-----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, Uz8yjBVhII5JaX23HUSRDrPFnz7sF+l15H4wkR13MfQJdgNLpWXo1gsWNehHduJ+ QQpm4VDHkjUx2vEJ3tHlFA== 0000950115-97-000336.txt : 19970311 0000950115-97-000336.hdr.sgml : 19970311 ACCESSION NUMBER: 0000950115-97-000336 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970310 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOVEREIGN BANCORP INC CENTRAL INDEX KEY: 0000811830 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 232453088 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-16533 FILM NUMBER: 97553815 BUSINESS ADDRESS: STREET 1: 1130 BERKSHIRE BLVD CITY: WYOMISSING STATE: PA ZIP: 19610 BUSINESS PHONE: 6103208400 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, 1996, 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 (I.R.S. Employer or organization) Identification No.) 1130 BERKSHIRE BOULEVARD, WYOMISSING, PENNSYLVANIA 19610 --------------------------------------------------- ------------- (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER: (215) 320-8400 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock (without par value) (Title of class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X . No . --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the shares of Common Stock of the Registrant held by nonaffiliates of the Registrant was $826,654,852 at March 3, 1997. As of March 3, 1997, the Registrant had 65,477,612 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE The Registrant's definitive Proxy Statement to be used in connection with its 1996 Annual Meeting of Shareholders is incorporated herein by reference in response to Part III hereof. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART I ITEM 1. BUSINESS. GENERAL Sovereign Bancorp, Inc. ("Sovereign") is a Pennsylvania business corporation and is the holding company for Sovereign Bank, a Federal Savings Bank ("Sovereign Bank") and for Sovereign Community Bank, formerly Colonial Bank for Savings, a Federal Savings Bank. Both Sovereign and Sovereign Bank are headquartered in Wyomissing, Pennsylvania, a suburb of Reading, Pennsylvania. Sovereign Community Bank is headquartered in Freehold, New Jersey. Sovereign Bank was created in 1984 under the name Penn Savings Bank, F.S.B. through the merger of two financial institutions with market areas primarily in Berks and Lancaster Counties, Pennsylvania. Sovereign Bank assumed its current name on December 31, 1991. Sovereign was incorporated by Sovereign Bank in 1987. From 1989 through 1995, Sovereign expanded its markets throughout eastern Pennsylvania, central New Jersey and northern Delaware by completing 14 acquisitions with assets totaling approximately $4.4 billion. At December 31, 1995, Sovereign had 120 offices and $8.1 billion in assets. On May 31, 1996, Sovereign acquired West Jersey Bancshares, Inc. ("West Jersey") in a transaction accounted for as a pooling-of-interests; however, the consolidated financial statements have not been restated due to immateriality. As a result of the West Jersey transaction, Sovereign acquired two branch offices located in Essex County, New Jersey and approximately $100.0 million in assets and assumed approximately $73.0 million of deposit liabilities. At December 31, 1996, Sovereign's consolidated assets, deposits and shareholders' equity were approximately $9.43 billion, $5.05 billion and $475.8 million, respectively. Based on assets at December 31, 1996, Sovereign is the largest thrift holding company headquartered in Pennsylvania. Sovereign's primary business consists of attracting deposits from its network of community banking offices, located throughout eastern Pennsylvania, New Jersey and northern Delaware, and originating commercial, consumer and residential mortgage loans in those communities. 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 hereof. SUBSIDIARIES Sovereign has two wholly-owned subsidiaries: Sovereign Bank and Sovereign Community Bank. In 1995, Sovereign Bank reorganized its existing subsidiary structure. Sovereign Bank now has the following wholly-owned subsidiaries: First Lancaster Financial Corp. and 201 Associates, Inc. 201 Associates, Inc. is a Delaware corporation whose primary purpose is to purchase and hold certain investment securities. First Lancaster Financial Corp. is a Pennsylvania business corporation whose primary function is to act as a holding company for The Sovereign Annuity Corp. and The Sovereign Agency, Inc. The Sovereign Annuity Corp. is a New Jersey corporation whose primary purpose is to market investment securities and mutual funds. The Sovereign Agency, Inc. is a New Jersey corporation whose primary purpose is to market insurance annuities. Sovereign Community Bank has no subsidiaries. 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 1 service corporations. At December 31, 1996, Sovereign Bank was authorized to have a maximum investment of approximately $185.4 million in such subsidiaries, pursuant to applicable federal regulations. As of such date, Sovereign Bank had a total investment of $2.0 million in subsidiary service corporations, which excludes 201 Associates, Inc., as it is considered to be an operating subsidiary for purposes of this test. EMPLOYEES At December 31, 1996, Sovereign had 1,304 full-time and 259 part-time employees. None of these employees is represented by a collective bargaining agent, and Sovereign believes it enjoys good relations with its personnel. COMPETITION Sovereign experiences substantial competition in attracting and retaining deposits and in lending funds. The primary factors in competing for deposits are the ability to offer attractive rates and the convenience of office locations. Direct competition for deposits comes primarily from other thrift institutions and commercial banks. Competition for deposits also comes from money market mutual funds, corporate and government securities, and credit unions. The primary factors in the competition for loans are interest rates, loan origination fees and the range of products and services offered. Competition for origination of real estate loans normally comes from other thrift institutions, commercial banks, mortgage bankers, mortgage brokers and insurance companies. ENVIRONMENTAL LAWS Environmentally related hazards have become a source of high risk and potentially unlimited liability for financial institutions relative to their loans. Environmentally contaminated properties owned by an institution's borrowers may result in a drastic reduction in the value of the collateral securing the institution's loans to such borrowers, high environmental clean up costs to the borrower affecting its ability to repay the loans, the subordination of any lien in favor of the institution to a state or federal lien securing clean up costs, and liability to the institution for clean up costs if it forecloses on the contaminated property or becomes involved in the management of the borrower. To minimize this risk, Sovereign Bank and Sovereign Community Bank may require an environmental examination of and report with respect to the property of any borrower or prospective borrower if circumstances affecting the property indicate a potential for contamination, taking into consideration the potential loss to the institution in relation to the burdens to the borrower. Such examination must be performed by an engineering firm experienced in environmental risk studies and acceptable to the institution, and the costs of such examinations and reports are the responsibility of the borrower. These costs may be substantial and may deter a prospective borrower from entering into a loan transaction with Sovereign Bank or Sovereign Community Bank. Sovereign is not aware of any borrower who is currently subject to any environmental investigation or clean up proceeding which is likely to have a material adverse effect on the financial condition or results of operations of Sovereign Bank or of Sovereign Community Bank. SUPERVISION AND REGULATION General. Sovereign is a "savings and loan holding company" registered with the Office of Thrift Supervision ("OTS") under the Home Owners' Loan Act ("HOLA") and as such, Sovereign is subject to OTS regulation, examination, supervision and reporting. The deposits of Sovereign Bank are insured by the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). The deposits of Sovereign Community Bank are insured by the Bank Insurance Fund ("BIF") of the FDIC. The SAIF and the BIF are administered by the FDIC, but are required to be separately maintained and not combined. See "Insurance of Deposit Accounts" below. Sovereign Bank and Sovereign Community Bank are required to file reports with the OTS describing their respective activities and financial condition and are periodically examined to test compliance with various regulatory requirements. Sovereign Bank and Sovereign Community Bank are also subject to examination by the FDIC. Such examinations are conducted for the purpose of protecting depositors 2 and the insurance fund and not for the purpose of protecting holders of equity or debt securities of Sovereign, Sovereign Bank or Sovereign Community 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 Community Bank is a member of the FHLB of New York. Sovereign Bank and Sovereign Community Bank are also subject to regulation by the Board of Governors of the Federal Reserve System with respect to reserves maintained against deposits and certain other matters. Except as described herein, Sovereign's management is not aware of any current recommendations by regulatory authorities that would have a material effect on Sovereign's operations, capital resources or liquidity. Holding Company Regulation. The HOLA prohibits a registered savings and loan holding company from directly or indirectly acquiring control, including through an acquisition by merger, consolidation or purchase of assets, of any savings association (as defined in HOLA to include a federal savings bank) or any other savings and loan holding company, without prior OTS approval. Generally, a savings and loan holding company may not acquire more than 5% of the voting shares of any savings association unless by merger, consolidation or purchase of assets. Certain regulations of the OTS describe standards for control under the HOLA. See "Control of Sovereign" below. Federal law empowers the Director of the OTS to take substantive action when the Director determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of any particular activity constitutes a serious risk to the financial safety, soundness or stability of a savings and loan holding company's subsidiary savings institution. The Director of the OTS has oversight authority for all holding company affiliates, not just the insured institution. Specifically, the Director of the OTS may, as necessary, (i) limit the payment of dividends by the savings institution; (ii) limit transactions between the savings institution, the holding company and the subsidiaries or affiliates of either; (iii) limit any activities of the savings institution that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings institution. Any such limits would be issued in the form of a directive having the legal efficacy of a cease and desist order. Control of Sovereign. Under the Savings and Loan Holding Company Act and the related Change in Bank Control Act (the "Control Act"), individuals, corporations or other entities acquiring Sovereign common stock may, alone or "in concert" with other investors, be deemed to control Sovereign and thereby Sovereign Bank and Sovereign Community 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, 1996, no individual corporation or other entity owned more than 10% of Sovereign's captial stock. Regulatory Capital Requirements. OTS regulations require savings associations to maintain a minimum tangible capital ratio of not less than 1.5%, a minimum core capital, or "leverage" ratio of not less than 3% and a minimum risk-based capital ratio (based upon credit risk) of not less than 8%. These standards are the same as the capital standards that are applicable to other insured depository institutions, such as banks. Federal banking agencies are required to ensure that their risk-based capital guidelines take adequate account of interest rate risk, concentration of credit risk and risks of 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 3 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 account of a savings association. At December 31, 1996, Sovereign Bank and Sovereign Community Bank each met the criteria to be classified as "well-capitalized." 4 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 did not have a material adverse effect on Sovereign's results of operations. Insurance of Deposit Accounts. The FDIC has implemented a risk-related premium schedule for all insured depository institutions that results in the assessment of premiums based on capital and supervisory measures. Under the risk-related premium schedule, the FDIC assigns, on a semi-annual basis, each institution to one of three capital groups (well-capitalized, adequately-capitalized or undercapitalized) and further assigns such institution to one of three subgroups within a capital group. The institution's subgroup assignment is based upon the FDIC's judgment of the institution's strength in light of supervisory evaluations, including examination reports, statistical analyses and other information relevant to measuring the risk posed by the institution. Only institutions with a total capital to risk-adjusted assets ratio of 10% or greater, a Tier 1 capital to risk-adjusted assets ratio of 6% or greater, and a Tier 1 leverage ratio of 5% or greater, are assigned to the well-capitalized group. At December 31, 1996, Sovereign Bank and Sovereign Community Bank were classified as well-capitalized for purposes of calculating insurance assessments. Institutions are prohibited from disclosing the risk classification of the subgroup to which they have been assigned. For the year ended December 31, 1996, the FDIC calculated deposit insurance assessments at the rate of $.23 for every $100 of deposits for the members of the SAIF in the lowest risk-based premium category and $.31 for every $100 of insured deposits for members of the SAIF in the highest risk-based premium category. In August 1995, the FDIC adopted an amendment to the BIF risk-based assessment schedule that lowers the deposit insurance assessment rate for most (90% or more) commercial banks and other depository institutions with deposits insured by the BIF to $.04 per $100 of insured deposits. On November 14, 1995, the FDIC further reduced the BIF assessment rates to a range of $.00 per $100 of insured deposits (subject to a minimum annual premium of $2,000) for those institutions with the least risk to $.27 for every $100 of insured deposits for institutions deemed to have the highest risk, beginning January 1, 1996. At the same time, the FDIC voted to retain the existing assessment rates for SAIF-insured institutions. The reduced BIF assessment rates resulted in a substantial disparity in the deposit insurance premiums paid by BIF and SAIF members and placed SAIF-insured savings associations at a significant competitive disadvantage to BIF-insured institutions. On September 30, 1996, legislation was signed into law which effectively ends the BIF/SAIF rate disparity by the year 2000, and significantly reduces the disparity for years 1997 through 1999. As part of the new law, SAIF-insured institutions were required to make a one-time payment of 65.7 basis points for all SAIF-insured deposits held as of March 31, 1995. At Sovereign, this amounted to an after-tax charge of $17.2 million. Sovereign Bank is subject to FDIC deposit insurance assessments at the rate applicable to SAIF-insured institutions except, however, that the deposits acquired on January 15, 1993, when Sovereign acquired Harmonia Bancorp, Inc. and the deposits acquired on May 31, 1996, when Sovereign acquired West Jersey Bancshares, Inc., remain subject to BIF insurance assessment rates. The balance of these Harmonia and West Jersey deposits was $886.5 million at December 31, 1996. Sovereign Community Bank, acquired by Sovereign on November 15, 1995, is subject to FDIC deposit insurance assessments at the rate applicable to BIF-insured institutions. At December 31, 1996, BIF-insured deposits held by Sovereign Community Bank totaled $217.0 million. Federal savings banks like Sovereign Bank and Sovereign Community Bank are required by OTS regulations to pay assessments to the OTS to fund the operations of the OTS. The general assessment is paid on a quarterly basis and is computed based on total assets of the institution, including subsidiaries. 5 TAXATION Federal Taxation. Sovereign and its subsidiaries are subject to those rules of federal income taxation generally applicable to corporations and report their respective income and expenses on the accrual basis method of accounting. Sovereign and its subsidiaries file a consolidated federal income tax return on a calendar year basis. Each member of the consolidated group separately computes its income and deductions. Intercompany distributions (including dividends) and certain other items of income and loss derived from intercompany transactions are eliminated upon consolidation of all the consolidated group members' respective taxable income and losses. In computing separate taxable income and loss, Sovereign Bank and Sovereign Community Bank each separately compute additions to its bad debt reserves, pursuant to the special preferential rules of Section 593 of the Internal Revenue Code of 1986, as amended (the "Code"), applicable only to certain savings banks, cooperative banks, and domestic building and loan associations (generically, sometimes referred to as either a "thrift" or a "savings institution"). Under certain circumstances, the separate bad debt reserve additions of Sovereign Bank and of Sovereign Community Bank may be subject to adjustments upon consolidation. 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. If Sovereign Bank or Sovereign Community Bank distributes amounts to stockholders (i.e., to Sovereign) and the distribution is treated as being from accumulated bad debt reserves, the distribution will cause Sovereign Bank or Sovereign Community Bank, as the case may be, to have additional taxable income. A distribution to stockholders is deemed to have been made from accumulated bad debt reserves to the extent that (a) the bad debt reserves exceed the amount that would have been accumulated on the basis of the experience method and (b) the distribution is a "nondividend distribution." A distribution in respect of stock is a "nondividend distribution" to the extent that, for federal income tax purposes, (i) it is in redemption of shares, (ii) it is pursuant to a partial or complete liquidation of the institution or (iii) the distribution, together with all other such distributions during the taxable year, exceeds the distributing savings institution's current and post-1951 accumulated earnings and profits. The amount of additional taxable income resulting from a "nondividend distribution" is an amount that, when reduced by the tax attributable to such distribution, is equal to the amount of the distribution. None of the limited circumstances requiring recapture are anticipated by Sovereign. The Code imposes a corporate alternative minimum tax ("AMT"). The corporate AMT only applies if such tax exceeds a corporation's regular tax liability. In general, the AMT is calculated by multiplying the corporate AMT rate of 20% by an amount equal to the excess of (i) the sum of (a) regular taxable income plus (b) certain adjustments and tax preference items ("alternative minimum taxable income" or "AMTI") over (ii) an exemption amount ($40,000 for a corporation, but such amount is reduced by 25% of the excess of AMTI over $150,000 and is completely eliminated when AMTI equals $310,000). The excess, if any, of the bad debt deduction using the "percentage of taxable income" method over the bad debt deduction calculated on the basis of actual experience method is treated as a preference item for determining AMTI. Although there are other applicable adjustment and preference items (e.g., the adjustment for depreciation) for determining AMTI of a savings institution, this particular preference item is significant in determining AMTI. If a savings institution is subject to AMT, then all or a portion of the amount of such preference will effectively be subject to a 20% surtax. Sovereign's consolidated federal income tax return, as well as certain prior year separate returns from predecessor companies for the tax years beginning after 1992, are open under the statute of limitations. 6 State Taxation. Sovereign and its nonthrift Pennsylvania subsidiaries are subject to the Pennsylvania Corporate Net Income Tax and Capital Stock Tax. The Corporate Net Income Tax rate for 1995 and thereafter is 9.99% and is imposed on a corporate taxpayer's unconsolidated taxable income for federal purposes with certain adjustments. In general, the Capital Stock Tax is a property tax imposed on a corporate taxpayer's capital stock value apportionable to the Commonwealth of Pennsylvania, which is determined in accordance with a fixed formula based upon average book income and net worth. In the case of a holding company, an optional elective method permits the corporate taxpayer to be taxed on only 10% of such capital stock value. The Capital Stock Tax rate is presently 1.275%. Sovereign Bank is taxed under the Pennsylvania Mutual Thrift Institutions Tax Act (the "Mutual Tax Act"). The Mutual Tax Act exempts Sovereign Bank from all other corporate taxes imposed by the Commonwealth of Pennsylvania for Pennsylvania purposes and from all local taxation imposed by political subdivisions of Pennsylvania, except taxes on real estate and real estate transfers. The Mutual Tax Act is a tax upon net income apportioned to Pennsylvania, determined in accordance with generally accepted accounting principles ("GAAP"), with certain modifications. The Mutual Tax Act, in computing GAAP income, allows for the deduction of interest earned on Pennsylvania governmental and federal securities, while disallowing a percentage of a thrift's interest expense deduction in the proportion of the interest income from those securities to the overall interest income of the institution. Pursuant to the Mutual Tax Act, Sovereign Bank's tax rate is presently 11.5% of such net income. Sovereign Bank and Sovereign Community Bank are also taxed under the New Jersey Savings Institution Tax. The New Jersey Savings Institution Tax rate is 3% and is imposed on the portion of the taxpayer's modified federal taxable income (with certain adjustments) that is properly attributable to New Jersey. Effective September 29, 1995, Sovereign Bank is subject to a Delaware Franchise Tax that is imposed on federal savings banks not headquartered in Delaware. The Delaware Franchise Tax, which is imposed on taxable income properly attributable to Delaware branches, varies from a rate of 8.7% on taxable income up to $20 million to a rate of 2.7% on taxable income over $30 million. ITEM 2. PROPERTIES. Sovereign Bank is the owner of a five-story office building in Wyomissing, Berks County, Pennsylvania. The building is used as Sovereign's and Sovereign Bank's executive offices and as Sovereign Bank's operations center. Sovereign Community Bank is the owner of a two-story office building in Freehold, Monmouth County, New Jersey. The building is used as Sovereign Community Bank's retail banking office and lending offices. Sovereign Bank has 120 branch offices, including 6 loan production and personalized banking offices. Sovereign owns 61 of these offices and leases 59. Branch office leases are generally long-term. Loan production and personalized banking office leases generally have terms of two years or less. Sovereign Community Bank has no branch offices. ITEM 3. LEGAL PROCEEDINGS. Sovereign is not involved in any pending legal proceedings other than nonmaterial legal proceedings occurring in the ordinary course of business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 7 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 3, 1997, is set forth below: Richard E. Mohn -- Age 66. Mr. Mohn was elected the Chairman of the Board of Sovereign on April 24, 1995. Mr. Mohn became Chairman of the Board of Sovereign Bank in November 1989. He is Chairman of Cloister Spring Water Company, Lancaster, Pennsylvania, a bottler and distributor of spring water. Jay S. Sidhu -- Age 45. Mr. Sidhu has served as President and Chief Executive Officer of Sovereign since November 21, 1989. Prior thereto, Mr. Sidhu served as Treasurer and Chief Financial Officer of Sovereign. Mr. Sidhu is also President and Chief Executive Officer of Sovereign Bank and Sovereign Community 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 44. Mr. Thompson serves as Chief Administrative Officer and Secretary of Sovereign and Chief Operating Officer and Secretary of Sovereign Bank. Upon Sovereign's acquisition of Sovereign Community Bank on November 15, 1995, Mr. Thompson became Secretary of Sovereign Community Bank. Mr. Thompson was hired as Sovereign Bank's General Counsel and Secretary in 1984. He was promoted to Vice President in 1985. In April 1986, he became Sovereign Bank's Senior Vice President for legal affairs and administration. In January 1990, he became Group Executive Officer -- Lending and in June 1995, he became Chief Administrative Officer of Sovereign and Sovereign Bank. Karl D. Gerhart -- Age 44. Mr. Gerhart was elected Chief Financial Officer and Treasurer of Sovereign on February 20, 1990. Mr. Gerhart is also Group Executive Officer, Treasurer and Chief Financial Officer of Sovereign Bank and Treasurer and Chief Financial Officer of Sovereign Community Bank. Mr. Gerhart joined Sovereign Bank in 1975 and in 1986 was promoted to Vice President -- Investments. In 1987, he became Sovereign Bank's Senior Vice President, Treasurer and Chief Investment Officer, responsible for managing Sovereign Bank's investment portfolio and interest rate risk. 8 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 3, 1997, the total number of holders of record of Sovereign's common stock was 9,753. The high and low bid prices reported on the NASDAQ National Market System for Sovereign's common stock for 1996, adjusted to reflect all stock dividends and splits, including a 20% stock split declared on January 16, 1997, were $11.375 and $7.750 and for 1995 were $8.500 and $5.938, respectively. During 1996, Sovereign paid a cash dividend of $.0175 per share in the first quarter, $.0175 per share in the second quarter, $.0175 per share in the third quarter and $.0175 per share in the fourth quarter. During 1995, Sovereign paid a cash dividend of $.0174 per share in the first quarter, $.0174 per share in the second quarter, $.0174 per share in the third quarter and $.0175 per share in the fourth quarter. During 1994, Sovereign paid a cash dividend of $.0280 per share in the first quarter, $.0213 in the second quarter, $.0215 in the third quarter and $.0174 in the fourth quarter. These per share amounts have been adjusted to reflect all stock dividends and stock splits declared through January 1997. For certain limitations on the ability of Sovereign Bank and of Sovereign Community Bank to pay dividends to Sovereign, see Part I, Item 1 "Business -- Supervision and Regulation -- Regulatory Capital Requirements" and Note 10 at Item 8 "Financial Statements and Supplementary Data" hereof. 9 ITEM 6. SELECTED FINANCIAL DATA. SELECTED FINANCIAL DATA(1) BALANCE SHEET DATA (IN THOUSANDS)
AT DECEMBER 31, --------------------------------------------------------------- 1996 1995 1994 1993 1992(2) ----------- ----------- ----------- ----------- ----------- Total assets..................................... $ 9,433,154 $ 8,078,287 $ 6,564,082 $ 4,877,166 $ 3,699,084 Loans............................................ 6,156,322 4,674,364 4,350,898 2,898,014 2,337,382 Allowance for possible loan losses............... 33,809 34,856 36,289 33,099 26,562 Investment and mortgage-backed securities available-for-sale............................. 484,339 889,509 87,128 -- -- Investment and mortgage-backed securities held-to-maturity............................... 2,431,948 2,077,212 1,816,840 1,689,304 1,001,356 Deposits......................................... 5,052,441 5,039,143 4,027,119 3,183,107 2,961,058 Borrowings....................................... 3,856,266 2,530,656 2,162,587 1,367,100 427,591 Stockholders' equity............................. 475,815 427,025 303,900 259,121 220,419
SUMMARY STATEMENT OF OPERATIONS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, ----------------------------------------------------- 1996 1995 1994 1993 1992(2) --------- --------- --------- --------- --------- Total interest income.................................... $ 616,250 $ 493,031 $ 354,141 $ 282,790 $ 199,431 Total interest expense................................... 399,540 318,805 198,741 153,318 118,585 --------- --------- --------- --------- --------- Net interest income...................................... 216,710 174,226 155,400 129,472 80,846 Provision for possible loan losses....................... 2,516 1,000 4,100 8,650 10,080 --------- --------- --------- --------- --------- Net interest income after provision for possible loan losses................................................. 214,194 173,226 151,300 120,822 70,766 --------- --------- --------- --------- --------- Other income............................................. 26,683 25,829 14,554 15,167 10,965 Other expenses........................................... 130,053 113,108 90,989 77,377 47,036 Non-recurring SAIF assessment............................ 27,818 -- -- -- -- --------- --------- --------- --------- --------- Income before income taxes and cumulative effect of change in accounting principle......................... 83,006 85,947 74,865 58,612 34,695 Income tax provision..................................... 31,543 29,539 28,467 22,998 15,057 --------- --------- --------- --------- --------- Income before cumulative effect of change in accounting principle.............................................. 51,463 56,408 46,398 35,614 19,638 Cumulative effect of change in accounting principle...... -- -- -- 4,800 -- --------- --------- --------- --------- --------- Net income............................................... $ 51,463 $ 56,408 $ 46,398 $ 40,414 $ 19,638 ========= ========= ========= ========= ========= Net income applicable to common stock.................... $ 45,213 $ 51,719 $ 46,398 $ 40,414 $ 19,638 ========= ========= ========= ========= =========
10 FINANCIAL RATIOS
TWELVE MONTHS ENDED DECEMBER 31, ------------------------------------------------------- 1996 1995 1994 1993 1992(2) --------- --------- --------- --------- ----------- Performance Ratios: Return on average equity(3)............................................ 15.14% 14.95% 16.47% 14.77% 13.51% Return on average total assets(3)...................................... .78 .78 .84 .81 .75 Average equity to average total assets................................. 5.14 5.22 5.09 5.51 5.53 Spread on average total assets......................................... 2.47 2.42 2.82 2.96 3.10 Stockholders' equity to total assets................................... 5.04 5.29 4.63 5.31 5.96 General and administrative expenses to average total assets............ 1.34 1.39 1.53 1.68 1.72 Efficiency ratio....................................................... 49.48 50.91 49.80 52.19 49.34 Asset Quality Ratios: Non-performing assets to total assets.................................. .54 .54 .62 .75 1.15 Non-performing loans to total loans.................................... .72 .83 .72 .81 .94 Allowance for loan losses to total loans............................... .55 .73 .83 1.12 1.11 Loan loss reserves to non-performing loans............................. 74.15 88.05 114.11 136.97 116.72 Capital Ratios: Tangible/leverage capital to tangible assets........................... 3.98 3.79 3.75 4.83 5.48 Leverage capital to risk-adjusted assets............................... 8.37 8.53 7.86 10.03 10.08 Risk-based capital to risk-adjusted assets............................. 12.97 14.27 12.65 16.20 11.98 Return on average risk-adjusted assets(3).............................. 1.61 1.68 1.77 1.66 1.44
SHARE DATA (4)
AT DECEMBER 31, ------------------------------------------------------- 1996 1995 1994 1993 1992(2) --------- --------- --------- --------- ----------- Common shares outstanding at end of period (in thousands)........... 59,641 54,558 54,680 49,628 48,818 Preferred shares outstanding at end of period (in thousands)........ 2,000 2,000 -- -- -- Earnings per common and common equivalent share:(5) Before cumulative effect of change in accounting principle...... $ .72 $ .83 $ .75 $ .58 $ .43 After cumulative effect of change in accounting principle....... .72 .83 .75 .67 .43 Book value per common and common equivalent share at end of period(6)......................................................... 6.64 6.17 5.04 4.37 3.78 Common share price at end of period................................. 10 15/16 8 1/16 5 7/8 9 5 1/8 Dividends paid per common share..................................... .070 .070 .088 .082 .068 Dividend payout ratio............................................... 9.72% 8.43% 11.73% 12.24% 15.81%
- ------------------ (1) The acquisitions of Valley Federal and Charter were accounted for as pooling-of-interests and accordingly, the consolidated financial statements have been restated to include the accounts of Valley Federal and Charter for all periods presented. (2) The acquisition of Harmonia was accounted for as a purchase at the close of business on December 31, 1992. Sovereign's consolidated balance sheet at December 31, 1992, includes Harmonia. Sovereign's 1992 consolidated results of operations do not include Harmonia's results. (3) The 1996 results do not include the non-recurring SAIF assessment of $17.2 million (after-tax) charged by the FDIC for the recapitalization of the SAIF. The 1993 results do not include a $4.8 million cumulative effect of change in accounting principle resulting from the adoption of Statement of Financial Accounting Standard No. 109 in 1993. (4) All per share data have been adjusted to reflect all stock dividends and stock splits declared through January 1997. (5) The 1996 results incude the non-recurring SAIF assessment described in Note 3 above. Excluding the non-recurring SAIF assessment, earnings per common and common equivalent share for 1996 would have been $.96. (6) Book value is calculated using equity divided by common shares and, if converted, preferred shares. 11 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. General. Sovereign and subsidiaries reported net operating income of $68.7 million for the year ended December 31, 1996. This represents an increase of 22% over net operating income of $56.4 million reported for 1995. Operating earnings per share were $.96 for 1996, which represents an increase of 16% over 1995 operating earnings per share of $.83. Return on average equity and return on average assets were 15.14% and .78%, respectively, for 1996 compared to 14.95% and .78%, respectively, for 1995. Return on average risk-adjusted assets was 1.61% for 1996 compared to 1.68% for 1995. The amounts presented exclude a non-recurring after-tax charge of $17.2 million paid to the Federal Deposit Insurance Corporation ("FDIC") during 1996 for the recapitalization of the Savings Association Insurance Fund ("SAIF"). Reported net income for the year ended December 31, 1996, including the impact of the non-recurring charge for the SAIF assessment, was $51.5 million or $.72 per share. Sovereign's financial results for 1996 include the following significant events: Interest Rate Environment. During 1996, unlike 1995, interest rates remained relatively stable, as the Federal Reserve System did not make any significant interest rate adjustments during the year. A flat yield curve (little difference between short-term and long-term interest rates) and a low interest rate environment caused Sovereign's net interest margin to stay relatively constant in 1996, averaging 2.59% for the year as compared to 2.54% for 1995. Predictions of interest rate increases during the first half of 1996 caused a temporary refinancing boom which tapered back to normal origination levels by mid-1996. West Jersey. On May 31, 1996, Sovereign acquired West Jersey Bancshares, Inc. ("West Jersey") in a transaction accounted for as a pooling-of-interests; however, the consolidated financial statements have not been restated due to immateriality. Sovereign acquired two branch offices located in Essex County, New Jersey and approximately $100.0 million in assets and assumed approximately $73.0 million of deposit liabilities. Accounting Changes. In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This Statement supersedes SFAS No. 122, "Accounting for Mortgage Servicing Rights," and SFAS No. 65, "Accounting for Certain Mortgage Banking Activities," although the practice of recording a servicing asset based on fair value is retained in SFAS No. 125. The Statement adopts the concept of recording only one "loan servicing asset," which is a departure from current accounting guidance and results in the elimination of the terms "normal servicing fee" and "excess servicing fee." Companies are required to adopt SFAS No. 125 on a prospective basis only for transactions occurring after December 31, 1996. Sovereign will adopt SFAS No. 125 in 1997 and does not anticipate the impact on its financial statements will be material. Stock Dividends/Splits. Sovereign declared a 20% stock split on January 16, 1997 and a 5% stock dividend on December 20, 1995 and on February 22, 1995. All per share information such as earnings, book value, share price and dividends have been restated to reflect all stock dividends and stock splits declared through January 1997. For a detailed discussion of Sovereign's stock dividends and stock splits, see Note 1(c) at Item 8 "Financial Statements and Supplementary Data" hereof. 12 RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 Net Interest Income. Net interest income for 1996 was $216.7 million compared to $174.2 million for 1995. This represents an increase of 24% and is primarily due to an increase in average balances resulting from internal growth and also an increase in Sovereign's interest rate spread. Interest on interest-earning deposits was $3.1 million for 1996 compared to $3.8 million for 1995. The average balance of interest-earning deposits was $11.1 million with an average yield of 27.59% for 1996 compared to an average balance of $23.9 million with an average yield of 16.10% for 1995. The high yields in 1996 and 1995 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-bearing deposits in 1997 and future years. Interest on investment and mortgage-backed securities available-for-sale was $33.7 million for 1996 compared to $10.1 million for 1995. The average balance of investment and mortgage-backed securities available-for-sale was $500.9 million with an average yield of 7.06% for 1996 compared to an average balance of $147.7 million with an average yield of 7.09% for 1995. The increase in average balance was the result of the reclassification of $750.2 million of securities from held-to-maturity to available-for-sale in December 1995. Interest on investment and mortgage-backed securities held-to-maturity was $173.3 million for 1996 compared to $151.6 million for 1995. The average balance of investment and mortgage-backed securities held-to-maturity was $2.43 billion with an average yield of 7.14% for 1996 compared to an average balance of $2.19 billion with an average yield of 6.92% for 1995. Interest and fees on loans were $406.2 million for 1996 compared to $327.5 million for 1995. The average balance of loans was $5.49 billion with an average yield of 7.40% for 1996 compared to an average balance of $4.50 billion with an average yield of 7.29% for 1995. The increases in average balance and interest income were primarily due to the origination of $2.06 billion of residential mortgage loans of which $1.71 billion (principally discounted adjustable rate loans) were retained in Sovereign's loan portfolio. The increase in average yield was the result of the upward repricing of discounted adjustable rate loans which Sovereign originated in 1995 and generally higher interest rates on newly originated loans in 1996. Interest on total deposits was $201.5 million for 1996 compared to $210.3 million for 1995. The average balance of total deposits was $4.97 billion with an average cost of 4.05% for 1996 compared to an average balance of $4.95 billion with an average cost of 4.25% for 1995. Despite a general rise in interest rates, the average cost of deposits decreased due to increased average balances of lower interest rate deposit products. Interest on total borrowings was $198.1 million for 1996 compared to $108.5 million for 1995. The average balance of total borrowings was $3.33 billion with an average cost of 5.95% for 1996 compared to an average balance of $1.83 billion with an average cost of 5.92% for 1995. The increase in average balance was the result of balance sheet growth being funded principally by borrowings. 13 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: SPREAD ANALYSIS
YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------------------------------- 1996 1995 1994 --------------------------------- --------------------------------- -------------------- AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST --------- --------- ----- --------- --------- ----------- --------- --------- Interest-earning assets: Interest-earning deposits.......... $ 11,136 $ 3,072 27.59% $ 23,868 $ 3,843 16.10% $ 43,503 $ 2,508 Investment and mortgage-backed securities available-for-sale(1)............ 500,857 33,722 7.06 147,658 10,118 7.09 104,296 6,188 Investment and mortgage-backed securities held-to-maturity...... 2,426,972 173,297 7.14 2,191,395 151,620 6.92 1,549,999 96,729 Net loans(2)(3).................... 5,488,984 406,159 7.40 4,496,756 327,450 7.29 3,581,685 248,716 --------- --------- ----- --------- --------- ----- --------- --------- Total interest-earning assets...... 8,427,949 616,250 7.33 6,859,677 493,031 7.19 5,279,483 354,141 Non-interest-earning assets........ 399,813 -- -- 366,931 -- -- 250,836 -- --------- --------- ----- ---------- --------- ----- ---------- --------- Total assets...................... $8,827,762 616,250 7.00 $7,226,608 493,031 6.83 $5,530,319 354,141 ========== --------- ----- ========== --------- ----- ========== --------- Interest-bearing liabilities: Deposits: Demand deposit and NOW accounts... $ 584,895 4,911 .84 $ 489,478 5,195 1.06 $ 353,067 4,153 Savings accounts.................. 1,025,063 23,925 2.33 975,643 23,158 2.37 944,178 24,267 Money market accounts............. 638,172 25,786 4.04 552,073 24,706 4.48 297,228 8,257 Certificates of deposit........... 2,725,540 146,861 5.39 2,929,025 157,208 5.37 1,989,931 85,135 --------- --------- ----- ---------- --------- ----- ---------- --------- Total deposits.................... 4,973,670 201,483 4.05 4,946,219 210,267 4.25 3,584,404 121,812 Total borrowings................... 3,325,935 198,057 5.95 1,832,446 108,538 5.92 1,588,560 76,929 --------- --------- ----- --------- --------- ----- ---------- --------- Total interest-bearing liabilities...................... 8,299,605 399,540 4.81 6,778,665 318,805 4.70 5,172,964 198,741 Non-interest-bearing liabilities... 74,448 -- -- 70,630 -- -- 75,694 -- --------- --------- ----- --------- --------- ----- ---------- --------- Total liabilities................. 8,374,053 399,540 4.77 6,849,295 318,805 4.65 5,248,658 198,741 Stockholders' equity............... 453,709 -- -- 377,313 -- -- 281,661 -- --------- --------- ----- --------- --------- ----- ---------- --------- Total liabilities and stockholders' equity............ $8,827,762 399,540 4.53 $7,226,608 318,805 4.41 $5,530,319 198,741 ========== --------- ----- ========== --------- ----- ========== --------- Interest rate spread(4)............ 2.47% 2.42% ===== ===== Net interest income/net interest margin(5)........................ $ 216,710 2.59% $174,226 2.54% $155,400 ========= ===== ======== ===== ======== Ratio of interest-earning assets to interest-bearing liabilities..... 1.02X 1.01x ===== ===== YIELD/ RATE ----------- Interest-earning assets: Interest-earning deposits.......... 5.77% Investment and mortgage-backed securities available-for-sale(1)............ 6.27 Investment and mortgage-backed securities held-to-maturity...... 6.24 Net loans(2)(3).................... 6.95 ---- Total interest-earning assets...... 6.72 Non-interest-earning assets........ -- ---- Total assets...................... 6.41 ---- Interest-bearing liabilities: Deposits: Demand deposit and NOW accounts... 1.18 Savings accounts.................. 2.57 Money market accounts............. 2.78 Certificates of deposit........... 4.28 ---- Total deposits.................... 3.40 Total borrowings................... 4.84 ---- Total interest-bearing liabilities...................... 3.84 Non-interest-bearing liabilities... -- ---- Total liabilities................. 3.79 Stockholders' equity............... -- ---- Total liabilities and stockholders' equity............ 3.59 ---- Interest rate spread(4)............ 2.82% ==== Net interest income/net interest margin(5)........................ 2.96% ==== Ratio of interest-earning assets to interest-bearing liabilities..... 1.02x ====
- ------------------ (1) The tax equivalent adjustments for the years ended December 31, 1996, 1995 and 1994 were $1,628,000, $344,000 and $346,000, respectively, and are based on an effective tax rate of 38% in 1996 and 1994 and 35% in 1995. (2) Amortization of net fees of $1,534,000, $2,574,000 and $476,000 for the years ended December 31, 1996, 1995 and 1994, respectively, are included in interest income. Average loan balances include non-accrual loans and loans held for resale. (3) The tax equivalent adjustments for the years ended December 31, 1996, 1995 and 1994, were $144,000, $144,000 and $150,000, respectively, and are based on an effective tax rate of 38% in 1996 and 1994 and 35% in 1995. (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 interest-earning assets. 14 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, ---------------------------------------------------------------- 1996 VS. 1995 1995 VS. 1994 INCREASE/(DECREASE) INCREASE/(DECREASE) ------------------------------- ------------------------------- VOLUME RATE TOTAL VOLUME RATE TOTAL --------- --------- --------- --------- --------- --------- Interest-earning assets: Interest-earning deposits....................... $ 2,286 $ (3,057) $ (771) $ (449) $ 1,784 $ 1,335 Investment and mortgage-backed securities available-for-sale.......................... 23,777 (173) 23,604 2,863 1,067 3,930 Investment and mortgage-backed securities held-to-maturity............................ 16,701 4,976 21,677 43,472 11,419 54,891 Net loans(1).................................... 73,341 5,368 78,709 66,140 12,594 78,734 --------- --------- Total interest-earning assets................... 123,219 138,890 --------- --------- Interest-bearing liabilities: Deposits...................................... 1,174 (9,958) (8,784) 53,273 35,182 88,455 Borrowings.................................... 88,933 586 89,519 12,885 18,724 31,609 --------- --------- Total interest-bearing liabilities.............. 80,735 120,064 --------- --------- Net change in net interest income............... $ 41,477 $ 1,007 $ 42,484 $ 42,395 $ (23,569) $ 18,826 ========= ========= ========= ========= ========= =========
- ------------------ (1) Includes non-accrual loans and loans held for resale. Provision for Possible Loan Losses. The provision for possible loan losses was $2.5 million for 1996 compared to $1.0 million for 1995 and $4.1 million for 1994. In 1996, Sovereign diversified its lending efforts and began to offer small business loans and an expanded line of consumer products, such as automobile loans and credit cards. As a result of the increased risk inherent in these products, Sovereign increased its 1996 loan loss provision by 150%, or $1.5 million over 1995 levels. Also, Sovereign acquired approximately $713,000 in loan loss reserves as a result of its acquisition of West Jersey during 1996. As Sovereign continues to place emphasis on small business and consumer lending in 1997 and future years, management will continually evaluate its loan portfolio and record additional loan loss reserves as is necessary. For additional information with respect to Sovereign's asset quality, see "Management"s Discussion and Analysis of Financial Condition and Results of Operations -- Credit Quality." During 1996, Sovereign charged-off (net of recoveries) $4.3 million of loans compared to $2.9 million during 1995. The increased level of charge-offs is primarily due to growth of $1.5 billion, or 31% in Sovereign's loan portfolio during 1996. 15 Table 3 presents the activity in the allowance for possible loan losses for the years indicated (in thousands): TABLE 3: RECONCILIATION OF THE ALLOWANCE FOR POSSIBLE LOAN LOSSES
DECEMBER 31, ----------------------------------------------------- 1996 1995 1994 1993 1992 --------- --------- --------- --------- --------- Allowance, beginning of year........................... $ 34,856 $ 36,289 $ 33,099 $ 26,562 $ 13,198 Charge-offs: Residential.......................................... 4,333 2,679 2,563 1,077 905 Commercial real estate............................... 192 498 2,932 292 618 Commercial........................................... -- -- -- 1 1,853 Consumer (including home equity lines of credit)..... 1,051 403 933 894 740 --------- --------- --------- --------- --------- Total charge-offs................................. 5,576 3,580 6,428 2,264 4,116 --------- --------- --------- --------- --------- Recoveries: Residential.......................................... 1,052 514 352 7 41 Commercial real estate............................... 75 125 82 49 54 Commercial........................................... -- -- 75 45 3 Consumer (including home equity lines of credit)..... 170 23 297 6 28 --------- --------- --------- --------- --------- Total recoveries.................................. 1,297 662 806 107 126 --------- --------- --------- --------- --------- Charge-offs, net of recoveries......................... 4,279 2,918 5,622 2,157 3,990 Provision for possible loan losses..................... 2,516 1,000 4,100 8,650 10,080 Acquired reserves and other additions.................. 716 485 4,712 44 7,274 --------- --------- --------- --------- --------- Allowance, end of year................................. $ 33,809 $ 34,856 $ 36,289 $ 33,099 $ 26,562 ========= ========= ========= ========= ========= Charge-offs, net of recoveries to average loans........................................ .077% .064% .155% .084% .237% ========= ========= ========= ========= =========
Table 4 summarizes the allocation of the allowance for possible loan losses and the percentage of such allocation to each loan type for the years indicated (in thousands): TABLE 4: ALLOCATION OF THE ALLOWANCE FOR POSSIBLE LOAN LOSSES
DECEMBER 31, ---------------------------------------------------------------------------------------------- BALANCE AT END OF PERIOD ATTRIBUTABLE TO: 1996 1995 1994 1993 - ------------------------------ ---------------------- ---------------------- ---------------------- ---------------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT --------- ----------- --------- ----------- --------- ----------- --------- ----------- Residential real estate....... $ 12,701 37.57% $ 10,520 30.18% $ 10,540 29.05% $ 6,737 20.35% Commercial real estate........ 1,814 5.36 698 2.00 657 1.81 1,180 3.57 Commercial.................... 369 1.09 181 .52 164 .45 125 .38 Consumer...................... 6,940 20.53 4,190 12.02 4,435 12.22 927 2.80 Unallocated................... 11,985 35.45 19,267 55.28 20,493 56.47 24,130 72.90 --------- ---------- --------- ---------- --------- ---------- --------- ---------- Total..................... $ 33,809 100.00% $ 34,856 100.00% $ 36,289 100.00% $ 33,099 100.00% ========= ========== ========= ========== ========= ========== ========= ========== BALANCE AT END OF PERIOD ATTRIBUTABLE TO: 1992 - ------------------------------ ---------------------- AMOUNT PERCENT --------- ----------- Residential real estate....... $ 7,316 27.54% Commercial real estate........ 1,663 6.26 Commercial.................... 135 .51 Consumer...................... 997 3.75 Unallocated................... 16,451 61.94 --------- ---------- Total..................... $ 26,562 100.00% ========= ==========
16 Other Income. Total other income was $26.7 million for 1996 compared to $25.8 million for 1995. Other loan fees and service charges were $5.1 million for 1996 compared to $4.4 million for 1995. This increase was primarily due to an increase in Sovereign's servicing portfolio. At December 31, 1996, Sovereign serviced $4.93 billion of its own loans and $1.14 billion of loans for others. This compares to $4.04 billion of its own loans and $947.1 million of loans for others at December 31, 1995. Deposit fees were $12.0 million for 1996 compared to $9.4 million for 1995. This increase was primarily the result of a 16% increase in the number of transaction accounts in 1996 compared to 1995. Gains on sales of loans and investment and mortgage-backed securities available-for-sale were $4.5 million for 1996 compared to $419,000 for 1995. This increase was primarily attributable to gains of $4.2 million related to the liquidation of $156.5 million of available-for-sale and equity securities in 1996. These gains were realized as part of Sovereign's ongoing management of risk in its available-for-sale portfolio and taking advantage of favorable market conditions. Gains on sales of loans held for resale were $1.4 million for 1996 compared to $6.1 million for 1995. This decrease was primarily due to a gain of $3.6 million from the sale of $238.5 million of mortgage servicing rights in 1995. Miscellaneous income was $3.7 million for 1996 compared to $5.5 million for 1995. This decrease was primarily due to a $2.6 million gain related to the sale of $130.6 million of deposits sold in 1995. General and Administrative Expenses. Total general and administrative expenses were $118.2 million for 1996 compared to $100.3 million for 1995. The 18% increase in general and administrative expenses from 1995 to 1996 compares to a 22% increase in the average balance sheet over the same time period. The ratio of general and administrative expenses to average assets was 1.34% for 1996 compared to 1.39% for 1995. Sovereign's efficiency ratio (all general and administrative expenses as a percentage of net interest income and recurring non-interest income) for 1996 was 49.48% compared to 50.91% for 1995. The decrease in these expense ratios was the result of efficiences realized from improved productivity and controlled expenses through process improvements and technological initiatives. Other Operating Expenses. Total other operating expenses were $39.7 million for 1996 compared to $12.8 million for 1995. This increase is primarily the result of a non-recurring assessment charge of $27.8 million paid to the FDIC for the recapitalization of the SAIF in 1996. Included in other operating expenses was amortization of goodwill and other intangible assets of $11.8 million for 1996 compared to $12.2 million for 1995 and net real estate owned ("REO") losses of $99,000 for 1996 compared to $657,000 for 1995. Income Tax Provision. The income tax provision was $31.5 million for 1996 compared to $29.5 million for 1995. The effective tax rate for 1996 was 38% compared to 34.4% for 1995. The increased effective tax rate in 1996 was primarily attributable to a lower than normal effective tax rate in 1995, which was caused by the reversal of certain tax reserves which management determined were no longer necessary. 17 FINANCIAL CONDITION Loan Portfolio. Sovereign's loan portfolio at December 31, 1996 was $6.16 billion compared to $4.67 billion at December 31, 1995. This increase is the result of record level residential first mortgage loan closings in 1996 of $2.06 billion including approximately $1.67 billion of variable rate mortgage loans. This compares to first mortgage loan closings of $1.06 billion including approximately $678.0 million of variable rate mortgage loans during 1995. Sovereign is currently placing an increased emphasis on commercial loan and consumer loan originations. As a result, during 1996, Sovereign closed $117.2 million of commercial loans and $665.1 million of consumer loans, including the purchase of approximately $200.0 million of government guaranteed student loans. These results compare to $7.1 million of commercial loans and $256.6 million of consumer loans closed during 1995. Sovereign's primary loan products are variable rate mortgage loans on owner occupied residential real estate. As a result, at December 31, 1996, 82% of Sovereign's total loan portfolio was secured by residential real estate and 78% of the total loan portfolio was comprised of variable rate loans. However, as a result of Sovereign's use of interest rate swaps for interest rate risk management, $561.2 million of variable rate mortgage loans have been effectively converted to fixed rate mortgage loans. Also, $248.6 million of intermediate variable rate mortgage loans (loans with a five-year fixed rate period) and $150.0 million of short-term variable rate mortgage loans (loans with less than a five-year fixed rate period) have effectively been converted to a variable rate over the fixed rate period. At December 31, 1996, Sovereign's total loan portfolio included $4.98 billion of first mortgage loans secured primarily by liens on owner-occupied one-to-four family residential properties. With its increased focus on non-residential lending, at December 31, 1996, Sovereign's total loan portfolio also included $201.1 million of commercial loans and $894.6 million of consumer loans, including $556.7 million of outstanding home equity loans ($324.6 million of additional unused commitments for home equity lines of credit) secured primarily by second mortgages on owner-occupied one-to-four family residential properties. 18 Table 5 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 5: COMPOSITION OF LOAN PORTFOLIO
AT DECEMBER 31, --------------------------------------------------------------------------------------------------------- 1996 1995 1994 1993 1992 ---------------------- ---------------------- ---------------------- ---------------------- --------- BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT BALANCE --------- ----------- --------- ----------- --------- ----------- --------- ----------- --------- Residential real estate loans...... $4,982,416 80.93% $3,998,048 85.53% $3,710,150 85.27% $2,434,520 84.01% $1,830,629 Residential construction loans........... 78,211 1.27 38,151 .82 49,094 1.13 23,086 .80 38,954 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total Residential Loans........... 5,060,627 82.20 4,036,199 86.35 3,759,244 86.40 2,457,606 84.81 1,869,583 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Multi-family loans............. 45,129 .74 75,218 1.61 95,216 2.19 117,257 4.04 125,443 Commercial real estate loans...... 67,837 1.10 48,853 1.05 42,943 .99 21,464 .74 33,243 Commercial loans.... 88,095 1.43 15,831 .34 5,730 .13 8,351 .29 7,565 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total Commercial Loans............. 201,061 3.27 139,902 3.00 143,889 3.31 147,072 5.07 166,251 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Consumer loans(1)........ 894,634 14.53 498,263 10.65 447,765 10.29 293,336 10.12 301,548 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total Loans..... $6,156,322 100.00% $4,674,364 100.00% $4,350,898 100.00% $2,898,014 100.00% $2,337,382 ========== ========== ========== ========== ========== ========== ========== ========== ========== Total Loans with:(2) Fixed rates....... $1,330,625 21.61% $1,134,542 24.27% $1,097,469 25.22% $ 905,320 31.24% $ 737,339 Variable rates.... 4,825,697 78.39 3,539,822 75.73 3,253,429 74.78 1,992,694 68.76 1,600,043 ---------- ----------- ---------- ---------- ---------- --------- ---------- ---------- ---------- Total Loans..... $6,156,322 100.00% $4,674,364 100.00% $4,350,898 100.00% $2,898,014 100.00% $2,337,382 ========== =========== ========== ========== ========== ========== ========== ========== ========== PERCENT ---------- Residential real estate loans...... 78.32% Residential construction loans........... 1.67 ---------- Total Residential Loans........... 79.99 ---------- Multi-family loans............. 5.37 Commercial real estate loans...... 1.43 Commercial loans.... .32 ---------- Total Commercial Loans............. 7.12 ---------- Consumer loans(1)........ 12.89 ---------- Total Loans..... 100.00% ========== Total Loans with:(2) Fixed rates....... 31.55% Variable rates.... 68.45 ---------- Total Loans..... 100.00% ==========
- ------------------ (1) Consumer loan balances at December 31, 1996, 1995, 1994, 1993 and 1992 include home equity loans of $556.7 million, $456.9 million, $413.0 million, $270.5 million and $260.5 million, respectively. (2) 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 of Financial Condition and Results of Operations -- Loan Portfolio." 19 Table 6 sets forth the maturity of Sovereign's residential construction, commercial real estate and commercial loans as scheduled to mature contractually at December 31, 1996 (in thousands): TABLE 6: LOAN MATURITY SCHEDULE
AMOUNTS AT DECEMBER 31, 1996, MATURING ----------------------------------------------------- IN ONE YEAR AFTER ONE YEAR AFTER OR LESS --FIVE YEARS FIVE YEARS TOTAL ------------ --------------- ----------- --------- Residential construction loans (net of loans in process of $41,935).................................................. $ 2,002 $ 3,544 $ 72,665 $ 78,211 Commercial real estate loans................................ 4,841 24,740 38,256 67,837 Commercial loans............................................ 36,966 36,398 14,731 88,095 ---------- --------- --------- --------- Total................................................. $ 43,809 $ 64,682 $ 125,652 $ 234,143 ========== ========= ========= ========= Loans with: Fixed rates............................................... $ 6,526 $ 30,637 $ 60,576 $ 97,739 Variable rates............................................ 37,283 34,045 65,076 136,404 ---------- --------- --------- --------- Total................................................. $ 43,809 $ 64,682 $ 125,652 $ 234,143 ========== ========= ========= =========
Credit Quality. Since Sovereign's primary loan products are residential loans, Sovereign has instituted various controls specifically designed to improve the credit quality of residential loans. For instance, Sovereign utilizes underwriting standards which comply with those of the Federal Home Loan Mortgage Corporation ("FHLMC") or the Federal National Mortgage Association ("FNMA"). Sovereign maintains an independent Loan Review Department which each month reviews a statistical sampling of all new originations for sound underwriting practices and reviews and rates all mortgage loan requests in excess of $300,000 with a loan-to-value ratio in excess of 75% and all applications for home equity lines of credit of $100,000 and over with a loan-to-value ratio in excess of 70%, prior to submission of the loan for underwriting. Results of these loan reviews are discussed at quarterly Loan Review meetings. Criticized loans and deficiencies in those loans are discussed. Guidelines are modified to prevent future deficiencies. Sovereign also closely monitors delinquencies as a means of maintaining high asset quality. Collection efforts begin as early as 15 days after a loan payment is due. All borrowers whose loans are more than 30 days past due are contacted by a collection officer in an effort to correct the delinquency. A variety of loss mitigation options are offered. Once a loan is more than 90 days past due, it is referred to the Asset Recovery and Liquidation Department and the process of liquidation begins. Sovereign monitors delinquency trends at 30, 60 and 90 days past due. These trends are discussed at the quarterly Loan Review and monthly Asset Review meetings, and with the Boards of Directors of Sovereign Bank and Sovereign Community Bank. At December 31, 1996, Sovereign's non-performing assets were $50.8 million compared to $43.7 million at December 31, 1995. Non-performing assets as a percentage of total assets were .54% at December 31, 1996 and 1995. At December 31, 1996, 89% of non-performing assets consisted of loans or REO related to one-to-four family residential real estate. The remainder of Sovereign's non- performing assets consist principally of commercial and multi-family REO; most of which have been acquired through acquisitions. Non-performing assets at December 31, 1996, included $6.6 million of REO which is carried at lower of cost or estimated fair value minus estimated costs to sell. Sovereign places all loans 90 days or more delinquent (except loans guaranteed by the government or secured by deposit accounts) on non-performing status. 20 Table 7 presents the composition of non-performing assets at the dates indicated (in thousands): TABLE 7: NON-PERFORMING ASSETS
AT DECEMBER 31, ----------------------------------------------------- 1996 1995 1994 1993 1992 --------- --------- --------- --------- --------- Non-accrual loans: Past due 90 days or more as to interest or principal: Residential................................................ $ 38,898 $ 33,580 $ 25,379 $ 20,740 $ 20,465 Other...................................................... 4.545 3,902 2,892 1,795 835 Past due less than 90 days as to interest or principal: Residential................................................ 639 644 2,980 1,056 -- Other...................................................... -- 739 -- -- -- --------- --------- --------- --------- --------- Total non-accrual loans........................................ 44,082 38,865 31,251 23,591 21,300 Restructured loans............................................. 145 296 99 372 1,183 --------- --------- --------- --------- --------- Total non-performing loans..................................... 44,227 39,161 31,350 23,963 22,483 Real estate owned: Residential.................................................. 5,929 2,437 6,104 4,510 7,655 Other........................................................ 660 2,076 3,087 8,306 12,247 --------- --------- --------- --------- --------- Total real estate owned........................................ 6,589 4,513 9,191 12,816 19,902 --------- --------- --------- --------- --------- Total non-performing assets.................................... $ 50,816 $ 43,674 $ 40,541 $ 36,779 $ 42,385 ========= ======== ======== ======== ========= Past due 90 days or more as to interest or principal and accruing interest(1)......................................... $ 10,955 $ -- $ -- $ 63 $ 75 Non-performing assets as a percentage of total assets.......... .54% .54% .62% .75% 1.15% Non-performing loans as a percentage of total loans............ .72 .83 .72 .81 .94 Non-performing assets as a percentage of total loans and real estate owned................................................. 1.00 .92 .93 1.24 1.75 Allowance for possible loan losses as a percentage of total non-performing assets........................................ 64.53 78.95 88.24 89.24 61.91 Allowance for possible loan losses as a percentage of total non-performing loans......................................... 74.15 88.05 114.11 136.97 116.72
- ------------------ (1) At December 31, 1996, non-performing assets past due 90 days or more as to interest or principal and accruing interest include $10.5 million of government-guaranteed student loans which are 100% guaranteed and Sovereign retains minimal risk of credit losses related to these loans. Potential problem loans (consisting of loans which management has serious doubts as to the ability of such borrowers to comply with present repayment terms, although not currently classified as non-performing loans) were comprised of 5 loans which amounted to $4.5 million at December 31, 1996 and consisted principally of multi-family loans. At December 31, 1996, Sovereign serviced, with recourse, a total of $60.1 million of single-family residential loans. Substantially all of this recourse servicing was acquired in the Jersey Shore acquisition. These are seasoned loans and historical loss experience has been minimal. The adequacy of Sovereign's allowance for possible loan losses is constantly evaluated. Management's evaluation of the adequacy of the allowance to absorb potential future loan losses takes into consideration the risks inherent in the loan portfolio, past loan loss experience, specific loans which have loss potential, geographic and industry concentrations, delinquency trends, economic conditions, the level of originations and other relevant factors. At December 31, 1996, Sovereign's loan delinquencies (all loans greater than 30 days delinquent) as a percentage of total loans was 1.54% compared to 1.32% at December 31, 1995. This increase is attributable to the growth of Sovereign's student loan portfolio and delinquencies associated with it. Sovereign's loan delinquencies as a percentage of total loans excluding student loans delinquencies was 1.27%, down slightly from 1995. 21 Sovereign's student loans are government-guaranteed which are 100% guaranteed and Sovereign retains minimal risk of credit losses related to these loans. These factors indicated to management that a provision for possible loan losses of $2.5 million was necessary to maintain the allowance for possible loan losses at a level which management conservatively estimates is necessary to absorb potential future losses in consideration of the factors noted above. Investment and Mortgage-backed Securities. 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 three years or less. At December 31, 1996, three securities, or 5% of Sovereign's total investment portfolio are classified as high risk securities as defined by the FFIEC Policy Statement on securities activities. The effective duration of the total investment portfolio at December 31, 1996 is 2.2 years. Investment and Mortgage-backed Securities Available-for-Sale. Securities expected to be held for an indefinite period of time are classified as available-for-sale and are carried at fair value, with unrealized gains and losses reported as a separate component of stockholders' equity, net of estimated income taxes. Decisions to purchase or sell these securities are based on economic conditions including changes in interest rates, liquidity, and asset liability management strategies. For additional information with respect to the amortized cost and estimated fair value of Sovereign's investment and mortgage-backed securities available-for-sale, see Note 4 at Item 8 "Financial Statements and Supplementary Data" hereof. The maturities of mortgage-backed securities available-for-sale are based upon contractually scheduled repayments. Expected maturities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties. Yields on tax-exempt securities were computed on a tax equivalent basis using Sovereign's effective tax rate of 38%. Table 8 sets forth the amortized cost, expected maturities and yields of Sovereign's investment and mortgage-backed securities available-for-sale at December 31, 1996 (in thousands): TABLE 8: INVESTMENT AND MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE MATURITY SCHEDULE
AMOUNTS AT DECEMBER 31, 1996, DUE ---------------------------------------------------------------------- NO STATED IN ONE YEAR ONE YEAR FIVE YEARS MATURITY OR LESS --FIVE YEARS --TEN YEARS OR RATE TOTAL ------------ ------------- -------------- -------------- --------- Investment Securities: U.S. Treasury and government agency securities.......................... $ -- $ 4,978 $ -- $ -- $ 4,978 -- 7.03% -- -- 7.03% Equity securities..................... -- -- 285,367 285,367 -- -- -- 4.66% 4.66% Mortgage-backed Securities: FHLMC................................. -- -- 25,288 -- 25,288 -- -- 6.58% -- 6.58% Collateralized mortgage obligations... 47,802 116,657 -- -- 164,459 7.14% 6.75% -- -- 6.86% ---------- --------- ---------- ---------- --------- Total investment and mortgage-backed securities available-for-sale............. $ 47,802 $ 121,635 $ 25,288 $ 285,367 $ 480,092 ========== ========= ========== ========== ========= 7.14% 6.76% 6.58% 4.66% 5.54% ========== ========= ========== ========== =========
22 Investment and Mortgage-backed Securities Held-to-Maturity. Securities that Sovereign has the intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. This portfolio is primarily comprised of U.S. Treasury and government agency securities; corporate debt securities; mortgage-backed securities issued by FHLMC, FNMA, the Government National Mortgage Association ("GNMA"), the RTC and private issuers; and collateralized mortgage obligations. For additional information with respect to the amortized cost and estimated fair value of Sovereign's investment and mortgage-backed securities held-to-maturity, see Note 4 at Item 8 "Financial Statements and Supplementary Data" hereof. The maturities of the mortgage-backed securities held-to-maturity are based upon contractually scheduled repayments. Expected maturities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties. Yields on tax-exempt securities were computed on a tax equivalent basis using Sovereign's effective tax rate of 38%. Table 9 sets forth the expected maturity and yields of Sovereign's investment and mortgage-backed securities held-to-maturity at December 31, 1996 (in thousands): TABLE 9: INVESTMENT AND MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY MATURITY SCHEDULE
AMOUNTS AT DECEMBER 31, 1996, 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.............................. $ 749 $ 2,520 $ -- $ -- $ 3,269 7.17% 6.21% -- -- 6.43% Corporate securities...................... -- 1,006 -- -- 1,006 -- 8.20% -- -- 8.20% Other securities.......................... 50,075 205 310 10 50,600 1.67% 3.65% 7.52% -- 1.71% Mortgage-backed Securities: FHLMC..................................... 9,983 28,041 93,512 6,339 137,875 7.06% 7.78% 6.34% 7.46% 6.74% FNMA...................................... 454 35,348 145,188 9,919 190,909 8.61% 7.06% 6.38% 6.87% 6.54% GNMA...................................... -- 444 14,941 172,558 187,943 -- 9.46% 6.75% 7.64% 7.57% RTC....................................... -- -- -- 25,284 25,284 -- -- -- 6.76% 6.76% Private issues............................ 6,083 137,935 102,580 896 247,494 7.31% 6.59% 6.79% 6.06% 6.69% Collateralized mortgage obligations....... 31,842 454,124 487,509 614,093 1,587,568 7.47% 7.27% 7.06% 6.73% 7.00% ---------- ---------- ---------- --------- ----------- Total investment and mortgage-backed securities held-to-maturity........... $ 99,186 $ 659,623 $ 844,040 $ 829,099 $ 2,431,948 ========== ========== ========== ========= =========== 4.49% 7.14% 6.83% 6.93% 6.85% ========== ========== ========== ========= ===========
23 Table 10 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 shareholders' equity which were held by Sovereign at December 31, 1996 (in thousands): TABLE 10: INVESTMENT AND MORTGAGE-BACKED SECURITIES
AT DECEMBER 31, 1996 ----------------------------- ISSUER CARRYING VALUE FAIR VALUE ------ -------------- ------------- CMS Securities Corp................................................................ $ 64,661 $ 63,832 G.E. Capital Mortgage Servicing, Inc............................................... 318,679 313,902 Housing Securities, Inc............................................................ 74,869 72,242 Independent National Mortgage Corp................................................. 65,677 65,425 PHH Mortgage Servicing Corp........................................................ 185,366 185,639 Prudential Home Mortgage Securities, Inc........................................... 207,456 207,380 Residential Funding Mortgage Securities, Inc....................................... 277,756 275,671 Securitized Asset Sales, Inc....................................................... 101,699 101,261 Saxon Mortgage Securities Corp..................................................... 47,666 46,036 ------------ ------------- Total............................................................................ $ 1,343,829 $ 1,331,388 ============ =============
Prior to the adoption of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," management determined the appropriate classification of securities at the time of purchase. If Sovereign had the intent and the ability at the time of purchase to hold securities until maturity or on a long-term basis, they were classified as investments and carried at amortized historical cost. Securities to be held for indefinite periods of time and not intended to be held-to-maturity or on a long-term basis were classified as available-for-sale and carried at the lower of cost or estimated fair value. Securities held for indefinite periods of time included securities that management intended to use as part of its asset/liability management strategy and that may have been sold in response to changes in interest rates, resultant prepayment risk, and other factors related to interest rate and resultant prepayment risk changes. Other Assets. Premises and equipment at December 31, 1996 was $53.6 million compared to $57.0 million at December 31, 1995. This decrease is attributable to depreciation and the disposition of certain fixed assets without a corresponding increase in purchases. Goodwill and intangible assets at December 31, 1996 were $111.5 million compared to $123.2 million at December 31, 1995. This decrease is due to the amortization of these assets with no additional goodwill created or acquired through acquisitions in 1996. Deposits. Deposits are attracted from within Sovereign's primary market area through the offering of various deposit instruments including NOW accounts, money market accounts, savings accounts, certificates of deposit and retirement savings plans. Total deposits at December 31, 1996 were $5.05 billion compared to $5.04 billion at December 31, 1995. 24 Table 11 presents the composition of Sovereign's deposits at the dates indicated (in thousands): TABLE 11: DEPOSIT PORTFOLIO COMPOSITION
AT DECEMBER 31, ---------------------------------------------------------------------------- 1996 1995 1994 ------------------------ ------------------------ ------------------------ % OF % OF % OF ACCOUNT TYPE BALANCE DEPOSITS BALANCE DEPOSITS BALANCE DEPOSITS - -------------------------------------------- ----------- ----------- ----------- ----------- ----------- ----------- Demand deposit and NOW accounts............. $ 659,828 13.06% $ 549,232 10.90% $ 426,548 10.59% Savings accounts............................ 991,970 19.63 925,842 18.37 925,667 22.98 Money market accounts....................... 610,491 12.08 720,997 14.31 388,579 9.65 Retail certificates of deposit.............. 2,672,567 52.90 2,731,009 54.20 2,207,531 54.82 ----------- ---------- ----------- ---------- ----------- ---------- Total retail deposits..................... 4,934,856 97.67 4,927,080 97.78 3,948,325 98.04 Jumbo certificates of deposit............... 117,585 2.33 112,063 2.22 78,794 1.96 ----------- ---------- ----------- ---------- ----------- ---------- Total deposits............................ $ 5,052,441 100.00% $ 5,039,143 100.00% $ 4,027,119 100.00% =========== ========== =========== ========== =========== ==========
Borrowings. Sovereign utilizes borrowings as a source of funds for its asset growth and its asset/liability management. Collateralized advances are available from the 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 securities fully guaranteed as to principal and interest by the U.S. Government or an agency thereof. Total borrowings at December 31, 1996 were $3.86 billion of which $2.76 billion were short-term compared to total borrowings of $2.53 billion of which $1.51 billion were short-term at December 31, 1995. Table 12 presents information regarding borrowings at the dates indicated (in thousands): TABLE 12: BORROWINGS
AT DECEMBER 31, ---------------------------------------------------------------------------------------- 1996 1995 1994 ---------------------------- ---------------------------- ---------------------------- WEIGHTED WEIGHTED WEIGHTED BALANCE AVERAGE RATE BALANCE AVERAGE RATE BALANCE AVERAGE RATE ----------- --------------- ----------- --------------- ----------- --------------- Securities sold under repurchase agreements........ $ -- --% $ 382,279 6.38% $ 608,810 5.72% FHLB advances.................. 3,688,518 5.85 1,979,551 5.75 1,434,081 5.25 Other borrowings............... 167,748 7.46 168,826 7.49 119,696 7.71 ----------- ---- ----------- ---- ----------- ---- Total borrowings............. $ 3,856,266 5.92% $ 2,530,656 5.96% $ 2,162,587 5.52% =========== ==== =========== ==== =========== ====
Through the use of interest rate swaps, $1.36 billion of the 1996 FHLB advances have been effectively converted to fixed rate obligations. At December 31, 1996, other borrowings include $50.0 million of subordinated debentures which have, through the use of an interest rate swap, been converted from a fixed rate obligation to a variable rate obligation. In addition, $500.0 million of borrowings have been protected from upward repricing through the use of interest rate caps. Stockholders' Equity. Total stockholders' equity at December 31, 1996 was $475.8 million compared to $427.0 million at December 31, 1995. The increase in stockholders' equity was primarily attributable to the retention of earnings of $51.5 million in 1996. 25 LIQUIDITY AND CAPITAL RESOURCES Sovereign Bank and Sovereign Community Bank are required under applicable federal regulations to maintain specified levels of "liquid" investments in cash and U.S. Treasury and other qualifying investments. Regulations currently in effect require Sovereign Bank to maintain liquid assets of not less than 5% of its net withdrawable accounts plus short-term borrowings, of which short-term liquid assets must consist of not less than 1%. These levels are changed from time to time by the OTS to reflect economic conditions. The liquidity ratio of Sovereign Bank and Sovereign Community Bank for December 1996 was 5.34% and 72.63%, respectively. Sovereign's primary financing sources are deposits obtained in its own market area and borrowings in the form of securities sold under repurchase agreements and advances from the FHLB. 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 $50 million per month. At December 31, 1996, Sovereign had $2.77 billion in unpledged investment and mortgage-backed securities which could be used to collateralize additional borrowings. Sovereign Bank can also borrow from the FHLB, subject to required collateralization. Other sources of funds include operating activities, repayments of principal on investment and mortgage-backed securities, repayment of principal on loans and other investing activities. Cash and cash equivalents decreased $42.6 million for 1996. Net cash provided by operating activities was $46.4 million for 1996. Net cash used by investing activities for 1996 was $1.33 billion consisting primarily of purchases of mortgage-backed securities and loans, partially offset by proceeds from sales of investment and mortgage-backed securities available-for-sale. Net cash used for purchases of loans was $885.0 million for 1996 compared to $305.8 million for 1995. This increase is primarily attributable to the purchase of approximately $200.0 million of government guaranteed student loans and increased purchases of residential mortgage loans through the secondary market. Net cash provided by financing activities for 1996 was $1.24 billion which includes an increase in short-term borrowings of $322.5 million and an increase in proceeds from long-term borrowings of $1.01 billion resulting from Sovereign's effort to extend borrowings to manage its interest rate risk and balance sheet growth that could not be funded through deposit growth. The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA") requires the OTS to prescribe uniformly applicable capital standards for all savings associations. These standards currently require institutions to maintain a minimum tangible capital ratio of not less than 1.5%, a minimum leverage capital ratio of not less than 3% of tangible assets and not less than 4% of risk-adjusted assets and a minimum risk-based capital ratio (based upon credit risk) of not less than 8%. In all cases, these standards are to be no less stringent than the capital standards that are applicable to national banks. The OTS requires a minimum leverage capital requirement of 3% for associations rated composite 1 under the OTS MACRO rating system. For all other savings associations, the minimum leverage capital requirement will be 3% plus at least an additional 100 to 200 basis points. The 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. 26 At December 31, 1996, Sovereign Bank and Sovereign Community Bank were classified as well-capitalized and were in compliance with all capital requirements. The following table sets forth the capital ratios of Sovereign Bank, Sovereign Community Bank and Sovereign Bancorp and the current regulatory requirements at December 31, 1996:
SOVEREIGN SOVEREIGN COMMUNITY SOVEREIGN BANK BANK BANCORP(1) REQUIREMENT ----------- ------------- ----------- --------------- Tangible capital to tangible assets............ 5.33% 5.33% 3.98% 1.50% Leverage (core) capital to tangible assets....................................... 5.33 5.33 3.98 3.00 Leverage (core) capital to risk-adjusted assets....................................... 11.51 9.13 8.37 4.00 Risk-based capital to risk-adjusted assets....................................... 12.25 10.06 12.97 8.00
- ------------------ (1) OTS capital regulations do not apply to holding companies. These ratios are computed as if those regulations did apply to Sovereign Bancorp. ASSET AND LIABILITY MANAGEMENT The objective of Sovereign's asset and liability management is to identify, measure and control its interest rate risk in order to produce consistent earnings that are not contingent upon favorable trends in interest rates. Sovereign manages its assets and liabilities to attain a stable net interest margin across a wide spectrum of interest rate environments. This is attained by monitoring the levels of interest rates, the relationships between the rates earned on assets and the rates paid on liabilities, the absolute amount of assets and liabilities which reprice or mature over similar periods, off-balance sheet positions and the effect of all these factors on the estimated level of net interest income. There are a number of industry standards used to measure an institution's interest rate risk position. Most common among these is the one year gap which is the ratio representing the difference between assets, liabilities and off-balance sheet positions which will mature or reprice within one year expressed as a percentage of total assets. Using management's estimates of asset prepayments, core deposit decay and core deposit repricing in its computation, Sovereign estimates that its cumulative one year gap position was a negative 7.69% at December 31, 1996. Sovereign also utilizes income simulation modeling in measuring its interest rate risk and managing its interest rate sensitivity. Income simulation considers not only the impact of changing market interest rates on forecasted net interest income, but also other factors such as yield curve relationships, the volume and mix of assets and liabilities, customer preferences and general market conditions. Sovereign Bank manages the one year interest rate gap within a range of +/-10%. A negative gap position implies that the bank is liability sensitive which could cause net interest income to decrease if interest rates rise. Sovereign manages the impact to net interest income in a +200 basis point instantaneous rate shock environment to be within a 5% loss. At December 31, 1996, Sovereign estimates that if interest rates rise by 200 basis points, net interest income would decrease by 1.62%. 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. Amortizing and non-amortizing interest rate swaps are generally used to convert fixed rate assets and liabilities to variable rate assets and liabilities and vice versa. Sovereign utilizes amortizing interest rate swaps to convert discounted adjustable rate loans to fixed rates for a period of time. The amortization of the notional amount of the interest rate swaps are tied to the level of an index such as 27 the One Year Treasury Constant Maturity, LIBOR, or a prepayment rate of a pool of mortgage-backed securities. In order for interest rate swaps to achieve the desired objective, Sovereign selects interest rate swaps that will have a high degree of correlation to the related financial instrument. Sovereign utilizes non-amortizing interest rate swaps to convert fixed rate liabilities to floating, and floating rate liabilities to fixed, to reduce Sovereign's overall cost of funds. Interest rate caps are generally used to limit the exposure from the repricing and maturity of liabilities and interest rate floors are generally used to limit the exposure from the repricing and maturity of assets. Interest rate caps and floors are also used to limit the exposure created by other interest rate swaps. In certain cases, interest rate caps or floors are simultaneously bought and sold to create a range of protection against changing interest rates while limiting the cost of that protection. Due to competitive conditions, Sovereign originates fixed rate residential mortgages. It exchanges the majority of these loans with FHLMC, FNMA and private investors. The loans are exchanged for cash or marketable fixed rate mortgage-backed securities which are generally sold. This helps insulate Sovereign from the interest rate risk associated with these fixed rate assets. Sovereign uses forward sales, cash sales and options on mortgage-backed securities as means of hedging loans in the mortgage pipeline which are originated for resale. Sovereign's primary funding source is deposits obtained in its own marketplace. Deposit programs at Sovereign are priced to meet management's asset/liability objectives, while taking into account the rates available on investment opportunities and also considering the cost of alternative funding sources. Borrowings are a significant funding source for Sovereign and have primarily been in the form of securities sold under repurchase agreements and advances from the FHLB. Since borrowings are not subject to the market constraints to which deposits are, Sovereign uses borrowings to add flexibility to its interest rate risk position. Table 13 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, 1996, 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): 28 TABLE 13: GAP ANALYSIS
0-3 4 MONTHS YEAR 2 MONTHS -1 YEAR & OVER TOTAL ---------- ----------- ----------- ---------- Interest-earning assets: Investment and mortgage-backed securities(1)(2) ............ $ 864,215 $ 321,335 $ 1,736,190 $2,921,740 6.41 % 6.94 % 6.97% 6.80% Loans(3) ................................................... 1,139,609 1,951,712 3,055,041 6,146,362 8.06 % 7.48 % 7.35% 7.52% ---------- ----------- ----------- ---------- Total interest-earning assets ................................ 2,003,824 2,273,047 4,791,231 9,068,102 7.35 % 7.40 % 7.21% 7.29% Non-interest-earning assets .................................. -- -- 365,052 365,052 ---------- ----------- ----------- ---------- Total assets ................................................. $2,003,824 $ 2,273,047 $ 5,156,283 $9,433,154 7.35 % 7.40 % 6.70% 7.01% ---------- ----------- ----------- ---------- Interest-bearing liabilities: Deposits(4) ................................................ $ 671,397 $ 1,798,143 $ 2,582,901 $5,052,441 4.50 % 4.67 % 3.39% 3.99% Borrowings ................................................. 1,625,283 1,146,426 1,084,557 3,856,266 5.63 % 5.96 % 6.32% 5.92% ---------- ----------- ----------- ---------- Total interest-bearing liabilities ........................... 2,296,680 2,944,569 3,667,458 8,908,707 5.30 % 5.17 % 4.26% 4.83% Non-interest-bearing liabilities ............................. -- -- 48,632 48,632 Stockholders' equity ......................................... -- -- 475,815 475,815 ---------- --------- ----------- ---------- Total liabilities and stockholders' equity ................... $2,296,680 $ 2,944,569 $ 4,191,905 $9,433,154 5.30 % 5.17 % 3.73% 4.56% ---------- ----------- ----------- ---------- Excess assets (liabilities) before effect of off-balance sheet positions .................................................. $ (292,856) $ (671,522) $ 964,378 ---------- ----------- ----------- To total assets ............................................ (3.10)% (7.12)% 10.22% 2.45% ========== =========== =========== ========== Cumulative excess assets (liabilities) before effect of off-balance sheet positions ................................ $ (292,856) $ (964,378) $ -- ========== =========== =========== To total assets .......................................... (3.10)% (10.22)% Effect of off-balance sheet positions on assets and liabilities ................................................ $ 940,601 $ (701,422) $ (239,179) ========== =========== =========== Excess assets (liabilities) after effect of off-balance sheet positions .................................................. $ 647,745 $(1,372,944) $ 725,199 ========== =========== =========== To total assets .......................................... 6.87 % (14.55)% 7.69% Cumulative excess assets (liabilities) after off-balance sheet positions .................................................. $ 647,745 $ (725,199) $ -- ========== =========== =========== To total assets .......................................... 6.87 % (7.69)%
- ------------------ (1) Includes interest-earning deposits. (2) Mortgage-backed securities include annual prepayment and repayment assumptions between 6% and 30% initially with gradual slowing thereafter. Balances on these securities are presented net of deferred loan fees. (3) Loan balances include annual prepayment and repayment assumptions between 6% and 35% initially with gradual slowing thereafter. Loan balances are presented net of deferred loan fees and include loans held for resale and the allowance for loan losses. (4) Savings, NOW, money market and demand deposit accounts have been assumed to decay at an annual rate of 20%. 29 Table 14 presents selected quarterly consolidated financial data (in thousands, except per share data): TABLE 14: SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA
THREE MONTHS ENDED -------------------------------------------------------------------------------------- DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31, 1996 1996 1996 1996 1995 1995 1995 1995 --------- --------- --------- --------- --------- --------- --------- --------- Total interest income.............. $164,456 $161,675 $150,193 $139,926 $136,575 $128,827 $116,220 $111,409 Total interest expense............. 108,755 106,459 95,331 88,995 90,137 85,150 74,845 68,673 -------- -------- -------- -------- -------- -------- -------- -------- Net interest income................ 55,701 55,216 54,862 50,931 46,438 43,677 41,375 42,736 Provision for possible loan losses........................... 1,000 500 516 500 250 250 250 250 -------- -------- -------- -------- -------- -------- -------- -------- Net interest income after provision........................ 54,701 54,716 54,346 50,431 46,188 43,427 41,125 42,486 Other income....................... 9,651 6,734 5,432 4,866 6,774 4,894 9,294 4,867 Other expenses..................... 33,761 33,598 32,707 29,987 28,940 26,447 28,929 28,792 Non-recurring SAIF assessment(1)... -- 27,818 -- -- -- -- -- -- -------- -------- -------- -------- -------- -------- -------- -------- Income before income taxes......... 30,591 34 27,071 25,310 24,022 21,874 21,490 18,561 Income tax provision............... 11,632 6 10,276 9,629 8,325 7,436 7,347 6,431 -------- -------- -------- -------- -------- -------- -------- -------- Net income......................... $ 18,959 $ 28 $ 16,795 $ 15,681 $ 15,697 $ 14,438 $ 14,143 $ 12,130 ======== ======== ======== ======== ======== ======== ======== ======== Net income before non-recurring SAIF assessment.................. $ 18,959 $ 17,275 $ 16,795 $ 15,681 $ 15,697 $ 14,438 $ 14,143 $ 12,130 ======== ======== ======== ======== ======== ======== ======== ======== Net income (loss) applicable to common stock..................... $ 17,396 $ (1,534) $ 15,233 $ 14,118 $ 14,134 $ 12,875 $ 12,580 $ 12,130 ======== ======== ======== ======== ======== ======== ======== ======== Earnings per common and common equivalent share(2)(3)........... $ .26 $ .00 $ .24 $ .22 $ .22 $ .20 $ .21 $ .20 Market prices(2) High............................. 11 3/8 9 3/16 9 3/8 9 1/4 8 1/2 8 1/2 7 5/8 7 3/16 Low.............................. 9 1/16 8 8 5/16 7 3/4 7 3/4 7 9/16 6 3/8 5 15/16 Dividends per share(2)............. .0175 .0175 .0175 .0175 .0175 .0174 .0174 .0174
- ------------------ (1) Reflects a one-time assessment of $17.2 million (after-tax) charged by the FDIC for the recapitalization of the SAIF. (2) All per share data have been adjusted to reflect all stock dividends and stock splits declared through January 1997. (3) The results for the three-month period ended September 30, 1996 include the non-recurring SAIF assessment described in Note 1 above. Excluding the non-recurring SAIF assessment, earnings per common and common equivalent share for the three-month period ended September 30, 1996 would have been $.24. 30 RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994 Net Income. Net income for the year ended December 31, 1995 was $56.4 million, a 22% increase over $46.4 million for the year ended December 31, 1994. On a per share basis, net income rose to $.83 in 1995 from $.75 in 1994. Return on average assets was .78% for 1995 compared to .84% for 1994. Return on average equity for 1995 was 14.95% compared to 16.47% for 1994. Net Interest Income. Net interest income for 1995 was $174.2 million compared to $155.4 million in 1994. This represents an increase of 12% and is primarily due to an increase in the size of the balance sheet resulting from recent acquisitions and internal growth, partially offset by a decline in Sovereign's interest rate spread. Interest on interest-earning deposits was $3.8 million for 1995 compared to $2.5 million for 1994. The average balance of interest-earning deposits was $23.9 million with an average yield of 16.10% for 1995 compared to an average balance of $43.5 million with an average yield of 5.77% for 1994. The high yield in 1995 was 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-bearing deposits in future years. Interest on investment and mortgage-backed securities available-for-sale was $10.1 million for 1995 compared to $6.2 million for 1994. The average balance of investment and mortgage-backed securities available-for-sale was $147.7 million with an average yield of 7.09% for 1995 compared to an average balance of $104.3 million with an average yield of 6.27% in 1994. The increase in average yield is the result of generally higher interest rates. Interest on investment and mortgage-backed securities held-to-maturity was $151.6 million for 1995 compared to $96.7 million for 1994. The average balance of investment and mortgage-backed securities held-to-maturity was $2.19 billion with an average yield of 6.92% for 1995 compared to an average balance of $1.55 billion with an average yield of 6.24% for 1994. Interest and fees on loans were $327.5 million for 1995 compared to $248.7 million for 1994. The average balance of loans was $4.50 billion with an average yield of 7.29% for 1995 compared to an average balance of $3.58 billion with an average yield of 6.95% for 1994. The increase in average balance was primarily due to the origination of $1.06 billion of residential mortgage loans of which $808.8 million (principally discounted adjustable rate loans) were retained in Sovereign's loan portfolio. The increase in yield was the result of the upward repricing of discounted adjustable rate loans which Sovereign originated in 1994. Interest on total deposits was $210.3 million for 1995 compared to $121.8 million for 1994. The average balance of total deposits was $4.95 billion with an average cost of 4.25% for 1995 compared to an average balance of $3.58 billion with an average cost of 3.40% for 1994. The increase in average balance was primarily due to the Berkeley acquisition. The increase in the average cost of deposits was a result of a general rise in interest rates. Interest on total borrowings was $108.5 million for 1995 compared to $76.9 million for 1994. The average balance of total borrowings was $1.83 billion with an average cost of 5.92% for 1995 compared to an average balance of $1.59 billion with an average cost of 4.84% for 1994. The increase in average cost of borrowings is a result of the general rise in interest rates and the cost of the subordinated debentures issued during 1995. Provision for Possible Loan Losses. The provision for possible loan losses for 1995 was $1.0 million compared to $4.1 million for 1994. The decreased loan loss provision from 1994 to 1995 was the result of two primary factors. During 1995, Sovereign's loan charge-offs (net of recoveries) decreased by 93% compared to 1994 levels, which coincides with the reduction of loan loss provision for 1995. Also, Sovereign acquired reserves of $485,000 from its Sovereign Community Bank 31 acquisition in 1995, which more than offset the credit risk of the acquired loan portfolio and helped to offset incremental provisioning in 1995. Management closely monitors the level of loan loss reserves in relation to current and anticipated origination levels, past loan loss experience, geographic and industry concentrations, the credit risk inherent in its loan portfolio, economic conditions, and several other factors. Other Income. Total other income was $25.8 million for 1995 compared to $14.6 million for 1994. Other loan fees and service charges were $4.4 million for 1995 compared to $5.0 million for 1994. This decrease was primarily due to a decrease in Sovereign's servicing portfolio. At December 31, 1995, Sovereign serviced $4.04 billion of its own loans and $947.1 million of loans for others. This compares to $3.90 billion of its own loans and $1.11 billion of loans for others at December 31, 1994. Deposit fees were $9.4 million for 1995 compared to $5.8 million for 1994. This increase was the result of the Berkeley acquisition and the full year effect of the Shadow Lawn acquisition. Gains on sales of loans and investment and mortgage-backed securities available-for-sale were $419,000 for 1995 compared to $494,000 for 1994. Gains on sales of loans held for resale were $6.1 million for 1995 compared to $1.5 million for 1994. The 1995 gain includes a $3.6 million gain recognized on the sale of $238.5 million of mortgage servicing rights. The 1994 gain includes a $1.1 million gain on the sale of servicing rights related to $111.4 million of residential mortgage loans. Miscellaneous income was $5.5 million for 1995 compared to $1.8 million for 1994. This increase includes a $2.6 million gain related to the sale of $130.6 million of deposits sold in 1995. General and Administrative Expenses. Total general and administrative expenses were $100.3 million for 1995 compared to $84.4 million for 1994. The 19% increase in general and administrative expenses from 1994 to 1995 compares to a 31% increase in the average balance sheet over the same time period. The ratio of general and administrative expenses to average assets was 1.39% for 1995 compared to 1.53% for 1994. This decrease in the expense ratio is the result of efficiencies realized from recent acquisitions and an increase in average balances without a corresponding increase in operating expenses. Sovereign's efficiency ratio for 1995 was 50.91% compared to 49.80% for 1994. Other Operating Expenses. Total other operating expenses were $12.8 million for 1995 compared to $6.6 million for 1994. Included in other operating expenses was amortization of goodwill and other intangible assets of $12.2 million for 1995 compared to $6.5 million for 1994. This increase was primarily the result of the Berkeley acquisition and a full year of amortization of goodwill and core deposit intangibles resulting from the Shadow Lawn acquisition. Net REO losses were $657,000 for 1995 compared to $91,000 for 1994. Income Tax Provision. The income tax provision for 1995 was $29.5 million compared to $28.5 million for 1994. The effective tax rate for 1995 was 34.4% compared to 38.0% for 1994. The decreased effective tax rate in 1995 as compared to 1994 was primarily attributable to the reversal of certain tax reserves during 1995 which management determined were no longer necessary. 32 MARKET AND DIVIDEND INFORMATION Sovereign's common and preferred stock is traded and listed on the NASDAQ National Market System under the symbol "SVRN" and "SVRNP," respectively. Options on Sovereign common stock are traded on the Philadelphia Stock Exchange (PHLX) under the symbol "SVRN" or "SQV." At December 31, 1996, the total number of holders of record of Sovereign's common stock was 8,559. Holders of Sovereign's common stock are entitled to receive dividends when, as and if declared by Sovereign's Board of Directors, out of funds legally available therefor. The timing and amount of any future dividends will depend on earnings, capital requirements, federal and state laws, regulations and policies and other factors including the amounts of dividends payable to Sovereign by its subsidiaries. The current quarterly dividend, adjusted to reflect all stock dividends and stock splits declared through January 1997, is $.020 per share. Holders of Sovereign's preferred stock are entitled to receive, when and as declared by the Board of Directors, out of assets of the Corporation legally available for payment, cash dividends payable quarterly at the rate of 6 1/4% per annum. Dividends on the preferred stock, calculated as a percentage of the liquidation preference, are payable quarterly on February 15, May 15, August 15 and November 15 of each year. 33 REPORT OF MANAGEMENT To Our Stockholders: FINANCIAL STATEMENTS Sovereign Bancorp, Inc. ("Sovereign") is responsible for the preparation, integrity and fair presentation of its published financial statements. 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 an effective internal control structure over financial 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 an effective internal control system can provide only reasonable assurance with respect to annual financial statement preparation. Further, because of changes in conditions, the effectiveness of an internal control system may vary over time. Management assessed Sovereign's internal control structure over financial reporting as of December 31, 1996. This assessment was based on criteria for effective internal control over the preparation of its published annual financial statements 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 an effective internal control structure over the preparation of its published annual financial statements as of December 31, 1996. 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, FSB ("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, 1996. JAY S. SIDHU KARL D. GERHART MARK R. MCCOLLOM PRESIDENT AND TREASURER AND CHIEF ACCOUNTING OFFICER CHIEF EXECUTIVE OFFICER CHIEF FINANCIAL OFFICER 34 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders Sovereign Bancorp, Inc. We have audited the accompanying consolidated balance sheets of Sovereign Bancorp, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. 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 assumptions 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, based on our audits, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sovereign Bancorp, Inc. and subsidiaries at December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. In 1995, the Company changed its method of accounting for mortgage servicing rights, as discussed in Note 1 to the consolidated financial statements. In 1994, the Company changed its method of accounting for investment and mortgage-backed securities, as discussed in Note 1 to the consolidated financial statements. /s/ ERNST & YOUNG LLP ----------------------- January 21, 1997 Reading, Pennsylvania 35 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
AT DECEMBER 31, ---------------------- 1996 1995 ---------- ---------- ASSETS Cash and amounts due from depository institutions................................. $ 99,721 $ 130,841 Interest-earning deposits......................................................... 5,453 16,930 Loans held for resale (approximate fair value of $24,056 and $71,297 at December 31, 1996 and 1995, respectively)............................................... 23,849 70,512 Investment and mortgage-backed securities available-for-sale...................... 484,339 889,509 Investment and mortgage-backed securities held-to-maturity (approximate fair value of $2,409,929 and $2,087,356 at December 31, 1996 and 1995, respectively)...... 2,431,948 2,077,212 Loans............................................................................. 6,156,322 4,674,364 Allowance for possible loan losses................................................ (33,809) (34,856) Premises and equipment............................................................ 53,592 56,951 Real estate owned................................................................. 6,589 4,514 Accrued interest receivable....................................................... 52,906 42,785 Goodwill and other intangible assets.............................................. 111,457 123,243 Other assets...................................................................... 40,787 26,282 ---------- ---------- TOTAL ASSETS................................................................ $9,433,154 $8,078,287 ========== ========== LIABILITIES Deposits.......................................................................... $5,052,441 $5,039,143 Borrowings Short-term..................................................................... 2,764,518 1,512,720 Long-term...................................................................... 1,091,748 1,017,936 Advance payments by borrowers for taxes and insurance............................. 23,335 22,117 Other liabilities................................................................. 25,297 59,346 ---------- ---------- Total Liabilities........................................................... 8,957,339 7,651,262 ---------- ---------- STOCKHOLDERS' EQUITY Preferred stock; no par value; $50 liquidation preference; 7,500,000 shares authorized; 2,000,000 shares issued and outstanding at December 31, 1996 and December 31, 1995........................................ 96,446 96,446 Common stock; no par value; 100,000,000 shares authorized; 63,716,294 shares issued at December 31, 1996 and 58,126,733 shares issued at December 31, 1995........................................................... 278,076 248,875 Unallocated common stock held by the Employee Stock Ownership Plan at cost; 4,067,047 shares at December 31, 1996 and 3,569,215 shares at December 31, 1995.............................................................. (33,015) (28,772) Treasury stock; at cost; 7,934 shares............................................. (88) -- Unrecognized gain on investment and mortgage-backed securities available-for-sale, net of tax..................................................................... 2,590 3,988 Retained earnings................................................................. 131,806 106,488 ---------- ---------- Total Stockholders' Equity..................................................... 475,815 427,025 ---------- ---------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................................. $9,433,154 $8,078,287 ========== ==========
See accompanying notes to consolidated financial statements. 36 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, ---------------------------- 1996 1995 1994 -------- -------- -------- INTEREST INCOME: Interest on interest-earning deposits.................................... $ 3,072 $ 3,843 $ 2,508 Interest and dividends on investment and mortgage-backed securities available-for-sale.................................................... 33,722 10,118 6,188 Interest and dividends on investment and mortgage-backed securities held-to-maturity...................................................... 173,297 151,620 96,729 Interest and fees on loans............................................... 406,159 327,450 248,716 -------- -------- -------- Total interest income........................................... 616,250 493,031 354,141 -------- -------- -------- INTEREST EXPENSE: Interest on deposits..................................................... 201,483 210,267 121,812 Interest on borrowings................................................... 198,057 108,538 76,929 -------- -------- -------- Total interest expense.......................................... 399,540 318,805 198,741 -------- -------- -------- NET INTEREST INCOME........................................................ 216,710 174,226 155,400 Provision for possible loan losses......................................... 2,516 1,000 4,100 -------- -------- -------- Net interest income after provision for possible loan losses............... 214,194 173,226 151,300 -------- -------- -------- OTHER INCOME: Other loan fees and service charges...................................... 5,101 4,445 5,018 Deposit fees............................................................. 11,984 9,427 5,755 Gain on sale of loans and investment and mortgage-backed securities available-for-sale.................................................... 4,520 419 494 Gain on sale of loans held for resale.................................... 1,419 6,079 1,486 Miscellaneous income..................................................... 3,659 5,459 1,801 -------- -------- -------- Total other income.............................................. 26,683 25,829 14,554 -------- -------- -------- GENERAL AND ADMINISTRATIVE EXPENSES: Salaries and employee benefits........................................... 51,480 41,158 33,896 Occupancy and equipment expenses......................................... 22,171 19,286 15,908 Outside services......................................................... 14,886 10,890 7,627 Deposit insurance premiums............................................... 8,997 10,423 7,627 Advertising.............................................................. 3,576 4,602 4,013 Other administrative expenses............................................ 17,081 13,908 15,319 -------- -------- -------- Total general and administrative expenses....................... 118,191 100,267 84,390 -------- -------- -------- OTHER OPERATING EXPENSES: Non-recurring SAIF assessment............................................ 27,818 -- -- Amortization of goodwill and other intangible assets..................... 11,763 12,184 6,508 Real estate owned losses................................................. 99 657 91 -------- -------- -------- Total other operating expenses.................................. 39,680 12,841 6,599 -------- -------- -------- Income before income taxes................................................. 83,006 85,947 74,865 Income tax provision....................................................... 31,543 29,539 28,467 -------- -------- -------- NET INCOME................................................................. $ 51,463 $ 56,408 $ 46,398 ======== ======== ======== NET INCOME APPLICABLE TO COMMON STOCK...................................... $ 45,213 $ 51,719 $ 46,398 ======== ======== ======== EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE(1) $ .72 $ .83 $ .75 ======== ======== ======== DIVIDENDS PER COMMON SHARE(1).............................................. $ .070 $ .070 $ .088 ======== ======== ========
- ------------------ (1) All per share data have been adjusted to reflect all stock dividends and stock splits declared through January 1997. See accompanying notes to consolidated financial statements. 37 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
UNALLOCATED COMMON COMMON PREFERRED STOCK SHARES SHARES COMMON PREFERRED RETAINED TREASURY HELD BY OUTSTANDING OUTSTANDING STOCK STOCK EARNINGS STOCK ESOP ------------- --------------- ----------- ----------- ----------- ----------- ----------- BALANCE, DECEMBER 31, 1993....... 49,628 -- $184,886 $ -- $ 76,193 $ (1,958) $ -- Net income....................... -- -- -- -- 46,398 -- -- Exercise of stock options........ 662 -- 1,318 -- -- -- -- Cash in lieu of fractional shares.......................... (1) -- (14) -- -- -- -- Sale of stock under Dividend Reinvestment Plan and Employee Stock Purchase Plan............. 229 -- 2,580 -- -- -- -- Stock dividends.................. 4,162 -- 38,135 -- (38,135) -- -- Dividends paid, $.0882 per share........................... -- -- -- -- (5,252) -- -- Treasury stock retired........... -- -- (1,958) -- -- 1,958 -- Unrecognized loss on investment and mortgage-backed securities available-for-sale, net of tax............................. -- -- -- -- -- -- -- Other............................ -- -- 11 -- 625 -- -- ------ ----- -------- ------- -------- -------- -------- BALANCE, DECEMBER 31, 1994....... 54,680 -- 224,958 -- 79,829 -- -- ------ ----- -------- ------- -------- -------- -------- Net Income....................... -- -- -- -- 56,408 -- -- Exercise of stock options........ 453 -- 840 -- -- -- -- Cash in lieu of fractional shares.......................... -- -- (2) -- -- -- -- Sale of stock under Dividend Reinvestment Plan and Employee Stock Purchase Plan............. 251 -- 1,963 -- -- -- -- Stock dividends.................. 2,743 -- 20,571 -- (20,571) -- -- Dividends paid on common stock, $.0697 per share................ -- -- -- -- (3,945) -- -- Preferred stock offering......... -- 2,000 -- 96,446 -- -- -- Dividends paid on preferred stock, $2.34 per share.......... -- -- -- -- (4,688) -- -- Unrecognized gain on investment and mortgage-backed securities available-for-sale, net of tax............................. -- -- -- -- -- -- -- Purchase of shares under Employee Stock Ownership Plan............ (3,757) -- -- -- -- -- (30,286) Allocation of shares under Employee Stock Ownership Plan... 188 -- -- -- -- -- 1,514 Other............................ -- -- 545 -- (545) -- -- ------ ----- -------- ------- -------- -------- -------- BALANCE, DECEMBER 31, 1995....... 54,558 2,000 248,875 96,446 106,488 -- (28,772) ------ ----- -------- ------- -------- -------- -------- Net Income....................... -- -- -- -- 51,463 -- -- Exercise of stock options........ 488 -- 1,322 -- -- -- -- Cash in lieu of fractional shares.......................... -- -- (2) -- (9) -- -- Sale of stock under Dividend Reinvestment Plan and Employee Stock Purchase Plan............. 201 -- 1,699 -- -- -- -- Stock dividends.................. 2,905 -- 24,509 -- (24,509) -- -- Stock dividends on unallocated Employee Stock Ownership Plan shares.......................... (179) -- -- -- 1,506 -- (1,506) Dividends paid on common stock, $.0700 per share................ -- -- -- -- (4,138) -- -- Dividends paid on preferred stock, $3.125 per share......... -- -- -- -- (6,250) -- -- Treasury stock repurchase........ (8) -- -- -- -- (88) -- Unrecognized loss on investment and mortgage-backed securities available-for-sale, net of tax............................. -- -- -- -- -- -- -- Purchase of shares under Employee Stock Ownership Plan............ (544) -- -- -- -- -- (4,559) Allocation of shares under Employee Stock Ownership Plan... 224 -- 643 -- -- -- 1,822 Issuance of stock for West Jersey.......................... 1,996 -- 1,030 -- 7,255 -- -- ------ ----- -------- ------- -------- -------- -------- BALANCE, DECEMBER 31, 1996....... 59,641 2,000 $278,076 $96,446 $131,806 $ (88) $(33,015) ====== ===== ======== ======= ======== ======== ======== UNRECOGNIZED LOSS/GAIN ON AVAILABLE- TOTAL FOR-SALE STOCKHOLDERS' PORTFOLIO EQUITY --------------- ------------- BALANCE, DECEMBER 31, 1993....... $ -- $ 259,121 Net income....................... -- 46,398 Exercise of stock options........ -- 1,318 Cash in lieu of fractional shares.......................... -- (14) Sale of stock under Dividend Reinvestment Plan and Employee Stock Purchase Plan............. -- 2,580 Stock dividends.................. -- -- Dividends paid, $.0882 per share........................... -- (5,252) Treasury stock retired........... -- -- Unrecognized loss on investment and mortgage-backed securities available-for-sale, net of tax............................. (887) (887) Other............................ -- 636 ------ -------- BALANCE, DECEMBER 31, 1994....... (887) 303,900 ------ -------- Net Income....................... -- 56,408 Exercise of stock options........ -- 840 Cash in lieu of fractional shares.......................... -- (2) Sale of stock under Dividend Reinvestment Plan and Employee Stock Purchase Plan............. -- 1,963 Stock dividends.................. -- -- Dividends paid on common stock, $.0697 per share................ -- (3,945) Preferred stock offering......... -- 96,446 Dividends paid on preferred stock, $2.34 per share.......... -- (4,688) Unrecognized gain on investment and mortgage-backed securities available-for-sale, net of tax............................. 4,875 4,875 Purchase of shares under Employee Stock Ownership Plan............ (30,286) Allocation of shares under Employee Stock Ownership Plan... -- 1,514 Other............................ -- -- ------ -------- BALANCE, DECEMBER 31, 1995....... 3,988 427,025 ------ -------- Net Income....................... -- 51,463 Exercise of stock options........ -- 1,322 Cash in lieu of fractional shares.......................... -- (11) Sale of stock under Dividend Reinvestment Plan and Employee Stock Purchase Plan............. -- 1,699 Stock dividends.................. -- -- Stock dividends on unallocated Employee Stock Ownership Plan shares.......................... -- -- Dividends paid on common stock, $.0700 per share................ -- (4,138) Dividends paid on preferred stock, $3.125 per share......... -- (6,250) Treasury stock repurchase........ -- (88) Unrecognized loss on investment and mortgage-backed securities available-for-sale, net of tax............................. (1,398) (1,398) Purchase of shares under Employee Stock Ownership Plan............ -- (4,559) Allocation of shares under Employee Stock Ownership Plan... -- 2,465 Issuance of stock for West Jersey.......................... -- 8,285 ------ ------------- BALANCE, DECEMBER 31, 1996....... $2,590 $475,815 ====== ========
See accompanying notes to consolidated financial statements. 38 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, ---------------------------------- 1996 1995 1994 ---------- ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income................................................................... $ 51,463 $ 56,408 $ 46,398 Adjustments to reconcile net income to net cash provided by operating activities: Provision for possible loan losses and deferred taxes...................... 9,037 5,269 9,837 Depreciation............................................................... 6,029 5,154 4,873 Amortization............................................................... 8,664 5,162 (533) Gain on sale of loans, investment and mortgage-backed securities and real estate owned............................................................. (4,421) (2,538) (1,504) Allocation of Employee Stock Ownership Plan................................ 2,465 1,514 -- Net change in: Loans held for resale.................................................... 46,663 (62,846) 44,901 Accrued interest receivable.............................................. (9,567) (12,416) (10,609) Prepaid expenses and other assets........................................ (28,807) (3,170) (69,089) Other liabilities........................................................ (35,087) 14,647 (4,826) ---------- ---------- ---------- Net cash provided by operating activities.................................... 46,439 7,184 19,448 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of investment and mortgage-backed securities: Available-for-sale......................................................... 655,127 37,393 750,441 Held-to-maturity........................................................... -- -- -- Proceeds from repayments and maturities of investment and mortgage-backed securities: Available-for-sale......................................................... 113,394 -- 3,961 Held-to-maturity........................................................... 464,317 335,313 333,412 Purchases of investment and mortgage-backed securities: Available-for-sale......................................................... (359,144) (83,860) (337,046) Held-to-maturity........................................................... (801,067) (1,322,625) (655,664) Proceeds from sales of loans................................................. 7,716 7,307 6,515 Purchase of loans............................................................ (885,033) (305,794) (72,808) Net change in loans other than purchases and sales........................... (532,489) (3,933) (1,012,243) Proceeds from sales of premises and equipment................................ 2,970 10,729 2,060 Purchases of premises and equipment.......................................... (5,152) (18,551) (4,820) Proceeds from sales of real estate owned..................................... 6,471 6,972 12,556 Net cash received from business combinations................................. 4,983 5,569 46,659 Other, net................................................................... -- -- (4,395) ---------- ---------- ---------- Net cash used by investing activities........................................ (1,327,907) (1,331,480) (931,372) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Assumption of deposits....................................................... -- 818,913 13,687 Net increase (decrease) in deposits.......................................... (73,063) 88,085 101,535 Net increase (decrease) in short-term borrowings............................. 322,472 (535,669) 731,231 Proceeds from long-term borrowings........................................... 1,005,001 905,499 75,000 Repayments of long-term borrowings........................................... -- (714) (3,019) Net increase (decrease) in advance payments by borrowers for taxes and insurance.................................................................. 1,103 (3,776) 3,992 Cash dividends paid to stockholders.......................................... (10,388) (8,633) (5,252) Net proceeds from issuance of common stock................................... 4,040 2,801 3,884 Net proceeds from issuance of preferred stock................................ -- 96,446 -- Advance to the Employee Stock Ownership Plan................................. (10,206) (30,286) -- Purchase of treasury stock................................................... (88) -- -- ---------- ---------- ---------- Net cash provided by financing activities.................................... 1,238,871 1,332,666 921,058 ---------- ---------- ---------- Net change in cash and cash equivalents...................................... (42,597) 8,370 9,134 Cash and cash equivalents at beginning of period............................. 147,771 139,401 130,267 ---------- ---------- ---------- Cash and cash equivalents at end of period................................... $ 105,174 $ 147,771 $ 139,401 ========== ========== ========== RECONCILIATION OF CASH AND CASH EQUIVALENTS TO CONSOLIDATED BALANCE SHEETS: Cash and amounts due from depository institutions............................ $ 99,721 $ 130,841 $ 110,270 Interest-earning deposits.................................................... 5,453 16,930 29,131 ---------- ---------- ---------- Cash and cash equivalents at end of period................................... $ 105,174 $ 147,771 $ 139,401 ========== ========== ==========
SUPPLEMENTAL DISCLOSURES: Income tax payments totaled $39.6 million in 1996, $20.6 million in 1995 and $23.7 million in 1994. Interest payments totaled $453.3 million in 1996, $303.6 million in 1995 and $196.0 million in 1994. Noncash activity consisted of mortgage loan securitization of $372.1 million in 1996, $200.9 million in 1995 and $159.5 million in 1994; reclassification of long-term borrowings to short-term borrowings of $931.7 million in 1996, $315.8 million in 1995 and $159.5 million in 1994; and reclassification of mortgage loans to real estate owned of $10.0 million in 1996, $4.5 million in 1995 and $7.2 million in 1994. See accompanying notes to consolidated financial statements. 39 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The following is a description of the significant accounting policies of Sovereign Bancorp, Inc. and subsidiaries ("Sovereign"). Such accounting policies are in accordance with generally accepted accounting principles and have been followed on a consistent basis, except as separately noted herein. a. Principles of Consolidation -- The accompanying financial statements include the accounts of the parent company, Sovereign Bancorp, Inc. and its wholly-owned subsidiaries: Sovereign Bank and Sovereign Community Bank. All material intercompany balances and transactions have been eliminated in consolidation. b. Use of Estimates -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. c. Per Share Information -- Earnings per share have been calculated based on the average common shares outstanding (including assumed conversion of preferred shares and excluding unallocated shares in Sovereign's Employee Stock Ownership Plan ("ESOP")) for the respective periods. Stock options are considered common stock equivalents and are included in the computation of the number of outstanding shares using the treasury stock method, unless anti-dilutive. The number of shares used in the computation of fully diluted earnings per share for the years ended December 31, 1996, 1995, and 1994 were 71.8 million, 67.9 million and 61.7 million, respectively. All per share data has been restated to reflect the effect of the 20% stock split which was authorized on January 16, 1997, with a record date of March 3, 1997, the 5% stock dividends which were authorized on December 20, 1995 and February 22, 1995, with record dates of February 1, 1996 and March 31, 1995, respectively, the 10% stock dividend which was authorized on April 19, 1994, with a record date of April 29, 1994 and all prior stock dividends and stock splits. d. Interest-Earning Deposits -- Interest-earning deposits consist of deposit accounts with the Federal Home Loan Bank of Pittsburgh ("FHLB") and deposits with other financial institutions generally having maturities of three months or less. e. Investment and Mortgage-backed Securities -- Effective January 1, 1994, Sovereign adopted Statement of Financial Accounting Standard ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Under SFAS No. 115, debt securities that the company has the intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. Securities expected to be held for an indefinite period of time are classified as available-for-sale and are carried at fair value with unrealized gains and losses reported as a separate component of stockholders' equity, net of estimated income taxes. Securities that are bought and held principally for the purpose of selling are classified as trading and reported at fair value, with unrealized gains and losses included in earnings. Sovereign has no securities held for trading. Gains or losses on the sales of securities are recognized at trade date utilizing the specific identification method. In 1993 and prior periods, investment and mortgage-backed securities were intended to be held-to-maturity and were generally carried at cost, adjusted for amortization of premiums and accretion of discounts, because Sovereign had both the intent and ability to hold these securities to maturity or on a long-term basis. Marketable equity securities were carried at the lower of cost or estimated fair value on an aggregate basis. Trading securities were carried at fair value. f. Forward Commitments and Options -- Sovereign utilizes forward commitments and/or options to hedge interest rate risk associated with loans held for resale and/or commitments to fund loans. Gains and losses on these transactions are included in the net gain or loss when the asset is sold. 40 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) g. Mortgage Banking Activity -- Loans held for resale consist of residential mortgage loans and mortgage-backed securities originated or purchased by Sovereign. They are recorded at the lower of cost or estimated fair value on an aggregate basis. Gains and losses are included in the consolidated statements of operations. The fair value calculation includes consideration of all open positions, outstanding commitments and related fees paid. Excess servicing fees are computed as the present value of the difference between the estimated future net revenues and normal servicing net revenues as established by the federally sponsored secondary market makers. Resultant premiums are deferred and amortized over the estimated life of the related mortgages using the constant yield method. Effective July 1, 1995, Sovereign prospectively adopted SFAS No. 122, "Accounting for Mortgage Servicing Rights." SFAS No. 122 requires that management recognize as separate assets, rights to service mortgage loans for others, however these servicing rights are acquired. Management should allocate the total cost of mortgage loans, either purchased or originated, to the loans and the mortgage servicing rights based on their relative fair value. The Statement also requires that management assess its capitalized mortgage servicing rights for impairment based on the fair value of those rights, and that this impairment be recognized through a valuation allowance. 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. Sovereign also takes into consideration any inherent risks, which historically have been minimal on these loan types, 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. h. Allowance for Possible Loan Losses -- An allowance for possible loan losses is maintained at a level that management considers adequate to provide for potential losses based upon an evaluation of known and inherent risks in the loan portfolio. Management's evaluation takes into consideration the risks inherent in the loan portfolio, past loan loss experience, specific loans which have loss potential, geographic and industry concentrations, delinquency trends, economic conditions, the level of originations and other relevant factors. While management uses the best information available to make such evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. i. 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 (unless government-guaranteed or 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) 41 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) 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. 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 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. j. Loan Fees, Discounts and Premiums -- Loan origination fees and certain direct loan origination costs are deferred and recognized as interest income in the consolidated statement of operations over the contractual life of the loan utilizing the level yield method, except in the case of certain discounted loans in which a portion of the net deferred fee may be amortized over the discount period. Discounts and premiums on loans purchased are amortized into income utilizing methods which approximate the level yield method. k. Premises and Equipment -- Premises and equipment are carried at cost, less accumulated depreciation. Depreciation is calculated utilizing both accelerated and straight-line methods. Estimated useful lives are as follows: Office buildings.......................................... 15 to 50 years Leasehold improvements.................................... 5 to 10 years Furniture, fixtures and equipment......................... 3 to 10 years Automobiles............................................... 3 years Expenditures for maintenance and repairs are charged to expense as incurred. 1. Real Estate Owned -- Real estate owned consists of properties acquired by or in lieu of foreclosure and properties that qualify for in-substance foreclosure. Real estate owned is stated at the lower of cost or estimated fair value minus estimated costs to sell. Write-downs of real estate owned which occur after the initial transfer from the loan portfolio are recorded as other operating expenses. Costs of holding foreclosed property are charged to expense in the current period, except for significant property improvements which are capitalized to the extent that carrying value does not exceed estimated fair value. m. Income Taxes -- Deferred income taxes are provided on temporary differences between amounts reported for financial statement and tax purposes in accordance with SFAS No. 109, "Accounting for Income Taxes." n. Interest Rate Exchange Agreements (Including Swaps, Caps, and Floors) -- Sovereign has entered into certain interest rate exchange agreements in connection with its asset/liability management program as hedges. Related fees are deferred and amortized on a straight line basis over the life of the interest rate exchange agreement. Net interest payments/receipts are accrued as an adjustment of interest expense/income on the hedged assets or liabilities. Gains or losses resulting from early termination of interest rate exchange agreements are deferred and amortized over the remaining term of the original exchange agreements. In the event the related asset/liability is disposed of, such deferred 42 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) gains or losses are recognized as an adjustment to the respective gain or loss on disposition. Changes in the value of interest rate exchange agreements are not recorded in the financial statements because the interest rate exchange agreements are designated as hedges. o. General and Administrative Expenses -- General and administrative expenses are classified on a functional basis, except for salaries and employee benefits. Certain direct loan origination costs are deferred and are being amortized as a yield adjustment through net interest income (see note 1-j). p. Consolidated Statement of Cash Flows -- For purposes of reporting cash flows, cash and cash equivalents include cash and amounts due from depository institutions, interest-earning deposits and securities purchased under resale agreements with an original maturity of three months or less. q. Reclassifications -- Certain amounts in the financial statements of prior periods have been reclassified to conform with the presentation used in these financial statements. These reclassifications have no effect on net income. r. Long-Lived Assets -- In March 1995, the Financial Accounting Standards Board ("FASB") issued SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of," which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. SFAS No. 121 also addresses the accounting for long-lived assets that are expected to be disposed of. Sovereign adopted SFAS No. 121 in 1996 and the effect of adoption was not material. s. Intangibles -- Core deposit intangibles are a measure of the value of consumer demand and savings deposits acquired in business combinations accounted for as purchases. Core deposit intangibles are being amortized on accelerated bases pursuant to core deposit studies and in accordance with SFAS No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions," over the estimated lives of the existing deposit relationships acquired, but not exceeding 15 years. Goodwill is the excess of the purchase price over the fair value of net assets of companies acquired through business combinations accounted for as purchases. Goodwill is being amortized using the straight line method over various periods not exceeding 20 years. The carrying amount of the goodwill is reviewed if facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as determined based on the loss of economic value, the carrying amount of the goodwill is reduced by the estimated loss of value. In addition, goodwill associated with impaired long-lived assets is included in the impairment evaluation which Sovereign assesses under the rules of SFAS No. 121. (2) BUSINESS COMBINATIONS On May 31, 1996, Sovereign acquired West Jersey Bancshares, Inc. ("West Jersey") in a transaction accounted for as a pooling-of-interests; however, the consolidated financial statements have not been restated due to immateriality. Sovereign acquired approximately $100.0 million in assets consisting principally of investment securities and loans and assumed approximately $73.0 million of deposit liabilities. West Jersey shareholders received .8335 shares of Sovereign common stock in exchange for each share of West Jersey common stock, or $8.91 per share. Sovereign issued 1.7 million new shares (2.0 million shares as adjusted for all subsequent stock dividends and stock splits) of Sovereign common stock in connection with the transaction, which was tax-free to West Jersey and West Jersey shareholders. On November 17, 1995, Sovereign acquired two branch offices and related deposits of Berkeley Federal Bank & Trust, FSB ("Berkeley"). Sovereign assumed approximately $111.7 million of deposits for a premium of $5.5 million. Of this premium, $604,000 was recorded as a core deposit 43 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (2) BUSINESS COMBINATIONS -- (CONTINUED) intangible and $4.9 million was recorded as goodwill. The balances of this core deposit intangible and goodwill at December 31, 1996 were $441,000 and $4.6 million, respectively. On November 15, 1995, Sovereign acquired Colonial State Bank in a transaction accounted for as a purchase. Sovereign acquired $46.5 million of assets consisting principally of loans and investment securities. Sovereign also assumed approximately $42.0 million of deposit liabilities. Sovereign acquired Colonial State Bank in exchange for $6.3 million in cash. This transaction added goodwill of $3.3 million to Sovereign's balance sheet. The balance of the goodwill at December 31, 1996 was $3.1 million. After receipt of regulatory approvals and pursuant to the terms of the agreement entered into by Sovereign and Colonial State Bank, upon acquisition, Colonial State Bank became a wholly-owned, BIF-insured subsidiary of Sovereign and converted to a federal savings bank under the name Colonial Bank for Savings, a Federal Savings Bank. On April 1, 1996, Colonial Bank for Savings, FSB was renamed Sovereign Community Bank. It is management's intention to merge Sovereign Community Bank into Sovereign Bank in 1997. On November 10, 1995, Sovereign completed the sale of its Pottsville, Pennsylvania branch office with related deposits totaling $23.9 million to Northwest Savings Bank ("Northwest") and the sale of its English Village branch office in North Wales, Pennsylvania with related deposits of $12.4 million to Union National Bank & Trust Company ("Union National"). As a result of these transactions, Sovereign recognized a pre-tax gain of $1.1 million and reduced goodwill by $568,000, respectively. On April 21, 1995, Sovereign completed its sale of seven southern New Jersey offices with related deposits totaling $106.7 million to Collective Bancorp, Inc. ("Collective"). Six of these offices had previously been purchased from Berkeley as part of a transaction which occurred on January 1, 1995. In addition, Sovereign acquired $7.0 million of deposits from Collective's Wilmington, Delaware branch office. As a result of this transaction, Sovereign recognized a pre-tax gain of $1.5 million and reduced its existing core deposit intangible by approximately $6.0 million. On January 1, 1995, Sovereign acquired 23 branch offices located in New Jersey and Delaware with $909.3 million of deposit liabilities from Berkeley. In exchange for assuming the deposits of the Berkeley offices, Sovereign acquired principally cash and fixed assets, net of a deposit premium of $66.6 million which was recorded as $7.6 million of core deposit intangible and $59.0 million of goodwill. The balances of this core deposit intangible and goodwill at December 31, 1996 were $3.4 million and $49.4 million, respectively. On November 1, 1994, Sovereign acquired Charter FSB Bancorp, Inc. ("Charter"). Sovereign exchanged a total of 7.0 million new shares (9.3 million shares as adjusted for all subsequent stock dividends and stock splits) of Sovereign common stock for all of the outstanding shares of Charter common stock. The acquisition of Charter was accounted for as a pooling-of-interests and accordingly, the consolidated financial statements have been restated to include the accounts of Charter for all periods presented. Sovereign's consolidated results of operations for the year ended December 31, 1994 include Charter's results of operations for the twelve-month period ended December 31, 1994. On September 16, 1994, Sovereign acquired the Chadds Ford, Pennsylvania office and related deposits of Second National Federal Savings Association ("Second National") from the Resolution Trust Corporation ("RTC"), receiver for Second National. Sovereign assumed approximately $14.4 million of deposits from the Chadds Ford office for a premium of $675,000, which was recorded as a core deposit intangible. The balance of this core deposit intangible was $337,000 at December 31, 1996. On August 5, 1994, Sovereign acquired Shadow Lawn Savings Bank ("Shadow Lawn") in a transaction accounted for as a purchase. Sovereign acquired $787.5 million of assets consisting principally of investment and mortgage-backed securities and loans. Sovereign also assumed approximately $730.6 million of deposit liabilities. Sovereign acquired Shadow Lawn in exchange for an estimated purchase price of $78.4 million of cash. This transaction added a core deposit intangible 44 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (2) BUSINESS COMBINATIONS -- (CONTINUED) of $13.0 million and goodwill of $26.7 million to Sovereign's balance sheet. The balances of this core deposit intangible and goodwill at December 31, 1996 were $7.4 million and $24.3 million, respectively. Following are selected unaudited pro forma results of operations for 1996, 1995 and 1994 as if the Colonial and Shadow Lawn acquisitions (which were accounted for as purchases) had occurred at the beginning of 1994 (in thousands, except per share data): YEAR ENDED DECEMBER 31, ---------------------------------- 1996 1995 1994 -------- -------- -------- Total interest and non-interest income..... $642,933 $522,160 $403,772 Net interest income........................ 216,710 176,016 171,531 Net income................................. 51,463 56,602 47,313 Earnings per common and common equivalent share................... .72 .83 .75 On June 25, 1996, Sovereign executed a Definitive Agreement to acquire First State Financial Services ("First State"), a $600.0 million holding company headquartered in West Caldwell, New Jersey. The transaction closed on February 18, 1997; accordingly, financial data for First State is not reflected in Sovereign's year-end financial results. First State's sole banking subsidiary, First Dewitt Bank, operates 14 branch offices located in central and northern New Jersey. The transaction will add loans of approximately $450.0 million and deposits of approximately $520.0 million to Sovereign's balance sheet. The terms of the agreement called for Sovereign to exchange 1.225 shares (1.47 shares as adjusted for all subsequent stock dividends and stock splits) of Sovereign common stock for each share of First State common stock. Sovereign will issue approximately 4.9 million new shares (5.9 million shares as adjusted for all subsequent stock dividends and stock splits) in connection with the transaction, which will be tax-free to First State and First State's shareholders, and will be accounted for as a pooling-of-interests. On February 5, 1997, Sovereign executed a Definitive Agreement to acquire Bankers Corp., Inc. ("Banker's"), a $2.5 billion financial services holding company headquartered in Perth Amboy, New Jersey. Bankers' sole banking subsidiary, Bankers Savings, operates 15 branch offices located in Middlesex, Monmouth, and Ocean counties, New Jersey. The transaction will add loans, deposits, and shareholders' equity to Sovereign of $1.7 billion, $1.6 billion, and $193.0 million, respectively. The terms of the Agreement call for Sovereign to exchange $25.50 in Sovereign common stock for each outstanding common share of Bankers. The transaction will be tax-free to Bankers and Bankers' shareholders, and will be accounted for as a pooling-of-interests. Sovereign anticipates that the transaction will close during the third quarter of 1997. (3) RESTRICTIONS ON CASH AND AMOUNTS DUE FROM DEPOSITORY INSTITUTIONS Sovereign Bank and Sovereign Community Bank are 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, 1996 and 1995 were $43.7 million and $50.8 million, respectively. 45 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (4) INVESTMENT AND MORTGAGE-BACKED SECURITIES The amortized cost and estimated fair value of investment and mortgage-backed securities are as follows (in thousands):
AT DECEMBER 31, ------------------------------------------------------------------------------------------------ 1996 1995 ------------------------------------------------ ---------------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR COST APPRECIATION DEPRECIATION VALUE COST APPRECIATION DEPRECIATION VALUE --------- ------------- ----------- --------- --------- ----------- ----------- --------- Investment and Mortgage- backed Securities Available-for-Sale: Investment Securities: U.S. Treasury and government agency securities.............. $ 4,978 $ 43 $ -- $ 5,021 $ 150,242 $ 131 $ 1,264 $ 149,109 Equity securities......... 285,367 3,725 -- 289,092 135,494 1,166 89 136,571 Mortgage-backed Securities: FHLMC..................... 25,288 -- 287 25,001 156,123 763 1,357 155,529 FNMA...................... -- -- -- -- 136,861 2,241 657 138,445 GNMA...................... -- -- -- -- 59,215 2,697 -- 61,912 Collateralized mortgage obligations............. 164,459 895 129 165,225 245,037 3,568 662 247,943 --------- ------ ----------- --------- --------- ----------- ----------- --------- Total investment and mortgage-backed securities available-for-sale........ $ 480,092 $ 4,663 $ 416 $ 484,339 $ 882,972 $ 10,566 $ 4,029 $ 889,509 --------- ------ ----------- --------- --------- ----------- ----------- --------- --------- ------ ----------- --------- --------- ----------- ----------- ---------
AT DECEMBER 31, ------------------------------------------------------------------------------------------------ 1996 1995 ------------------------------------------------ ---------------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR COST APPRECIATION DEPRECIATION VALUE COST APPRECIATION DEPRECIATION VALUE --------- ------------- ----------- --------- --------- ----------- ----------- --------- Investment and Mortgage- backed Securities Held-to- Maturity: Investment Securities: U.S. Treasury and government agency securities.............. $ 3,269 $ 46 $ 25 $ 3,290 $ 4,993 $ 37 $ -- $ 5,030 Corporate securities...... 1,006 32 -- 1,038 1,010 60 -- 1,070 Other securities.......... 50,600 -- -- 50,600 482 -- -- 482 Mortgage-backed Securities: FHLMC..................... 137,875 849 3,311 135,413 168,713 1,730 1,274 169,169 FNMA...................... 190,909 369 5,029 186,249 221,046 1,240 2,026 220,260 GNMA...................... 187,943 3,559 207 191,295 170,064 6,548 80 176,532 RTC....................... -- -- -- -- 28,954 -- 4,456 24,498 Private issues............ 272,778 87 9,529 263,336 284,640 622 2,626 282,636 Collateralized mortgage obligations............. 1,587,568 4,521 13,381 1,578,708 1,197,310 10,556 187 1,207,679 --------- ------ ----------- --------- --------- ----------- ----------- --------- Total investment and mortgage-backed securities held-to-maturity.......... $2,431,948 $ 9,463 $ 31,482 $2,409,929 $2,077,212 $ 20,793 $ 10,649 $2,087,356 --------- ------ ----------- --------- --------- ----------- ----------- --------- --------- ------ ----------- --------- --------- ----------- ----------- ---------
46 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (4) INVESTMENT AND MORTGAGE-BACKED SECURITIES The amortized cost and estimated fair value of investment and mortgage-backed securities at December 31, 1996 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (in thousands):
AMORTIZED FAIR COST VALUE ----------- ----------- Investment and Mortgage-backed Securities Available-for-Sale: Due in one year or less...................................................... $ -- $ -- Due after one year through five years........................................ 11,802 11,815 Due after five years through ten years....................................... 15,545 15,424 Due after ten years.......................................................... 167,378 168,008 No stated maturity........................................................... 285,367 289,092 ----------- ----------- Total investment and mortgage-backed securities available-for-sale......... $ 480,092 $ 484,339 ----------- ----------- ----------- ----------- AMORTIZED FAIR COST VALUE ----------- ----------- Investment and Mortgage-backed Securities Held-to-Maturity: Due in one year or less...................................................... $ 58,471 $ 58,500 Due after one year through five years........................................ 49,157 49,456 Due after five years through ten years....................................... 46,688 46,957 Due after ten years.......................................................... 2,277,632 2,255,016 ----------- ----------- Total investment and mortgage-backed securities held-to-maturity........... $ 2,431,948 $2,409,929 ----------- ----------- ----------- -----------
There were no sales of investment and mortgage-backed securities held-to-maturity in 1996, 1995 and 1994. Proceeds from sales of investment and mortgage-backed securities available-for-sale and the realized gross gains and losses from those sales are as follows (in thousands):
AVAILABLE-FOR-SALE ------------------------------ YEAR ENDED DECEMBER 31, ------------------------------ 1996 1995 1994 -------- ------- -------- Proceeds from sales..................................................... $655,127 $37,393 $750,441 -------- ------- -------- -------- ------- -------- Gross realized gains.................................................... $ 8,857 $ 326 $ 2,377 Gross realized losses................................................... 4,435 7 840 -------- ------- -------- Net realized gains...................................................... $ 4,422 $ 319 $ 1,537 -------- ------- -------- -------- ------- --------
Investment and mortgage-backed securities with an estimated fair value of $98.9 million and $578.3 million were pledged as collateral for borrowings, interest rate agreements and public deposits at December 31, 1996 and 1995, respectively. In May 1993, the FASB issued SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." SFAS No. 115 requires management to classify investments in equity securities that have readily determinable fair values and all investments in debt securities as either held-to-maturity and reported at amortized cost, available-for-sale and reported at fair value with unrealized gains and losses reported in a separate component of stockholders' equity, or trading securities and reported at fair value with unrealized gains and losses included in earnings. Effective January 1, 1994, Sovereign adopted SFAS No. 115 and classified $1.29 billion of securities as held-to-maturity, $391.0 million of securities as available-for-sale and $6.5 million of securities as trading securities. The 47 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (4) INVESTMENT AND MORTGAGE-BACKED SECURITIES -- (CONTINUED) adoption of SFAS No. 115 resulted in an $836,000 increase to stockholders' equity accounted for as the cumulative effect of a change in accounting principle in 1994. On November 15, 1995, the FASB issued a Special Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities." On December 7, 1995, in accordance with provisions in that Special Report, Sovereign reclassified $750.2 million of securities from held-to-maturity to available-for-sale. This reclassification resulted in a $1.7 million unrealized gain, net of tax, which is included in Sovereign's stockholders' equity at December 31, 1995. (5) LOANS A summary of loans included in the consolidated balance sheets follows (in thousands): AT DECEMBER 31, ------------------------ 1996 1995 ---------- ---------- BALANCE BALANCE ---------- ---------- Residential real estate loans ...................... $4,982,416 $3,998,048 Residential construction loans (net of loans in process of $41,935 and $33,095, respectively) .... 78,211 38,151 ---------- ---------- Total Residential Loans ....................... 5,060,627 4,036,199 ---------- ---------- Multi-family loans ................................. 45,129 75,218 Commercial real estate loans ....................... 67,837 48,853 Commercial loans ................................... 88,095 15,831 ---------- ---------- Total Commercial Loans ........................ 201,061 139,902 ---------- ---------- Consumer loans(1) .................................. 894,634 498,263 ---------- ---------- Total Loans ................................... $6,156,322 $4,674,364 ---------- ---------- ---------- ---------- Total Loans with: Fixed rates ...................................... $1,330,625 $1,134,542 Variable rates ................................... 4,825,697 3,539,822 ---------- ---------- Total Loans ................................... $6,156,322 $4,674,364 ---------- ---------- ---------- ---------- - ------------------ (1) Consumer loan balances at December 31, 1996 and 1995 include home equity loans of $556.7 million and $456.9 million, respectively. As a result of Sovereign's use of interest rate swaps, $561.2 million of variable rate mortgage loans have been effectively converted to fixed rate mortgage loans. Also, $248.6 million of intermediate variable rate mortgage loans (loans with a five-year fixed rate period) and $150.0 million of short-term variable rate mortgage loans (loans with less than a five year fixed rate period) have effectively been converted to a variable rate over the fixed rate period. The majority of all loans are located in Sovereign's marketplace (eastern Pennsylvania, New Jersey and northern Delaware). This is Sovereign's only significant geographic concentration. The total amount of loans being serviced for the benefit of others was $1.14 billion and $947.1 million at December 31, 1996 and 1995, respectively. During 1995, Sovereign recognized a gain of $3.6 million on the sale of servicing rights related to $238.5 million of residential mortgage loans. At December 31, 1996 and 1995, Sovereign had capitalized excess servicing assets of $815,000 and $2.3 million and originated mortgage servicing rights of $5.5 million and $1.9 million, respectively and no purchased servicing assets. 48 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (5) LOANS -- (CONTINUED) Effective July 1, 1995, Sovereign prospectively adopted SFAS No. 122, "Accounting for Mortgage Servicing Rights." SFAS No. 122 requires that management recognize as separate assets, rights to service mortgage loans for others, however those servicing rights are acquired. Management should allocate the total cost of mortgage loans, either purchased or originated, to the loans and the mortgage servicing rights based on their relative fair value. The Statement also requires that management assess its capitalized mortgage servicing rights for impairment based on the fair value of those rights, and that this impairment be recognized through a valuation allowance. The activity in the allowance for possible loan losses is as follows (in thousands): YEAR ENDED DECEMBER 31, ------------------------------- 1996 1995 1994 ------- ------- ------- Balance, beginning of period ............... $34,856 $36,289 $33,099 Acquired reserves and other additions ...... 716 485 4,712 Provision for possible loan losses ......... 2,516 1,000 4,100 Charge-offs ................................ 5,576 3,580 6,428 Recoveries ................................. 1,297 662 806 ------- ------- ------- Balance, end of period ..................... $33,809 $34,856 $36,289 ------- ------- ------- ------- ------- ------- In May 1993, the FASB issued SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." SFAS No. 114 requires that certain impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. In October 1994, the FASB issued SFAS No. 118, "Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures," that amends SFAS No. 114 and eliminates its provisions regarding how a creditor should report income on an impaired loan. Originally, SFAS No. 114 would have required creditors to apply one of two allowable methods. As a result of the amendment, creditors may now continue to use existing methods for recognizing income on impaired loans, including methods that are required by certain industry regulators. SFAS No. 118 also clarified SFAS No. 114's disclosure requirements. Consistent with SFAS No. 114, Sovereign excludes all residential and consumer loans from the requirements of this Statement, as these smaller-balance, homogeneous loans are collectively evaluated for impairment. SFAS No. 114 and SFAS No. 118 were adopted by Sovereign beginning January 1, 1995. The effect of SFAS No. 114 and SFAS No. 118 on Sovereign was not significant. (6) PREMISES AND EQUIPMENT A summary of premises and equipment, less accumulated depreciation and amortization, follows (in thousands): AT DECEMBER 31, -------------------------- 1996 1995 -------- -------- Land ....................................... $ 9,895 $ 10,067 Office buildings ........................... 37,395 38,133 Furniture, fixtures, and equipment ......... 49,871 45,681 Leasehold improvements ..................... 6,538 5,937 Automobiles ................................ 900 914 -------- -------- 104,599 100,732 Less accumulated depreciation .............. (51,007) (43,781) -------- -------- Total premises and equipment .......... $ 53,592 $ 56,951 -------- -------- -------- -------- 49 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (6) PREMISES AND EQUIPMENT -- (CONTINUED) 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, 1996, are summarized as follows (in thousands): 1997................................................................ $ 2,986 1998................................................................ 2,466 1999................................................................ 1,954 2000................................................................ 1,531 2001................................................................ 1,338 Thereafter.......................................................... 4,232 --------- $ 14,507 --------- --------- Total rental expense for all leases for the years ended December 31, 1996, 1995 and 1994 was $3.2 million, $2.7 million and $2.1 million, respectively. (7) ACCRUED INTEREST RECEIVABLE Accrued interest receivable is summarized as follows (in thousands): AT DECEMBER 31, ---------------------- 1996 1995 ------- ------- Accrued interest receivable on: Investment and mortgage-backed securities ........ $17,399 $17,106 Loans ............................................ 35,507 25,679 ------- ------- Total interest receivable ................... $52,906 $42,785 ------- ------- ------- ------- Accrued interest receivable is stated net of an allowance for potentially uncollected interest (for loans on non-accrual and for loans that have been restructured). If these non-accruing and restructured loans had been current in accordance with their original terms and had been outstanding throughout the period, gross interest income for the years ended December 31, 1996 and 1995 would have increased by approximately $3.3 million and $2.5 million, respectively. Interest income, which was recorded on these loans for the years ended December 31, 1996 and 1995 was $1.6 million and $1.1 million, respectively. (8) DEPOSITS Deposits are summarized as follows (in thousands):
AT DECEMBER 31, ------------------------------------------------------------------------------ 1996 1995 --------------------------------------- ------------------------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE TYPE OF ACCOUNT BALANCE PERCENT RATE BALANCE PERCENT RATE - --------------------------------- ---------- ------- -------- ---------- ------- -------- Demand deposit accounts.......... $ 241,044 5% --% $ 168,757 3% --% NOW accounts..................... 418,784 8 1.27 380,475 8 1.26 Savings accounts................. 991,970 20 2.40 925,842 19 2.31 Money market accounts............ 610,491 12 3.98 720,997 14 4.36 Retail certificates of deposit... 2,672,567 53 5.31 2,731,009 54 5.48 Jumbo certificates of deposit.... 117,585 2 5.45 112,063 2 5.70 ---------- ----- ----- ---------- --- ----- Total deposits.............. $5,052,441 100% 3.99% $5,039,143 100% 4.24% ---------- ----- ----- ---------- --- ----- ---------- ----- ----- ---------- --- -----
50 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (8) DEPOSITS -- (CONTINUED) 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, 1996 (in thousands):
WITHIN SIX MOS. - ONE - THREE - FIVE - OVER SIX MOS. ONE YR. THREE YRS. FIVE YRS. TEN YRS. TEN YRS. TOTAL -------- ---------- ---------- --------- -------- -------- ---------- Certificate accounts by rate: 2.001 -- 4.000%......................... $27,726 $ 166 $ 478 $ 284 $ 25 $ 32 $ 28,711 4.001 -- 6.000%......................... 14 1,946,757 628,319 18,372 7,507 52 2,601,021 6.001 -- 8.000%......................... 22,771 16,134 51,805 21,532 31,762 3,347 147,351 8.001 -- 10.000%........................ 1,083 1,063 5,607 727 883 461 9,824 Above 10.000%........................... 198 167 344 843 1,693 -- 3,245 -------- ---------- -------- ------- ------- ------ ---------- Total certificate accounts.............. $51,792 $1,964,287 $686,553 $41,758 $41,870 $3,892 $2,790,152 -------- ---------- -------- ------- ------- ------ ---------- -------- ---------- -------- ------- ------- ------ ----------
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, 1996: AT DECEMBER 31, 1996 --------------- (IN THOUSANDS) Three months or less.................................... $ 77,269 Over three through six months........................... 50,471 Over six through twelve months.......................... 46,822 Over twelve months...................................... 62,767 -------- Total.............................................. $237,329 -------- -------- Interest expense on deposits is summarized as follows (in thousands): YEAR ENDED DECEMBER 31, ---------------------------------- 1996 1995 1994 -------- -------- -------- Demand deposit and NOW accounts.......... $ 4,911 $ 5,195 $ 4,153 Savings accounts......................... 23,925 23,158 24,267 Money market accounts.................... 25,786 24,706 8,257 Certificates of deposit.................. 146,861 157,208 85,135 -------- -------- -------- Total interest expense on deposits..... $201,483 $210,267 $121,812 -------- -------- -------- -------- -------- -------- The majority of Sovereign's deposits are insured by the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). As a result, for 1996, Sovereign paid insurance fees equal to $.23 per $100.00 (23 basis points) of insured deposits annually, the lowest rate permitted. Banks which are insured by the Bank Insurance Fund ("BIF") of the FDIC have been required to pay rates as low as 4.4 basis points since September 30, 1995, and most BIF-insured institutions have been required to pay only $2,000 in annual insurance premiums since January 2, 1996. On September 30, 1996, legislation was signed into law which effectively ends the BIF/SAIF disparity by the year 2000. As part of the new law, SAIF-insured institutions were required to make a one-time payment of 65.7 basis points for all SAIF-insured deposits held as of March 31, 1995. At Sovereign, this amounted to an after-tax charge of $17.2 million. 51 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (9) SHORT-TERM AND LONG-TERM BORROWINGS Short-term Borrowings. Short-term borrowings included in the consolidated balance sheets are as follows (in thousands): AT DECEMBER 31, ---------- ---------- 1996 1995 ---------- ---------- Securities sold under repurchase agreements .... $ -- $ 382,279 Federal Home Loan Bank advances ................ 2,764,518 1,128,886 Amortizing loans ............................... -- 1,555 ---------- ---------- Total short-term borrowings ............... $2,764,518 $1,512,720 ---------- ---------- ---------- ---------- Included in short-term borrowings are sales of securities under repurchase agreements. Securities underlying these repurchase agreements consisted of mortgage-backed securities which had a book value of $387.2 million and a market value of $392.6 million at December 31, 1995. At December 31, 1995, short-term borrowings include an 11.60% amortizing loan with principal of $714,000 which is collateralized by 15% of the outstanding shares of common stock of Sovereign Bank (all of the outstanding shares of Sovereign Bank are owned by Sovereign Bancorp). Qualifying repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as a liability in the balance sheet. The dollar amount of securities underlying the agreements remains in the asset accounts, although the securities underlying the agreements are delivered to the brokers who arranged the transactions. In certain instances, the broker may have sold, loaned, or disposed of the securities to other parties in the normal course of their operations, and have agreed to resell to Sovereign substantially similar securities at the maturity of the agreements. The broker/dealers who participate with Sovereign in these agreements are primary broker/dealers reporting to the Federal Reserve Bank of New York. The following table summarizes information regarding securities sold under repurchase agreements (in thousands): SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
DECEMBER 31, ------------------------------------ 1996 1995 1994 -------- -------- -------- Balance .............................................. $ -- $382,279 $608,810 Weighted average interest rate ....................... --% 6.38% 5.72% Maximum amount outstanding at any month-end during the period ................................... $288,155 $630,077 $608,810 Average amount outstanding during the period ......... $181,526 $477,195 $427,509 Weighted average interest rate during the period ..... 6.57% 6.01% 4.49%
52 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (9) SHORT-TERM AND LONG-TERM BORROWINGS -- (CONTINUED) The following table summarizes information regarding short-term FHLB advances (in thousands): FEDERAL HOME LOAN BANK ADVANCES
DECEMBER 31, ------------------------------------------ 1996 1995 1994 ---------- ---------- ---------- Balance .......................................... $2,764,518 $1,128,886 $1,113,916 Weighted average interest rate ................... 5.79% 5.65% 5.33% Maximum amount outstanding at any month-end during the period .............................. $3,278,866 $1,128,886 $1,113,916 Average amount outstanding during the period ..... $1,997,239 $ 792,450 $ 616,869 Weighted average interest rate during the period . 5.88% 5.54% 4.57%
Long-term Borrowings. Long-term FHLB advances had weighted average interest rates of 6.03% and 5.88% at December 31, 1996 and 1995, respectively. Long-term borrowings are as follows (in thousands):
AT DECEMBER 31, ------------------------- 1996 1995 ---------- ---------- FHLB advances, maturing January 1998 to May 1998 ....... $ 924,000 $ 850,665 6.75% senior notes, due July 1, 2000 ................... 49,517 49,379 6.75% subordinated debentures, due September 1, 2000 ... 49,585 49,472 8.50% subordinated debentures, due September 15, 2002 .. 19,550 19,471 8.00% subordinated debentures, due March 15, 2003 ...... 49,096 48,949 ---------- ---------- Total long-term borrowings ........................ $1,091,748 $1,017,936 ---------- ---------- ---------- ----------
The 6.75% notes are non-amortizing and are not redeemable prior to maturity. The 6.75% debentures are non-amortizing and are not redeemable prior to maturity. The 6.75% debentures have, through the use of an interest rate swap, been effectively converted from a fixed rate obligation to a variable rate obligation tied to the 3-month LIBOR plus 140.5 basis points. The 8.50% debentures are non-amortizing and are redeemable at the option of Sovereign in whole or in part at any time on or after September 15, 1999. The 8.00% debentures are non-amortizing and are not redeemable prior to maturity. 53 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (10) STOCKHOLDERS' EQUITY The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA") requires institutions regulated by the OTS to have minimum regulatory tangible capital equal to 1.5% of total tangible assets, a minimum leverage capital ratio equal to 3% of tangible assets and 4% of risk-adjusted assets and a risk-based capital ratio equal to 8%. Sovereign Bank and Sovereign Community Bank were in compliance with all of these capital requirements as of December 31, 1996. The following schedule summarizes the actual capital balances of Sovereign Bank and Sovereign Community Bank at December 31, 1996 (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 ............ $489,416 $489,416 $489,416 $520,701 Minimum capital requirement ... 137,728 275,455 170,047 340,094 -------- -------- -------- -------- Excess ...................... $351,688 $213,961 $319,369 $180,607 -------- -------- -------- -------- -------- -------- -------- -------- Capital ratio ................. 5.33% 5.33% 11.51% 12.25% Sovereign Community Bank: - ------------------------- Regulatory capital ............ $ 12,246 $ 12,246 $ 12,246 $ 13,495 Minimum capital requirement ... 3,444 6,888 5,367 10,734 -------- -------- -------- -------- Excess ...................... $ 8,802 $ 5,358 $ 6,879 $ 2,761 -------- -------- -------- -------- -------- -------- -------- -------- Capital ratio ................. 5.33% 5.33% 9.13% 10.06%
OTS capital regulations do not apply to holding companies. The following schedule summarizes actual capital balances of Sovereign Bancorp at December 31, 1996 as if those regulations did apply to Sovereign Bancorp (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 ............ $368,375 $368,375 $368,375 $570,909 Minimum capital requirement ... 138,954 277,909 176,035 352,069 -------- -------- -------- -------- Excess ...................... $229,421 $ 90,466 $192,340 $218,840 -------- -------- -------- -------- -------- -------- -------- -------- Capital ratio ................. 3.98% 3.98% 8.37% 12.97%
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, 1996, Sovereign Bank and Sovereign Community Bank were both classified as well-capitalized and were in compliance with all capital requirements. Management anticipates that Sovereign Bank and 54 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (10) STOCKHOLDERS' EQUITY -- (CONTINUED) Sovereign Community Bank will each continue to be classified as well-capitalized and will be in compliance with all regulatory capital requirements. 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, 1996 includes $48.9 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, 1996, purchases of common 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 acquirer at a substantially reduced price. On May 17, 1995, Sovereign completed the sale of 2.0 million shares of Convertible Preferred Stock, raising $96.7 million in capital. The 6 1/4% non-voting, Cumulative Convertible Preferred Stock is convertible at the option of the holder at any time, unless previously redeemed, at a conversion rate (adjusted to reflect all stock dividends and stock splits declared through January 1997) of 5.987 shares of common stock for each share of preferred stock; equivalent to a conversion price of $8.352 per share of common stock. The preferred stock may not be redeemed prior to May 15, 1998. Thereafter, the preferred stock is redeemable at the option of Sovereign, in whole or in part, at $52.188 per share during the twelve months beginning May 15, 1998, and thereafter at prices declining ratably to par on and after May 15, 2005. (11) STOCK OPTION PLANS Sovereign grants stock options for a fixed number of shares to key officers and directors with an exercise price equal to the fair value of the shares at the date of grant. Sovereign accounts for stock option grants in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees," and accordingly, recognizes no compensation expense for the stock option grants. There are 10.8 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 declared through January 1997. 55 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (11) STOCK OPTION PLANS -- (CONTINUED)
1988 1989 1990 1996 1986 PLAN PLAN PLAN PLAN 1993 PLAN PLAN ----------- --------- --------- -------- -------------------- ----- OPTION PRICE ...... $1.15-$8.33 $1.52 $5.00 $1.56 $4.84 $5.25 $8.33 TOTAL - ------------------- ----------- -------- --------- -------- ------- -------- ----- --------- Options outstanding December 31, 1994 .......... 1,184,952 103,554 -- 434,978 137,645 720,894 -- 2,582,023 ----------- -------- -------- -------- ------- -------- ----- --------- Granted ......... 8,820 -- -- -- -- -- -- 8,820 Exercised ....... (176,264) (103,554) -- (161,784) (41,158) -- -- (482,760) Forfeited ....... -- -- -- -- (1,799) (115,260) -- (117,059) Options outstanding December 31, 1995 .......... 1,017,508 -- -- 273,194 94,688 605,634 -- 1,991,024 ---------- -------- -------- -------- ------- -------- ----- --------- Granted ......... 71,820 -- 134,937 -- -- -- 9,600 216,357 Exercised ....... (114,254) -- (126,935) (205,141) (42,284) -- -- (488,614) Forfeited ....... (1,260) -- -- -- -- (46,104) -- (47,364) Options outstanding December 31, 1996 .......... 973,814 -- 8,002 68,053 52,404 559,530 9,600 1,671,403 ---------- -------- -------- -------- ------- -------- ----- --------- Options exercisable December 31, 1996 .......... 901,994 -- 8,002 68,053 52,404 -- -- 1,030,453 ---------- -------- -------- -------- ------- -------- ----- --------- ---------- -------- -------- -------- ------- -------- ----- ---------
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation," which provides companies with a choice either to expense the fair value of employee stock options over the vesting period (recognition method) or to continue the previous practice but disclose the pro forma effects on net income and earnings per share had the fair value method been used (disclosure only method). Companies electing the disclosure only method will be required to include the pro forma effects of all awards granted in fiscal years beginning after December 15, 1994. Sovereign adopted the disclosure only method during 1996. 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: 1986 PLAN 1996 PLAN ------------------------ --------- Grant date .................... 12/6/95 1/24/96 6/26/96 Options granted ............... 8,820 71,820 9,600 Options forfeited ............. -- 1,260 -- Expected volatility ........... .292 .292 .292 Expected life in years ........ 6 6 6 Stock price on date of grant .. $ 8.33 $ 7.84 $ 8.33 Exercise price ................ $ 8.33 $ 7.84 $ 8.33 Expected dividend yield ....... .21% .22% .21% Risk-free interest rate ....... 5.55% 6.30% 6.86% Vesting period in years ....... 1 1 1 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 56 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (11) STOCK OPTION PLANS -- (CONTINUED) 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. Pro forma disclosures of the impact on net income and earnings per share are not shown as the impact of applying SFAS No. 123's fair value method to Sovereign's stock-based awards is immaterial. (12) EMPLOYEE BENEFIT PLANS Sovereign sponsors a non-contributory defined benefit pension plan which covers substantially all employees who have attained the age of 21 and completed one year of service. Benefits under the plan are based upon years of service and the employees' average compensation computed based upon the five consecutive plan years of highest pay during the ten years preceding retirement or termination. It is Sovereign's policy to fund the minimum contribution as determined by an actuarial valuation. The net periodic pension costs for this plan are comprised of the following components (in thousands):
1996 1995 1994 ------- ------- ------- Service cost benefits earned during the period .............. $ 1,194 $ 851 $ 1,082 Interest cost on projected benefit obligation ............... 1,470 1,378 1,333 Actual (return) loss on plan assets ......................... (2,946) (4,656) 181 Amortization (accretion) of unrecognized net assets and other deferred amounts, net ..................................... 802 2,953 (1,667) ------- ------- ------- Net periodic pension expense .............................. $ 520 $ 526 $ 929 ------- ------- ------- ------- ------- -------
The following table sets forth the pension plan's funded status at December 31, 1996 and 1995 (in thousands):
1996 1995 ------- ------- Fair value of plan assets ............................... $26,072 $23,225 ------- ------- ------- ------- Projected benefit obligation: Vested benefits ....................................... $20,276 $19,800 Non-vested benefits ................................... 449 335 Effect of projected future salary increases ........... 2,411 1,701 ------- ------- Projected benefit obligation ....................... $23,136 $21,836 ------- ------- ------- ------- Plan assets in excess of the projected benefit obligation $ 2,937 $ 1,389 Unrecognized net asset existing at transition date ...... (164) (205) Unrecognized net loss ................................... 498 1,720 Unrecognized prior service cost ......................... (102) (112) ------- ------- Net pension asset included in balance sheet ........... $ 3,169 $ 2,792 ------- ------- ------- -------
In determining the projected benefit obligation, the assumed discount rates at December 31, 1996, 1995 and 1994 were 7.00%, 7.00% and 8.00%, respectively. The weighted average rate of salary increase was 5.00% for 1996, 5.00% for 1995 and 4.75% for 1994. The expected long-term rate of return on assets used in determining net periodic pension expense was 9.00% for all three years. The pension plan's assets consist primarily of common stock, fixed income securities such as corporate bonds and U.S. Treasury securities and units of certain common trust funds. 57 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (12) EMPLOYEE BENEFIT PLANS -- (CONTINUED) Sovereign also maintains a 401(k) savings plan. Substantially all employees of Sovereign are eligible to participate in the 401(k) savings plan on the January 1 and July 1 following their completion of one year of service and attaining age 21. Sovereign's contributions to this plan were $100,000, $109,000 and $111,000 during 1996, 1995 and 1994, respectively. Pursuant to this plan, employees can contribute up to 10% of their compensation to the plan. Sovereign contributes 50% of the employee contribution up to 6% of compensation in the form of Sovereign common stock. Sovereign maintains an ESOP. Substantially all employees of Sovereign are eligible to participate in the ESOP on the January 1 or July 1 following their completion of one year of service and attaining age 21. The ESOP is a deferred contribution plan which provides retirement benefits for participants and beneficiaries by purchasing Sovereign common stock in the open market. The amount of annual contributions to the ESOP by Sovereign is determined by the Board of Directors based upon the financial performance of Sovereign each year. Sovereign recognized as expense $2.5 million, $1.6 million and $1.5 million to the ESOP during 1996, 1995 and 1994, respectively. On November 21, 1994, Sovereign's Board of Directors authorized an amendment to Sovereign's ESOP to add a leverage feature to purchase up to 4.2 million shares of Sovereign's outstanding common stock in the open market or in negotiated transactions. The ESOP is funded through direct loans from Sovereign totaling $40.0 million in 1996. The proceeds from these loans were used to purchase outstanding shares of Sovereign's common stock. As the debt on these loans is repaid, shares of Sovereign common stock are released and become eligible for allocation to employee accounts. In addition, dividends are paid on all shares of Sovereign common stock, including unallocated shares held by the ESOP. Dividends on the unallocated shares are allocated on a pro-rata basis when purchased shares are released. Compensation expense is recognized based on the fair value of the shares committed to be released to employees and the shares then become outstanding for earnings per share computations. Sovereign has committed to make contributions sufficient to provide for the ESOP debt requirements. At December 31, 1996, the ESOP held 4.5 million shares of which 412,000 shares were allocated to employee accounts. The unallocated ESOP shares are presented as a reduction of stockholders' equity in the consolidated financial statements. At December 31, 1996, the fair value of the unallocated shares held by the ESOP was $44.5 million. Sovereign's Compensation Committee administers the ESOP. Under the ESOP, the trustees are directed to vote all allocated shares held in the ESOP in accordance with the instructions of the participants to whom the shares have been allocated. In addition, the trustees shall vote in their sole discretion any shares in the unallocated suspense account. In 1992, Sovereign implemented the Employee Stock Purchase Plan which permits eligible employees to purchase Sovereign common stock directly from Sovereign. Purchases of common stock are limited to 15% of a participant's compensation. During 1996, 1995 and 1994, 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, 1996, 1995 and 1994 was $41,000, $31,000 and $31,000, respectively. 58 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (13) 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, ------------------------------------- 1996 1995 1994 ------- ------- ------- Current: Federal ......................... $23,326 $23,251 $12,986 State ........................... 2,401 2,931 3,155 ------- ------- ------- 25,727 26,182 16,141 Deferred .......................... 5,816 3,357 12,326 ------- ------- ------- Total income tax expense ........ $31,543 $29,539 $28,467 ------- ------- ------- ------- ------- ------- The following is a reconciliation of the actual tax provisions with taxes computed at the federal statutory rate of 35% for 1996, 1995 and 1994:
YEAR ENDED DECEMBER 31, --------------------------- 1996 1995 1994 ----- ---- ---- Federal income tax at statutory rate ............................ 35.0% 35.0% 35.0% Increase (decrease) in taxes resulting from: Tax-exempt interest ........................................... (1.4) (.3) (.4) State income taxes, net of federal tax benefit ................ 1.9 2.2 2.8 Amortization of intangible assets and other purchase accounting adjustments ................................................. 2.1 2.4 1.7 Other ........................................................... .4 (4.9) (1.1) ---- ---- ---- 38.0% 34.4% 38.0% ---- ---- ---- ---- ---- ----
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, ------------------------------------ 1996 1995 1994 -------- -------- -------- Deferred tax assets: Allowance for possible loan losses ............ $ 12,036 $ 13,937 $ 14,106 Merger related liabilities .................... 1,006 785 392 Purchase accounting adjustments ............... 2,329 3,538 7,846 Unrealized loss on available-for-sale portfolio -- -- 567 Other ......................................... 3,350 1,003 1,374 -------- -------- -------- Total gross deferred tax assets ............... 18,721 19,263 24,285 Less valuation allowance ...................... (900) (900) (900) -------- -------- -------- Net deferred tax assets ....................... $ 17,821 $ 18,363 $ 23,385 -------- -------- -------- Deferred tax liabilities: Purchase accounting adjustments ............... $ (7,188) $ (8,559) $ (9,038) Deferred loan fees ............................ (5,530) (2,952) (2,088) Unrealized gain on available-for-sale portfolio (1,815) (2,708) -- Other ......................................... (8,826) (5,684) (183) -------- -------- -------- Total gross deferred tax liabilities .......... $(23,359) $(19,903) $(11,309) -------- -------- -------- Net deferred tax (liability) asset ............ $ (5,538) $ (1,540) $ 12,076 -------- -------- -------- -------- -------- --------
59 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (13) INCOME TAXES -- (CONTINUED) The valuation allowance for deferred tax assets is unchanged from the balance at January 1, 1994, and is primarily related to state deductible temporary differences resulting from the Harmonia acquisition. Sovereign has determined that it is not required to establish any additional valuation reserve for deferred tax assets since it is more likely than not that deferred tax assets (other than those for which a valuation allowance has been established) will be principally realized through carry back to taxable income in prior years. Sovereign's conclusion that it is "more likely than not" that the deferred tax assets will be realized is based on a history of growth in earnings and the prospects for continued growth including an analysis of potential uncertainties that may affect future operating results. Sovereign will continue to review the criteria related to the recognition of deferred tax assets on a quarterly basis. (14) COMMITMENTS AND CONTINGENCIES Financial Instruments Sovereign is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to manage its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit, loans sold with recourse, forward contracts and interest rate swaps, caps and floors. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The contract or notional amounts of these financial instruments reflect the extent of involvement Sovereign has in particular classes of financial instruments. Sovereign's exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and loans sold with recourse is represented by the contractual 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, ------------------------- 1996 1995 ---------- ---------- Financial instruments whose contract amounts represent credit risk: Commitments to extend credit.................................................... $ 499,335 $ 420,763 Standby letters of credit....................................................... 2,763 648 Loans sold with recourse........................................................ 60,113 78,193 Financial instruments whose notional or contract amounts exceed the amount of credit risk: Forward contracts............................................................... 32,500 77,250 Interest rate swaps............................................................. 2,517,013 1,211,130 Interest rate caps.............................................................. 500,000 1,446,000
60 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (14) 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 counterparty. Collateral held usually consists of real estate but may include securities, accounts receivable, inventory and property, plant and equipment. Standby letters of credit are conditional commitments issued by Sovereign to guarantee the performance of a customer to a third party. The guarantees are primarily issued to support public and private borrowing arrangements. Most guarantees expire in 1997, one guarantee expires in September 2000 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 residential loans. The forward contracts used by Sovereign in its mortgage banking activities are contracts for delayed delivery of securities in which Sovereign agrees to make delivery of a specified instrument, at a specified future date, at a specified price or yield. Risks arise from the possible inability of counterparties to meet the terms of their contracts and from movements in securities' values and interest rates. Interest rate swaps, caps and floors enable Sovereign to transfer, modify or reduce its interest rate risk and are used as part of asset and liability management. Sovereign may become a principal in the exchange of interest payments with another party and therefore, is exposed to loss should one of the other parties default. Sovereign minimizes this risk by performing credit reviews on counterparties. Notional principal amounts often are used to express the volume of these transactions, but the amounts potentially subject to credit risk are much smaller. Litigation At December 31, 1996, Sovereign was party to a number of lawsuits. While any litigation has an element of uncertainty, management, after reviewing these actions with legal counsel, is of the opinion that the liability, if any, resulting from these actions will not have a material effect on the financial condition or results of operations of Sovereign. 61 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (15) 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, ------------------------------------------------------------- 1996 1995 ------------------------------- ---------------------------- CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE ---------- ---------- ---------- ---------- Financial Assets: Cash and amounts due from depository institutions ......................... $ 99,721 $ 99,721 $ 130,841 $ 130,841 Interest-earning deposits ............... 5,453 5,453 16,930 16,930 Loans held for resale ................... 23,849 24,056 70,512 71,297 Investment and mortgage-backed securities available-for-sale ................... 484,339 484,339 889,509 889,509 Investment and mortgage-backed securities held-to-maturity ..................... 2,431,948 2,409,929 2,077,212 2,087,356 Loans, net .............................. 6,122,513 6,113,543 4,639,508 4,669,233 Excess servicing ........................ 815 4,187 2,328 7,330 Originated mortgage servicing rights .... 5,483 6,854 1,894 2,840 Financial Liabilities: Deposits ................................ 5,052,441 5,049,856 5,039,143 5,050,523 Borrowings(1) ........................... 3,870,413 3,874,375 2,542,465 2,557,990 Unrecognized Financial Instruments:(2) Commitments to extend credit ............ 1,315 1,239 930 869 Standby letters of credit ............... 7 12 4 6 Loans sold with recourse ................ 301 120 391 156 Interest rate swaps, caps and floors .... 9,283 3,755 12,777 (9,873)
- ------------------ (1) Borrowings are shown without unamortized cap premiums, as cap premiums are reflected separately below in "Interest rate swaps, caps and floors." (2) The amounts shown under "carrying value" represent accruals or deferred income (cost) arising from those unrecognized financial instruments. The following methods and assumptions were used to estimate the fair value of each class of financial instruments: Cash and amounts due from depository institutions and interest-earning deposits. For these short-term instruments, the carrying amount is a reasonable estimate of fair value. 62 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (15) FAIR VALUE OF FINANCIAL INSTRUMENTS -- (CONTINUED) Loans held for resale. Fair values are estimated using quoted rates based upon secondary market sources for securities backed by similar loans. Fair value estimates include consideration of all open positions (including forward contracts), outstanding commitments and related fees paid. Investment and mortgage-backed securities available-for-sale. The fair value of investment and mortgage-backed securities available-for-sale are based on quoted market prices as of the balance sheet date. Investment and mortgage-backed securities held-to-maturity. The carrying amounts for short-term investment and mortgage-backed securities held-to-maturity approximate fair value because of the short maturity of these instruments and they do not present unanticipated credit concerns. The fair value of long-term investments and mortgage-backed securities held-to-maturity is estimated based upon bid quotations received from securities dealers and an independent pricing servicing bureau. Loans. Fair value is estimated by discounting cash flows using estimated market discount rates at which similar loans would be made to borrowers and reflect similar credit ratings and interest rate risk for the same remaining maturities. Excess servicing and originated mortgage servicing rights. The fair value of excess servicing and originated mortgage servicing rights is estimated using quoted rates based upon secondary market sources. The estimated fair value approximates the amount for which the servicing could currently be sold. Deposits. The fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, NOW accounts, savings accounts and certain money market accounts, is equal to the amount payable on demand as of 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 counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. Standby letters of credit. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. Loans sold with recourse. The fair value of loans sold with recourse is estimated based upon the cost to terminate Sovereign's obligations under the recourse provisions. Interest rate swaps, caps and floors. The fair value of interest rate swaps, caps and floors which represent the estimated amount Sovereign would receive or pay to terminate the contracts or agreements, taking into account current interest rates and when appropriate, the current creditworthiness of the counterparties are obtained from dealer quotes. 63 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (16) INTEREST RATE EXCHANGE AGREEMENTS Amortizing and non-amortizing interest rate swaps are generally used to convert fixed rate assets and liabilities to variable rate assets and liabilities and vice versa. Interest rate caps are generally used to limit the exposure from the repricing and maturity of liabilities. Interest rate floors are generally used to limit the exposure from repricing and maturity of assets. Interest rate caps and floors are also used to limit the exposure created by other interest rate swaps. In certain cases, interest rate caps or floors are simultaneously bought and sold to create a range of protection against changing interest rates while limiting the cost of that protection. The following table presents information regarding interest rate exchange agreements at the dates indicated (in thousands):
AT DECEMBER 31, 1996 AT DECEMBER 31, 1995 --------------------------------------------- --------------------------------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE NOTIONAL BOOK ESTIMATED MATURITY NOTIONAL BOOK ESTIMATED MATURITY AMOUNT VALUE FAIR VALUE IN YEARS AMOUNT VALUE FAIR VALUE IN YEARS --------- --------- ----------- ---------- --------- ----- ---------- -------- Amortizing interest rate swaps: Pay variable-receive fixed(1).................. $ 713,448 $ -- $(10,459) 3.6 $ 585,429 $ -- $(4,066) 4.2 Pay fixed-receive variable(2)............... 398,565 -- (464) 2.3 295,701 -- (3,653) 3.3 Non-amortizing interest rate swaps: Pay variable-receive fixed(3).................. 50,000 -- (1,738) 3.7 50,000 -- (837) 4.6 Pay fixed-receive variable(4)............... 1,355,000 -- 9,152 2.2 280,000 -- (2,780) 1.8 Interest rate caps(5)......... 500,000 9,283 7,264 4.5 1,446,000 12,777 1,463 1.6 --------- ------ -------- ---------- ------- ------- $3,017,013 $9,283 $ 3,755 $2,657,130 $12,777 $(9,873) ---------- ------ -------- ---------- ------- ------- ---------- ------ -------- ---------- ------- -------
- ------------------ (1) The weighted average pay rate was 5.50% and 5.56% and the weighted average receive rate was 5.93% and 5.61% at December 31, 1996 and 1995, respectively. (2) The weighted average pay rate was 6.76% and 6.87% and the weighted average receive rate was 6.18% and 6.92% at December 31, 1996 and 1995, respectively. (3) The weighted average pay rate was 6.91% and 7.28% and the weighted average receive rate was 6.75% and 6.75% at December 31, 1996 and 1995, respectively. (4) The weighted average pay rate was 5.28% and 5.91% and the weighted average receive rate was 5.53% and 5.89% at December 31, 1996 and 1995, respectively. (5) The weighted average contract rate was 6.00% and 6.36% at December 31, 1996 and 1995, respectively. The following table summarizes by notional amounts the activity of Sovereign's interest rate exchange agreements (in thousands):
AMORTIZING NON-AMORTIZING INTEREST INTEREST INTEREST RATE RATE SWAPS RATE SWAPS CAPS ---------- --------------- ------------- Balance, December 31, 1993............................. $ 620,934 $ 50,000 $ 300,000 ---------- ---------- ---------- Additions............................................ 591,800 200,000 980,000 Maturities/Amortization.............................. 127,089 -- 50,000 Terminations......................................... -- -- 780,000 ---------- ---------- ---------- Balance, December 31, 1994............................. 1,085,645 250,000 450,000 ---------- ---------- ---------- Additions............................................ 300,000 280,000 996,000 Maturities/Amortization.............................. 326,795 200,000 -- Terminations......................................... 177,720 -- -- ---------- ---------- ---------- Balance, December 31, 1995............................. 881,130 330,000 1,446,000 ---------- ---------- ---------- Additions............................................ 300,000 1,125,000 500,000 Maturities/Amortization.............................. 69,117 -- 450,000 Terminations......................................... -- 50,000 996,000 ---------- ---------- ---------- Balance, December 31, 1996............................. $1,112,013 $1,405,000 $ 500,000 ========== ========== ==========
64 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (16) INTEREST RATE EXCHANGE AGREEMENTS -- (CONTINUED) At December 31, 1996, Sovereign's balance sheet included a net deferred loss of $4.9 million related to interest rate exchange agreements terminated in December 1995 and June 1996 which were originally accounted for as hedges. Of this net deferred loss, $4.4 million will amortize into interest expense in 1997 and $465,000 will amortize into interest expense in 1998. Net interest income resulting from interest rate exchange agreements includes $5.1 million of income and $7.4 million of expense for 1996, $1.7 million of income and $3.6 million of expense for 1995 and $10.0 million of income and $2.0 million of expense for 1994. (17) PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for Sovereign Bancorp, Inc. is as follows (in thousands):
BALANCE SHEETS ------------------------ AT DECEMBER 31, ------------------------ 1996 1995 -------- -------- Assets Interest-earning deposits .................... $ 61 $ 280 Investment securities ........................ 17,010 9,129 Investment in subsidiaries ................... 615,045 542,869 Other assets ................................. 16,352 46,342 -------- -------- Total Assets ................................... $648,468 $598,620 -------- -------- -------- -------- Liabilities and Stockholders' Equity Short-term borrowings ........................ $ -- $ 714 Long-term borrowings ......................... 167,748 167,271 Other liabilities ............................ 4,905 3,610 Stockholders' equity ......................... 475,815 427,025 -------- -------- Total Liabilities and Stockholders' Equity ..... $648,468 $598,620 -------- -------- -------- --------
STATEMENTS OF OPERATIONS ----------------------------------- YEAR ENDED DECEMBER 31, ----------------------------------- 1996 1995 1994 ------- ------- ------- Interest income ................................................... $ 2,676 $ 4,308 $ 192 Other income ...................................................... 3 2,791 13,008 ------- ------- ------- Total income ...................................................... 2,679 7,099 13,200 ------- ------- ------- Interest expense .................................................. 13,117 11,758 9,341 Other expense ..................................................... 5,365 4,532 3,858 ------- ------- ------- Total expense ..................................................... 18,482 16,290 13,199 ------- ------- ------- Income before taxes, dividends and equity in undistributed earnings of subsidiaries ................................................. (15,803) (9,191) 1 Income taxes ...................................................... (5,373) (4,181) -- ------- ------- ------- Income before earnings of subsidiaries ............................ (10,430) (5,010) 1 Distributed earnings from subsidiaries ............................ -- 19,544 18,246 Undistributed earnings of subsidiaries ............................ 61,893 41,874 28,151 ------- ------- ------- Net Income ........................................................ $51,463 $56,408 $46,398 ------- ------- ------- ------- ------- -------
65 SOVEREIGN BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (17) PARENT COMPANY FINANCIAL INFORMATION -- (CONTINUED)
STATEMENTS OF CASH FLOWS ------------------------------ YEAR ENDED DECEMBER 31, ------------------------------ 1996 1995 1994 -------- -------- -------- Cash Flows from Operating Activities: Net income................................................................... $51,463 $56,408 $46,398 Adjustments to reconcile net income to net cash provided by operating activities: Dividends received from subsidiaries(1)................................... -- 19,544 18,246 Earnings from subsidiaries................................................ (61,893) (61,418) (46,397) Allocation of Employee Stock Ownership Plan shares........................ 2,465 1,514 -- Change in other assets.................................................... 29,990 (45,277) 10,439 Change in other liabilities............................................... 1,295 2,608 (3,168) -------- -------- -------- Net cash provided (used) by operating activities............................... 23,320 (26,621) 25,518 -------- -------- -------- Cash Flows from Investing Activities: Investment in subsidiaries................................................... (10,283) (88,137) (17,140) Maturity and repayments of investment securities............................. 849 505 5,319 Net change in investment securities(1)....................................... (8,730) -- (10,096) Other, net................................................................... 5,857 4,875 (251) -------- -------- -------- Net cash used by investing activities.......................................... (12,307) (82,757) (22,168) -------- -------- -------- Cash Flows from Financing Activities: Net change in short-term borrowings.......................................... (714) (714) -- Net change in long-term borrowings........................................... 477 (376) (1,092) Cash dividends paid to stockholders.......................................... (10,388) (8,633) (5,252) Net cash received from debt offering......................................... -- 49,379 -- Net proceeds from issuance of common stock................................... 4,040 2,801 3,884 Net proceeds from issuance of preferred stock................................ -- 96,446 -- Purchase of Employee Stock Ownership Plan shares............................. (4,559) (30,286) -- Purchase of treasury stock................................................... (88) -- -- -------- -------- -------- Net cash provided (used) by financing activities............................... (11,232) 108,617 (2,460) -------- -------- -------- Increase (decrease) in cash and cash equivalents............................... (219) (761) 890 Cash and cash equivalents at beginning of period............................... 280 1,041 151 -------- -------- -------- Cash and cash equivalents at end of period..................................... $ 61 $ 280 $ 1,041 -------- -------- -------- -------- -------- --------
- ------------------ (1) The 1996 results reflect the dissolution and subsequent merger of Sovereign Investment Corporation into Sovereign Bancorp during 1996. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 66 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 1997 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" in the Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (A) 1. FINANCIAL STATEMENTS. Consolidated financial statements are omitted because the required information is either not applicable, not required or is shown in the respective financial statements in the notes thereto. 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. (Incorporated by reference to Exhibit 3.2 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.) (4.1) Sovereign Bancorp, Inc. has certain long-term debt outstanding. None of the instruments evidencing such debt authorizes an amount of securities in excess of 10% of the total assets of Sovereign Bancorp, Inc. and its subsidiaries on a consolidated basis; therefore, copies of such instruments are not included as exhibits to this Annual Report on Form 10-K. Sovereign Bancorp, Inc. agrees to furnish copies of such instruments to the Commission on request. 67 (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 September 15, 1992, between Sovereign Bancorp, Inc., Sovereign Bank, a Federal Savings Bank, and Jay S. Sidhu. (Incorporated by reference to Exhibit 10.3 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.) (10.4) Agreement dated as of September 15, 1992, between Sovereign Bank, a Federal Savings Bank and Karl D. Gerhart. (Incorporated by reference to Exhibit 10.4 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.) (10.5) Agreement dated as of September 15, 1992, between Sovereign Bank, a Federal Savings Bank and Lawrence M. Thompson, Jr. (Incorporated by reference to Exhibit 10.5 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.) (10.6) Penn Savings Bank Senior Officer Incentive Plan. (Incorporated by reference to Exhibit 10.6 to Sovereign's Annual Report on Form 10-K for the year ended December 31, 1994.) (10.11) Rights Agreement dated September 19, 1989, between Sovereign Bancorp, Inc. and Harris Trust Company of New York. (Incorporated by reference to Exhibit 4.3 to Sovereign's Registration Statement No. 33-89586 on Form S-8). (10.12) Sovereign Bancorp, Inc. Non-Employee Director Incentive Compensation Plan. (Incorporated by reference to Exhibit 10.12 to Sovereign's Registration Statement No. 33-43195 on Form S-1). (10.14) 1993 Sovereign Bancorp, Inc. Stock Option Plan. (Incorporated by reference to Exhibit 10.23 to Sovereign's Annual Report on Form 10-K for the year ended December 31, 1992). (10.15) Indemnification Agreement dated December 21, 1993, between Sovereign Bank and Jay S. Sidhu. (Incorporated by reference to Exhibit 10.25 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.) (10.16) Agreement and Plan of Merger, dated June 16, 1994, by and between Sovereign Bancorp, Inc. and Charter FSB Bancorp, Inc. (Incorporated by reference to Exhibit 2.1 to Sovereign's Registration Statement No. 33-82846 on Form S-4.) (10.17) Branch Purchase and Deposit Assumption Agreement, dated September 19, 1994, between Berkeley Federal Bank & Trust FSB and Sovereign Bank, a Federal Savings Bank. (Incorporated by reference to Exhibit 2.1 to Sovereign's Current Report on Form 8-K dated September 16, 1994.) (10.18) Employment Agreement dated as of August 8, 1988, between Charter Federal Savings Bank and Patrick J. Petrone. (Incorporated by reference to Exhibit 10.23 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.) (10.19) Amendment to Employment Agreement between Patrick J. Petrone and Charter Federal Savings Bank, dated October 17, 1994. (Incorporated by reference to Exhibit 10.24 to Sovereign's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.) (10.20) Charter FSB Bancorp, Inc. Stock Incentive Plan. (Incorporated by reference to Exhibit 4.1 to Registration Statement No. 33-36895 of Charter FSB Bancorp, Inc. on Form S-8). (10.21) Amendments to Charter FSB Bancorp, Inc. Stock Incentive Plan. (Incorporated herein by reference to Exhibit 4.2 to Registration Statement No. 33-36895 of Charter FSB Bancorp, Inc. on Form S-8.) (10.22) Charter FSB Bancorp, Inc. Stock Option Plan for Non-Employee Directors. (Incorporated by reference to Exhibit 4.1 to Registration Statement No. 33-36896 of Charter FSB Bancorp, Inc. Form S-8.) 68 (10.23) Amendments to Charter FSB Bancorp, Inc. Stock Option Plan for Non-Employee Directors. (Incorporated herein by reference to Exhibit 4.2 to Registration Statement No. 33-36896 of Charter FSB Bancorp, Inc. on Form S-8). (10.24) Amendment to Rights Agreement, dated as of September 27, 1995, between Sovereign Bancorp, Inc. and Chemical Bank, as successor to Harris Trust Company of New York, as Rights Agent. (Incorporated by reference to Exhibit 2.2 of Amendment No. 1 of Sovereign's Registration Statement on Form 8-A.) (10.26) Agreement and Plan of Merger, dated September 29, 1995, between Sovereign Bancorp, Inc. and West Jersey Bancshares, Inc. (Incorporated by reference to Exhibit 2.1 to Sovereign's Registration Statement 33-64807 on Form S-4.) (11.1) Computation of Per Share Earnings. (21) Subsidiaries of the Registrant (23.1) Consent of Ernst & Young LLP, Independent Auditors. (27) Financial Data Schedule (B) REPORTS ON FORM 8-K. 1. Report on Form 8-K, dated February 2, 1996 (date of earliest event -- January 31, 1996), contained a press release outlining Sovereign's strategic vision for year 2000. 2. Report on Form 8-K, dated February 13, 1996 (date of earliest event -- January 18, 1996), contained a press release announcing Sovereign's earnings for the year ended December 31, 1995. 3. Report on Form 8-K, dated May 31, 1996 (date of earliest event -- May 31, 1996), contained a press release announcing Sovereign's completion of the acquisition of West Jersey Bancshares, Inc. 4. Report on Form 8-K, dated July 29, 1996 (date of earliest event -- July 15, 1996), contained a press release announcing Sovereign's earnings for the second quarter of 1996. 5. Report on Form 8-K, dated October 30, 1996 (date of earliest event -- October 22, 1996), contained a press release announcing Sovereign's earnings for the third quarter of 1996. 6. Report on Form 8-K, dated November 27, 1996 (date of earliest event -- November 26, 1996), contained a press release announcing an amendment to the Definitive Agreement and Plan of Merger, dated as of June 24, 1996, between Sovereign and First State Financial Services, Inc. 69 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 3, 1997 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/ FRED D. HAFER Director March 3, 1997 - ------------------------- Fred D. Hafer /S/ HOWARD D. MACKEY Director March 3, 1997 - ------------------------- Howard D. Mackey /S/ RICHARD E. MOHN Chairman of Board and Director March 3, 1997 - ------------------------- Richard E. Mohn /S/ RHODA S. OBERHOLTZER Director March 3, 1997 - ------------------------- Rhoda S. Oberholtzer /S/ PATRICK J. PETRONE Director March 3, 1997 - ------------------------- Patrick J. Petrone /S/ DANIEL K. ROTHERMEL Director March 3, 1997 - ------------------------- Daniel K. Rothermel /S/ JAY S. SIDHU Director, President and Chief March 3, 1997 - ------------------------- Executive Officer Jay S. Sidhu (Principal Executive Officer) /S/ G. ARTHUR WEAVER Director March 3, 1997 - ------------------------- G. Arthur Weaver /S/ THEODORE ZIAYLEK, JR. Director March 3, 1997 - ------------------------- Theodore Ziaylek, Jr. /S/ KARL D. GERHART Chief Financial Officer March 3, 1997 - ------------------------- Karl D. Gerhart 70 EX-11.1 2 COMPUTATION OF EARNINGS PER SHARE SOVEREIGN BANCORP, INC. AND SUBSIDIARIES PART IV, ITEM 14(a)-EXHIBIT 11.1 Computation of Earnings Per Share (in thousands, except per share data)
1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- Net income(1) $51,463 $56,408 $46,398 $40,414 $19,638 ------- ------- ------- ------- ------- Average common and common equivalent shares outstanding at end of period(2) 70,464 66,437 59,701 58,921 44,284 Stock options considered to be common stock equivalents, net of shares assumed to be repurchased under the treasury stock method(2) 1,371 1,445 1,972 2,166 1,915 ------- ------- ------- ------- ------- Total common and common equivalent shares(2) 71,835 67,882 61,673 61,087 46,199 ======= ======= ======= ======= ======= Net income per share before cumulative effect of change in accounting principle(2) $ 0.72 $ 0.83 $ 0.75 $ 0.58 $ 0.43 ======= ======= ======= ======= ======= Net income per share after cumulative effect of change in accounting principle(2) $ 0.72 $ 0.83 $ 0.75 $ 0.67 $ 0.43 ======= ======= ======= ======= =======
(1) The 1996 results include a non-recurring SAIF assessment of $17.2 million (after-tax) charged by the FDIC for the recapitalization of the SAIF. The 1993 results do not include a $4.8 million cumulative effect of change in accounting principle resulting from the adoption of Statement of Financial Accounting Standard No. 109 in 1993. (2) All per share data have been adjusted for all stock dividends and stock splits through January 1997. EX-21 3 SUBSIDIARIES OF SOVEREIGN BANCORP, INC. EXHIBIT 21 Subsidiaries of Sovereign Bancorp, Inc. State or other jurisdiction of Subsidiary Incorporation - ---------- --------------- Sovereign Bank, a Federal Savings Bank .............. United States of America Sovereign Community Bank ............................ United States of America First Lancaster Financial Corp. ..................... Pennsylvania 201 Associates, Inc. ................................ Delaware Sovereign Annuity Corp., Inc. ....................... New Jersey Sovereign Agency, Inc. .............................. New Jersey March 3, 1997 EX-23.1 4 CONSENT OF INDEPENDENT AUDITORS Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statements (Form S-3 No. 333-09113, Form S-3 No. 33-46870, Form S-8 No. 33-20186, Form S-8 No. 33-29038, Form S-8 No. 33-39453, Form S-8 No. 33-44108, Form S-8 No. 33-89586, and Form S-8 No. 33-89592) of Sovereign Bancorp, Inc. and in the related Prospectus of our report dated January 21, 1997, with respect to the consolidated financial statements of Sovereign Bancorp, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 1996. Reading, Pennsylvania /s/ Ernst & Young LLP March 7, 1997 EX-27 5
5 12-Mos Dec-31-1996 Jan-01-1996 Dec-31-1996 105,174 2,916,287 6,180,171 (33,809) 0 211,739 104,599 (51,007) 9,433,154 8,957,339 0 0 96,446 245,061 134,308 9,433,154 0 642,933 0 118,191 11,862 2,516 399,540 83,006 31,543 0 0 27,818 0 51,463 .760 .720
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