923 33,297 22,368 19,671 11,721 Past due less than 90 days as to interest or principal: Real estate related............................. -- -- 555 639 3,884 Other........................................... -- -- -- 160 739 ------- -------- -------- -------- -------- Total non-accrual loans............................. 73,433 96,555 88,853 99,185 97,915 Other............................................... 1,978 3,404 6,524 -- -- Restructured loans.................................. 3,755 141 327 1,561 3,772 ------- -------- -------- -------- -------- Total non-performing loans.......................... 79,166 100,100 95,704 100,746 101,687 Other real estate owned and other repossessed assets: Residential real estate owned..................... 2,344 12,147 11,299 13,669 9,988 Commercial real estate owned...................... 1,223 665 710 4,380 11,676 Other repossessed assets.......................... 1,762 2,772 -- -- -- ------- -------- -------- -------- -------- Total other real estate owned and other repossessed assets............................................ 5,329 15,584 12,009 18,049 21,664 ------- -------- -------- -------- -------- Total non-performing assets......................... $84,495 $115,684 $107,713 $118,795 $123,351 ======= ======== ======== ======== ======== Past due 90 days or more as to interest or principal and accruing interest(1).......................... $10,238 $ 9,975 $ 7,053 $ 16,722 $ 2,299 Non-performing assets as a percentage of total assets............................................ .32% .53% .61% .78% .94% Non-performing loans as a percentage of total loans............................................. .56 .89 .85 1.05 1.34 Non-performing assets as a percentage of total loans and other real estate owned....................... .65 1.08 1.01 1.41 1.65 Allowance for loan losses as a percentage of total non-performing assets............................. 152.4 111.5 103.7 58.5 53.5 Allowance for loan losses as a percentage of total non-performing loans.............................. 162.7 128.9 116.7 69.0 65.0
- ------------------ (1) Non-performing assets past due 90 days or more as to interest or principal and accruing interest include government guaranteed student loans of $8.3 million, $6.6 million, $6.7 million and $10.5 million at December 31, 1999, 1998, 1997, and 1996 respectively, and also included are auto loans past due between 90 and 120 days of $1.9 million, and $3.4 million at December 31, 1999 and 1998, respectively. Impaired Loans. At December 31, 1999 and 1998, the gross recorded investment in impaired loans totaled $108 million and $63.3 million, respectively. The increase in the investment in impaired loans at December 31, 1999 compared to December 31, 1998 was primarily the result of Sovereign's recent balance sheet transformation strategy which places more emphasis on building the commercial and consumer loan portfolios. Along with higher yields, these loan types also bring greater risk of impairment, especially as the portfolio becomes more seasoned. Sovereign classifies all commercial loans that are greater than 90 days delinquent on non-accrual status, and classifies certain criticized loans as impaired. Impaired loans includes a significant portion of potential problem loans discussed in a following paragraph. These are primarily commercial loans that have been classified internally but are not necessarily 90 days delinquent. Gross interest income for the years ended December 31, 1999, 1998 and 1997 would have increased by approximately $5.0 million, $9.5 million and $7.5 million, respectively, had Sovereign's period end non-accruing and restructured loans been current in accordance with their original terms and outstanding throughout the period. Interest income recorded on these loans for the years ended December 31, 1999, 1998, and 1997 was $2.1 million, $3.3 million and $2.4 million, respectively. 20 Potential problem loans (consisting of loans for which management has doubts as to the ability of such borrowers to comply with present repayment terms, although not currently classified as non-performing loans) amounted to approximately $95.9 million at December 31, 1999 and consisted principally of commercial loans. Allowance for Loan Loss. The adequacy of Sovereign's allowance for loan losses is regularly evaluated. Management's evaluation of the adequacy of the allowance to absorb potential loan losses takes into consideration the risks inherent in the loan portfolio, past loan loss experience, specific loans which have loss potential, geographic and industry concentrations, delinquency trends, economic conditions, the level of originations and other relevant factors. Management also considers loan quality, changes in the size and character of the loan portfolio, consultation with regulatory authorities, amount of non-performing loans, delinquency trends, economic conditions and industry trends when determining the allowance. At December 31, 1999, Sovereign's loan delinquencies (all loans greater than 30 days delinquent) as a percentage of total loans was 1.79% compared to 2.95% at December 31, 1998. This decrease was primarily attributable to Sovereign's business decision to accelerate the disposition of certain non-performing residential mortgage loans, as well as improved collections efforts for its loan portfolio. Overall, management believes delinquencies, charge-offs and non-performing statistics are improved compared to previous years because of changes in Sovereign's underwriting and credit monitoring process during 1999, and the fact in the current year versus prior year, a larger percentage of Sovereign's loan portfolio (primarily indirect and commercial loans) represents internally generated loans that were underwritten using Sovereign's own underwriting policy. At December 31, 1998, Sovereign's loan portfolio was 46% residential, 34% consumer and 20% commercial. At December 31, 1999, Sovereign's loan portfolio was 40% residential, 31% consumer and 29% commercial. Along with higher yields, management believes this shift in loan composition brings higher inherent risk. Table 7 summarizes Sovereign's allocation of the allowance for loan losses for allocated and unallocated allowances by loan type, and the percentage of each loan type of total portfolio loans (in thousands): TABLE 7: ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
AT DECEMBER 31, ------------------------------------------------------------------------------------ 1999 1998 1997 1996 ------------------- ------------------- ------------------- ------------------ % OF % OF % OF % OF LOANS TO LOANS TO LOANS TO LOANS TO TOTAL TOTAL TOTAL TOTAL AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS -------- -------- -------- -------- -------- -------- ------- -------- Allocated allowances: Commercial loans............. $ 58,784 29% $ 38,354 20% $ 30,793 12% $21,091 9% Residential real estate mortgage loans............. 19,535 40 22,427 46 36,351 60 25,835 78 Consumer loans............... 43,455 31 48,083 34 24,300 28 10,274 13 Unallocated allowances......... 11,212 n/a 24,938 n/a 25,379 n/a 16,647 n/a -------- -------- -------- ------- Total allowance for loan losses....................... $132,986 100% $133,802 100% $116,823 100% $73,847 100% ======== === ======== === ======== === ======= === AT DECEMBER 31, ------------------ 1995 ------------------ % OF LOANS TO TOTAL AMOUNT LOANS ------- -------- Allocated allowances: Commercial loans............. $13,753 9% Residential real estate mortgage loans............. 23,968 81 Consumer loans............... 6,748 10 Unallocated allowances......... 23,046 n/a ------- Total allowance for loan losses....................... $67,515 100% ======= ===
Sovereign maintains an allowance for loan losses sufficient to absorb inherent losses in the loan portfolio. As discussed in Credit Management, Sovereign believes the current allowance to be at a level adequate to cover such inherent losses. At December 31, 1999, the Company's total allowance was $133.0 million. The Company's total allowance at year-end equated to approximately 3.2 times the average charge-offs for the last three years and 4.5 times the average net charge-offs for the same three-year period. Because historical charge-offs are not necessarily indicative of future charge-off levels, the Company also gives consideration to other risk indicators when determining the appropriate allowance level. The allowance for loan losses consists of two elements: (i) an allocated allowance, which is comprised of allowances established on specific loans, and class allowances based on historical loan loss experience and current trends, and (ii) unallocated allowances based on both general economic conditions and other risk 21 factors in the Company's individual markets and portfolios, and to account for a level of imprecision in management's estimation process. The specific allowance element of the allocated allowance is based on a regular analysis of criticized loans where internal credit ratings are below a predetermined classification. This analysis is performed at the relationship manager level, and periodically reviewed by the loan review department. The specific allowance established for these criticized loans is based on a careful analysis of related collateral value, cash flow considerations and, if applicable, guarantor capacity. The class allowance element of the allocated allowance is determined by an internal loan grading process in conjunction with associated allowance factors. These class allowance factors are updated annually and are based primarily on actual historical loss experience, consultation with regulatory authorities, and peer groups loss experience. While this analysis is conducted annually, the Company has the ability to revise the class allowance factors whenever necessary in order to address improving or deteriorating credit quality trends or specific risks associated with a given loan pool classification. Regardless of the extent of the Company analysis of customer performance, portfolio evaluations, trends or risk management processes established, certain inherent, but undetected losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer's financial condition or changes in their unique business conditions; the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends; volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits; and the sensitivity of assumptions utilized to establish allocated allowances for homogeneous groups of loans among other factors. The Company maintains an unallocated allowance to recognize the existence of these exposures. These other risk factors are continuously reviewed and revised by management where conditions indicate that the estimates initially applied are different from actual results. A comprehensive analysis of the allowance for loan losses is performed by the Company on a quarterly basis. In addition, a review of allowance levels based on nationally published statistics is conducted on an annual basis. The Company has an Asset Review Committee, which has the responsibility of affirming allowance methodology and assessing the general and specific allowance factors in relation to estimated and actual net charge-off trends. This Committee is also responsible for assessing the appropriateness of the allowance for loan losses for each loan pool classification at Sovereign. Residential Portfolio. The allowance for the residential mortgage portfolio decreased from $22.4 million at December 31, 1998 to $19.5 million at December 31, 1999. The decrease was due primarily to the aforementioned sale of the non-performing loan portfolio during 1999, which enhanced the overall performance of the remaining portfolio. Consumer Portfolio. The allowance for the consumer loan portfolio decreased from $48.1 million at December 31, 1998 to $43.5 million at December 31, 1999, and is due to management's continual assessment of the credit quality of the consumer portfolio. Specifically, during 1999, the Company enhanced its underwriting and credit monitoring processes related to its indirect auto portfolio, which has resulted in a decrease in delinquencies outstanding to 2.23% of the December 31, 1999 portfolio from 4.95% of the December 31, 1998 portfolio. Charge-offs related to the indirect portfolio were .90% of the portfolio, down from 1.69% in 1998. Additionally, as acquired consumer portfolios continued to season and were exposed to Sovereign's credit monitoring and collection processes, Sovereign could accurately monitor loss statistics and the Company determined that the general reserve factors associated with such portfolios could be reduced. Commercial Portfolio. The portion of the allowance for loan losses related to the Commercial portfolio has increased $20.4 million, or 35%, to $58.8 million at December 31, 1999. This increase is primarily attributable to the significant growth in the commercial loan portfolio. 22 Unallocated Allowance. The decrease in the unallocated allowance versus the prior year is related to the Company's ability to reallocate the unallocated allowance to the various portfolios as a result of management's enhancement of its credit analysis, and favorable delinquency and non-performing statistics. Investment Securities. Sovereign's investment portfolio is concentrated in mortgage-backed securities and collateralized mortgage obligations issued by federal agencies or private label issues. The private label issues have ratings of "AAA" by Standard and Poor's and Fitch at the date of issuance. The classes are backed by single-family residential loans which are primary residences geographically dispersed throughout the United States. Sovereign purchases classes which are senior positions backed by subordinate classes. The subordinate classes absorb the losses and must be completely eliminated before any losses flow through the senior positions. Sovereign's strategy is to purchase classes which have an average life of four years or less. The effective duration of the total investment portfolio at December 31, 1999 was 3.6 years. Investment 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. For additional information with respect to the amortized cost and estimated fair value of Sovereign's investment securities available-for-sale, see Note 4 in the "Notes to Consolidated Financial Statements" hereof. The actual maturities of mortgage-backed securities available-for-sale will differ from contractual maturities because borrowers may have the right to put or repay obligations with or without put or prepayment penalties. Table 8 presents the book value, expected maturities and yields of Sovereign's investment securities available-for-sale at December 31, 1999 (in thousands): TABLE 8: INVESTMENT AND MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE
AT DECEMBER 31, 1999, DUE ----------------------------------------------------------------------------- AFTER 10 IN ONE YEAR ONE YEAR/ FIVE YEARS/ YEARS/ OR LESS FIVE YEARS TEN YEARS NO MATURITY TOTAL ----------- ---------- ----------- ----------- ---------- Investment Securities: U.S. Treasury and government agency securities....................... $ 34,812 $ 41,209 $ -- $ -- $ 76,021 5.18% 5.12% 5.15% Corporate securities............... -- -- 36,597 193,737 230,334 7.76% 8.47% 8.36% Asset-backed securities............ 137,309 365,421 122,888 38,506 664,124 6.85% 6.84% 6.90% 6.45% 6.83% Equities........................... -- -- -- 20,753 20,753 2.66% 2.66% FHLB stock......................... -- -- -- 524,397 524,397 6.50% 6.50% Agency preferred stock............. -- -- -- 429,628 429,628 7.88% 7.88% Municipal securities............... -- 715 1,520 29,944 32,179 4.87% 5.33% 5.07% 5.08% Mortgage-backed Securities: U.S. government agency passthroughs..................... 33,135 186,642 102,696 135,894 458,367 7.16% 7.01% 6.85% 6.75% 6.91% Non-agency passthroughs............ 205,943 1,263,993 563,193 522,854 2,555,983 6.83% 6.81% 6.78% 6.75% 6.79% Collateralized mortgage obligations...................... 281,309 1,625,889 637,457 493,771 3,038,426 6.58% 6.58% 6.60% 6.58% 6.58% -------- ---------- ---------- ---------- ---------- Total investment and mortgage-backed securities available-for-sale...... $692,508 $3,483,869 $1,464,351 $2,389,484 $8,030,212 ======== ========== ========== ========== ========== Weighted average yield............... 6.67% 6.70% 6.74% 6.94% 6.77% ======== ========== ========== ========== ==========
23 Investment 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"), and private issuers; and collateralized mortgage obligations. For additional information with respect to the amortized cost and estimated fair value of Sovereign's investment securities held-to-maturity, see Note 4 in the "Notes to Consolidated Financial Statements" hereof. The actual maturities of the mortgage-backed securities held-to-maturity will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties. Table 9 presents the book value, expected maturity and yields of Sovereign's investment securities held-to-maturity at December 31, 1999 (in thousands): TABLE 9: INVESTMENT AND MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY
AT DECEMBER 31, 1999, DUE --------------------------------------------------------------------------- IN ONE YEAR ONE YEAR/ FIVE YEARS/ AFTER OR LESS FIVE YEARS TEN YEARS TEN YEARS TOTAL ----------- ---------- ----------- --------- ---------- Investment Securities: U.S. Treasury and government agency securities......................... $ 1,137 $ 2,968 $ 509 $ 193 $ 4,807 6.22% 6.91% 6.70% 6.94% 6.73% Corporate securities(1).............. 1,289,567 2,503 32,783 1,974 1,326,827 6.02% 8.99% 10.25% 10.25% 6.14% Municipal securities................. 646 1,861 426 342 3,275 3.69% 5.06% 6.22% 6.80% 5.12% Mortgage-backed Securities: U.S. government agency passthroughs....................... 105,734 273,405 79,441 41,286 499,866 7.28% 7.29% 7.32% 7.36% 7.30% Non-agency passthroughs.............. 14,558 31,893 5,117 751 52,319 6.00% 6.12% 6.37% 6.74% 6.12% Collateralized mortgage obligations........................ 136,621 265,168 48,158 25,010 474,957 6.45% 6.71% 6.56% 6.74% 6.62% ---------- -------- -------- ------- ---------- Total investment and mortgage-backed securities held-to-maturity.......... $1,548,263 $577,798 $166,434 $69,556 $2,362,051 ========== ======== ======== ======= ========== Weighted Average Yield................. 6.14% 6.96% 7.64% 7.21% 6.48% ========== ======== ======== ======= ==========
- ------------------ (1) Corporate securities maturing in one year or less represents commercial paper obligations held in escrow pending completion of the Sovereign Bank New England acquisition. See LIQUIDITY AND CAPITAL RESOURCES for a more complete discussion of the financings completed to fund the acquisition and the escrow requirements of certain of the agreements. Table 10 presents the book value of investment securities by obligation (dollars in thousands): TABLE 10: INVESTMENT SECURITIES BY OBLIGOR
AT DECEMBER 31, ------------------------------------ 1999 1998 1997 ---------- ---------- ---------- Investment securities available-for-sale: U.S. Treasury and government agency securities........... $ 964,016 $ 660,649 $ 932,126 State and municipal securities........................... 32,179 35,046 -- Other securities......................................... 7,034,017 5,966,732 1,024,136 ---------- ---------- ---------- Total investment securities available-for-sale........... $8,030,212 $6,662,427 $1,956,262 ========== ========== ========== Investment securities held-to-maturity: U.S. Treasury and government agency securities........... $ 504,673 $ 732,754 $1,090,677 State and municipal securities........................... 3,275 8,064 2,302 Other securities......................................... 1,854,103 1,098,837 2,323,472 ---------- ---------- ---------- Total investment securities held-to-maturity............. $2,362,051 $1,839,655 $3,416,451 ========== ========== ==========
24 Table 11 presents the 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 stockholders' equity which were held by Sovereign at December 31, 1999 (in thousands): TABLE 11: INVESTMENT SECURITIES OF SINGLE ISSUERS
AT DECEMBER 31, 1999 ------------------------------ AMORTIZED COST FAIR VALUE -------------- ---------- Cendant Mortgage............................................ $ 487,580 $ 478,740 CMSI........................................................ 242,859 236,486 Countrywide Home Loans, Inc................................. 617,291 590,863 First Nationwide Trust...................................... 282,217 264,059 G.E. Capital Mortgage Servicing, Inc........................ 853,456 822,066 Norwest Asset Securities Corporation........................ 846,824 799,073 PNC Mortgage Securities Corporation......................... 1,172,930 1,113,071 Residential Asset Securitization Trust...................... 345,923 332,828 Residential Funding Corporation............................. 855,186 828,141 Structured Asset Securities Corporation..................... 429,064 405,685 ---------- ---------- Total..................................................... $6,133,330 $5,871,012 ========== ==========
Other Assets. At December 31, 1999, premises and equipment, net of accumulated depreciation, was $119 million compared to $98.5 million at December 31, 1998. This increase was primarily attributable to Sovereign's acquisitions of Peoples and Network during the second quarter of 1999. Total goodwill and other intangible assets at December 31, 1999 were $434 million compared to $426 million at December 31, 1998. This increase was also attributable to Sovereign's acquisitions of Peoples and Network, which added approximately $45 million of goodwill and other intangibles to Sovereign's balance sheet. Sovereign's increase in other assets during 1999 was primarily attributable to the purchase of $150 million of BOLI during the year, and associated $23 million of earnings on the entire $413 million BOLI portfolio. Deposits. Deposits are attracted from within Sovereign's primary market area through the offering of various deposit instruments including demand and NOW accounts, money market accounts, savings accounts, certificates of deposit and retirement savings plans. Total deposits at December 31, 1999 were $11.7 billion compared to $12.3 billion at December 31, 1998. Table 12 presents the composition of Sovereign's deposits at the dates indicated (in thousands): TABLE 12: DEPOSIT PORTFOLIO COMPOSITION
AT DECEMBER 31, ----------------------------------------------------------------------- 1999 1998 1997 ---------------------- ---------------------- --------------------- % OF % OF % OF BALANCE DEPOSITS BALANCE DEPOSITS BALANCE DEPOSITS ----------- -------- ----------- -------- ---------- -------- Demand deposit and NOW accounts....... $ 2,667,731 22.8% $ 2,385,686 19.4% $1,334,852 14.0% Savings accounts...................... 2,142,708 18.3 2,295,448 18.6 1,900,334 20.0 Money market accounts................. 1,345,325 11.5 1,545,634 12.5 916,788 9.6 Retail certificates of deposit........ 4,708,057 40.2 5,172,196 42.0 4,673,467 49.1 ----------- ----- ----------- ----- ---------- ----- Total retail deposits............... 10,863,821 92.8 11,398,964 92.5 8,825,441 92.7 Jumbo certificates of deposit......... 855,825 7.2 923,752 7.5 689,853 7.3 ----------- ----- ----------- ----- ---------- ----- Total deposits...................... $11,719,646 100.0% $12,322,716 100.0% $9,515,294 100.0% =========== ===== =========== ===== ========== =====
Borrowings. Sovereign utilizes borrowings as a source of funds for its asset growth and its asset/liability management. Collateralized advances are available from the Federal Home Loan Bank of Pittsburgh ("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 investment securities. 25 Total borrowings at December 31, 1999 were $12.7 billion, of which $6.9 billion were short-term, compared to total borrowings of $7.9 billion, of which $3.9 billion were short-term, at December 31, 1998. The increase in FHLB advances is principally due to loan growth during the period being funded by borrowings. The increase in other borrowings is due to $700 million senior notes and $500 million senior secured credit facility, issued in November and December, 1999, in anticipation of the acquisition of Sovereign Bank New England. See the following Liquidity and Capital Resources section for a more complete description of these debt instruments. Table 13 presents information regarding Sovereign's borrowings at the dates indicated (in thousands): TABLE 13: BORROWINGS
AT DECEMBER 31, -------------------------------------------------------------------------------------- 1999 1998 1997 -------------------------- --------------------------- --------------------------- WEIGHTED WEIGHTED WEIGHTED BALANCE AVERAGE RATE BALANCE AVERAGE RATE BALANCE AVERAGE RATE ----------- ------------ ---------- -------------- ---------- -------------- Securities sold under repurchase agreements.......... $ 584,553 4.69% $ 655,540 5.46% $1,150,093 5.70% FHLB advances......... 10,484,904 5.43 6,901,505 5.14 5,525,399 5.93 Other borrowings...... 1,593,681 10.74 345,194 8.19 189,442 5.90 ----------- ----- ---------- ---- ---------- ---- Total borrowings.... $12,663,138 6.06% $7,902,239 5.30% $6,864,934 5.94% =========== ===== ========== ==== ========== ====
Through the use of interest rate swaps, $200 million of the FHLB advances at December 31, 1999 have been effectively converted from variable rate obligations to fixed rate obligations. An additional $1.1 billion of borrowings have been protected from upward repricing through the use of interest rate caps. 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 securities and other qualifying investments. Regulations currently in effect require Sovereign Bank to maintain liquid assets of not less than 4% of its net withdrawable accounts plus short-term borrowings. These levels are changed from time to time by the Office of Thrift Supervision (OTS) to reflect economic conditions. Sovereign Bank's liquidity ratio for December 1999 was 42.6%. 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. While the majority of Sovereign's certificate of deposit accounts are expected to mature within a one year period, historically, the retention rate has been approximately 70%. If a significant portion of maturing certificates would not renew at maturity, the impact on Sovereign's operations and liquidity would be minimal due to cash flows produced by Sovereign's investment portfolio which approximate $100 million per month. Sovereign Bank can also borrow from the FHLB, subject to required collateralization. Other sources of funds include operating activities, repayments of principal on investment securities, repayment of principal on loans and other investing activities. Sovereign also maintains strong relationships with numerous investment banking firms, and has the ability to access the capital markets through a variety of products and structures, should liquidity or capital needs arise. Sovereign raised $1.8 billion of debt and equity in November and December 1999, to finance its pending acquisition of Sovereign Bank New England. Components of these financings were as follows: COMMON STOCK: 43.8 million shares of common stock were issued on November 15, 1999 resulting in net proceeds to Sovereign of $331.5 million. 26 PIERS UNITS: 5.75 million units of Trust Preferred Income Equity Redeemable Securities (PIERS) on November 15, 1999, resulting in net proceeds to Sovereign of $278.3 million, $91.5 million of which has been allocated to the value of the warrants and is treated as original issue discount. The original issue discount is accreted into Trust Preferred Securities expense over the life of the unit resulting in an effective yield of 11.74%. Each PIERS unit consists of: A preferred security issued by Sovereign Capital Trust II (the Trust), having a stated liquidation amount of $50, representing an undivided beneficial ownership interest in the Trust, which assets consist solely of debentures issued by Sovereign. Distributions are payable quarterly beginning February 15, 2000 at an annual rate of 7.5% of the stated liquidation value; and A warrant to purchase, subject to antidilution adjustments, 5.3355 shares of Sovereign common stock at any time prior to November 20, 2029. SENIOR NOTES: $200 million of 10.25% notes due May 15, 2004, and $500 million of 10.5% notes due November 15, 2006, on November 15, 1999 resulting in net proceeds to Sovereign of $681.3 million. The senior notes are unsecured senior obligations of Sovereign and rank equally with all existing and future senior indebtedness. SENIOR SECURED CREDIT FACILITY: $500 million floating rate senior secured credit facility resulting in net proceeds to Sovereign of $485.5 million on December 16, 1999. The senior secured credit facility is secured primarily by the stock of Sovereign Bank, which is wholly owned by Sovereign Bancorp. The senior facility will mature on the date six months prior to the maturity date of the 10.25% senior notes, but in no event later than June 30, 2003. The facility amortizes in quarterly installments in the following annual percentages of principal: 2000-5%, $25 million; 2001-15%, $75 million; 2002-40%, $200 million; and 2003-40%, $200 million with mandatory prepayments occurring if Sovereign's cash flow exceeds predetermined levels. Interest is calculated, at the option of the borrower, at LIBOR plus 3.5%, or the sum of a) the highest of (i) lender's base rate, (ii) .50% over lender's three month CD rate, or (iii) .50% over the Federal Funds Effective Rate, plus b) 2.50%. An amount sufficient to pay principal, premium and accrued interest of the Senior Notes and the Senior Secured Credit Facility is presently being held in escrow pending the completion of the final closing of the Sovereign Bank New England transaction. If the final closing does not occur, the amount in escrow plus accrued and unpaid interest will be refunded to investors. At December 31, 1999, investment securities held-to-maturity includes $1.3 billion of commercial paper of commercial obligors as required under the escrow agreements. On May 15, 1998, Sovereign redeemed all outstanding shares of its 6 1/4% Cumulative Convertible Preferred Stock, Series B. Cash and cash equivalents decreased $160 million for 1999. Net cash used by operating activities was $23.6 million for 1999. Net cash used by investing activities for 1999 was $3.6 billion consisting primarily of purchases of mortgage-backed securities, partially offset by proceeds from sales, repayments and maturities of investment securities and sales of loans. Net cash provided by financing activities for 1999 was $3.5 billion which was primarily attributable to an increase in long-term and short-term borrowings, offset somewhat by a decrease in retail and jumbo certificates of deposit. At December 31, 1999, Sovereign Bank was classified as well-capitalized and was in compliance with all capital requirements. For a detailed discussion on regulatory capital requirements, see Note 12 in the "Notes to Consolidated Financial Statements" hereof. The following table sets forth the capital ratios of Sovereign Bancorp and Sovereign Bank and the current regulatory requirements at December 31, 1999:
WELL SOVEREIGN SOVEREIGN MINIMUM CAPITALIZED BANCORP(1) BANK REQUIREMENT REQUIREMENT ---------- --------- ----------- ----------- Tangible capital to tangible assets................ 6.28% 8.20% 2.00% None Leverage (core) capital to tangible assets......... 7.52 8.20 3.00 5.00% Leverage (core) capital to risk-adjusted assets.... 11.72 13.69 4.00 6.00 Risk-based capital to risk-adjusted assets......... 14.89 14.55 8.00 10.00
- ------------------ (1) OTS capital regulations do not apply to thrift holding companies. Sovereign Bancorp ratios are computed using quarterly average tangible assets, which is consistent with the method used by bank holding companies. 27 ASSET AND LIABILITY MANAGEMENT The objective of Sovereign's asset and liability management is to identify, measure and manage 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. Sovereign measures interest rate risk utilizing three tools: net interest income simulation analysis in multiple interest rate environments, instantaneous parallel interest rate shocks and lastly, gap analysis, which is a schedule measuring the difference between assets, liabilities and off-balance sheet positions which will mature or reprice within specific terms. Income simulation considers not only the impact of changing market interest rates on forecasted net income, but also other factors, such as yield curve relationships, the volume and mix of assets and liabilities, customer preferences and general market conditions. Sovereign manages the impact to net interest income in a +/- 200 basis point instantaneous rate shock environment to be within a 10% variance. Sovereign estimates that if interest rates decline by 200 basis points, net interest income would decrease by $75.9 million, or 7.6%, for 1999 as compared to $52.4 million, or 8.5%, for 1998. Conversely, if interest rates increase by 200 basis points, net interest income would decrease by $98.1 million, or 9.6%, for 1999 as compared to $22.1 million, or 3.6%, for 1998. Sovereign generally manages the one-year interest rate gap within a +/- 10% range. A positive gap position implies that the bank is asset sensitive, which could cause net interest income to decrease if interest rates fall. Conversely, a negative gap position implies that the bank is liability sensitive, which could cause net interest income to decrease if interest rates rise. Sovereign estimates that the cumulative one-year gap position was a negative 17.8% and a positive 5.7% at December 31, 1999 and 1998, respectively. The negative position at December 31, 1999, is a result of positioning for the Sovereign Bank New England acquisition in 2000. 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 that changes in interest rates have on net interest income. Interest rate swaps are generally used to convert fixed rate assets and liabilities to variable rate assets and liabilities and vice versa. Sovereign utilizes interest rate swaps that have a high degree of correlation to the related financial instrument. At December 31, 1999, Sovereign's principal off-balance sheet transactions were to convert liabilities from fixed rate to floating rate to reduce the 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 and floors are simultaneously bought and sold to create a range of protection against changing interest rates while limiting the cost of that protection. As part of its mortgage banking strategy, Sovereign originates fixed rate residential mortgages. It sells the majority of these loans to FHLMC, FNMA and private investors. The loans are exchanged for cash or marketable fixed rate mortgage-backed securities which are generally sold. This helps insulate Sovereign from the interest rate risk associated with these fixed rate assets. Sovereign uses forward sales, cash sales and options on mortgage-backed securities as a means of hedging loans in the mortgage pipeline which are originated for sale. Sovereign's primary funding source is deposits obtained in its own marketplace. Deposit programs at Sovereign are priced to meet management's asset/liability objectives, while taking into account the rates available on lending 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. 28 Table 14 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, 1999, 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 14: GAP ANALYSIS
AT DECEMBER 31, 1999 REPRICING ----------------------------------------------------------------- 0-3 4 MONTHS YEAR 2 MONTHS -1 YEAR & OVER TOTAL ------------ ------------ ------------ ----------- Interest-earning assets: Investment securities(1)(2)............... $ 2,304,250 $ 860,211 $ 7,247,040 $10,411,501 6.17% 7.19% 7.10% 6.90% Loans(3).................................... 3,842,973 3,488,219 6,957,273 14,288,465 8.34% 7.95% 7.77% 7.97% ------------ ------------ ------------ ----------- Total interest-earning assets............... 6,147,223 4,348,430 14,204,313 24,699,966 7.53% 7.80% 7.43% 7.52% Non-interest-earning assets................. -- -- 1,907,146 1,907,146 ------------ ------------ ------------ ----------- Total assets................................ $ 6,147,223 $ 4,348,430 $ 16,111,459 $26,607,112 7.53% 7.80% 6.55% 6.98% Interest-bearing liabilities: Deposits(4)............................... $ 3,873,342 $ 3,317,566 $ 4,528,738 $11,719,646 4.49% 4.72% 2.05% 3.61% Borrowings.................................. 7,763,274 1,395,377 3,504,487 12,663,138 5.90% 5.31% 6.43% 5.98% ------------ ------------ ------------ ----------- Total interest-bearing liabilities.......... 11,636,616 4,712,943 8,033,225 24,382,784 5.43% 4.90% 3.95% 4.84% Non-interest-bearing liabilities............ -- -- 402,833 402,833 Stockholders' equity........................ -- -- 1,821,495 1,821,495 ------------ ------------ ------------ ----------- Total liabilities and stockholders' equity.................................... $ 11,636,616 $ 4,712,943 $ 10,257,553 $26,607,112 5.43% 4.90% 3.08% 4.43% ------------ ------------ ------------ ----------- Excess assets (liabilities) before effect of off-balance sheet positions............... $ (5,489,393) $ (364,513) $ 5,853,906 ------------ ------------ ------------ To total assets......................... (20.63)% (1.37)% 22.00% ============ ============ ============ Cumulative excess assets (liabilities) before effect of off-balance sheet positions................................. $ (5,489,393) $ (5,853,906) $ -- ============ ============ ============ To total assets......................... (20.63)% (22.00)% Effect of off-balance sheet positions on assets and liabilities.................... $ 1,047,700 $ 77,300 $ (1,125,000) ------------ ------------ ------------ Excess assets (liabilities) after effect of off-balance sheet positions............... $ (4,441,693) $ (287,213) $ 4,728,906 ============ ============ ============ To total assets......................... (16.69)% (1.08)% 17.77% Cumulative excess assets (liabilities) after off-balance sheet positions............... $ (4,441,693) $ (4,728,906) $ -- ============ ============ ============ To total assets......................... (16.69)% (17.77)%
- ------------------ (1) Includes interest-earning deposits. (2) Investment securities include market rate prepayment and repayment assumptions. (3) Loan balances include annual prepayment and repayment assumptions between 7% and 35% initially with gradual slowing thereafter. Loan balances are presented net of deferred loan fees and include loans held for sale and the allowance for loan losses. (4) Savings, NOW, money market and demand deposit accounts have been assumed to decay at an annual rate of 14.6%. 29 Table 15 presents selected quarterly consolidated financial data (in thousands, except per share data): TABLE 15: SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA
THREE MONTHS ENDED --------------------------------------------------------------------------------------- DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31, 1999 1999 1999 1999 1998 1998 1998 1998 -------- --------- -------- -------- -------- --------- -------- -------- Total interest income........... $445,902 $ 415,954 $377,444 $368,028 $357,631 $ 341,768 $331,860 $324,112 Total interest expense.......... 280,315 254,086 230,036 228,236 224,915 220,521 212,828 203,495 -------- --------- -------- -------- -------- --------- -------- -------- Net interest income............. 165,587 161,868 147,408 139,792 132,716 121,247 119,032 120,617 Provision for loan losses....... 7,500 7,500 7,500 7,500 7,000 7,001 7,200 6,760 -------- --------- -------- -------- -------- --------- -------- -------- Net interest income after provision..................... 158,087 154,368 139,908 132,292 125,716 114,246 111,832 113,857 -------- --------- -------- -------- -------- --------- -------- -------- Gain on sale of loans and investment securities......... (2,196) (299) 3,362 3,408 7,455 6,262 3,075 3,052 Other income.................... 31,993 35,250 29,928 28,896 24,421 19,484 22,118 19,314 Other expenses(1)............... 148,722 103,843 98,445 95,369 93,397 74,164 70,282 71,851 Merger-related charges(2)....... -- -- -- -- -- 10,860 -- 39,072 -------- --------- -------- -------- -------- --------- -------- -------- Income before income taxes...... 39,162 85,476 74,753 69,227 64,195 54,968 66,743 25,300 Income tax provision............ 9,939 29,488 25,974 23,914 20,524 20,178 23,849 10,200 -------- --------- -------- -------- -------- --------- -------- -------- Net income...................... $ 29,223 $ 55,988 $ 48,779 $ 45,313 $ 43,671 $ 34,790 $ 42,894 $ 15,100 ======== ========= ======== ======== ======== ========= ======== ======== Net income before special charges(1).................... $ 52,220 $ 55,988 $ 48,779 $ 45,313 $ 43,671 $ 42,781 $ 42,894 $ 40,941 ======== ========= ======== ======== ======== ========= ======== ======== Net income applicable to common stock......................... $ 52,220 $ 55,988 $ 48,779 $ 45,313 $ 43,671 $ 34,790 $ 42,894 $ 13,604 ======== ========= ======== ======== ======== ========= ======== ======== Basic earnings per share(3)(4)................... $ 0.14 $ 0.31 $ 0.31 $ 0.28 $ .27 $ .22 $ .29 $ .10 Diluted earnings per share(3)(4)................... 0.14 0.31 0.30 0.28 .27 .22 .27 .09 Operating basic earnings per share(3)(5)................... 0.29 0.31 0.31 0.28 .27 .27 .29 .27 Operating diluted earnings per share(3)(5)................... 0.29 0.31 0.30 0.28 .27 .26 .27 .26 Market prices(3) High.......................... 92 3/64 12 7/8 17 1/2 14 9/16 14 7/16 18 1/4 22 3/16 18 15/16 Low........................... 7 3/16 9 3/32 11 5/8 11 15/16 9 12 16 5/16 14 15/16 Dividends per common share(3)(6)................... 0.024 0.027 0.026 0.021 .021 .020 .023 .020
- ------------------ (1) Other expenses for the quarter ended December 31, 1999 includes special charges related to merger-related and other integration charges of $30.8 million. See "Reconciliation of Net Income to Operating Earnings" on page 19 of Management's Discussion and Analysis. (2) Reflects merger charges of $10.9 million ($7.8 million after-tax) related to the acquisitions of Carnegie and First Home during the three-month period ended September 30, 1998. Reflects merger charges of $39.1 million ($25.5 million after-tax) related to the acquisition of ML Bancorp during the three-month period ended March 31, 1998. (3) All per share data have been adjusted to reflect all stock dividends and stock splits. (4) Results for the three-month periods ended September 30, 1998, and March 31, 1998 include the merger-related charges described in Note 1 above. (5) Results for the three-month periods ended September 30, 1998, and March 31, 1998 exclude the merger-related charges described in Note 1 above. (6) The higher dividend rate in prior periods is the result of acquisitions which were accounted for as a pooling-of-interests. 30 Pending Accounting Pronouncements. In June 1999, The Financial Accounting Standards Board ("FASB") issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133", which delays the effective date of SFAS No. 133. Accordingly, SFAS No. 133, shall be effective for all fiscal years beginning after June 15, 2000. SFAS No. 133 requires the recognition of all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value as a component of income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be off-set against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. Sovereign expects to adopt SFAS No. 133 effective January 1, 2001. Management reduced its off-balance sheet positions during 1999 so that the adoption of SFAS No. 133 will not have a material impact on the financial condition of the company. The Year 2000 Computer Issue. The Year 2000 ("Y2K") computer issue refers to concerns about the inability of many computers, computer based systems, related software, and other electronic devices (collectively "computer systems") to process dates accurately after 1999. Sovereign initiated a project in 1998 to update its computer systems to be Y2K compliant, and to monitor the compliance status of computer systems of its outside service providers. Accordingly, contingency plans were developed for any process determined to be mission critical to Sovereign. Sovereign has experienced no significant internal Y2K related problems internally or with outside service providers. All known remediation and other critical projects throughout the Company have been completed and no material future Y2K related problems or expenses are expected. General and Administrative expense includes $5.7 million and $6.5 million of Y2K remediation expense at December 31, 1999 and 1998, respectively. 31 RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 Net Income. Net operating income for the year ended December 31, 1998 was $170 million. This represents an increase of 22% over net operating income of $139 million reported for 1997. Operating earnings per share was $1.06 for 1998, which represents an increase of 19% over 1997 operating earnings per share of $.89. On an operating basis, return on average equity and return on average assets were 15.47% and .87%, respectively, for 1998 compared to 14.83% and .85%, respectively, for 1997. See Reconciliation of Operating Earnings to Net Income for a detailed explanation of amounts excluded from operating earnings. For additional information with respect to Sovereign's merger-related charges, see Note 2 in the "Notes to Consolidated Financial Statements" hereof. All per share amounts presented in Management's Discussion and Analysis of Financial Condition and Results of Operations have been calculated based on average diluted shares outstanding and have been adjusted to reflect all stock dividends and stock splits. Net income for the year ended December 31, 1998, including the impact of the merger-related charges, was $136 million or $.85 per share. Net income for the year ended December 31, 1997, including the impact of the merger-related charges, was $103 million or $.66 per share. Net Interest Income. Net interest income for 1998 was $494 million compared to $432 million for 1997. This represents an increase of 14% and was primarily due to an increase in average balances resulting from internal growth and acquisitions during the period. Interest on interest-earning deposits was $7.4 million for 1998 compared to $5.4 million for 1997. The average balance of interest-earning deposits was $56.4 million with an average yield of 13.12% for 1998 compared to an average balance of $32.3 million with an average yield of 16.71% for 1997. The high yields on interest-earning deposits were the result of a contractual arrangement whereby a third-party vendor performed check processing and reconcilement functions for Sovereign's disbursement accounts. Under the agreement, the vendor is required to pay Sovereign interest on disbursed funds during the two to three day float period, effectively producing interest income with no corresponding asset balance. Interest on investment securities available-for-sale was $284 million for 1998 compared to $102 million for 1997. The average balance of investment securities available-for-sale was $4.3 billion with an average yield of 6.75% for 1998 compared to an average balance of $1.6 billion with an average yield of 6.77% for 1997. The increase in the average balance of investment securities available-for-sale was due to favorable market conditions which have created opportunities for Sovereign to realign its investment portfolio and an active decision by management to increase balance sheet flexibility by placing more investments into available-for-sale. Interest on investment securities held-to-maturity was $182 million for 1998 compared to $280 million for 1997. The average balance on investment securities held-to-maturity was $2.5 billion with an average yield of 7.22% for 1998 compared to an average balance of $3.9 billion with an average yield of 7.18% for 1997. Interest and fees on loans were $881 million for 1998 compared to $791 million for 1997. The average balance of net loans was $11.1 billion with an average yield of 7.94% for 1998 compared to an average balance of $10.1 billion with an average yield of 7.82% for 1997. The increases in average balance and average yield were primarily the result of continued growth in Sovereign's commercial lending and auto finance divisions, Sovereign's acquisition of 93 CoreStates branch offices, which added approximately $725 million of higher yielding commercial and consumer loans to Sovereign's loan portfolio, as well as planned run-off of lower yielding residential loans. Interest on total deposits was $440 million for 1998 compared to $379 million for 1997. The average balance of total deposits was $10.7 billion with an average cost of 4.11% for 1998 compared to an average balance of $9.0 billion with an average cost of 4.21% for 1997. The increase in the average balance and the decrease in the average cost of deposits was primarily the result of Sovereign's acquisition of approximately $2.2 billion of low cost deposits from the CoreStates branch acquisition and strong internal core deposit growth during 1998. 32 Interest on total borrowings was $421 million for 1998 compared to $368 million for 1997. The average balance of total borrowings was $7.4 billion with an average cost of 5.69% for 1998 compared to an average balance of $6.2 billion with an average cost of 5.97% for 1997. The increase in the average balance and the decrease in the average cost of borrowings was the result of balance sheet growth being partially funded by borrowings and generally lower borrowing rates in 1998 compared to 1997. Provision for Loan Losses. The provision for loan losses was $28.0 million for 1998 compared to $41.1 million for 1997. The higher loan loss provision for 1997 included $24.9 million of reserves recorded as part of the merger charges related to Sovereign's acquisitions of First State and Bankers during 1997. These additional reserves were added as a result of Sovereign's conservative approach with respect to an aggressive workout plan for certain non-performing assets acquired from First State and Bankers. Excluding these merger-related charges, Sovereign's loan loss provision for 1998 increased 73% from 1997 levels. In addition, during 1998, Sovereign established an initial loan loss allowance of $20.5 million related to $725 million of loans acquired in connection with its Core States branch acquisition, and during 1997, Sovereign established an initial loan loss allowance of $22.0 million in connection with its acquisition of Fleet Financial Group Inc.'s ("Fleet") Automobile Finance Division ("Fleet Auto"). Sovereign's net charge-offs for 1998 were $33.6 million and consisted of charge-offs of $46.3 million and recoveries of $12.7 million. This compares to 1997 net charge-offs of $18.8 million consisting of charge-offs of $24.2 million and recoveries of $5.4 million. The ratio of net loan charge-offs to average loans, including loans held for sale, was .30% for 1998, compared to .18% for 1997 and .19% for 1996. Commercial loan net charge-offs as a percentage of average commercial loans were .14% for 1998, compared to .14% for 1997 and .85% for 1996. The higher figure for 1996 was due to charge-offs related to a pool of non-performing loans charged-off by First State, a predecessor institution acquired by Sovereign, previous to its 1997 acquisition that was accounted for as a pooling-of-interests. Consumer loan net charge-offs as a percentage of average consumer loans were .80% for 1998, compared to .55% for 1997 and .18% for 1996. Residential real estate mortgage loan net charge-offs as a percentage of average residential mortgage loans, including loans held for sale, were .08% for 1998, .11% for 1997 and .13% for 1996. Sovereign's increased level of consumer and commercial loan charge-offs in 1998 was primarily related to Sovereign's acquisition activity over the past two years. Although commercial and consumer lending will typically result in higher net charge-off levels than residential lending, historically, it has also resulted in higher income potential. Other Income. Total other income was $105 million for 1998 compared to $48.7 million for 1997. Several factors contributed to the increase in other income as discussed below. Retail banking fees were $31.1 million for 1998 compared to $23.9 million for 1997. This increase was primarily the result of an increase in the number of Sovereign's transaction accounts and a larger retail customer base over the last year. Mortgage banking revenues were $28.2 million for 1998 compared to $23.9 million for 1997. This increase was primarily due to internal restructuring and management enhancements made to this business unit during 1998 and a favorable external environment. Loan fees and service charges were $7.1 million for 1998 compared to $3.5 million for 1997. This increase was directly attributable to the full year effect of fees earned on Sovereign's auto loan portfolio which was acquired in September 1997. Loan fees and service charges result primarily from Sovereign's loan servicing portfolio. At December 31, 1998, Sovereign serviced $9.2 billion of its own loans and $6.7 billion of loans for others. This compares to $9.3 billion of its own loans and $6.4 billion of loans for others at December 31, 1997. Gains on sales of loans and investment securities were $19.8 million for 1998 compared to losses of $7.2 million for 1997, which included investment security net gains (losses) of $15.8 million and $(9.2) million, and net gains on sales of loans of $4.0 million and $2.0 million in 1998 and 1997, respectively. This increase was in part due to a net gain of $2.8 million resulting from the sale of Sovereign's credit card portfolio during the second quarter of 1998. The remaining increase was the result of gains on sales of investment securities available-for-sale during 1998 and a $10.3 million (pre-tax) loss on the liquidation of $750 million of investments including certain held-to-maturity securities in conjunction with the Bankers 33 acquisition during the third quarter of 1997. This sale was completed in accordance with the provisions of Statement of Financial Accounting standard ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities" to maintain Sovereign's pre-merger interest rate risk position. Sovereign recognized $12.6 million from its investment in BOLI, which was made during the first quarter of 1998. Miscellaneous income was $6.4 million for 1998 compared to $4.5 million for 1997. This increase was primarily due to increased inter-change income resulting from growth in the number and transaction volume of Sovereign's debit cards over the last year. General and Administrative Expenses. Total general and administrative expenses were $327 million for 1998 compared to $244 million for 1997. Sovereign's efficiency ratio (all general and administrative expenses as a percentage of net interest income and recurring non-interest income) for 1998 was 46.6% compared to 46.1% for 1997. The increase in general and administrative expenses during 1998 was primarily due to Sovereign's overall franchise growth, as well as special systems-related charges. These special systems-related charges include Sovereign's conversion to a new commercial bank data processing system and its Year 2000 initiatives. Other Operating Expenses. Total other operating expenses were $32.3 million for 1998 compared to $25.6 million for 1997. Other operating expenses included amortization of goodwill and other intangible assets of $20.6 million for 1998 compared to $13.2 million for 1997, Trust Preferred Securities expense of $12.5 million for 1998 compared to $11.7 million for 1997, and other net real estate owned ("OREO") gains of $804,000 for 1998 compared to net OREO losses of $767,000 for 1997. Income Tax Provision. The income tax provision was $74.8 million for 1998 compared to $67.3 million for 1997. The effective tax rate for 1998 was 35.4% compared to 39.6% for 1997. The effective tax rates for 1998 and 1997 include the effect of certain non-deductible expenses incurred in conjunction with Sovereign's acquisitions during each of these years. 34 TO OUR STOCKHOLDERS: FINANCIAL STATEMENTS Sovereign Bancorp, Inc. ("Sovereign") is responsible for the preparation, integrity and fair presentation of its published financial statements as of December 31, 1999, and for the year then ended. The consolidated financial statements of Sovereign have been prepared in accordance with generally accepted accounting principles and, as such, include some amounts that are based on judgments and estimates of management. INTERNAL CONTROLS OVER FINANCIAL REPORTING Management is responsible for establishing and maintaining effective internal control over financial reporting presented in conformity with generally accepted accounting principles and regulatory reporting. The system contains monitoring mechanisms, and actions are taken to correct deficiencies identified. There are inherent limitations in the effectiveness of any system of internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time. Management assessed Sovereign's internal control structure over financial reporting presented in conformity with generally accepted accounting principles and regulatory reporting as of December 31, 1999. This assessment was based on criteria for effective internal control over financial reporting described in "Internal Control -- Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that Sovereign maintained effective internal control over financial reporting presented in conformity with generally accepted accounting principles and regulatory reporting as of December 31, 1999. COMPLIANCE WITH LAWS AND REGULATIONS Management is also responsible for compliance with the federal and state laws and regulations concerning dividend restrictions and federal laws and regulations concerning loans to insiders designated by the Office of Thrift Supervision as safety and soundness laws and regulations. Management assessed compliance by Sovereign Bank with the designated laws and regulations relating to safety and soundness. Based on this assessment, management believes that Sovereign Bank complied, in all significant respects, with the designated laws and regulations related to safety and soundness for the year ended December 31, 1999. /s/ JAY S. SIDHU /s/ DENNIS S. MARLO /s/ MARK R. MCCOLLOM ---------------- ------------------- -------------------- Jay S. Sidhu Dennis S. Marlo Mark R. McCollom President and Treasurer and Chief Accounting Officer Chief Executive Officer Chief Financial Officer
ITEM 7A. MANAGEMENT'S DISCUSSION OF MARKET RISK Incorporated by reference from Part II, Item 7 "Management's Discussion and Analysis of Financial Conditions and Results of Operations--Asset and Liability Management" hereof. 35 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. as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the management of Sovereign. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1997 financial statements of ML Bancorp, Inc., Carnegie Bancorp, or First Home Bancorp Inc., which combined statements reflect combined net interest income constituting 21.1% of the related consolidated financial statement totals for the year ended December 31, 1997. Those statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to data included for ML Bancorp, Inc., Carnegie Bancorp and First Home Bancorp Inc., for 1997, is based solely on the reports of the other auditors. We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 the overall financial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the reports of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sovereign Bancorp, Inc. at December 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. /s/ ERNST & YOUNG LLP January 24, 2000 except for Note 22, as to which the date is February 28, 2000 Philadelphia, Pennsylvania 36 SOVEREIGN BANCORP, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
YEAR ENDED DECEMBER 31, ---------------------------- 1999 1998 ----------- ----------- Assets Cash and amounts due from depository institutions......... $ 373,996 $ 471,074 Interest-earning deposits................................. 19,238 82,650 Loans held for sale (fair value approximates $62,439 and $297,414).............................................. 61,925 296,930 Investment securities available-for-sale.................. 8,030,212 6,662,427 Investment securities held-to-maturity (fair value approximates $2,367,025 and $1,860,583)................ 2,362,051 1,839,655 Loans..................................................... 14,226,540 11,285,840 Allowance for loan losses................................. (132,986) (133,802) Premises and equipment.................................... 119,201 98,491 Other real estate owned and other repossessed assets...... 5,329 15,584 Accrued interest receivable............................... 164,720 147,441 Goodwill and other intangible assets...................... 434,078 425,925 Other assets.............................................. 942,808 721,658 ----------- ----------- Total Assets......................................... $26,607,112 $21,913,873 =========== =========== Liabilities Deposits.................................................. $11,719,646 $12,322,716 Borrowings Short-term............................................. 6,902,414 3,922,352 Long-term.............................................. 5,760,724 3,979,887 Advance payments by borrowers for taxes and insurance..... 28,222 27,655 Other liabilities......................................... 58,265 328,145 ----------- ----------- Total Liabilities.................................... 24,469,271 20,580,755 ----------- ----------- Corporation-obligated mandatorily redeemable capital securities of subsidiary trusts holding solely subordinated debentures of Sovereign Bancorp, Inc. ("Trust Preferred Securities")......................... 316,346 129,050 ----------- ----------- Stockholders' Equity Preferred stock; no par value; $50 liquidation preference; 7,500,000 shares authorized; 0 shares issued and outstanding............................................ -- -- Common stock; no par value; 400,000,000 shares authorized; issued 230,647,896 and 164,146,353..................... 1,251,583 649,341 Warrants.................................................. 91,500 -- Unallocated common stock held by the Employee Stock Ownership Plan (4,793,792 shares and 4,340,572 shares at cost)............................................... (33,841) (26,892) Treasury stock (383,875 shares and 78,626 shares at cost).................................................. (3,595) (1,086) Accumulated other comprehensive income.................... (210,932) 18,120 Retained earnings......................................... 726,780 564,585 ----------- ----------- Total Stockholders' Equity........................... 1,821,495 1,204,068 ----------- ----------- Total Liabilities and Stockholders' Equity........... $26,607,112 $21,913,873 =========== ===========
See accompanying notes to consolidated financial statements. 37 SOVEREIGN BANCORP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE DATA)
YEAR ENDED DECEMBER 31, ------------------------------------------ 1999 1998 1997 ---------- ---------- ---------- Interest Income: Interest on interest-earning deposits............... $ 4,721 $ 7,397 $ 5,392 Interest and dividends on investment securities available-for-sale............................... 543,631 284,392 102,123 Interest and dividends on investment securities held-to-maturity................................. 99,813 182,499 279,900 Interest and fees on loans.......................... 959,164 881,083 791,362 ---------- ---------- ---------- Total interest income.......................... 1,607,329 1,355,371 1,178,777 ---------- ---------- ---------- Interest Expense: Interest on deposits................................ 428,055 440,300 378,813 Interest on borrowings.............................. 564,618 421,459 367,882 ---------- ---------- ---------- Total interest expense......................... 992,673 861,759 746,695 ---------- ---------- ---------- Net Interest Income................................... 614,656 493,612 432,082 Provision for loan losses............................. 30,000 27,961 41,125 ---------- ---------- ---------- Net interest income after provision for loan losses... 584,656 465,651 390,957 ---------- ---------- ---------- Other Income: Retail banking fees................................. 49,177 31,078 23,892 Mortgage banking fees............................... 29,926 28,209 23,937 Loan fees and service charges....................... 8,856 7,075 3,536 Gain on sale of loans and investment securities..... 4,275 19,844 (7,192) Bank owned life insurance........................... 22,813 12,572 -- Miscellaneous income................................ 15,295 6,403 4,515 ---------- ---------- ---------- Total other income............................. 130,342 105,181 48,688 ---------- ---------- ---------- General and Administrative Expenses: Compensation and benefits........................... 154,880 124,357 105,487 Occupancy and equipment............................. 67,564 53,837 41,067 Outside services.................................... 93,340 47,523 28,708 Merger-related charges.............................. -- 49,932 19,224 Other administrative................................ 77,145 51,644 49,693 ---------- ---------- ---------- Total general and administrative expenses...... 392,929 327,293 244,179 ---------- ---------- ---------- Other Operating Expenses: Amortization of goodwill and other intangibles...... 37,967 20,609 13,160 Trust Preferred Securities expense.................. 15,393 12,528 11,677 Other real estate owned (gains)/losses, net......... 95 (804) 767 ---------- ---------- ---------- Total other operating expenses................. 53,455 32,333 25,604 ---------- ---------- ---------- Income before income taxes............................ 268,614 211,206 169,862 Income tax provision.................................. 89,315 74,751 67,324 ---------- ---------- ---------- NET INCOME............................................ $ 179,299 $ 136,455 $ 102,538 ========== ========== ========== NET INCOME APPLICABLE TO COMMON STOCK................. $ 179,299 $ 134,959 $ 96,294 ========== ========== ========== Basic Earnings Per Share.............................. $ 1.02 $ .88 $ .70 ========== ========== ========== Diluted Earnings Per Share............................ $ 1.01 $ .85 $ .66 ========== ========== ========== Dividends Per Common Share............................ $ .098 $ .084 $ .114 ========== ========== ==========
See accompanying notes to consolidated financial statements. 38 SOVEREIGN BANCORP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
COMMON PREFERRED SHARES SHARES COMMON PREFERRED RETAINED OUTSTANDING OUTSTANDING STOCK WARRANTS STOCK EARNINGS ----------- ----------- ---------- -------- --------- -------- Balance, December 31, 1996............................. 134,000 2,000 $ 524,464 $ -- $96,446 $373,974 Comprehensive income: Net income........................................... -- -- -- -- -- 102,538 Unrecognized income on investment securities available-for-sale, net of tax..................... -- -- -- -- -- -- Total comprehensive income Exercise of stock options.............................. 3,207 -- 12,527 -- -- -- Cash in lieu of fractional shares...................... (3) -- (28) -- -- (2) Sale of stock under Dividend Reinvestment and Employee Stock Purchase Plan.................................. 216 -- 2,544 -- -- -- Stock dividends........................................ 200 -- 1,855 -- -- (1,855) Dividends paid on common stock......................... -- -- -- -- -- (15,550) Dividends paid on preferred stock...................... -- -- -- -- -- (6,244) Treasury stock repurchase.............................. (40) -- -- -- -- -- Treasury stock sold.................................... 2,608 -- 17,423 -- -- -- Retirement of treasury shares.......................... -- -- (41,981) -- -- -- Conversion of preferred stock.......................... 25 (4) 170 -- (170) -- Allocation of shares under Employee Stock Ownership Plan................................................. 796 -- 5,132 -- -- -- Adjustment for First State's different fiscal year end.................................................. 209 -- 1,010 -- -- (6,217) Other.................................................. -- -- 211 -- -- -- ------- ------ ---------- ------- ------- -------- Balance, December 31, 1997............................. 141,218 1,996 523,327 -- 96,276 446,644 ------- ------ ---------- ------- ------- -------- Comprehensive income: Net income........................................... -- -- -- -- -- 136,455 Change in unrecognized income on investment securities available-for-sale, net of tax..................... -- -- -- -- -- -- Total comprehensive income Exercise of stock options.............................. 2,296 -- 15,910 -- -- -- Cash in lieu of fractional shares...................... -- -- (68) -- -- -- Sale of stock under Dividend Reinvestment and Employee Stock Purchase Plan.................................. 296 -- 4,609 -- -- -- Dividends paid on common stock......................... -- -- -- -- -- (12,790) Dividends paid on preferred stock...................... -- -- -- -- -- (1,496) Treasury stock repurchase.............................. (86) -- -- -- -- -- Treasury stock sold.................................... 18 -- -- -- -- -- Conversion of preferred stock.......................... 14,342 (1,996) 96,270 -- (96,270) -- Redemption of preferred stock.......................... -- -- -- -- (6) -- Allocation of shares under Employee Stock Ownership Plan................................................. 1,643 -- 9,293 -- -- -- Adjustment for ML Bancorp's different fiscal year end.................................................. -- -- -- -- -- (4,228) ------- ------ ---------- ------- ------- -------- Balance, December 31, 1998............................. 159,727 -- 649,341 -- -- 564,585 ------- ------ ---------- ------- ------- -------- Comprehensive income: Net income........................................... -- -- -- -- -- 179,299 Change in unrecognized loss on investment securities available-for-sale, net of tax..................... -- -- -- -- -- -- Total comprehensive loss............................... Issuance of common stock............................... 43,810 -- 331,478 -- -- -- Issuance of warrants................................... -- -- -- 91,500 -- -- Exercise of stock options.............................. 721 -- 6,919 -- -- -- Cash in lieu of fractional shares...................... -- -- (6) -- -- -- Sale of stock under Dividend Reinvestment and Employee Stock Purchase Plan.................................. 408 -- 4,412 -- -- -- Dividends paid on common stock......................... -- -- -- -- -- (17,104) Treasury stock repurchase.............................. (3,351) -- -- -- -- -- Treasury stock sold.................................... 26 -- -- -- -- -- Allocation of shares under Employee Stock Ownership Plan................................................. 270 -- 1,268 -- -- -- Acquisition of Network Companies....................... 235 -- 3,000 -- -- -- Acquisition of People's Bancorp, Inc................... 23,624 -- 255,171 -- -- -- ------- ------ ---------- ------- ------- -------- Balance, December 31, 1999............................. 225,470 -- $1,251,583 $91,500 $ -- $726,780 ======= ====== ========== ======= ======= ========
See accompanying notes to consolidated financial statements. 39 SOVEREIGN BANCORP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
ACCUMULATED UNALLOCATED OTHER TOTAL TREASURY STOCK HELD COMPREHENSIVE STOCKHOLDERS' STOCK BY ESOP INCOME EQUITY -------- ----------- ------------- ------------- Balance, December 31, 1996.................................. $(64,798) $(40,652) $ 317 $ 889,751 Comprehensive income: Net income................................................ -- -- -- 102,538 Unrecognized income on investment securities available-for-sale, net of tax.............................................. -- -- 18,399 18,399 ---------- Total comprehensive income.................................. 120,937 Exercise of stock options................................... 5,423 -- -- 17,950 Cash in lieu of fractional shares........................... -- -- -- (30) Sale of stock under Dividend Reinvestment and Employee Stock Purchase Plan............................................. -- -- -- 2,544 Stock dividends............................................. -- -- -- -- Dividends paid on common stock.............................. -- -- -- (15,550) Dividends paid on preferred stock........................... -- -- -- (6,244) Treasury stock repurchase................................... (473) -- -- (473) Treasury stock sold......................................... 17,682 -- -- 35,105 Retirement of treasury shares............................... 41,981 -- -- -- Conversion of preferred stock............................... -- -- -- -- Allocation of shares under Employee Stock Ownership Plan.... -- 3,441 -- 8,573 Adjustment for First State's different fiscal year end...... -- -- 228 (4,979) Other....................................................... -- -- -- 211 -------- -------- --------- ---------- Balance, December 31, 1997.................................. (185) (37,211) 18,944 1,047,795 -------- -------- --------- ---------- Comprehensive income: Net income................................................ -- -- -- 136,455 Change in unrecognized income on investment securities available-for-sale, net of tax.......................... -- -- (32) (32) ---------- Total comprehensive income 136,423 Exercise of stock options................................... -- -- -- 15,910 Cash in lieu of fractional shares........................... -- -- -- (68) Sale of stock under Dividend Reinvestment and Employee Stock Purchase Plan............................................. -- -- -- 4,609 Dividends paid on common stock.............................. -- -- -- (12,790) Dividends paid on preferred stock........................... -- -- -- (1,496) Treasury stock repurchase................................... (1,258) -- -- (1,258) Treasury stock sold......................................... 357 -- -- 357 Conversion of preferred stock............................... -- -- -- -- Redemption of preferred stock............................... -- -- -- (6) Allocation of shares under Employee Stock Ownership Plan.... -- 10,319 -- 19,612 Adjustment for ML Bancorp's different fiscal year end....... -- -- (792) (5,020) -------- -------- --------- ---------- Balance, December 31, 1998.................................. (1,086) (26,892) 18,120 1,204,068 -------- -------- --------- ---------- Comprehensive income: Net income................................................ -- -- -- 179,299 Change in unrecognized loss on investment securities available-for-sale, net of tax.......................... -- -- (229,052) (229,052) ---------- Total comprehensive loss.................................... (49,753) Issuance of common stock.................................... -- -- -- 331,478 Issuance of warrants........................................ -- -- -- 91,500 Exercise of stock options................................... -- -- -- 6,919 Cash in lieu of fractional shares........................... -- -- -- (6) Sale of stock under Dividend Reinvestment and Employee Stock Purchase Plan............................................. -- -- -- 4,412 Dividends paid on common stock.............................. -- -- -- (17,104) Treasury stock repurchase................................... (47,152) -- -- (47,152) Treasury stock sold......................................... 285 -- -- 285 Allocation of shares under Employee Stock Ownership Plan.... -- 1,821 -- 3,089 Acquisition of Network Companies............................ -- -- -- 3,000 Acquisition of People's Bancorp, Inc........................ 44,358 (8,770) -- 290,759 -------- -------- --------- ---------- Balance, December 31, 1999.................................. $ (3,595) $(33,841) $(210,932) $1,821,495 ======== ======== ========= ==========
See accompanying notes to consolidated financial statements. 40 SOVEREIGN BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------------------ 1999 1998 1997 ---------- ---------- ---------- Cash Flows From Operating Activities: Net income................................................ $ 179,299 $ 136,455 $ 102,538 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses and deferred taxes............ 27,684 37,508 30,812 Depreciation............................................ 18,802 13,434 12,070 Amortization............................................ 58,830 18,204 34,725 Gain/Loss on sale of loans, investment securities and real estate owned...................................... (4,484) (20,076) 7,959 Allocation of Employee Stock Ownership Plan............. 3,089 19,612 8,573 Net change in: Loans held for sale....................................... 235,005 13,748 (172,305) Accrued interest receivable............................... (9,262) (39,560) (18,108) Other assets.............................................. (273,033) (467,329) (66,276) Other liabilities......................................... (259,538) 272,989 6,128 ---------- ---------- ---------- Net cash used by operating activities....................... (23,608) (15,015) (53,884) ---------- ---------- ---------- Cash Flows From Investing Activities: Proceeds from sales of investment securities.............. 5,553,469 2,157,904 847,215 Proceeds from repayments and maturities of investment securities: Available-for-sale...................................... 1,644,019 1,109,075 314,998 Held-to-maturity........................................ 793,031 2,062,628 965,549 Purchases of investment securities: Available-for-sale...................................... (8,024,026) (7,996,541) (1,072,205) Held-to-maturity........................................ (1,312,372) (471,326) (1,418,741) Proceeds from sales of loans.............................. 1,188,173 1,422,279 23,570 Purchase of loans......................................... (2,022,695) (1,966,864) (2,794,487) Net change in loans other than purchases and sales........ (1,561,471) 464,382 1,027,549 Proceeds from sales of premises and equipment............. 5,757 18,437 10,112 Purchases of premises and equipment....................... (39,844) (32,872) (15,790) Proceeds from sales of real estate owned.................. 17,081 19,069 19,593 Net cash received from/(paid for) business combinations... 112,998 (302,808) (8,552) Other, net................................................ -- (4,228) (4,996) ---------- ---------- ---------- Net cash used by investing activities....................... (3,645,880) (3,520,865) (2,106,185) ---------- ---------- ---------- Cash Flows From Financing Activities: Assumption of deposits.................................... -- 2,231,149 -- Net increase/(decrease) in deposits....................... (1,117,500) 576,982 855,750 Net increase/(decrease) in short-term borrowings.......... 2,023,868 (2,135,369) 638,573 Proceeds from long-term borrowings........................ 2,500,894 3,169,839 621,630 Repayments of long-term borrowings........................ (455,959) Net increase/(decrease) in advance payments by borrowers for taxes and insurance................................. 568 (14,192) (420) Proceeds from issuance of Trust Preferred Securities...... 187,231 -- 97,574 Cash dividends paid to stockholders....................... (17,104) (14,286) (23,777) Redemption of preferred stock............................. -- (6) -- Proceeds from issuance of common stock.................... 342,803 20,451 17,919 Proceeds from issuance of warrants........................ 91,500 Advance to the Employee Stock Ownership Plan.............. (436) -- (325) (Purchase)/issuance of treasury stock..................... (46,867) (901) 34,632 ---------- ---------- ---------- Net cash provided by financing activities................... 3,508,998 3,833,667 2,241,556 ---------- ---------- ---------- Net change in cash and cash equivalents..................... (160,490) 297,787 81,487 Cash and cash equivalents at beginning of period............ 553,724 255,937 174,450 ---------- ---------- ---------- Cash and cash equivalents at end of period.................. $ 393,234 $ 553,724 $ 255,937 ========== ========== ==========
Supplemental Disclosures: Income tax payments totaled $101 million in 1999, $77.4 million in 1998, and $63.2 million in 1997. Interest payments totaled $963 million in 1999, $848 million in 1998, and $717 million in 1997. Noncash activity consisted of mortgage loan securitization of $1.0 billion in 1999, $1.2 billion in 1998, and $283 million in 1997; reclassification of long-term borrowings to short-term borrowings of $536 million in 1999, $613 million in 1998, and $862 million in 1997; and reclassification of mortgage loans to real estate owned of $11.7 million in 1999, $18.8 million in 1998, and $22.1 million in 1997. See accompanying notes to consolidated financial statements. 41 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Sovereign Bancorp, Inc. and subsidiaries ("Sovereign") is a Pennsylvania business corporation and is the holding company of Sovereign Bank. Sovereign is headquartered in Philadelphia, Pennsylvania and Sovereign Bank is headquartered in Wyomissing, Pennsylvania, a suburb of Reading, Pennsylvania. Sovereign's primary business consists of attracting deposits from its network of community banking offices, located throughout eastern and northcentral Pennsylvania, New Jersey and northern Delaware, and originating commercial, consumer and residential mortgage loans in those communities. Sovereign also serves customers throughout New York and several New England States. The following is a description of the significant accounting policies of Sovereign. Such accounting policies are in accordance with generally accepted accounting principles and have been followed on a consistent basis. 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, Sovereign Delaware Investment Corporation, Sovereign Deleware Escrow Company, Sovereign Capital Trust I, Sovereign Capital Trust II, and ML Capital Trust I. 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 -- All per share data has been restated to reflect the effect of the 6-for-5 stock split which was authorized on January 22, 1998, with a record date of March 31, 1998 and the 6-for-5 stock split which was authorized on January 16, 1997, with a record date of March 3, 1997. Basic earnings per share is calculated by dividing income available to common stockholders by the weighted average common shares outstanding, excluding options, warrants, and convertible securities from the calculation. In calculating diluted earnings per share, the dilutive effect of options and warrants is calculated using the treasury stock method using the average market price of the period. The dilutive effect of convertible debt or preferred stock is calculated using the converted method. See Note 20 for computation of earnings per share. 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 Securities -- Investment 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. Gains or losses on the sales of securities are recognized at trade date utilizing the specific identification method. f. Forward Commitments and Options -- Sovereign utilizes forward commitments and options to hedge interest rate risk associated with loans held for sale. 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 sale consist of residential mortgage loans originated or purchased by Sovereign and mortgage-backed securities originated 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. 42 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) 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. Mortgage servicing rights are amortized against loan servicing fee income on an accelerated basis in proportion to, and over the period of, estimated net future loan servicing fee income, which periods initially do not exceed eight years. For purposes of measuring impairment of capitalized mortgage servicing rights and minimizing the impact of risk, Sovereign conservatively evaluates the loans underlying these rights by stratifying them into certain homogeneous categories which include, but are not limited to, residential real estate 30-year and 15-year fixed rate mortgage loans, adjustable rate mortgage loans and balloon loans. See Note 6 for details of mortgage banking activity. h. Allowance for Loan Losses -- An allowance for loan losses is maintained at a level that management considers adequate to provide for 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 losses, 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. The allowance for loan losses consists of two elements: (i) an allocated allowance, which is comprised of allowances established on specific loans, and class allowances based on historical loan loss experience and current trends, and (ii) unallocated allowances based on both general economic conditions and other risk factors in the Company's individual markets and portfolios, and to account for a level of imprecision in management's estimation process. The specific allowance element is based on a regular analysis of criticized loans where internal credit ratings are below a predetermined classification. This analysis is performed at the relationship manager level, and periodically reviewed by the loan review department. The specific allowance established for these criticized loans is based on a careful analysis of related collateral value, cash flow considerations and, if applicable, guarantor capacity. The class allowance element is determined by an internal loan grading process in conjunction with associated allowance factors. These class allowance factors are updated annually and are based primarily on actual historical loss experience, consultation with regulatory authorities, and peer groups loss experience. While this analysis is conducted annually, the Company has the ability to revise the class allowance factors whenever necessary in order to address improving or deteriorating credit quality trends or specific risks associated with a given loan pool classification. Regardless of the extent of the Company analysis of customer performance, portfolio evaluations, trends or risk management processes established, certain inherent, but undetected losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer's financial condition or changes in their unique business conditions; the judgemental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends; volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits; and the sensitivity of assumptions utilized to establish allocated allowances for homogeneous groups of loans among other factors. The Company maintains an unallocated allowance to recognize the existence of these exposures. These other risk factors are continuously reviewed and revised by management where conditions indicate that the estimates initially applied are different from actual results. 43 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) A comprehensive analysis of the allowance for loan losses is performed by the Company on a quarterly basis. In addition, a review of allowance levels based on nationally published statistics is conducted on an annual basis. The Company also has an asset review committee, which has the responsibility of affirming allowance methodology and assessing the general and specific allowance factors in relation to estimated and actual net charge-off trends. This committee is also responsible for assessing the appropriateness of the allowance for loan losses for each loan pool classification at Sovereign. i. Loans -- Interest on loans is credited to income as it is earned. Interest income is not recognized on loans when the loan payment is 90 days or more delinquent (except auto loans, government-guaranteed loans or loans secured by deposit accounts) or sooner if management believes the loan has become impaired. Sovereign defines impairment as the existence of one or a combination of any of the following loan weaknesses: o The primary source of repayment is gone or severely impaired and Sovereign may have to rely on the secondary source o Loss does not seem likely, but sufficient problems have arisen to cause Sovereign to go to abnormal lengths to protect its position in order to maintain a high probability of repayment o Obligors are unable to generate enough cash flow to reduce their debts o Deterioration in collateral value or inadequate inspection or verification of value (if the collateral is expected to be a source of repayment) o Flaws in documentation leave Sovereign in a subordinated or unsecured position when the collateral is needed for repayment of the loan When a loan is placed on non-accrual status, all accrued yet uncollected interest is reversed from income. Payments received on non-accrual loans are generally applied to the outstanding principal balance. A non-accrual loan is a loan in which it is probable that scheduled payments of principal and interest will not be paid when due according to the contractual terms of the loan agreement. In order for a non-accrual loan to revert to accruing status, all delinquent interest must be paid and Sovereign must approve a repayment plan. Loans delinquent 180 days or more (120 days for auto loans) are considered for charge-off unless it can be clearly demonstrated that repayment will occur regardless of the delinquency status. Examples of this would include: a loan which is secured by collateral and is in the process of collection; a loan supported by a valid guarantee or insurance; or a loan supported by a valid claim against a solvent estate. A decision to charge-off a loan does not necessarily mean that the asset has no recovery or salvage value, but rather it is not practical to defer writing off the balance, even though partial or full recovery may be realized in the future. SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," 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 the fair value of the collateral if the loan is collateral dependent, as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures." For purposes of measuring impairment as set forth by the provisions of SFAS No. 114 and SFAS No. 118, Sovereign defines impaired loans as non-accrual loans and certain loans which are still accruing, which management has specifically identified as being impaired. The non-accrual portion is determined by collectively evaluating large groups of smaller balance, homogeneous loans such as residential mortgages and consumer loans. j. Loan Fees, Discounts and Premiums -- Loan origination fees and certain direct loan origination costs are deferred and recognized as adjustments to 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 44 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) 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 the straight-line method. 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. Other Real Estate Owned -- Other real estate owned ("OREO") consists of properties acquired by or in lieu of foreclosure. OREO is stated at the lower of cost or estimated fair value minus estimated costs to sell. Write-downs of OREO 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 which are designated as hedges. Derivatives used as hedges must be effective at reducing the risk associated with the exposure being hedged and must be designated as a hedge at the inception of the derivative contract. To ensure effectiveness, the company performs an analysis to ensure that changes in fair value or cash flow of the derivative correlates to the equivalent changes in the asset or liability being hedged. Related fees are deferred and amortized on a straight line basis over the life of the interest rate exchange agreement, which corresponds to the estimated life of the asset or liability item being hedged. 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 and are reflected in other income. 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 j. above). 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 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 current period financial statements. These reclassifications have no effect on net income. r. Intangibles -- Core deposit intangibles are a measure of the value of checking and savings deposits acquired in business combinations accounted for as purchases. Core deposit intangibles are amortized in accordance with SFAS No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions," over 45 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) the estimated lives of the existing deposit relationships acquired, but not exceeding 10 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 and core deposit intangibles are being amortized using the straight line method over various periods not exceeding 25 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, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." s. Segment Reporting -- SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" requires that public companies report certain information about operating segments in complete sets of financial statements of the company and in condensed financial statements of interim periods issued to shareholders. It also requires that public companies report certain information about their products and services, the geographic areas in which they operate, and their major customers. Sovereign is a large regional bank which offers a wide array of products and services to its customers. Pursuant to its super-community banking strategy, emphasis is placed on building relationships with its customers, as opposed to building specific lines of business. As a result, as Sovereign is not organized around discernable lines of business and prefers to work as an integrated unit to customize solutions for its customers, with business line emphasis and product offerings changing over time as needs and demands change. Thus, all necessary requirements of SFAS No. 131 have been met by Sovereign as of December 31, 1999. t. Pending Accounting Pronouncements -- In June 1999, The Financial Accounting Standards Board ("FASB") issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133", which delays the effective date of SFAS No. 133. Accordingly, SFAS No. 133, shall be effective for all fiscal years beginning after June 15, 2000. SFASNo. 133 requires the recognition of all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value as a component of income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be off-set against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. Sovereign expects to adopt SFAS No. 133 effective January 1, 2001. Management reduced its off-balance sheet positions during 1999 so that the adoption of SFAS No.133 will not have a material impact on the financial condition of the company. NOTE 2 -- BUSINESS COMBINATIONS On June 30, 1999, Sovereign acquired Peoples Bancorp, Inc. ("Peoples"), a $1.4 billion bank holding company headquartered in Lawrenceville, New Jersey whose principal operating subsidiary operated 14 community banking offices in Mercer, Burlington and Ocean counties, New Jersey. The transaction added investments, loans and deposits to Sovereign of approximately $922 million, $503 million and $515 million, respectively. In accordance with the merger agreement, Peoples' shareholders received .80 shares of Sovereign common stock for each outstanding share of Peoples common stock. Sovereign issued approximately 23.6 million shares of Sovereign common stock in connection with the transaction, which was accounted for as a purchase. Sovereign recorded total intangibles of $39.5 million, of which $9.8 million was allocated to a core deposit intangible and $29.7 million was allocated to goodwill. The goodwill and core deposit intangible are being amortized over 25 years and 10 years, respectively. Sovereign's results of operations include the operations of Peoples from June, 30 1999 and thereafter. On June 15, 1999, Sovereign acquired The Network Companies ("Network"), a privately held specialty leasing company headquartered in Commack, New York. Network provides financing for the purchase or lease of equipment and specialty vehicles plus other specialty products for businesses throughout the United 46 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 2 -- BUSINESS COMBINATIONS -- (CONTINUED) States, with transactions ranging from $15,000 to $250,000. The purchase price of $6 million consisted of $4 million of stock and $2 million of cash. The acquisition was accounted for as a purchase. Sovereign paid a premium of $6 million, all of which was allocated to goodwill. Network had total assets of approximately $50 million. The goodwill is being amortized over 25 years. Sovereign's results of operations include the operations of Network from June 15, 1999 and thereafter. On September 4, 1998, Sovereign acquired 93 former CoreStates Financial Corp. ("CoreStates") branch offices from First Union Corporation ("First Union"). The former CoreStates offices are located throughout Pennsylvania and New Jersey and added approximately $2.2 billion of commercial bank deposits and $725 million of commercial and consumer loans to Sovereign's balance sheet. This transaction was accounted for as a purchase. Sovereign paid a premium of $325 million for the CoreStates branches which was allocated to core deposit intangible and goodwill. Additionally, Sovereign established an initial loan loss reserve of $20.5 million. The goodwill and core deposit intangible are being amortized over 25 years and 10 years, respectively. Sovereign's results of operations include the operations of the aforementioned branches from September 4, 1998 and thereafter. On July 31, 1998, Sovereign acquired Carnegie Bancorp ("Carnegie"), a $414 million commercial bank holding company headquartered in Princeton, New Jersey which operated seven branch offices throughout central New Jersey and one in Pennsylvania. Carnegie added loans, deposits and stockholders' equity to Sovereign of approximately $286 million, $329 million and $37 million, respectively. In accordance with the merger agreement, Carnegie common stock shareholders received 2.022 shares of Sovereign common stock in exchange for each share of Carnegie common stock. This transaction was accounted for as a pooling-of-interests. On July 31, 1998, Sovereign acquired First Home Bancorp Inc. ("First Home"), a $510 million savings bank holding company headquartered in Pennsville, New Jersey. First Home had one principal operating subsidiary which operated ten branch offices in Salem, Gloucester and Camden counties, New Jersey and New Castle County, Delaware. First Home added loans, deposits and stockholders' equity to Sovereign of approximately $273 million, $320 million and $38 million, respectively. In accordance with the merger agreement, First Home common stock shareholders received 1.779 shares of Sovereign common stock in exchange for each share of First Home common stock. This transaction was accounted for as a pooling-of-interests. As a result of the Carnegie and First Home transactions, Sovereign issued approximately 10.9 million new shares of common stock during the third quarter of 1998. On February 28, 1998, Sovereign acquired ML Bancorp, Inc. ("ML Bancorp"), a $2.4 billion bank holding company headquartered in Villanova, Pennsylvania. ML Bancorp's principal operating subsidiary, Main Line Bank, operated 29 branch offices located in the suburbs of Philadelphia, Pennsylvania. The transaction added loans, deposits and stockholders' equity to Sovereign of $1.1 billion, $1.0 billion and $201 million, respectively. In accordance with the merger agreement, ML Bancorp shareholders received 1.62 adjusted shares of Sovereign common stock in exchange for each share of ML Bancorp common stock. Approximately 20.5 million adjusted new shares of Sovereign common stock were issued in connection with the transaction. This transaction was accounted for as a pooling-of-interests. Prior to the combination, ML Bancorp's fiscal year end was March 31, and accordingly, Sovereign's consolidated results of operations for the twelve-month period ended December 31, 1998 include ML Bancorp's results of operations for the two-month period ended February 28, 1998, Sovereign's consolidated results of operations for the twelve-month period ended December 31, 1997 include ML Bancorp's results of operations for the eleven-month period ended February 28, 1998 and a net decrease to Sovereign's stockholders' equity of $5.0 million has been made to reflect ML Bancorp's activity for the two-month period ended February 28, 1998. That activity consisted of net income of $4.2 million and net unrealized gains on investment securities available-for-sale of $792,000. 47 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 2 -- BUSINESS COMBINATIONS -- (CONTINUED) The pre-merger results of operations for Sovereign, ML Bancorp, Carnegie and First Home (which were acquired pursuant to transactions accounted for as a pooling-of-interests) were as follows (in thousands):
SOVEREIGN ML BANCORP(1) CARNEGIE(2) FIRST HOME(2) COMBINED ---------- ------------- ----------- ------------- ---------- Year Ended December 31, 1998 Interest income................ $1,284,933 $27,935 $19,517 $22,986 $1,355,371 Interest expense............... 821,529 16,295 9,848 14,087 861,759 Provision for loan losses...... 27,467 -- 260 234 27,961 Other income................... 100,962 3,441 427 808 105,638 Non-interest expense........... 332,710 8,534 10,180 8,659 360,083 Income tax provision........... 71,539 2,319 390 503 74,751 ---------- ------- ------- ------- ---------- Net Income..................... $ 132,650 $ 4,228 $ (734) $ 311 $ 136,455 ========== ======= ======= ======= ==========
- ------------------ (1) Reflects ML Bancorp's results of operations for the two-month period ended February 28, 1998. (2) Reflects Carnegie and First Home results of operations for the seven-month period ended July 31,1998. During 1998, Sovereign recorded pre-tax merger-related charges of $49.9 million, ($33.5 million after-tax) or $.21 per share, primarily related to costs incurred in connection with its acquisitions of ML Bancorp, Inc., Carnegie Bancorp and First Home Bancorp, Inc. The components of the merger-related charges were as follows (in thousands):
REQUIRING CASH CASH OUTFLOW PROVISION OUTFLOW TO DATE --------- --------- ------- Severance and employee-related costs........................ $22,257 $22,257 $22,257 Merger transaction costs.................................... 5,307 5,307 5,307 Writedowns of assets........................................ 13,350 -- -- Office closing costs........................................ 3,085 1,274 1,274 Miscellaneous............................................... 5,933 5,933 5,933 ------- ------- ------- Total....................................................... $49,932 $34,771 $34,771 ======= ======= =======
Severance and employee-related costs relate primarily to severance costs and related taxes for employees of the three companies who were displaced as a result of merger, as well as the termination and distribution of ML Bancorp's ESOP and restricted stock plans in connection with the merger. Writedowns of assets include obsolescence of data processing equipment at all three companies as well as writedowns of servicing-related assets at ML Bancorp. The entire provision of $49.9 million was used in 1998. On September 19, 1997, Sovereign purchased Fleet Financial Group Inc.'s ("Fleet") Automobile Finance Division ("Fleet Auto"). Fleet Auto consisted of approximately $2.0 billion of indirect auto loans, automotive floor plan loans and loans to automotive lessors. Fleet Auto had business relationships with over 2,000 automotive dealerships and served approximately 225,000 customers throughout New Jersey, New York and several New England states. Sovereign purchased Fleet Auto at a discount, which in part, reflected the need to establish initial reserves for possible loan losses of approximately $22.0 million or 1.50% of the indirect auto loans acquired. The transaction added $10.7 million of goodwill to Sovereign's balance sheet. Sovereign's consolidated results of operations include Fleet Auto's results of operations from September 19, 1997 and thereafter. On August 29, 1997, Sovereign acquired Bankers Corp. ("Bankers"), a $2.6 billion financial services holding company headquartered in Perth Amboy, New Jersey. Bankers' sole banking subsidiary, Bankers Savings, operated 15 branch offices located in Middlesex, Monmouth and Ocean counties, New Jersey. The transaction added loans, deposits, and shareholders' equity to Sovereign of $1.5 billion, $1.7 billion, and $204 million, respectively. In accordance with the merger agreement, Bankers shareholders received 1.854 adjusted 48 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 2 -- BUSINESS COMBINATIONS -- (CONTINUED) shares of Sovereign common stock in exchange for each share of Bankers common stock. Sovereign issued approximately 23.0 million adjusted new shares of Sovereign common stock in connection with the transaction. This transaction was accounted for as a pooling-of-interests. On February 18, 1997, Sovereign acquired First State Financial Services, Inc. ("First State"), a $603 million savings institution headquartered in West Caldwell, New Jersey with 14 branch offices located throughout central and northern New Jersey. In accordance with the merger agreement, First State shareholders received 1.225 adjusted shares of Sovereign common stock in exchange for each share of First State common stock. Sovereign issued approximately 4.9 million adjusted new shares of Sovereign common stock in connection with the transaction. This transaction was accounted for as a pooling-of-interests. Prior to the combination, First State's fiscal year end was September 30, and accordingly, Sovereign's consolidated results of operations for the year ended December 31, 1997 include First State's results of operations for the twelve-month period ended December 31, 1997. A net decrease to Sovereign's stockholders' equity of $5.0 million has been made to reflect First State's activity for the three-month period ended December 31, 1996. That activity consisted of proceeds from the exercise of stock options of $1.0 million, net income of $6.2 million and net unrealized losses on investment securities available-for-sale of $228,000. The pre-merger results of operations for Sovereign, First State and Bankers (which were acquired pursuant to transactions accounted for as a pooling-of-interests) were as follows (in thousands):
SOVEREIGN(1) BANKERS COMBINED ------------ ------- -------- Year Ended December 31, 1997 (unaudited) Interest income......................................... $360,816 $89,398 $450,214 Interest expense........................................ 234,302 55,548 289,850 Provision for loan losses............................... 9,700 2,300 12,000 Other income............................................ 16,905 1,222 18,127 Non-interest expense.................................... 82,776 10,278 93,054 Income tax provision.................................... 20,230 8,172 28,402 -------- ------- -------- Net income.............................................. $ 30,713 $14,322 $ 45,035 ======== ======= ========
- ------------------ (1) Sovereign's result of operations include First State's results of operations. 49 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 2 -- BUSINESS COMBINATIONS -- (CONTINUED) During 1997, Sovereign recorded pre-tax merger-related charges of $44.1 million ($29.8 million after-tax) or $.19 per share, primarily related to costs incurred in connection with its acquisitions of Bankers and First State. The components of the merger-related charges were as follows (in thousands):
REQUIRING CASH CASH OUTFLOW PROVISION OUTFLOW TO DATE --------- --------- ------- Severance and employee-related costs........................ $ 8,613 $ 8,613 $ 8,613 Merger transaction costs.................................... 5,811 5,811 5,811 Credit-related reserves..................................... 24,900 -- -- Loss on sales of assets..................................... 1,093 -- -- Office closing costs........................................ 2,330 -- -- Miscellaneous............................................... 1,377 1,377 1,377 ------- ------- ------- Total....................................................... $44,124 $15,801 $15,801 ======= ======= =======
Severance and employee-related costs relate primarily to severance costs and related taxes for employees of the two companies who were displaced as a result of the mergers. Credit-related costs relate to additional reserves which Sovereign determined would be necessary as a result of its conservative approach with respect to an aggressive workout plan for certain assets acquired from Bankers and First State. With the exception of the credit-related reserves, the remaining reserves of $19.2 million were used in 1997. NOTE 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, 1999 and 1998 were $72 million and $237 million, respectively. NOTE 4 -- INVESTMENT SECURITIES The amortized cost and estimated fair value of investment securities are as follows (in thousands):
AT DECEMBER 31, --------------------------------------------------------------------------------- 1999 1998 ----------------------------------------------------- ------------------------- AMORTIZED UNREALIZED UNREALIZED AMORTIZED UNREALIZED COST APPRECIATION DEPRECIATION FAIR VALUE COST APPRECIATION ---------- ------------ ------------ ---------- ---------- ------------ Investment Securities Available-for-Sale: Investment Securities: U.S. Treasury and government agency securities.............. $ 77,229 $ 2 $ 1,210 $ 76,021 $ 35,480 $ 1 Corporate securities/Trust preferred............... 243,915 650 14,231 230,334 40,784 1,627 Asset-backed securities... 685,274 -- 21,149 664,125 193,154 45 Equities.................. 32,142 31 11,420 20,753 54,383 5,381 FHLB stock................ 524,397 -- -- 524,397 345,324 -- Agency preferred stock.... 425,888 4,135 395 429,628 456,861 9,856 Municipal securities...... 32,813 745 1,379 32,179 34,609 1,066 Mortgage-backed Securities: Passthroughs: U.S. government agencies.............. 478,462 909 21,004 458,367 168,840 1,951 Non-agencies............ 2,688,315 -- 132,333 2,555,982 1,969,322 15,976 Collateralized mortgage obligations........... 3,166,472 2,564 130,610 3,038,426 3,335,794 11,168 ---------- ------- -------- ---------- ---------- ------- Total investment securities available-for-sale........ $8,354,907 $ 9,036 $333,731 $8,030,212 $6,634,551 $47,071 ========== ======= ======== ========== ========== ======= AT DECEMBER 31, ------------------------- 1998 ------------------------- UNREALIZED DEPRECIATION FAIR VALUE ------------ ---------- Investment Securities Available-for-Sale: Investment Securities: U.S. Treasury and government agency securities.............. $ 63 $ 35,418 Corporate securities/Trust preferred............... 121 42,290 Asset-backed securities... 897 192,302 Equities.................. 9,654 50,110 FHLB stock................ -- 345,324 Agency preferred stock.... 5 466,712 Municipal securities...... 629 35,046 Mortgage-backed Securities: Passthroughs: U.S. government agencies.............. 335 170,456 Non-agencies............ 5,510 1,979,788 Collateralized mortgage obligations........... 1,981 3,344,981 ------- ---------- Total investment securities available-for-sale........ $19,195 $6,662,427 ======= ==========
50 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 4 -- INVESTMENT SECURITIES -- (CONTINUED)
AT DECEMBER 31, ------------------------------------------------------- 1999 ----------------------------------------------------- AMORTIZED UNREALIZED UNREALIZED COST APPRECIATION DEPRECIATION FAIR VALUE ---------- ------------ ------------ ---------- Investment Securities Held-to-Maturity: Investment Securities: U.S. Treasury and government agency securities.............. $ 4,807 $ -- $ 109 $ 4,698 Corporate securities...... 1,326,827 9,852 165 1,336,514 Municipal securities...... 3,275 96 22 3,349 Mortgage-backed securities: Passthroughs: U.S. government agencies.............. 499,866 2,516 2,365 500,017 Non-agency.............. 52,319 377 224 52,472 Collateralized mortgage obligations........... 474,957 2,520 7,502 469,975 ---------- ------- -------- ---------- Total investment securities held-to-maturity.......... $2,362,051 $15,361 $ 10,387 $2,367,025 ========== ======= ======== ========== AT DECEMBER 31, --------------------------------------------------- 1998 1998 ------------------------- ------------------------- AMORTIZED UNREALIZED UNREALIZED COST APPRECIATION DEPRECIATION FAIR VALUE ---------- ------------ ------------ ---------- Investment Securities Held-to-Maturity: Investment Securities: U.S. Treasury and government agency securities.............. $ 31,179 $ 151 $ 78 $ 31,252 Corporate securities...... 42,249 3,526 26 45,749 Municipal securities...... 8,064 165 -- 8,229 Mortgage-backed securities: Passthroughs: U.S. government agencies.............. 715,558 14,113 285 729,386 Non-agency.............. 74,523 1,165 136 75,552 Collateralized mortgage obligations........... 968,082 4,541 2,208 970,415 ---------- ------- ------- ---------- Total investment securities held-to-maturity.......... $1,839,655 $23,661 $ 2,733 $1,860,583 ========== ======= ======= ==========
The amortized cost and estimated fair value of investment securities at December 31, 1999 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 COST FAIR VALUE ---------- ---------- Investment Securities Available-for-Sale: Due in one year or less................................... $ 880,376 $ 692,508 Due after one year through five years..................... 3,533,633 3,484,706 Due after five years through ten years.................... 1,512,764 1,463,514 Due after ten years....................................... 1,892,805 1,844,334 No stated maturity........................................ 556,539 545,150 ---------- ---------- Total investment securities available-for-sale......... $8,376,117 $8,030,212 ========== ========== AMORTIZED COST FAIR VALUE ---------- ---------- Investment Securities Held-to-Maturity: Due in one year or less................................... $1,548,263 $1,555,406 Due after one year through five years..................... 577,798 583,267 Due after five years through ten years.................... 166,434 162,251 Due after ten years....................................... 69,556 66,101 No stated maturity........................................ -- -- ---------- ---------- Total investment securities held-to-maturity........... $2,362,051 $2,367,025 ========== ==========
51 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 4 -- INVESTMENT SECURITIES -- (CONTINUED) Proceeds from sales of investment securities and the realized gross gains and losses from those sales are as follows (in thousands):
HELD-TO-MATURITY AVAILABLE-FOR-SALE YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, ---------------------------------- ------------------- 1999 1998 1997 1998 1997 ---------- ---------- -------- ------- --------- Proceeds from sales..................... $1,681,580 $2,145,929 $295,933 $12,432 $ 561,316 ========== ========== ======== ======= ========= Gross realized gains.................... 8,335 27,729 3,751 -- 183 Gross realized losses................... 4,603 11,449 2,893 457 10,217 ---------- ---------- -------- ------- --------- Net realized gains/(losses)............. $ 3,732 $ 16,280 $ 858 $ (457) $ (10,034) ========== ========== ======== ======= =========
Proceeds from sales of investment securities held-to-maturity for the years ended December 31, 1998 and 1997 was the result of the liquidation of certain held-to-maturity securities acquired from ML Bancorp in 1998 and Bankers in 1997. These sales were completed in accordance with the provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" to maintain Sovereign's pre-merger interest rate risk position, and the impact of these sales was included as part of the merger-related charges for ML Bancorp and Bankers. Tax-exempt income included in interest and dividends on investment securities for the years ended December 31, 1999, 1998 and 1997 was $19.3 million, $17.9 million and $10.5 million, respectively. Tax expense/(benefit) related to net realized gains and losses from sales of investment securities for the years ended December 31, 1999, 1998 and 1997 were $1.2 million, $5.7 million and $(3.2) million, respectively. Investment securities with an estimated fair value of $2.7 billion and $1.8 billion were pledged as collateral for borrowings, interest rate agreements and public deposits at December 31, 1999 and 1998, respectively. During the fourth quarter of 1999, Sovereign raised $1.8 billion of debt and equity in anticipation of its planned acquisition of Sovereign Bank New England. Under the terms of the financing agreements, Sovereign was required to escrow certain proceeds, with limited ability to invest such proceeds, subject to completion of the acquisition. Investment securities held-to-maturity include $1.3 billion of commercial paper representing the escrowed balances at December 31, 1999. 52 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 5 -- LOANS A summary of loans included in the consolidated balance sheets follows (in thousands):
AT DECEMBER 31, ------------------------- 1999 1998 ----------- ----------- Residential real estate loans.............................. $ 5,623,295 $ 5,113,537 Residential construction loans (net of loans in process of $31,447 and $89,569, respectively)....................... 59,264 62,536 ----------- ----------- Total Residential Loans............................... 5,682,559 5,176,073 ----------- ----------- Commercial real estate loans............................... 1,516,953 887,938 Commercial loans........................................... 1,690,744 717,440 Automotive floor plan loans................................ 730,623 578,147 Multi-family loans......................................... 137,019 115,195 ----------- ----------- Total Commercial Loans................................ 4,075,339 2,298,720 ----------- ----------- Home equity loans.......................................... 1,957,945 1,750,883 Auto loans................................................. 1,936,980 1,510,676 Loans to automotive lessors................................ 288,636 252,856 Student loans.............................................. 249,279 256,744 Other...................................................... 35,802 39,888 ----------- ----------- Total Consumer Loans.................................. 4,468,642 3,811,047 ----------- ----------- Total Loans(1)........................................ $14,226,540 $11,285,840 =========== =========== Total Loans with:(2) Fixed rate............................................... $ 8,707,951 $ 5,798,158 Variable rate............................................ 5,518,589 5,487,682 ----------- ----------- Total Loans(1)........................................ $14,226,540 $11,285,840 =========== ===========
- ------------------ (1) Loan totals are net of deferred loan fees and unamortized premiums and discounts of $24.0 million for 1999 and $16.9 million for 1998. (2) Loan totals do not reflect the impact of off-balance sheet interest rate swaps used for interest rate risk management as discussed below. Loans to related parties include loans made to certain officers, directors and their affiliated interests. At December 31, 1999 and 1998, loans to related parties totaled $9.2 million and $2.7 million, respectively. The activity in the allowance for loan losses is as follows (in thousands):
YEAR ENDED DECEMBER 31, ------------------------------ 1999 1998 1997 -------- -------- -------- Balance, beginning of period.......................... $133,802 $116,823 $ 73,847 Acquired reserves and other additions................. 4,799 22,660 20,652 Provision for loan losses............................. 30,000 27,961 41,125 Charge-offs........................................... 55,023 46,330 24,184 Recoveries............................................ 19,408 12,688 5,383 -------- -------- -------- Balance, end of period................................ $132,986 $133,802 $116,823 ======== ======== ========
53 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 5 -- LOANS -- (CONTINUED) Sovereign requires loan officers to follow specific procedures in the early identification and collection of problem loans. If a loan becomes delinquent or the loan officer is not successful in the resolution of the problem loan, the account is transferred to Sovereign's Asset Recovery Team. At this time the account is analyzed for collateral values and the cash flows available to repay the loan. If it is determined that there is a collateral shortfall and insufficient cash flow to repay the debt, a reserve will be established. At any time during this process and at the loan officer's discretion, the account may be placed on non-accrual status. By following these procedures, losses are minimized on impaired loans. Impaired loans are summarized as follows (in thousands):
AT DECEMBER 31, ------------------ 1999 1998 -------- ------- Impaired loans without a related allowance.................. $ -- $ -- Impaired loans with a related allowance..................... 108,215 63,296 -------- ------- Total impaired loans...................................... $108,215 $63,296 ======== ======= Allowance for impaired loans................................ $ 23,033 $18,582 ======== =======
If Sovereign's 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, 1999, 1998 and 1997 would have increased by approximately $5.0 million, $9.8 million and $7.5 million, respectively. Interest income recorded on these loans for the years ended December 31, 1999, 1998 and 1997 was $2.1 million, $3.3 million and $2.4 million, respectively. The average balance of impaired loans for 1999, 1998 and 1997 was $82.3 million, $58.1 million and $29.2 million, respectively. NOTE 6 -- MORTGAGE BANKING ACTIVITY At December 31, 1999, 1998, and 1997, Sovereign serviced loans for the benefit of others totaled $5.7 billion, $6.7 billion, and $6.4 billion, respectively. The following table presents the activity of Sovereign's mortgage servicing rights for the years indicated. This activity does not reflect the reduction from the activity in Sovereign's valuation allowance for mortgage servicing rights presented in the table below (in thousands):
1999 1998 1997 -------- -------- -------- Balance, beginning of year............................. $ 75,627 $ 68,063 $ 58,759 Net servicing assets recognized during the year........ 14,605 19,439 19,979 Amortization and other................................. (12,883) (11,875) (10,675) -------- -------- -------- Balance, end of year................................... $ 77,349 $ 75,627 $ 68,063 ======== ======== ========
For valuation purposes, at December 31, 1999, a weighted average discount rate of 9.89% was assumed and assumed prepayment speeds were consistent with published secondary market rates for Sovereign's market area. Sovereign also takes into consideration any inherent risks, as well as other relevant factors associated with each portfolio. Prices are obtained in the secondary market and are based upon current market prices of similarly traded loans and/or comparable secondary market instruments. 54 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 6 -- MORTGAGE BANKING ACTIVITY -- (CONTINUED) Activity in the valuation allowance for mortgage servicing rights for the years indicated consisted of the following (in thousands):
YEAR ENDED DECEMBER 31, -------------------------- 1999 1998 1997 ------- ------- ------ Balance, beginning of year................................ $13,295 $ 3,295 $2,200 Change in valuation allowance for mortgage servicing rights.................................................. (8,437) 10,000 1,095 ------- ------- ------ Balance, end of year...................................... $ 4,858 $13,295 $3,295 ======= ======= ======
NOTE 7 -- PREMISES AND EQUIPMENT A summary of premises and equipment, less accumulated depreciation and amortization, follows (in thousands):
AT DECEMBER 31, ------------------- 1999 1998 -------- -------- Land........................................................ $ 15,790 $ 14,923 Office buildings............................................ 84,130 69,542 Furniture, fixtures, and equipment.......................... 116,163 94,055 Leasehold improvements...................................... 22,154 21,351 Automobiles................................................. 883 849 -------- -------- 239,120 200,720 Less accumulated depreciation............................... (119,919) (102,229) -------- -------- Total premises and equipment.............................. $119,201 $ 98,491 ======== ========
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, 1999, are summarized as follows (in thousands):
AT DECEMBER 31, 1999 --------------- 2000.................................................. $15,155 2001.................................................. 14,049 2002.................................................. 11,957 2003.................................................. 9,587 2004.................................................. 6,451 Thereafter............................................ 27,045 ------- Total............................................... $84,244 =======
Total rental expense for all leases for the years ended December 31, 1999, 1998, and 1997 was $16.5 million, $10.6 million and $7.9 million, respectively. 55 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 8 -- ACCRUED INTEREST RECEIVABLE Accrued interest receivable is summarized as follows (in thousands):
AT DECEMBER 31, ---------------------- 1999 1998 -------- -------- Accrued interest receivable on: Investment securities..................................... $ 58,749 $ 57,809 Loans..................................................... 105,971 89,632 -------- -------- Total interest receivable.............................. $164,720 $147,441 ======== ========
NOTE 9 -- DEPOSITS Deposits are summarized as follows (in thousands):
AT DECEMBER 31, -------------------------------------------------------------------------- 1999 1998 ---------------------------------- ---------------------------------- BALANCE PERCENT RATE BALANCE PERCENT RATE ----------- ------- ---- ----------- ------- ---- Demand deposit accounts................ $ 1,089,472 9% --% $ 1,104,170 9% --% NOW accounts........................... 1,578,259 14 2.24 1,281,516 10 1.24 Savings accounts....................... 2,142,708 18 2.69 2,295,448 19 2.83 Money market accounts.................. 1,345,325 12 4.17 1,545,634 13 3.78 Retail certificates of deposit......... 4,708,057 40 5.00 5,172,196 42 5.24 Jumbo certificates of deposit.......... 855,825 7 5.56 923,752 7 5.40 ----------- --- ---- ----------- --- ---- Total deposits....................... $11,719,646 100% 3.64% $12,322,716 100% 3.73% =========== === ==== =========== === ====
Certificate accounts are frequently renewed at maturity rather than paid out. The following table sets forth the maturity of Sovereign's certificates of deposit as scheduled to mature contractually at December 31, 1999 (in thousands):
WITHIN SIX SIX MOS. ONE/ THREE/ FIVE/ OVER MOS. ONE YR. THREE YRS. FIVE YRS. TEN YRS. TEN YRS. TOTAL ---------- ---------- ---------- --------- -------- -------- ---------- Certificate accounts by rate: Less than 4.001%................. $ 19,217 $ 973 $ 8,560 $ 56 $ 421 $ 22,989 $ 52,216 4.001% -- 6.000%................. 3,411,736 1,372,275 308,254 80,134 36,130 100,491 5,309,020 6.001% -- 8.000%................. 109,397 19,439 30,516 25,754 10,533 8 195,647 8.001% -- 10.000%................ 874 298 850 422 1,117 144 3,705 Above 10.000%.................... 549 377 275 128 1,887 78 3,294 ---------- ---------- -------- -------- ------- -------- ---------- Total certificate accounts....... $3,541,773 $1,393,362 $348,455 $106,494 $50,088 $123,710 $5,563,882 ========== ========== ======== ======== ======= ======== ==========
The following table sets forth the maturity of Sovereign's certificates of deposit as scheduled to mature contractually at December 31, 1999 (in thousands):
AT DECEMBER 31, 1999 --------------- 2000........................................................ $4,935,135 2001........................................................ 242,720 2002........................................................ 105,735 2003........................................................ 60,322 2004........................................................ 46,172 Thereafter.................................................. 173,798 ---------- Total..................................................... $5,563,882 ==========
56 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 9 -- DEPOSITS -- (CONTINUED) The following table sets forth the maturity of Sovereign's certificates of deposit of $100,000 or more as scheduled to mature contractually at December 31, 1999 (in thousands):
AT DECEMBER 31, 1999 --------------- Three months or less........................................ $ 317,341 Over three through six months............................... 591,903 Over six through twelve months.............................. 240,868 Over twelve months.......................................... 60,907 ---------- Total..................................................... $1,211,019 ==========
Interest expense on deposits is summarized as follows (in thousands):
AT DECEMBER 31, ------------------------------------ 1999 1998 1997 -------- -------- -------- Demand deposit and NOW accounts........................... $ 21,851 $ 16,387 $ 7,967 Savings accounts.......................................... 58,333 62,694 58,974 Money market accounts..................................... 50,246 45,055 33,719 Certificates of deposit................................... 297,625 316,164 278,153 -------- -------- -------- Total interest expense on deposits...................... $428,055 $440,300 $378,813 ======== ======== ========
Deposits of related parties include deposits made by certain officers, directors and their affiliated interests. At December 31, 1999 and 1998, deposits of related parties totaled $2.4 million and $1.7 million, respectively. NOTE 10 -- 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, -------------------------- 1999 1998 ---------- ---------- Securities sold under repurchase agreements................. $ 414,553 $ 315,540 Federal Home Loan Bank advances............................. 6,403,952 3,409,243 Current portion of long-term borrowings..................... 83,909 197,569 ---------- ---------- Total short-term borrowings............................... $6,902,414 $3,922,352 ========== ==========
Included in short-term borrowings are sales of securities under repurchase agreements, and retail repurchase agreements. Securities underlying sales of securities under repurchase agreements consisted of investment securities which had an amortized cost of $141 million and $180 million and a market value of $139 million and $182 million at December 31, 1999 and 1998, respectively. 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 primarily broker/dealers reporting to the Federal Reserve Bank of New York. 57 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 10 -- SHORT-TERM AND LONG-TERM BORROWINGS -- (CONTINUED) The following table summarizes information regarding short-term securities sold under repurchase agreements (in thousands):
DECEMBER 31, ------------------------------------------ 1999 1998 1997 ---------- ---------- ---------- Balance............................................... $ 414,553 $ 315,540 $ 787,700 Weighted average interest rate........................ 4.22% 5.32% 5.61% Maximum amount outstanding at any month-end during the year................................................ $2,747,239 $ 956,394 $1,515,156 Average amount outstanding during the year............ $1,428,756 $ 525,986 $1,222,183 Weighted average interest rate during the year........ 5.50% 5.39% 5.67%
The following table summarizes information regarding short-term FHLB advances (in thousands):
DECEMBER 31, ------------------------------------------ 1999 1998 1997 ---------- ---------- ---------- Balance............................................... $6,403,952 $3,409,243 $4,626,401 Weighted average interest rate........................ 5.67% 5.32% 5.91% Maximum amount outstanding at any month-end during the year................................................ $6,403,952 $5,361,401 $4,709,176 Average amount outstanding during the year............ $3,867,391 $4,420,827 $3,718,562 Weighted average interest rate during the year........ 5.58% 5.98% 6.03%
Long-term Borrowings. Long-term securities sold under repurchase agreements had weighted average interest rates of 5.78% and 5.58% at December 31, 1999 and 1998, respectively. Long-term FHLB advances had weighted average interest rates of 4.89% and 4.96% at December 31, 1999 and 1998, respectively. Long-term borrowings, excluding portion classified as short-term are as follows (in thousands):
AT DECEMBER 31, -------------------------- 1999 1998 ---------- ---------- Securities sold under repurchase agreements, maturing January 2001 to November 2002............................. $ 170,000 $ 340,000 FHLB advances, maturing January 2001 to April 2012.......... 4,080,952 3,492,262 Senior Secured Credit Facility, due June 30, 2003........... 500,000 -- 6.75% senior notes, due July 1, 2000(1)..................... -- 49,896 6.625% senior notes, due March 15, 2001..................... 239,843 -- 10.25% senior notes, due May 15, 2004....................... 200,000 -- 10.50% senior notes, due November 15, 2006.................. 500,000 -- 6.75% subordinated debentures, due 2000(1).................. -- 27,822 8.50% subordinated debentures, due 2002..................... 19,987 19,982 8.00% subordinated debentures, due 2003..................... 49,942 49,925 ---------- ---------- Total long-term borrowings................................ $5,760,724 $3,979,887 ========== ==========
- ------------------ (1) Notes/debentures mature during year 2000 and therefore are reflected in short-term borrowings on page 57. Included in long-term borrowings are sales of securities under repurchase agreements. Securities underlying these repurchase agreements consist of investment securities which had a book value of $195 million and $340 million, and a market value of $192 million and $344 million at December 31, 1999 and 1998, respectively. FHLB advances are collateralized by qualifying mortgage-related assets as defined by the FHLB. 58 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 10 -- SHORT-TERM AND LONG-TERM BORROWINGS -- (CONTINUED) The Senior Secured Credit Facility will mature on the date six months prior to the maturity date of the 10.25% senior notes, but in no event later than June 30, 2003. The facility amortizes in quarterly installments in the following annual percentages of principal: 2000 -- 5%, $25 million ; 2001 -- 15%, $75 million; 2002 -- 40%, $200 million; and 2003 -- 40%, $200 million with mandatory prepayments occurring if Sovereign's cash flow exceeds predetermined levels. Interest is calculated, at the option of the borrower, at LIBOR plus 3.5%, or the sum of a) the highest of (i) lender's base rate, (ii) .50% over lender's three month CD rate, or (iii) .50% over the Federal Funds Effective Rate, plus b) 2.50%. Interest was calculated under the LIBOR option (9.96%) at December 31, 1999. The Senior Secured Credit Facility is secured primarily by first perfected security interest in the stock of Sovereign Bank owned by Sovereign Bancorp. The Senior Secured Credit Facility subjects Sovereign to a number of affirmative and negative covenants. The 6.75% senior notes are non-amortizing and are not redeemable prior to maturity. The senior 6.625%, 10.25% and 10.50% notes are non-amortizing and are redeemable, at a significant premium, at any time prior to maturity. The 6.75% and 8.00% subordinated debentures are non-amortizing and are not redeemable prior to maturity. The 8.50% subordinated debentures are non-amortizing and are redeemable at the option of Sovereign in whole or in part. The 6.75% subordinated debentures and a portion of the FHLB advances have, through the use of interest rate swaps, been effectively converted from fixed rate obligations to variable rate obligations. The Senior Secured Credit Facility and the 10.25% and 10.5% Senior Notes require Sovereign to escrow funds sufficient to redeem these debts in the event the Sovereign Bank New England acquisition is not completed. Sovereign's ability to invest these funds is limited to investment categories specified in the escrow agreements. At the December 31, 1999, investment securities held-to-maturity includes $1.3 billion of commercial paper of commercial obligors as required under the escrow agreements. The following table sets forth the maturity of Sovereign's short-term and long-term borrowings as scheduled to mature contractually at December 31, 1999 (in thousands):
AT DECEMBER 31, 1999 --------------- 2000........................................................ $ 6,902,414 2001........................................................ 599,843 2002........................................................ 589,987 2003........................................................ 764,942 2004........................................................ 650,700 Thereafter.................................................. 3,155,252 ----------- Total..................................................... $12,663,138 ===========
NOTE 11 -- TRUST PREFERRED SECURITIES On November 15, 1999, Sovereign issued 5,750,000 units of Trust Preferred Income Equity Redeemable Securities (PIERS) resulting in net proceeds to Sovereign of $278.3 million with a stated maturity of January 15, 2030, of which $91,500 has been allocated to the value of the warrants and is treated as original issue discount. The original issue discount is accreted into Trust Preferred Securities expense over the life of the unit resulting in an effective yield of 11.74%. Each PIERS unit consists of: A preferred capital security (Trust Preferred II) issued by Sovereign Capital Trust II (Trust II), valued at $32.50, having a stated liquidation amount of $50, representing an undivided beneficial ownership interest in Trust II, which assets consist solely of debentures issued by Sovereign. 59 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 11 -- TRUST PREFERRED SECURITIES -- (CONTINUED) Distributions are payable quarterly beginning February 15, 2000 at an annual rate of 7.5% of the stated liquidation value; and A warrant to purchase, subject to antidilution adjustments, 5.3355 shares of Sovereign common stock at any time prior to November 20, 2029. The warrants were valued at $17.50 per unit. The Trust Preferred II securities were issued by a special-purpose statutory trust created expressly for the issuance of these securities. Distributions on Trust II will be payable at an annual rate of 7.5% of the stated liquidation amount of $50 per capital security, payable quarterly. After issue discount and issuance costs, proceeds of $186.8 million were invested in Junior Subordinated Debentures of Sovereign, at terms identical to the Trust Preferred II offering. Cash distributions on Trust Preferred II will be made to the extent interest on the debentures is received by Trust II. Sovereign may defer interest payments on the debentures for a period not exceeding 20 consecutive quarters or beyond the original maturity date. Holders may require Sovereign to repurchase the Trust Preferred II securities at accreted value following exercise of the warrants. In the event of certain changes or amendments to regulatory requirements or federal tax rules, Sovereign may elect to redeem the Trust Preferred II securities at 100% of accreted value and to redeem the warrants at their value (combined value $50). Sovereign may elect to redeem the Trust Preferred II securities and the warrants at $50, if the value of Sovereign's common stock on 20 trading days out of the preceding 30 consecutive trading days and on the day the election is made exceeds $14.99 after November 20, 2002; $13.12 after November 15, 2003; or $11.25 after November 15, 2004. During March 1997, Sovereign issued $100 million of preferred capital securities ("Trust Preferred") through Sovereign Capital Trust I ("Trust"), a special-purpose statutory trust created expressly for the issuance of these securities. Distributions on the Trust Preferred will be payable at an annual rate of 9% of the stated liquidation amount of $1,000 per capital security, payable semi-annually. After issuance costs, proceeds of $97.6 million were invested in Junior Subordinated Debentures of Sovereign, at terms identical to the Trust Preferred offering. Cash distributions on the Trust Preferred are made to the extent interest on the debentures is received by the Trust. In the event of certain changes or amendments to regulatory requirements or federal tax rules, the Trust Preferred securities are redeemable in whole. Otherwise, the Trust Preferred securities are generally redeemable in whole or in part on or after April 1, 2007, at a declining redemption price ranging from 103.875% to 100% of the liquidation amount. On or after April 1, 2017, the Trust Preferred securities may be redeemed at 100% of the liquidation amount. During March 1997, ML Bancorp, a predecessor company of Sovereign, issued $50.0 million of Trust Preferred securities at an interest rate of 9.875%, with a scheduled maturity of March 1, 2027. The securities were issued by ML Capital Trust I and proceeds from the issuance were invested in Junior Subordinated Debentures issued by ML Bancorp. Sovereign assumed ML Bancorp's obligations under this offering and has the option, subject to required regulatory approval, to prepay the securities beginning March 1, 2007. The Trust Preferred offerings are classified as and are similar to a minority interest and are presented as "Corporation-obligated mandatorily redeemable capital securities of subsidiary trust holding solely subordinated debentures of Sovereign Bancorp, Inc." The Trust Preferred offerings qualify for Tier I capital treatment for Sovereign and the loan payments from Sovereign to the Trust are fully tax deductible. The warrants, included in the PIERS units, are classified as additional capital within stockholders' equity. NOTE 12 -- STOCKHOLDERS' EQUITY The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA") requires institutions regulated by the Office of Thrift Supervision (OTS) to have a minimum leverage capital ratio equal to 3% of tangible assets, and 4% of risk-adjusted assets, and a risk-based capital ratio equal to 8%. The Federal Deposit Insurance Corporation Improvement Act ("FDICIA") requires OTSregulated institutions to have a 60 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 12 -- STOCKHOLDERS' EQUITY -- (CONTINUED) minimum tangible capital equal to 2% of total tangible assets. Sovereign Bank was in compliance with all of these capital requirements as of December 31, 1999. The following schedule summarizes the actual capital balances of Sovereign Bank at December 31, 1999 (in thousands):
TANGIBLE LEVERAGE LEVERAGE RISK-BASED CAPITAL TO CAPITAL TO CAPITAL TO CAPITAL TO TANGIBLE TANGIBLE RISK-ADJUSTED RISK-ADJUSTED ASSETS ASSETS ASSETS ASSETS ---------- ---------- ------------- ------------- Sovereign Bank: Regulatory capital.......................... $2,062,070 $2,062,070 $2,062,070 $2,190,805 Minimum capital requirement................. 502,666 753,999 602,377 1,204,755 ---------- ---------- ---------- ---------- Excess.................................... $1,559,404 $1,308,071 $1,459,693 $ 986,050 ========== ========== ========== ========== Capital ratio............................... 8.20% 8.20% 13.69% 14.55%
OTS capital regulations do not apply to thrift holding companies. The following schedule summarizes actual capital balances and ratios of Sovereign Bancorp at December 31, 1999 using average tangible assets which is consistent with the method used by bank holding companies (in thousands):
TANGIBLE LEVERAGE LEVERAGE RISK-BASED CAPITAL TO CAPITAL TO CAPITAL TO CAPITAL TO TANGIBLE TANGIBLE RISK-ADJUSTED RISK-ADJUSTED ASSETS ASSETS ASSETS ASSETS ---------- ---------- ------------- ------------- Sovereign Bancorp: Regulatory capital.......................... $1,591,695 $1,908,041 $1,908,041 $2,424,776 Minimum capital requirement................. 527,546 760,786 651,477 1,302,955 ---------- ---------- ---------- ---------- Excess.................................... $1,064,149 $1,147,255 $1,256,564 $1,121,821 ========== ========== ========== ========== Capital ratio............................... 6.28% 7.52% 11.72% 14.89%
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA") established five capital tiers: well-capitalized, adequately-capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. 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, 1999, Sovereign Bank was classified as well-capitalized and in compliance with all capital requirements. Management anticipates that Sovereign Bank will continue to be classified as well-capitalized and will be in compliance with all regulatory capital requirements. Although Sovereign Bancorp is not subject to OTS capital requirements, depending upon the specific facts regarding a proposed acquisition, the OTS could determine that the pro forma financial condition of a savings and loan holding company may be inadequate and therefore condition approval on making prescribed capital levels. As a result of provisions of the Small Business Jobs Protection Act of 1996 (the "Jobs Protection Act"), which repealed the tax reserve method for bad debts for thrift institutions and the circumstances requiring bad debt recapture for large institutions, Sovereign must determine the tax deduction for bad debt based on actual charge-offs. The Jobs Protection Act retained the existing base year bad debt reserve and requires recapture into taxable income in certain circumstances such as in the case of certain excess distributions or complete redemptions. None of the limited circumstances requiring recapture are anticipated by Sovereign. Retained earnings at December 31, 1999 included $79.6 million in bad debt reserves, for which no deferred taxes have been provided due to the indefinite nature of the recapture provisions. 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, 1999, purchases of common 61 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 12 -- STOCKHOLDERS' EQUITY -- (CONTINUED) stock with reinvested dividends are made at a 5% discount from the 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 acquiree at a substantially reduced price. On November 15, 1999, Sovereign raised $1.3 billion of debt and equity. This included issuance of 43.8 million shares of common stock resulting in net proceeds of $331.5 million. In connection with the PIERS offering as described in the preceding note, Sovereign issued 5.75 million warrants with a fair value, net of offering expenses, of $91.5 million, classified as stockholders' equity. The conversion of all warrants would result in an additional 30.7 million shares outstanding before the effect of repurchase of shares assumed under the treasury stock method used for fully diluted EPS calculations. On May 15, 1998, Sovereign redeemed all outstanding shares of its 6 1/4% Cumulative Convertible Preferred Stock, Series B and issued 14.3 million shares of common stock in connection with this redemption. NOTE 13 -- STOCK OPTION PLANS Sovereign grants stock options for a fixed number of shares to key officers, certain employees and directors with an exercise price equal to the fair market value of the shares at the date of grant. Sovereign's stock options expire not more than ten years and one month after the date of grant and become fully vested and exercisable within a one to five year period after 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 14.2 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. The following table provides a summary of the Company's stock option activity for the years ended December 31, 1999, 1998 and 1997 and stock options exercisable at the end of each of those years (number of options in thousands).
PRICE PER SHARES SHARE ---------- --------------- Options outstanding December 31, 1996 (3,758,345 shares exercisable).............................................. 8,065,895 $ .96 - $8.94 Granted..................................................... 1,382,278 8.17 - 15.94 Exercised................................................... (3,388,704) .97 - 7.51 Forfeited................................................... (26,016) 3.84 - 10.54 Options outstanding December 31, 1997 (4,351,317 shares exercisable).............................................. 6,033,453 .96 - 16.77 Granted..................................................... 934,070 13.38 - 20.25 Exercised................................................... (2,295,265) .97 - 10.54 Forfeited................................................... (172,550) 8.22 - 20.25 Options outstanding December 31, 1998 (3,371,038 shares exercisable).............................................. 4,499,708 .96 - 20.25 Options exchanged in conjunction with Peoples acquisition... 473,531 4.41 - 6.86 Granted..................................................... 2,216,479 8.28 - 12.44 Exercised................................................... (720,811) .96 - 8.83 Forfeited................................................... (110,015) 3.78 - 16.35 Options outstanding December 31, 1999 (4,154,213 shares exercisable).............................................. 6,358,892 $ 1.30 - $20.25 ========== ===============
62 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 13 -- STOCK OPTION PLANS -- (CONTINUED) The following table summarizes Sovereign's stock options outstanding at December 31, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------- ---------------------- WTD. AVG. WTD. AVG. WTD. AVG. EXERCISE REMAINING EXERCISE EXERCISE PRICES SHARES PRICE CONTRACTUAL LIFE SHARES PRICE --------------- ---------- --------- ---------------- ---------- --------- $ .96-$ 6.94 2,504,011 $ 4.36 4.70 2,504,011 $ 4.36 $7.27-$12.71 2,504,181 $11.01 9.19 299,502 $ 8.65 $13.28-$20.25 1,350,700 $14.67 8.15 1,350,700 $14.67 ---------- ------ ---- ---------- ------ Total 6,358,892 $ 9.17 7.20 4,154,213 $ 8.02 ========== ====== ==== ========== ======
Companies have 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). Sovereign follows the disclosure only method. Pro forma information regarding net income and earnings per share is required by SFAS No. 123 and has been determined as if Sovereign had accounted for its employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions: Grant date year.............................. 1999 1998 1997 Expected volatility.......................... .296 .278 .200-.840 Expected life in years....................... 6.00 6.00 4.00-7.50 Stock price on date of grant................. $ 8.28-$12.44 $13.38-$20.25 $ 8.17-$15.94 Exercise price............................... $ 8.28-$12.44 $13.38-$20.25 $ 8.17-$15.94 Weighted average exercise price.............. $ 11.34 $ 15.41 $ 10.60 Weighted average fair value.................. $ 3.98 $ 5.45 $ 4.44 Expected dividend yield...................... 1.40% .67% .21%-3.00% Risk-free interest rate...................... 5.17%-6.75% 4.65%-5.72% 5.76%-6.88% Vesting period in years...................... 1-5 1 0-4
The Black-Scholes option valuation model was developed for use in estimating the fair market value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because Sovereign's employee stock options have characteristics significantly different from those traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide reliable single measure of fair value of its employee stock options. The pro forma reduction to net income for 1999, 1998 and 1997 was $3.2 million, $2.9 million and $2.8 million, respectively. The pro forma reduction to diluted earnings per share was $.02, each year. 63 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 14 -- EMPLOYEE BENEFIT PLANS Sovereign sponsors a non-contributory defined benefit pension plan (Sovereign Plan) covering substantially all employees who have attained the age of 21 and completed one year of service. Effective March 31, 1999, Sovereign announced its intention to terminate the Sovereign Plan and is in the process of completing that termination. Benefit accruals were frozen at March 31, 1999, and a curtailment gain of $1.6 million was recorded. Benefits under the Sovereign Plan were based upon years of service and the employees' average compensation computed based on the five consecutive plan years of highest pay during the ten years preceding retirement or termination. Sovereign also sponsors a supplemental executive retirement plan, several defined benefit pension and other plans covering former employees of institutions acquired by Sovereign. Benefits are frozen under all acquired defined benefit pension plans and Sovereign is in the process of terminating these plans. It is Sovereign's policy to fund the minimum contribution as determined by actuarial valuation. Net periodic pension costs for these plans are comprised of the following components (in thousands of dollars):
AT DECEMBER 31, ------------------------------- 1999 1998 1997 ------- ------ ------ Service cost benefits earned during the period........... $ 351 $2,248 $1,928 Interest cost on projected benefit obligation............ 2,568 2,498 2,550 Actual return on plan assets............................. (224) (7,028) (7,227) Amortization of unrecognized net assets and other deferred amounts, net.................................. (2,308) 3,761 3,037 Curtailment gain......................................... (1,564) -- -- Asset gain............................................... -- -- 331 ------- ------ ------ Net periodic pension expense........................... $(1,177) $1,479 $ 619 ======= ====== ======
64 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 14 -- EMPLOYEE BENEFIT PLANS -- (CONTINUED) The following table sets forth the Change in Benefit Obligation. Change in Plan Assets and funded status for Sovereign's pension plan at December 31, 1999 and 1998 (in thousands).
YEAR ENDED DECEMBER 31, -------------------- 1999 1998 ------- ------- Change in Benefit Obligation: Benefit obligation at beginning of year................... $38,159 $37,214 Service cost.............................................. 351 2,248 Interest cost............................................. 2,568 2,498 Actuarial gains........................................... 3,849 895 Benefits paid and annuity purchases....................... (5,972) (4,696) Acquisitions.............................................. 4,941 -- Curtailment............................................... (4,174) -- Assumption changes........................................ 4,360 -- ------- ------- Benefit obligation at end of year......................... $44,082 $38,159 ======= ======= Change in Plan Assets: Fair value of plan assets at beginning of year............ $46,901 $44,464 Actual return on plan assets.............................. 203 7,028 Company contributions..................................... 104 105 Benefits paid and annuity purchases....................... (5,972) (4,696) Acquisitions.............................................. 4,706 -- ------- ------- Fair value of plan assets at end of year.................. $45,942 $46,901 ======= ======= Funded status of the plan................................. $ 1,860 $ 8,742 Unrecognized net actuarial gain (loss).................... 931 (5,351) Unrecognized net transition asset......................... -- 1,176 Unrecognized prior service cost........................... 660 773 ------- ------- Prepaid benefit cost...................................... $ 3,451 $ 5,340 ======= =======
In determining the projected benefit obligation, the assumed discount rates at December 31, 1999, 1998 and 1997 were 6.31%, 6.75% and 6.77%, respectively. The weighted average rate of salary increase was 4.50% for 1999, 4.50% for 1998 and 4.46% for 1997. The expected long-term rate of return on assets used in determining net periodic pension expense was 5.13% for 1999, 9.00% for 1998 and 8.92% for 1997. The pension plans' assets consist primarily of short-term U.S. Treasury and government agency securities, units of fixed income common trust funds, and Sovereign common stock. At December 31, 1999 the Sovereign Plan held approximately 79,000 shares of Sovereign stock with a fair market value of $0.6 million. Sovereign maintains a 401(k) savings plan. Substantially all employees of Sovereign are eligible to participate in the 401(k) savings plan following their completion of one year of service and attaining age 21. Sovereign's contributions to this plan were $2.1 million, $1.5 million and $753,000 during 1999, 1998 and 1997, 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 Employee Stock Ownership Plan ("Sovereign ESOP"), and substantially all employees of Sovereign are eligible to participate in the Sovereign ESOP following their completion of one year of service and attaining age 21. The Sovereign 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 Sovereign ESOP by Sovereign is determined by the Board 65 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 14 -- EMPLOYEE BENEFIT PLANS -- (CONTINUED) of Directors based upon the financial performance of Sovereign each year. Sovereign recognized as expense $3.4 million, $4.0 million and $7.7 million to the ESOP during 1999, 1998 and 1997, respectively. On November 21, 1994, Sovereign's Board of Directors authorized an amendment to the Sovereign ESOP to add a leverage feature to purchase up to 6.7 million shares of Sovereign's outstanding common stock in the open market or in negotiated transactions. The Sovereign ESOP is funded through direct loans from Sovereign. 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 Sovereign 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. Sovereign has committed to make contributions sufficient to provide for the ESOP debt requirements. Peoples also sponsored a leveraged ESOP that Sovereign intends to terminate effective March 31, 2000. At December 31, 1999, the ESOPs held 6.4 million shares of Sovereign stock of which 1.6 million shares were allocated to participant accounts. The unallocated ESOP shares are presented as a reduction of stockholders' equity in the consolidated financial statements. The unallocated ESOP shares had a fair market value of $36.0 million at December 31, 1999. Sovereign recognized as expense $3.4 million, $4.0 million and $7.7 million for the ESOPs in 1999, 1998 and 1997, respectively. At December 31, 1999, the ESOPs had $45.4 million of loans outstanding from Sovereign. Sovereign maintains several bonus deferral plans for selected management and executive employees. These plans allow employees to defer 50% or more of their bonus to purchase Sovereign stock. The deferred amount is placed in a grantor trust and invested in Sovereign common stock. Matching contributions ranging from 25% to 100% are made by Sovereign into the trust and are also invested in Sovereign stock. Earnings on the deferral and matching contributions are also invested in Sovereign stock. Expense is recognized ratably over the vesting periods of the plans. Benefits vest ratably over three years under the management plan and after five years under the executive plan. Benefits also vest under the plans in the event of termination by reason of death, disability, retirement, involuntary termination or the occurrence of a change of control as defined by the plans. Voluntary termination or termination for cause (as defined) generally result in forfeiture of the unvested balance including employee deferrals. Sovereign recognized as expense $1.0 million, $285,000 and $250,000 for these plans in 1999, 1998 and 1997, respectively. Sovereign maintains an 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 1999, 1998 and 1997, 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, 1999, 1998 and 1997 was $136,000, $106,000 and $46,000, respectively. 66 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 15 -- INCOME TAXES The provision for income taxes in the consolidated statement of operations is comprised of the following components (in thousands):
YEAR ENDED DECEMBER 31, --------------------------------- 1999 1998 1997 ------- ------- ------- Current: Federal.............................................. $69,656 $92,311 $73,431 State................................................ 807 1,121 4,282 ------- ------- ------- 70,463 93,432 77,713 Deferred............................................... 18,852 (18,681) (10,389) ------- ------- ------- Total income tax expense............................. $89,315 $74,751 $67,324 ======= ======= =======
The following is a reconciliation of the actual tax provisions with taxes computed at the federal statutory rate of 35% for each of the years indicated:
YEAR ENDED DECEMBER 31, -------------------------- 1999 1998 1997 ---- ---- ---- Federal income tax at statutory rate........................ 35.0% 35.0% 35.0% Increase/(decrease) in taxes resulting from: Tax-exempt income......................................... (5.8) (5.2) (2.0) State income taxes, net of federal tax benefit............ 0.2 0.3 1.6 Amortization of intangible assets and other purchase accounting adjustments................................. 0.9 0.8 1.0 Non-deductible, merger-related costs...................... -- 3.1 2.1 Other..................................................... 2.9 1.4 1.9 ---- ---- ---- 33.2% 35.4% 39.6% ==== ==== ====
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, ---------------------------- 1999 1998 1997 -------- ------- ------- Deferred tax assets: Allowance for possible loan losses.................... $ 43,766 $37,849 $37,390 Purchased mortgage servicing rights................... 3,532 4,356 5,364 Employee benefits..................................... 1,344 888 2,593 Merger-related liabilities............................ 6,339 2,313 1,104 Purchase accounting adjustments....................... 8,765 370 1,071 Unrealized loss on available-for-sale portfolio....... 113,764 -- 89 Net operating loss carry forwards..................... 8,630 1,393 1,810 Other................................................. 5,472 847 5,621 -------- ------- ------- Total gross deferred tax assets.................... $191,612 $48,016 $55,042 -------- ------- ------- Deferred tax liabilities: Purchase accounting adjustments....................... $ 8,177 $ 5,402 $ 6,473 Deferred loan fees.................................... 10,505 7,144 5,739 Tax bad debt reserve recapture........................ 4,393 2,406 2,888 Originated mortgage servicing rights.................. 8,269 3,843 2,678 Option premiums....................................... 2,716 2,716 9,799 Unrealized gain on available-for-sale portfolio....... -- 9,757 9,625 Other................................................. 11,145 4,163 6,609 -------- ------- ------- Total gross deferred tax liabilities.................. $ 45,205 $35,431 $43,811 -------- ------- ------- Net deferred tax asset.................................. $146,407 $12,585 $11,231 ======== ======= =======
67 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 15 -- INCOME TAXES -- (CONTINUED) The Small Business Job Protection Act of 1996 ("the Act") repealed the tax bad debt deduction computed under the percentage of taxable income method for tax years beginning after December 31, 1995 and requires thrifts to recapture into income, over a six-year period, the amount by which their tax bad debt reserves exceed their base year reserves. As a result, Sovereign is required to recapture $15.2 million, of which $5.3 million has been recaptured through December 31, 1999, related to its tax bad debt reserve in excess of its base year reserve. Sovereign previously recorded a deferred tax liability for this excess and therefore, the recapture will not impact the statement of operations. Sovereign has determined that it is not required to establish any valuation reserve for deferred tax assets since it is more likely than not that deferred tax assets will ultimately be realized. 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. NOTE 16 -- 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 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, --------------------------- 1999 1998 ---------- ---------- Financial instruments whose contract amounts represent credit risk: Commitments to extend credit............................ $2,236,688 $1,191,599 Standby letters of credit............................... 76,775 21,153 Loans sold with recourse................................ 25,214 35,375 Financial instruments whose notional or contract amounts exceed the amount of credit risk: Forward contracts....................................... 75,335 608,104 Interest rate swaps..................................... 452,300 2,955,164 Interest rate caps...................................... 1,200,000 1,200,000
68 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 16 -- COMMITMENTS AND CONTINGENCIES -- (CONTINUED) 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 counter party. 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. Most guarantees expire by June 2003 and one guarantee for $1.4 million expires in January 2011. 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. Loans sold with recourse primarily represent single-family residential loans. These are seasoned loans with decreasing balances and historical loss experience has been minimal. 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 counter parties 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 counter parties default. Sovereign minimizes this risk by performing credit reviews on counter parties. Notional principal amounts often are used to express the volume of these transactions, but the amounts potentially subject to credit risk are significantly smaller. Litigation At December 31, 1999, Sovereign was party to a number of lawsuits, which arise during the normal course of business. 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. 69 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 17 -- FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents disclosures about the fair value of financial instruments as defined by SFAS No. 107, "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 presented below 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, ----------------------------------------------------- 1999 1998 ------------------------- ------------------------- CARRYING CARRYING VALUE FAIR VALUE VALUE FAIR VALUE ----------- ----------- ----------- ----------- Financial Assets: Cash and amounts due from depository institutions.......................... $ 373,996 $ 373,996 $ 471,074 $ 471,074 Interest-earning deposits............... 19,238 19,238 82,650 82,650 Loans held for sale..................... 61,925 62,439 296,930 297,414 Investment securities available-for-sale.................... 8,030,212 8,030,212 6,662,427 6,662,427 Investment securities held-to-maturity...................... 2,362,051 2,367,025 1,839,655 1,860,583 Loans, net.............................. 14,093,554 13,955,482 11,152,038 11,180,004 Mortgage servicing rights............... 72,491 76,606 62,332 64,840 Financial Liabilities: Deposits................................ 11,719,646 11,686,094 12,322,716 12,314,608 Borrowings(1)........................... 12,663,138 12,442,697 7,907,805 7,887,676 Unrecognized Financial Instruments:(2) Commitments to extend credit............ 16,003 16,086 5,875 5,880 Loans sold with recourse................ 126 50 177 71 Interest rate swaps, caps and floors.... 4,463 1,198 7,213 (55,755)
- ------------------ (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 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 sale. 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 securities available-for-sale. The fair value of investment securities available-for-sale are based on quoted market prices as of the balance sheet date. In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," changes in fair value are reflected in the carrying value of the asset and are shown as a separate component of stockholders' equity. 70 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 17 -- FAIR VALUE OF FINANCIAL INSTRUMENTS -- (CONTINUED) Investment securities held-to-maturity. The carrying amounts for short-term investment 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 investment 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. Mortgage servicing rights. The fair value of mortgage servicing rights are 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 the balance sheet date. 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 counter parties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. 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 counter parties are obtained from dealer quotes. 71 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 18 -- INTEREST RATE EXCHANGE AGREEMENTS Interest rate swaps are generally used to convert fixed rate assets and liabilities to variable rate assets and liabilities and vice versa. Interest rate caps are generally used to limit the exposure from repricing of liabilities. Interest rate floors are generally used to limit the exposure from repricing of assets. In certain cases, interest rate caps and floors are simultaneously bought and sold to create a range of protection against changing interest rates while limiting the cost of that protection. The following table presents information regarding interest rate exchange agreements at the dates indicated (in thousands):
AT DECEMBER 31, AT DECEMBER 31, ------------------------------------------ ------------------------------------------ WEIGHTED WEIGHTED ESTIMATED AVERAGE ESTIMATED AVERAGE NOTIONAL BOOK FAIR MATURITY NOTIONAL BOOK FAIR MATURITY AMOUNT VALUE VALUE IN YEARS AMOUNT VALUE VALUE IN YEARS ---------- ------ --------- -------- ---------- ------ --------- -------- Amortizing interest rate swaps: Pay fixed-receive variable(1)........ $ -- $ -- $ -- -- $ 175,164 $ -- $ (617) .3 Non-amortizing interest rate swaps: Pay variable-receive fixed(2)........ 252,300 -- (6,846) 7.0 -- -- -- -- Pay fixed-receive variable(3)........ 200,000 -- 8,853 3.1 2,780,000 -- (48,382) 4.8 Interest rate caps/floors/corridors(4)............. 1,200,000 4,463 (809) 2.6 1,200,000 7,213 (6,756) 3.2 ---------- ------ ------ ---------- ------ -------- $1,652,300 $4,463 $1,198 $4,155,164 $7,213 $(55,755) ========== ====== ====== ========== ====== ========
- ------------------ (1) The weighted average pay rate was 6.87% and the weighted average receive rate was 5.99% at December 31, 1998. (2) The weighted average pay rate was 7.24% and the weighted average receive rate was 7.00% at December 31, 1999. (3) The weighted average pay rate was 5.41% and 5.42% and the weighted average receive rate was 6.13% and 5.26% at December 31, 1999 and 1998, respectively. (4) The weighted average strike price range was 5.25% - 9.00% at December 31, 1999 and 5.25% - 9.00% at December 31, 1998. The following table summarizes by notional amounts the activity of Sovereign's interest rate exchange agreements (in thousands):
AMORTIZING NON-AMORTIZING INTEREST RATE INTEREST INTEREST CAPS, FLOORS, RATE SWAPS RATE SWAPS CORRIDORS TOTAL ---------- -------------- ------------- ---------- Balance, December 31, 1996.................. $1,112,013 $1,405,000 $ 500,000 $3,017,013 ---------- ---------- ---------- ---------- Additions................................. -- 4,145,000 700,000 4,845,000 Maturities/Amortization................... 151,136 151,501 -- 302,637 Terminations.............................. 150,000 2,600,000 -- 2,750,000 ---------- ---------- ---------- ---------- Balance, December 31, 1997.................. 810,877 2,798,499 1,200,000 4,809,376 ---------- ---------- ---------- ---------- Additions................................. -- 1,650,000 -- 1,650,000 Maturities/Amortization................... 86,497 100,000 -- 186,497 Terminations.............................. 549,216 1,568,499 -- 2,117,715 ---------- ---------- ---------- ---------- Balance, December 31, 1998.................. 175,164 2,780,000 1,200,000 4,155,164 ---------- ---------- ---------- ---------- Additions................................. -- 352,300 -- 352,300 Maturities/Amortization................... 175,164 370,000 -- 545,164 Terminations.............................. -- 2,310,000 -- 2,310,000 ---------- ---------- ---------- ---------- Balance, December 31, 1999.................. $ -- $ 452,300 $1,200,000 $1,652,300 ========== ========== ========== ==========
Net interest income resulting from interest rate exchange agreements included $.5 million of income and $8.9 million of expense for 1999, $6.8 million of income and $4.5 million of expense for 1998 and $4.8 million of income and $4.8 million of expense for 1997. 72 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 19 -- PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for Sovereign Bancorp is as follows (in thousands):
BALANCE SHEETS --------------------------- AT DECEMBER 31, --------------------------- 1999 1998 ---------- ---------- Assets Cash and due from banks................................... $ 2 $ 114 Investment securities held-to-maturity.................... 765,736 -- Investment in subsidiaries Bank subsidiary........................................ 2,299,508 1,487,423 Non-bank subsidiaries.................................. 664,908 211,568 Other assets.............................................. 46,312 11,706 ---------- ---------- Total Assets................................................ $3,776,466 $1,710,811 ========== ========== Liabilities & Stockholders' Equity Borrowings: Short-term borrowings.................................. $ 77,894 $ 200,148 Long-term borrowings................................... 1,509,773 147,625 Non-bank affiliate borrowings.......................... 347,605 144,870 Other liabilities......................................... 19,699 14,100 ---------- ---------- Total liabilities........................................... 1,954,971 506,743 ---------- ---------- Stockholders' Equity........................................ 1,821,495 1,204,068 ---------- ---------- Total Liabilities and Stockholders' Equity.................. $3,776,466 $1,710,811 ========== ==========
STATEMENTS OF OPERATIONS ------------------------------ YEAR ENDED DECEMBER 31, ------------------------------ 1999 1998 1997 -------- -------- -------- Dividends from Bank subsidiary.............................. $ -- $ -- $ 1,771 Interest income............................................. 6,847 12,222 8,907 Other income................................................ 149 5,749 8,681 -------- -------- -------- Total income................................................ 6,996 17,971 19,359 -------- -------- -------- Interest expense............................................ 56,668 29,556 24,468 Other expense............................................... 28,976 8,122 9,676 -------- -------- -------- Total expense............................................... 85,644 37,678 34,144 -------- -------- -------- Loss before income taxes and equity in earnings of subsidiaries.............................................. (78,648) (19,707) (14,785) Income taxes................................................ (26,058) (6,461) (8,399) -------- -------- -------- Loss before equity in earnings of subsidiaries.............. (52,590) (13,246) (6,386) Equity in earnings of: Bank subsidiary...................... 226,219 149,442 109,287 Non-bank subsidiaries................ 5,670 259 (363) -------- -------- -------- Net Income.................................................. $179,299 $136,455 $102,538 ======== ======== ========
73 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 19 -- PARENT COMPANY FINANCIAL INFORMATION -- (CONTINUED)
STATEMENTS OF CASH FLOWS -------------------------------- YEAR ENDED DECEMBER 31, -------------------------------- 1999 1998 1997 ---------- -------- -------- Cash Flows from Operating Activities: Net income................................................ $ 179,299 $136,455 $102,538 Adjustments to reconcile net income to net cash provided by operating activities: Dividend received from bank subsidiary................. -- -- (1,771) Earnings from: Bank subsidiary...................................... (226,219) (149,442) (109,287) Non-bank subsidiaries................................ (5,670) (259) 363 Other, net............................................. (25,969) 29,123 15,808 ---------- -------- -------- Net cash provided (used) by operating activities............ (78,559) 15,877 7,651 ---------- -------- -------- Cash Flows from Investing Activities: Net capital contributed to subsidiaries................... (739,777) (346,648) (15,832) Investment securities: Maturity and repayments................................ -- 6,183 2,097 Net purchase and sales................................. (994,788) 97,084 (69,545) Net cash received from business combinations.............. 51 -- -- Other, net................................................ -- (4,228) (638) ---------- -------- -------- Net cash used by investing activities....................... (1,734,514) (247,609) (83,918) ---------- -------- -------- Cash Flows from Financing Activities: Net change in borrowings.................................. 275,807 219,215 54,133 Net proceeds received from debt offering.................. 1,166,822 -- -- Sale (acquisition) of treasury stock...................... (46,867) (901) 34,632 Cash dividends paid to stockholders....................... (17,104) (14,286) (23,777) Net proceeds from issuance of common stock................ 342,803 20,451 17,919 Net proceeds from issuance of warrants.................... 91,500 -- -- Other, net................................................ -- (6) 170 ---------- -------- -------- Net cash provided by financing activities................... 1,812,961 224,473 83,077 ---------- -------- -------- (Decrease) increase in cash and cash equivalents............ (112) (7,259) 6,810 Cash and cash equivalents at beginning of period............ 114 7,373 563 ---------- -------- -------- Cash and cash equivalents at end of period.................. $ 2 $ 114 $ 7,373 ========== ======== ========
74 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 20 -- EARNINGS PER SHARE The following table presents the computation of earnings per share based on the provisions of SFAS No. 128 for the years indicated (in thousands, except per share data):
YEAR ENDED DECEMBER 31, ------------------------------ 1999 1998 1997 -------- -------- -------- Net income.................................................. $179,299 $136,455 $102,538 Less preferred dividends.................................... -- (1,496) (6,244) -------- -------- -------- Net income attributable to common stock..................... $179,299 $134,959 $ 96,294 ======== ======== ======== Weighted average basic shares............................... 176,021 152,910 136,997 Weighted average diluted shares............................. 176,021 158,172 151,356 Dilutive effect of average stock options.................... 2,146 3,039 4,550 -------- -------- -------- Total weighted average diluted shares....................... 178,167 161,211 155,906 ======== ======== ======== Net income per common share: Basic..................................................... $ 1.02 $ .88 $ .70 ======== ======== ======== Diluted................................................... $ 1.01 $ .85 $ .66 ======== ======== ========
NOTE 21 -- COMPREHENSIVE INCOME/(LOSS) The following table presents the components of comprehensive income, net of related tax, based on the provisions of SFAS No. 130 for the years indicated (in thousands):
YEAR ENDED DECEMBER 31, ------------------------------ 1999 1998 1997 -------- -------- -------- Net income.................................................. $179,299 $136,455 $102,538 -------- -------- -------- Unrealized (losses) gains on securities arising during the year...................................................... (216,644) (16,095) 18,399 Less reclassification adjustment(1)......................... 12,408 (16,063) -- -------- -------- -------- Net unrealized (losses) gains recognized in other comprehensive income...................................... (229,052) (32) 18,399 -------- -------- -------- Comprehensive income/(loss)................................. $(49,753) $136,423 $120,937 ======== ======== ========
- ------------------ (1) Sovereign has not calculated the reclassification adjustment for 1997. Accumulated other comprehensive income, net of related tax, consisted of net unrealized losses on securities of $210.9 million at December 31, 1999 and unrealized gains on securities of $18.1 million and $18.9 million at December 31, 1998 and 1997, respectively. 75 SOVEREIGN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 22 -- SUBSEQUENT EVENT -- PENDING ACQUISITION OF SOVEREIGN BANK NEW ENGLAND On September 3, 1999, Sovereign entered into a purchase and assumption agreement with FleetBoston Financial to acquire branch banking offices located in Connecticut, Massachusetts, New Hampshire and Rhode Island, and related deposit liabilities, loans and other assets associated with the business of those branches. On February 28, 2000, Sovereign and FleetBoston Financial agreed to restructure certain terms of the agreement. Sovereign will purchase approximately $12 billion of deposits, $9 billion of loans and 285 community banking offices. The acquisition, which results in the creation of Sovereign Bank New England, the third largest bank in New England, includes the following: the former Fleet Bank community banking franchise in eastern Massachusetts; the entire former BankBoston community banking franchise in Rhode Island; and select community banking offices of Fleet Bank in southern New Hampshire and BankBoston in Connecticut. In addition, Sovereign is acquiring a substantial portion of the middle market and small business-lending group from Fleet in Massachusetts and New Hampshire, and from BankBoston in Rhode Island and Connecticut. The acquisition includes the purchase of fully functioning business units, with the necessary management, relationship officers, support staffs, and other infrastructure for the acquired loans and deposits to be fully serviced. Sovereign has obtained the receipt of all required regulatory approvals for this acquisition. ACQUISITION TIMETABLE
DATE DIVESTED UNITS DEPOSITS BRANCHES LOANS ---- -------------- ------------ -------- ------------ March 24, 2000......... Rhode Island, Connecticut (BankBoston) $4.0 billion 90 $3.2 billion June 16, 2000.......... Eastern Mass (Fleet) $4.0 billion 86 $3.5 billion July 21, 2000.......... Central Mass, New Hampshire (Fleet) $4.0 billion 109 $2.4 billion
Total consideration for the entire consumer and banking franchise is 12% of acquired deposits, or approximately $1.4 billion. Sovereign will pay approximately $1.1 billion as the purchases are completed according to the above schedule. Sovereign will pay the remaining $340 million in periodic installments between January 2001 and October 2001 if FleetBoston complies with its non-compete obligations under the agreement and certain other conditions are met. Sovereign paid a non-refundable deposit of $200 million to FleetBoston to be credited against amounts due on the third closing, and is required to comply at each closing with the acquisition plan included with its application as approved by the Office of Thrift Supervision. Sovereign raised approximately $1.8 billion of debt and equity in November and December, 1999 to finance the acquisition. See Notes 10, 11 and 12 to these financial statements for a more complete description of these financings. 76 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 in the definitive Proxy Statement to be used in connection with Sovereign's 1999 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" in 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" in the Proxy Statement and (ii) the section captioned "Performance Graph" in 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" in the Proxy Statement and (ii) that portion of the section captioned "Election of Directors" in 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" and "Other" in the Proxy Statement. 77 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (A) 1. FINANCIAL STATEMENTS. The following financial statements are filed as part of this 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. (Incorporated by reference to Exhibit 3.1 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 31, 1995.) (3.2) By-Laws of Sovereign Bancorp, Inc. (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 31, 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 March 1, 1997, between Sovereign Bancorp, Inc., Sovereign Bank, and Jay S. Sidhu. (Incorporated by reference to Exhibit 10.1 to Sovereign's Quarterly Report on Form 10-Q for the quarter ended December 31, 1997.) (10.4) Agreement dated as of May 1, 1997, between ML Bancorp, Inc. (a predecessor company of Sovereign Bancorp, Inc.) and Dennis S. Marlo. (10.5) Agreement dated as of September 25, 1997, between Sovereign Bank and Lawrence M. Thompson, Jr. (incorporated by reference to exhibit 10.5 to Sovereign's Annual Report on Form 10-K for the year ended December 31, 1997.) (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.) (10.7) 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).
78 (10.8) 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). (10.9) 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). (10.10) 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.) (10.11) 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.) (10.12) 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.) (10.13) 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.) (10.14) Sovereign Bancorp, Inc. 1997 Non-Employee Directors' Stock Option Plan. (Incorporated by reference to Exhibit "A" to Sovereign's definitive proxy statement dated March 16, 1998.) (10.15) Sovereign Bancorp, Inc. 1996 Stock Option Plan. (Incorporated by reference to Exhibit "A" to Sovereign's definitive proxy statement dated March 15, 1996.) (10.16) Amended and Restated Purchase and Assumption Agreement by and among Fleet Boston Corporation, Fleet National Bank, Fleet Bank-NH, BankBoston, N.A., Sovereign Bank and Sovereign Bancorp, Inc., dated February 28, 2000. (Incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K, dated March 3, 2000, of Sovereign Bancorp, Inc.) (21) Subsidiaries of the Registrant (23.1) Consent of Ernst & Young LLP, Independent Auditors. (23.2) Consent of KPMG LLP, Independent Auditors. (23.3) Consent of PricewaterhouseCoopers LLP, Independent Accountants. (23.4) Consent of Arthur Andersen LLP, Independent Public Accountants. (27) Financial Data Schedule (99.1) Report of KPMG LLP, Independent Auditors. (99.2) Report of PricewaterhouseCoopers LLP, Independent Accountants. (99.3) Report of Arthur Andersen LLP, Independent Public Accountants.
(B) REPORTS ON FORM 8-K 1. Report on Form 8-K, dated November 16, 1999 (date of earliest event--November 10, 1999) reports, under Items 5 and 7, the completion by Sovereign Bancorp, Inc. of its public offerings of the Common Stock, the Senior Notes and the Units in connection with Sovereign Bank's purchase of assets and assumption of liabilities from Fleet National Bank, Fleet Bank-NH and BankBoston, N.A. 2. Report on Form 8-K, dated October 26, 1999 (date of earliest event--October 19, 1999) reports, under Items 5 and 7, the filing by Sovereign Bancorp, Inc. of its preliminary Prospectus Supplements for the Common Stock, the Senor Notes and the Units in connection with Sovereign Bank's purchase of assets and assumption of liabilities from Fleet National Bank, Fleet Bank-NH and BankBoston, N.A. 79 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 23, 2000 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 DATE --------- ----- ---- /S/BRIAN HARD Director March 27, 2000 Brian Hard /S/RICHARD E. MOHN Chairman of Board and Director March 23, 2000 Richard E. Mohn /S/RHODA S. OBERHOLTZER Director March 23, 2000 Rhoda S. Oberholtzer /S/PATRICK J. PETRONE Director March 23, 2000 Patrick J. Petrone /S/DANIEL K. ROTHERMEL Director March 23, 2000 Daniel K. Rothermel /S/JAY S. SIDHU Director, President and Chief March 23, 2000 Jay S. Sidhu Executive Officer (Principal Executive Officer) /S/CAMERON C. TROILO Director March 23, 2000 Cameron C. Troilo /S/G. ARTHUR WEAVER Director March 23, 2000 G. Arthur Weaver /S/DENNIS S. MARLO Chief Financial Officer March 23, 2000 Dennis S. Marlo /S/MARK R. MCCOLLOM Chief Accounting Officer March 27, 2000 Mark R. McCollom
80 EX-21 2 DIRECT AND INDIRECT SUBSIDIARIES OF SOVEREIGN EXHIBIT 21 SOVEREIGN BANCORP, INC. PART IV, ITEM 14(a) Direct and Indirect Subsidiaries of Sovereign Bancorp, Inc. State or other jurisdiction Subsidiary of Incorporation - ---------- --------------------------- Sovereign Bank ..................................... United States of America Sovereign Capital Trust I .......................... Delaware Sovereign Capital Trust II ......................... Delaware ML Capital Trust I ................................. Delaware First Lancaster Financial Corp. .................... Pennsylvania 201 Associates, Inc. ............................... Delaware Sovereign Annuity Corp., Inc. ...................... New Jersey Sovereign Agency, Inc. ............................. New Jersey Sovereign REIT Holdings, Inc. ...................... Delaware Sovereign Real Estate Investment Trust ............. Delaware Main Line Abstract Corporation ..................... Pennsylvania 1130 Abstract, Inc. ................................ Pennsylvania Sovereign Trust Company ............................ New Jersey Sovereign Delaware Investment Corporation .......... Delaware Sovereign Delaware Escrow Company .................. Delaware EX-23.1 3 CONSENT OF INDEPENDENT AUDITORS 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. 33-89526, Form S-8 No. 33-89592, Form S-8 No. 333-05251, Form S-8 No. 333-05309, Form S-3 No. 33-46870, and Form S-3 No. 333-86961) of Sovereign Bancorp, Inc. of our report dated January 24, 2000 (except for Note 22, as to which the date is February 28, 2000), with respect to the consolidated financial statements of Sovereign Bancorp, Inc. included in its Annual Report on Form 10-K for the year ended December 31, 1999. /s/ Ernst & Young LLP Philadelphia, Pennsylvania March 29, 2000 EX-23.2 4 CONSENT OF INDEPENDENT AUDITORS The Board of Directors Sovereign Bancorp, Inc. We consent to the incorporation by reference in the Form 10K, and in the registration statements on Form S-8 (File No. 33-05251, 33-20186, 33-29038,33-39453, 33-44108, 33-89526, 33-89592, 333-05309) and Form S-3 (File No. 33-46870) of Sovereign Bancorp, Inc. of our report dated June 15, 1998, relating to the consolidated statements of operations, cash flows and changes in stockholders' equity of ML Bancorp, Inc. and Subsidiaries for the eleven month period ended February 27, 1998 which report appeared in the Form 8-K on June 23, 1998. /s/ KPMG LLP Philadelphia, Pennsylvania March 29, 2000 EX-23.3 5 CONSENT OF INDEPENDENT AUDITORS Consent of Independent Accountants We consent to the incorporation by reference in the registration statements of Sovereign Bancorp, Inc. on Forms S-8 (File Nos. 33-05251, 33-20186, 33-29038, 33-39453, 33-44108, 33-89526, 33-89592 and 333-05309) and on Forms S-3 (File Nos. 33-46870 and 333-86961) of our report dated February 2, 1998, on our audits of the consolidated statements of income, retained earnings and cash flows of Carnegie Bancorp and Subsidiaries for the year ended December 31, 1997, which report is included in this Annual Report on Form 10-K. /s/ PricewaterhouseCoopers LLP Princeton, New Jersey March 29, 2000 EX-23.4 6 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS Exhibit 23.4 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation by reference, of our report dated February 9, 1998 on the December 31, 1997 financial statements of First Home Bancorp, Inc. and subsidiaries, included in Sovereign Bancorp, Inc.'s Form 10-K filed on or about March 30, 1999, into the Registration Statements on Form S-8 (Nos. 33-20186, 33-29038, 33-39453, 33-44108, 33-89526, 33-89592, 333-05251, 333-05309) and on Form S-3 (Nos. 33-46870, 333-86961) of Sovereign Bancorp, Inc. It should be noted that we have not audited any financial statements of First Home Bancorp, Inc and subsidiaries subsequent to December 31, 1997 or performed any audit procedures subsequent to the date of our report. /s/ Arthur Andersen LLP Philadelphia, Pennsylvania March 29, 2000 EX-99.1 7 INDEPENDENT AUDITOR'S REPORT Independent Auditor's Report The Board of Directors ML Bancorp, Inc.: We have audited the accompanying consolidated statements of operations, changes in stockholders' equity and cash flows for the eleven-month period ended February 27, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audit in accordance with generally accepted auditing standards. Those standards required 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 the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of ML Bancorp, Inc. and subsidiaries for the eleven-month period ended February 27, 1998 in conformity with generally accepted accounting principles. /s/ KPMG LLP Philadelphia, PA June 15, 1998 EX-99.2 8 REPORT OF INDEPENDENT ACCOUNTANTS Report of Independent Accountants To the Board of Directors and: Stockholders of Carnegie Bancorp: We have audited the consolidated statements of income, retained earnings, and cash flows for the year ended December 31, 1997. 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 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 the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of their operations and their cash flows for the year ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ PricewaterhouseCoopers LLP Princeton, New Jersey February 2, 1998 EX-99.3 9 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors of First Home Bancorp Inc.: We have audited the accompanying consolidated statement of financial condition of First Home Bancorp Inc. and subsidiaries (the "Company") as of December 31, 1997, and the related consolidated statements of income, shareholders' equity and cash flows for the year 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 audit. We conducted our audit 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 the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Home Bancorp Inc. and subsidiaries as of December 31, 1997, and the results of their operations and their cash flows for the year then ended, in conformity with generally accepted accounting principles. /s/ Arthur Andersen LLP Philadelphia, Pa. February 9, 1998 EX-27 10 FDS
9 1,000 U.S. Dollars 12-MOS DEC-31-1999 DEC-31-1999 1.000 373,996 19,238 0 0 8,030,212 2,362,051 2,367,025 14,226,540 (132,986) 26,607,112 11,719,646 6,902,414 402,833 5,760,724 0 0 1,217,742 603,753 26,607,112 959,164 648,165 0 1,607,329 428,055 992,673 614,656 30,000 34,201 53,455 268,614 268,614 0 0 179,299 1.02 1.01 2.86 73,433 10,238 3,755 95,937 133,802 55,023 19,408 132,986 121,774 0 11,212
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