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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934, for the fiscal year ended
December 31, 1995, or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934, for the transition period
from N/A to __________.
Commission File Number 0-16533
SOVEREIGN BANCORP, INC.
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2453088
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1130 Berkshire Boulevard, Wyomissing, Pennsylvania 19610
(Address of principal executive offices) Zip Code)
Registrant's telephone number: (215) 320-8400
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock (without par value)
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X . No. .
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of Registrant's knowledge,
in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the shares of Common Stock of the
Registrant held by nonaffiliates of the Registrant was
$508,253,463 at March 4, 1996. As of March 4, 1996, the
Registrant had 47,835,620 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's definitive Proxy Statement to be used in
connection with its 1996 Annual Meeting of Shareholders is
incorporated herein by reference in response to Part III hereof.
PART I
Item 1. BUSINESS.
General
Sovereign Bancorp, Inc. ("Sovereign") is a Pennsylvania
business corporation and is the holding company for Sovereign
Bank, a Federal Savings Bank ("Sovereign Bank") and for Colonial
Bank for Savings, a Federal Savings Bank ("Colonial Bank"). Both
Sovereign and Sovereign Bank are headquartered in Wyomissing,
Pennsylvania, a suburb of Reading, Pennsylvania. Colonial Bank
is headquartered in Freehold, New Jersey.
Sovereign Bank was created in 1984 under the name Penn
Savings Bank, F.S.B. through the merger of two financial
institutions with market areas primarily in Berks and Lancaster
Counties, Pennsylvania. Sovereign Bank assumed its current name
on December 31, 1991. Sovereign was incorporated by Sovereign
Bank in 1987.
From 1989 through 1994, Sovereign expanded its markets
throughout eastern Pennsylvania and central New Jersey by
completing ten acquisitions with assets totaling approximately
$3.3 billion. At December 31, 1994, Sovereign had 130 offices
and $6.6 billion in assets.
On November 17, 1995, Sovereign acquired two branch offices
located in Bergen County, New Jersey, and related deposits from
Berkeley. Sovereign assumed approximately $111.7 million in
deposits for a premium of $5.5 million. The acquisition was
accounted for as a purchase.
On November 15, 1995, Sovereign acquired Colonial State Bank
in a transaction accounted for as a purchase. After receipt of
regulatory approvals and pursuant to the terms of the agreement
entered into by Sovereign and Colonial State Bank, upon
acquisition, Colonial State Bank became a wholly-owned, BIF
insured, subsidiary of Sovereign and converted to a federal
savings bank under the name Colonial Bank for Savings, a Federal
Savings Bank. Sovereign acquired Colonial Bank in exchange for
$6.3 million in cash. Sovereign acquired $46.5 million in
assets, consisting principally of loans and investment
securities, and also assumed approximately $42.0 million in
deposit liabilities.
On November 10, 1995, Sovereign completed the sale of its
Pottsville, Pennsylvania, branch office with related deposits
totaling $23.9 million to Northwest Savings Bank and the sale of
its English Village branch office in North Wales, Pennsylvania
with related deposits of $12.4 million to Union National Bank &
Trust Company.
On April 21, 1995, Sovereign completed its sale of seven
southern New Jersey offices with related deposits totalling
$106.7 million to Collective Bancorp, Inc. ("Collective"). Six
of these offices had previously been purchased from Berkeley as
part of the transaction which closed on January 1, 1995. In
addition, Sovereign acquired $7.0 million in deposits from
Collective's Wilmington, Delaware branch office.
On January 1, 1995, Sovereign acquired 23 branch offices
located in New Jersey and Delaware, $909.3 million of related
deposits, cash and fixed assets from Berkeley Federal Bank &
Trust, FSB ("Berkeley") for a premium of $66.6 million. The
acquisition was accounted for as a purchase.
On November 1, 1994, Sovereign acquired Charter FSB Bancorp,
Inc. ("Charter"), with assets of $405.8 million and 10 offices
located in Morris and Sussex Counties, New Jersey. Sovereign
exchanged a total of 7.0 million new shares (7.7 million shares
as adjusted for all subsequent stock dividends) of Sovereign
common stock for all the outstanding shares of Charter. The
acquisition was accounted for as a pooling-of-interests.
On September 16, 1994, Sovereign acquired the Chadds Ford
Pennsylvania office and $14.4 million of related deposits of
Second National Federal Savings Association ("Second National")
from the Resolution Trust Corporation, receiver for Second
National, and received approximately $13.7 million of cash. The
acquisition was accounted for as a purchase.
On August 5, 1994, Sovereign acquired all the capital stock
of Shadow Lawn Savings Bank ("Shadow Lawn") with assets of
$787.5 million and 17 offices located in Monmouth and Ocean
Counties, New Jersey. Sovereign also assumed approximately
$730.6 million of deposit liabilities. Sovereign acquired Shadow
Lawn in exchange for $78.4 million of cash. The acquisition was
accounted for as a purchase.
On November 5, 1993, Sovereign acquired Valley Federal
Savings and Loan Association ("Valley Federal"). At
September 30, 1993, Valley Federal had total assets, deposits and
stockholders' equity of $315.7 million, $256.4 million and
$18.6 million, respectively. Sovereign exchanged a total of
2.9 million new shares (3.5 million shares as adjusted for all
subsequent stock dividends) of Sovereign common stock with a
value of $32.3 million for all of the outstanding shares of
Valley Federal common stock. The acquisition was accounted for
as a pooling-of-interests.
On August 27, 1993, Sovereign assumed $252.3 million of
deposit liabilities and received $233.7 million of cash from the
RTC as receiver of 9 branch offices of Home Unity Federal Savings
and Loan Association.
On January 15, 1993, Sovereign formally acquired Harmonia
Bancorp, Inc. ("Harmonia") in a transaction that was accounted or
as a purchase. Sovereign acquired total assets of $621.0 million
and assumed liabilities consisting principally of deposits in
exchange for $19.6 million of cash and 9.6 million new shares
(11.6 million shares as adjusted for all subsequent stock
dividends) of Sovereign common stock, issued at a value of
$66.1 million.
On October 2, 1995, Sovereign entered into an Agreement to
acquire West Jersey Bancshares, Inc. ("West Jersey") and West
Jersey's wholly-owned subsidiary, West Jersey Community Bank
("WJCB"). WJCB is a $101 million New Jersey commercial bank
headquartered in Fairfield, New Jersey. The terms of the
Agreement call for Sovereign to exchange $8.40 in Sovereign
common stock (subject to adjustment) for each share of West
Jersey common stock. Subject to regulatory approvals and
pursuant to the Agreement, the acquisition will be effected by
the merger of West Jersey with and into Sovereign and the merger
of WJCB with and into Sovereign Bank. The acquisition is
expected to close in April 1996, and is expected to be tax free
and accounted for as a pooling-of-interests.
At December 31, 1995, Sovereign's consolidated assets,
deposits and shareholders' equity were approximately $8.08
billion, $5.04 billion and $427.0 million, respectively. Based
on assets at December 31, 1995, Sovereign is the largest thrift
holding company headquartered in Pennsylvania.
Sovereign's primary business consists of attracting deposits
from its network of community banking offices, located in
Pennsylvania, New Jersey and Delaware, and originating
residential mortgage loans and home equity lines of credit in
those communities. Sovereign Bank originates mortgage loans
through its community banking offices and its Outside Sales
Division that consists of commissioned employees who conduct
business out of loan production offices. Sovereign also
originates mortgage loans through its Wholesale Division that
uses a network of independent mortgage bankers and brokers. All
underwriting for the Wholesale Division is performed by Sovereign
Bank.
Sovereign operates in a heavily regulated environment.
Changes in laws and regulations affecting it and its subsidiaries
may have an impact on its operations. See "Business -
Supervision and Regulation."
For additional information with respect to Sovereign's
business activities see Part III, Item 7 hereof.
The following table sets forth the maturity schedule for
Sovereign's loan portfolio (excluding residential real estate and
consumer loans):
Amounts at December 31, 1995, Maturing
-------------------------------------------------
LOAN MATURITY SCHEDULE In One Year After One Year After
(IN THOUSANDS) or Less - Five Years Five Years Total
----------- -------------- ---------- -----
Commercial real estate
loans: $2,487 $ 7,793 $36,897 $ 47,177
Real estate construction
loans:
Residential
(net of loans in
process of
$23,365) 267 791 37,093 38,151
Residential development
(net of loans in
process of
$736) 1,255 - 421 1,676
Commercial loans 4,871 3,674 7,286 15,831
------- ------- ------- --------
Total $ 8,880 $12,258 $81,697 $102,835
======= ======= ======= ========
Loans with:
Fixed rates $ 2,403 $ 8,631 $15,742 $ 26,776
Variable rates 6,477 3,627 65,955 76,059
------- ------- ------- --------
Total $ 8,880 $12,258 $81,697 $102,835
======= ======= ======= ========
The following table summarizes the allocation of the
allowance for possible loan losses and the percentage of such
allocation to each loan type for the past five years:
ALLOCATION OF THE ALLOWANCE FOR POSSIBLE LOAN LOSSES
(IN THOUSANDS)
December 31,
--------------------------------------------------------------------------------------------------------
Balance at end of
Period Attributable to: 1995 1994 1993 1992 1991
- ----------------------- ------------------- ------------------- ------------------ ------------------ ------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
Residential real
estate $10,520 30.18% $10,540 29.05% $ 6,737 20.35% $ 7,316 27.54% $ 4,061 30.77%
Commercial real
estate 698 2.00 657 1.81 1,180 3.57 1,663 6.26 777 5.89
Commercial 181 .52 164 0.45 125 0.38 135 0.51 225 1.70
Consumer 4,190 12.02 4,435 12.22 927 2.80 997 3.75 754 5.71
Unallocated 19,267 55.28 20,493 56.47 24,130 72.90 16,451 61.94 7,381 55.93
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total $34,856 100.00% $36,289 100.00% $33,099 100.00% $26,562 100.00% $13,198 100.00%
======= ======= ======= ====== ======= ====== ======= ====== ======= ======
The following table sets forth the maturity and yields of
Sovereign's investment and mortgage-backed securities held-to-
maturity at December 31, 1995. The maturities of mortgage-backed
securities held-to-maturity are based upon contractually
scheduled repayments. Expected maturities will differ from
contractual maturities because borrowers may have the right to
call or repay obligations with or without call or prepayment
penalties. Yields on tax-exempt securities were computed on a
tax equivalent basis using Sovereign's federal tax rate of 35%.
Amounts at December 31, 1995, Due
----------------------------------------------------------------
INVESTMENT AND MORTGAGE-BACKED
SECURITIES HELD-TO-MATURITY
(IN THOUSANDS)
After One After Five
In One Year Year- Years- After
or Less Five Years Ten Years Ten Years Total
----------- ---------- ---------- --------- -----
Investment Securities:
- ----------------------
U.S. Treasury and U.S. $498 $2,995 $1,500 -- $4,993
Government Agency 6.84% 6.40% 7.09% -- 6.65%
Securities
Corporate securities -- 1,010 -- -- 1,010
-- 8.20% -- -- 8.20%
Other securities -- 305 177 -- 482
-- 4.17% 1.94% -- 3.35%
Mortgage-backed Securities:
- ---------------------------
FHLMC 6,022 63,896 88,237 10,558 168,713
7.61% 7.34% 6.36% 7.97% 6.88%
FNMA 633 48,131 156,822 15,460 221,046
7.77% 7.11% 6.45% 7.01% 6.64%
GNMA -- 540 12,891 156,633 170,064
-- 9.61% 6.61% 8.90% 8.73%
RTC -- -- 28,954 -- 28,954
-- -- 6.80% -- 6.80%
Private Issues -- 139,489 91,509 53,642 284,640
-- 6.33% 6.82% 6.98% 6.61%
Collateralized Mortgage Obligations 478 1,088,394 42,168 66,270 1,197,310
7.75% 7.40% 6.45% 6.52% 7.32%
----- --------- ------ ------ ---------
TOTAL $7,631 $1,344,760 $422,258 $302,563 $2,077,212
====== ========== ======== ======== ==========
7.58% 7.27% 6.54% 7.91% 7.22%
====== ========== ======== ======== ==========
The following table sets forth the maturities and yields of
Sovereign's investment and mortgage-backed securities
available-for-sale at December 31, 1995. The maturities of the
mortgage-backed securities available-for-sale are based upon
contractually scheduled repayments. Expected maturities will
differ from contractual maturities because borrowers may have the
right to call or repay obligations with or without call or
prepayment penalties. Yields on tax-exempt securities were
computed on a tax equivalent basis using Sovereign's federal tax
rate of 35%.
Amounts at December 31, 1995, Due
INVESTMENT AND MORTGAGE-BACKED
SECURITIES AVAILABLE-FOR-SALE
(IN THOUSANDS)
No
After One After Five Stated
In One Year Year- Years- After Maturity
or Less Five Years Ten Years Ten Years or Rate Total
Investment Securities:
U.S. Treasury and U.S.
Government Agency
Securities $12,001 $133,234 $5,007 $ -- $ -- $150,242
4.61% 5.26% 6.25% -- -- 5.24%
Equity Securities -- -- -- -- 135,494 135,494
-- -- -- -- 4.75% 4.75%
Mortgage-backed Securities:
FHLMC -- 131,370 -- 24,753 -- 156,123
-- 5.42% -- 7.61% -- 5.77%
FNMA -- 64,906 -- 71,955 -- 136,861
-- 5.63% -- 7.65% -- 6.69%
GNMA -- -- -- 59,215 -- 59,215
-- -- -- 8.87% -- 8.87%
Collateralized Mortgage
Obligations 46,201 198,836 -- -- -- 245,037
7.50% 7.54% -- -- -- 7.53%
TOTAL $58,202 $528,346 $5,007 $155,923 $135,494 $882,972
6.90% 6.20% 6.25% 8.11% 4.75% 6.36%
At December 31, 1995, Sovereign held the following
securities of single issuers (other than obligations of the
United States and its political subdivisions, agencies and
corporations) having an aggregate book value in excess of 10% of
Sovereign's shareholders' equity:
INVESTMENT AND MORTGAGE-BACKED
SECURITIES At December 31, 1995
(IN THOUSANDS)
Issuer Book Value Market Value
G.E. Capital Mortgage Servicing, Inc. $ 189,944 $ 190,868
Prudential Home Mortgage Securities,
Inc. 162,809 164,260
Residential Funding Mortgage
Securities, Inc. 138,472 139,262
Securitized Asset Sales, Inc. 136,244 136,804
PHH Mortgage Servicing Corp. 101,097 102,986
Housing Security, Inc. 91,682 90,581
Independent National Mortgage Corp. 73,095 73,508
Capstead Mortgage Corp. 72,906 72,969
Saxon Mortgage Securities Corp. 55,822 54,820
TOTAL $1,022,071 $1,026,058
========== ==========
The following table sets forth the maturity of certificates
of deposit of $100,000 or more at December 31, 1995:
At December 31,
1995
(IN THOUSANDS)
Three months or less. . . . . . . . $94,918
Over three through six months. . . 71,231
Over six through twelve months. . . 40,002
Over twelve months. . . . . . . . . 20,245
Total. . . . . . . . . . . . . $226,396
========
Subsidiaries
Sovereign has three wholly-owned subsidiaries: Sovereign
Bank, Colonial Bank and Sovereign Investment Corporation, a
Delaware corporation that purchases and holds investment
securities.
In 1995, Sovereign Bank reorganized its existing subsidiary
structure. Sovereign Bank now has the following wholly-owned
subsidiaries: First Lancaster Financial Corp. and
201 Associates, Inc. 201 Associates, Inc. is a Delaware
corporation whose primary purpose is to purchase and hold certain
investment securities. First Lancaster Financial Corp. is a
Pennsylvania business corporation whose primary function is to
act as a holding company for The Sovereign Annuity Corp. and The
Sovereign Agency, Inc. Sovereign Annuity Corp. is a New Jersey
corporation whose primary purpose is to market investment
securities and mutual funds. The Sovereign Agency, Inc. is a
New Jersey corporation whose primary purpose is to market
insurance annuities. Colonial Bank has one subsidiary: CSB
Building Corporation, a New Jersey corporation whose primary
purpose is to hold title to property.
Federal regulations generally permit federally-chartered
savings institutions to invest up to 2% of assets in the capital
stock of, and make secured and unsecured loans to, certain types
of subsidiary service corporations. At December 31, 1995,
Sovereign Bank was authorized to have a maximum investment of
approximately $160.2 million in such subsidiaries, pursuant to
applicable federal regulations. As of such date, Sovereign Bank
had a total investment of $28.4 million in subsidiary service
corporations.
Employees
At December 31, 1995, Sovereign had 1,272 full-time and 232
part-time employees. None of these employees is represented by a
collective bargaining agent, and Sovereign believes it enjoys
good relations with its personnel.
Competition
Sovereign experiences substantial competition in attracting
and retaining deposits and in lending funds. The primary factors
in competing for deposits are the ability to offer attractive
rates and the convenience of office locations. Direct
competition for deposits comes primarily from other thrift
institutions and commercial banks. Competition for deposits also
comes from money market mutual funds, corporate and government
securities, and credit unions. The primary factors in the
competition for loans are interest rates, loan origination fees
and the range of products and services offered. Competition for
origination of real estate loans normally comes from other thrift
institutions, commercial banks, mortgage bankers, mortgage
brokers and insurance companies.
Environmental Laws
Environmentally related hazards have become a source of high
risk and potentially unlimited liability for financial
institutions relative to their loans. Environmentally
contaminated properties owned by an institution's borrowers may
result in a drastic reduction in the value of the collateral
securing the institution's loans to such borrowers, high
environmental clean up costs to the borrower affecting its
ability to repay the loans, the subordination of any lien in
favor of the institution to a state or federal lien securing
clean up costs, and liability to the institution for clean up
costs if it forecloses on the contaminated property or becomes
involved in the management of the borrower. To minimize this
risk, Sovereign Bank and Colonial Bank may require an
environmental examination of and report with respect to the
property of any borrower or prospective borrower if circumstances
affecting the property indicate a potential for contamination,
taking into consideration the potential loss to the institution
in relation to the burdens to the borrower. Such examination
must be performed by an engineering firm experienced in
environmental risk studies and acceptable to the institution, and
the costs of such examinations and reports are the responsibility
of the borrower. These costs may be substantial and may deter a
prospective borrower from entering into a loan transaction with
Sovereign Bank or Colonial Bank. Sovereign is not aware of any
borrower who is currently subject to any environmental
investigation or clean up proceeding which is likely to have a
material adverse effect on the financial condition or results of
operations of Sovereign Bank or of Colonial Bank.
Supervision and Regulation
General. Sovereign is a "savings and loan holding company"
registered with the Office of Thrift Supervision ("OTS") under
the Home Owners' Loan Act ("HOLA") and, as such, Sovereign is
subject to OTS regulation, examination, supervision and
reporting. The deposits of Sovereign Bank are insured by the
Savings Association Insurance Fund (the "SAIF") of the Federal
Deposit Insurance Corporation (the "FDIC"). The deposits of
Colonial Bank are insured by the Bank Insurance Fund (the "BIF")
of the FDIC. The SAIF and the BIF are administered by the FDIC,
but are required to be separately maintained and not combined.
See "Insurance of Deposit Accounts" below. Sovereign Bank and
Colonial Bank are required to file reports with the OTS
describing their respective activities and financial condition
and are periodically examined to test compliance with various
regulatory requirements. Sovereign Bank and Colonial Bank are
also subject to examination by the FDIC. Such examinations are
conducted for the purpose of protecting depositors and the
insurance fund and not for the purpose of protecting holders of
equity or debt securities of Sovereign, Sovereign Bank or
Colonial Bank. Sovereign Bank is a member of the Federal Home
Loan Bank ("FHLB") of Pittsburgh, which is one of the twelve
regional banks comprising the FHLB system. Colonial Bank is a
member of the FHLB of New York. Sovereign Bank and Colonial Bank
are also subject to regulation by the Board of Governors of the
Federal Reserve System with respect to reserves maintained
against deposits and certain other matters. Except as described
herein, Sovereign's management is not aware of any current
recommendations by regulatory authorities that would have a
material effect on Sovereign's operations, capital resources or
liquidity.
Holding Company Regulation. The HOLA prohibits a registered
savings and loan holding company from directly or indirectly
acquiring control, including through an acquisition by merger,
consolidation or purchase of assets, of any savings association
(as defined in HOLA to include a federal savings bank) or any
other savings and loan holding company, without prior OTS
approval. Generally, a savings and loan holding company may not
acquire more than 5% of the voting shares of any savings
association unless by merger, consolidation or purchase of
assets. Certain regulations of the OTS describe standards for
control under the HOLA. See "Control of Sovereign" below.
Federal law empowers the Director of the OTS to take
substantive action when the Director determines that there is
reasonable cause to believe that the continuation by a savings
and loan holding company of any particular activity constitutes a
serious risk to the financial safety, soundness or stability of a
savings and loan holding company's subsidiary savings
institution. The Director of the OTS has oversight authority for
all holding company affiliates, not just the insured institution.
Specifically, the Director of the OTS may, as necessary,
(i) limit the payment of dividends by the savings institution;
(ii) limit transactions between the savings institution, the
holding company and the subsidiaries or affiliates of either;
(iii) limit any activities of the savings institution that might
create a serious risk that the liabilities of the holding company
and its affiliates may be imposed on the savings institution.
Any such limits would be issued in the form of a directive having
the legal efficacy of a cease and desist order.
Control of Sovereign. Under the Savings and Loan Holding
Company Act and the related Change in Bank Control Act (the
"Control Act"), individuals, corporations or other entities
acquiring Sovereign common stock may, alone or "in concert" with
other investors, be deemed to control Sovereign and thereby
Sovereign Bank and Colonial Bank. If deemed to control
Sovereign, such person or group will be required to obtain OTS
approval to acquire Sovereign's common stock and will be subject
to certain ongoing reporting procedures and restrictions under
federal law and regulations. Under the regulations, ownership of
25% of the capital stock of Sovereign will be deemed to
constitute "control," and ownership of more than 10% of the
capital stock may also be deemed to constitute "control" if
certain other control factors are present. It is possible that
even lower levels of ownership of such securities could
constitute "control" under the regulations.
Regulatory Capital Requirements. OTS Regulations require
savings associations to maintain a minimum tangible capital ratio
of not less than 1.5%, a minimum core capital, or "leverage,"
ratio of not less than 3% and a minimum risk-based capital ratio
(based upon credit risk) of not less than 8%. These standards
are the same as the capital standards that are applicable to
other insured depository institutions, such as banks. Federal
banking agencies are required to ensure that their risk-based
capital guidelines take adequate account of interest rate risk,
concentration of credit risk and risks of nontraditional
activities. In August, 1995, the federal banking agencies,
including the OTS, issued a rule modifying their then-existing
risk-based capital standards to provide for consideration of
interest rate risk when assessing the capital adequacy of an
institution. This new rule implements the first step of a
two-step process by explicitly including a depository
institution's exposure to declines in the value of its capital
due to changes in interest rates as one factor that the banking
agencies will consider in evaluating an institution's capital
adequacy. The new rule does not establish a measurement
framework for assessing an institution's interest rate risk
exposure level. Examiners will use data collected by the banking
agencies to determine the adequacy of an individual institution's
capital in light of interest rate risk. Examiners will also
consider historical financial performance, earnings exposure to
interest rate movements and the adequacy of internal interest
rate risk management, among other things. This case-by-case
approach for assessing an institution's capital adequacy for
interest rate risk is transitional. The second step of the
Federal banking agencies' interest rate risk regulation will be
to establish an explicit minimum capital charge for interest rate
risk, based on measured levels of interest rate risk exposure.
The banking agencies will implement this second step at some
future date.
The federal banking agencies, including the OTS, also
adopted final rules relating to concentration of credit risk and
risks of non-traditional activities effective on January 17,
1995. The agencies declined to adopt a quantitative test for
concentrations of credit risk and, instead, provided that such
risk would be considered in addition to other risks in assessing
an institution's overall capital adequacy. Institutions with
higher concentration of credit risk will be required to maintain
greater levels of capital. Similarly, the federal agencies
incorporated the evaluation of the risks of non-traditional
activities into the overall assessment of capital adequacy. The
agencies also indicated that proposed rules regarding specific
types of non-traditional activities will be promulgated from time
to time.
Under the Federal Deposit Insurance Act ("FDIA") insured
depository institutions must be classified in one of five defined
categories (well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized). Under OTS regulations, an institution will be
considered "well capitalized" if it has (i) a total risk-based
capital ratio of 10% or greater, (ii) a Tier 1 risk-based capital
ratio of 6% or greater, (iii) a leverage ratio of 5% or greater
and (iv) is not subject to any order or written directive to meet
and maintain a specific capital level. An "adequately
capitalized" institution is one that has (i) a total risk-based
capital ratio of 8% or greater, (ii) a Tier 1 risk-based capital
ratio of 4% or greater, (iii) a leverage ratio of 4% or greater
(or 3% or greater in the case of a bank with the highest
composite regulatory examination rating) and (iv) does not meet
the definition of a well capitalized institution. An institution
will be considered (A) "undercapitalized" if it has (i) a total
risk-based capital ratio of less than 8%, (ii) a Tier 1 risk-
based capital ratio of less than 4% or (iii) a leverage ratio of
less than 4% (or 3% in the case of an institution with the
highest regulatory examination rating); (B) "significantly
undercapitalized" if the institution has (i) a total risk-based
capital ratio of less than 6%, (ii) a Tier 1 risk-based capital
ratio of less than 3% or (iii) a leverage ratio of less than 3%;
and (C) "critically undercapitalized" if the institution has a
ratio of tangible equity to total assets of equal to or less than
2%. The OTS may, under certain circumstances, reclassify a "well
capitalized" institution as "adequately capitalized" or require
an "adequately capitalized" or "undercapitalized" institution to
comply with supervisory actions as if it were in the next lower
category. Such a reclassification could be made if the OTS
determines that the institution is in an unsafe or unsound
condition (which could include unsatisfactory examination
ratings). A savings institution's capital category is determined
with respect to its most recent thrift financial report filed
with the OTS. In the event an institution's capital deteriorates
to the undercapitalized category or below, the FDIA and OTS
regulations prescribe an increasing amount of regulatory
intervention, including the adoption by the institution of a
capital restoration plan, a guarantee of the plan by its parent
holding company and the placement of a hold on increases in
assets, number of branches and lines of business.
If capital has reached the significantly or critically
undercapitalized levels, further material restrictions can be
imposed, including restrictions on interest payable on accounts,
dismissal of management and (in critically undercapitalized
situations) appointment of a receiver or conservator. Critically
undercapitalized institutions generally may not, beginning 60
days after becoming critically undercapitalized, make any payment
of principal or interest on their subordinated debt. All but
well capitalized institutions are prohibited from accepting
brokered deposits without prior regulatory approval. Pursuant to
the FDIA and OTS regulations, savings associations which are not
categorized as well capitalized or adequately capitalized are
restricted from making capital distributions which include cash
dividends, stock redemptions or repurchases, cash-out mergers,
interest payments on certain convertible debt and other
transactions charged to the capital account of a savings
association. At December 31, 1995, Sovereign Bank and Colonial
Bank each met the criteria to be classified as "well
capitalized."
Standards for Safety and Soundness. The federal banking
agencies adopted, effective in August, 1995, certain operational
and managerial standards for depository institutions, including
internal audit system components, loan documentation
requirements, asset growth parameters, and compensation standards
for officers, directors and employees. Sovereign does not
anticipate that the implementation or enforcement of these
guidelines will have a material adverse effect on its results of
operations.
Insurance of Deposit Accounts. The FDIC has implemented a
risk-related premium schedule for all insured depository
institutions that results in the assessment of premiums based on
capital and supervisory measures. Under the risk-related premium
schedule, the FDIC assigns, on a semiannual basis, each
institution to one of three capital groups (well-capitalized,
adequately capitalized or undercapitalized) and further assigns
such institution to one of three subgroups within a capital
group. The institution's subgroup assignment is based upon the
FDIC's judgment of the institution's strength in light of
supervisory evaluations, including examination reports,
statistical analyses and other information relevant to measuring
the risk posed by the institution. Only institutions with a
total capital to risk-adjusted assets ratio of 10.00% or greater,
a Tier 1 capital to risk-based assets ratio of 6% or greater, and
a Tier 1 leverage ratio of 5.0% or greater, are assigned to the
well-capitalized group. As of December 31, 1995, Sovereign Bank
and Colonial Bank were classified as well capitalized for
purposes of calculating insurance assessments. Institutions are
prohibited from disclosing the risk classification to which they
have been assigned. As of December 31, 1995, the FDIC calculated
deposit insurance assessments at the rate of $.23 for every $100
of deposits for the members of SAIF in the lowest risk-based
premium category and $0.31 for every $100 of insured deposits for
members of SAIF in the highest risk-based premium category.
In August, 1995, the FDIC adopted an amendment to the BIF
risk-based assessment schedule that lowers the deposit insurance
assessment rate for most (90% or more) commercial banks and other
depository institutions with deposits insured by BIF to $.04 per
$100 of insured deposits. On November 14, 1995, the FDIC further
reduced the BIF assessment rates to a range of $.00 per $100 of
insured deposits (subject to a minimum annual premium of $2,000)
for those institutions with the least risk to $0.27 for every
$100 of insured deposits for institutions deemed to have the
highest risk, beginning January 1, 1996. At the same time, the
FDIC voted to retain the existing assessment rates for SAIF-
insured institutions. The reduced BIF assessment rates result in
a substantial disparity in the deposit insurance premiums paid by
BIF and SAIF members and could place SAIF-insured savings
associations at a significant competitive disadvantage to
BIF-insured institutions.
Sovereign Bank is subject to FDIC deposit insurance
assessments at the rate applicable to SAIF-insured institutions
except, however, that the deposits acquired, on January 15, 1993,
when Sovereign acquired Harmonia Bancorp, Inc., remain subject to
BIF insurance assessment rates. The balance of these Harmonia
deposits was $756.0 million at December 31, 1995. Colonial Bank,
acquired by Sovereign on November 15, 1995, is subject to FDIC
deposit insurance assessments at the rate applicable to BIF
insured institutions.
Federal savings banks like Sovereign Bank and Colonial Bank
are required by OTS regulations to pay assessments to the OTS to
fund the operations of the OTS. The general assessment is paid
on a quarterly basis and is computed based on total assets of the
institution, including subsidiaries.
Taxation
Federal Taxation. Sovereign and its subsidiaries are
subject to those rules of federal income taxation generally
applicable to corporations and report their respective income and
expenses on the accrual basis method of accounting. Sovereign
and its subsidiaries file a consolidated federal income tax
return on a calendar year basis. Each member of the consolidated
group separately computes its income and deductions.
Intercompany distributions (including dividends) and certain
other items of income and loss derived from intercompany
transactions are eliminated upon consolidation of all the
consolidated group members' respective taxable income and losses.
In computing separate taxable income and loss, Sovereign
Bank and Colonial Bank each separately computes additions to its
bad debt reserves, pursuant to the special preferential rules of
Section 593 of the Internal Revenue Code of 1986, as amended (the
"Code"), applicable only to certain savings banks, cooperative
banks, and domestic building and loan associations (generically,
sometimes referred to as either a "thrift" or a "savings
institution"). Under certain circumstances, the separate bad
debt reserve additions of Sovereign Bank and of Colonial Bank may
be subject to adjustments upon consolidation.
For purposes of computing the annual deductible addition to
the bad debt reserve, Sovereign Bank and Colonial Bank each must
separate its loans into "qualifying real property loans" (i.e.,
generally those loans secured by interests in real property -
"qualifying loans") and all other loans ("nonqualifying loans").
The deduction with respect to "nonqualifying loans" must be
computed under the experience method (using actual historical
experience), which essentially approximates a deduction for
Sovereign Bank's or Colonial Bank's actual charge-offs, as the
case may be. A savings institution, which meets the qualifying
assets test (as further described below), is able to compute its
bad debt deduction with respect to "qualifying loans" using one
of two methods (whichever results in the larger deduction):
(i) experience method, or (ii) the "percentage of taxable income
method" (less the amount deductible for the addition to the
reserve for "nonqualifying loans"). The amount so determined is
subject to limitation in certain cases. The sum of the additions
to each reserve for Sovereign Bank and for Colonial Bank for each
year is the annual consolidated bad debt deduction, subject to
any consolidating adjustments referred to above. Sovereign Bank
and Colonial Bank intend to elect to utilize whatever available
method provides the maximum bad debt reserve additions.
If Sovereign Bank or Colonial Bank distributes amounts to
stockholders (i.e., to Sovereign) and the distribution is treated
as being from accumulated bad debt reserves, the distribution
will cause Sovereign Bank or Colonial Bank, as the case may be,
to have additional taxable income. A distribution to
stockholders is deemed to have been made from accumulated bad
debt reserves to the extent that (a) the bad debt reserves exceed
the amount that would have been accumulated on the basis of the
experience method, and (b) the distribution is a "nondividend
distribution." A distribution in respect of stock is a
"nondividend distribution" to the extent that, for federal income
tax purposes, (i) it is in redemption of shares, (ii) it is
pursuant to a partial or complete liquidation of the institution
or (iii) the distribution, together with all other such
distributions during the taxable year, exceeds the distributing
savings institution's current and post-1951 accumulated earnings
and profits. The amount of additional taxable income resulting
from a "nondividend distribution" is an amount that, when reduced
by the tax attributable to such distribution, is equal to the
amount of the distribution.
The Code imposes a corporate alternative minimum tax
("AMT"). The corporate AMT only applies if such tax exceeds a
corporation's regular tax liability. In general, the AMT is
calculated by multiplying the corporate AMT rate of 20% by an
amount equal to the excess of (i) the sum of (a) regular taxable
income plus (b) certain adjustments and tax preference items
("alternative minimum taxable income" or "AMTI") over (ii) an
exemption amount ($40,000 for a corporation, but such amount is
reduced by 25% of the excess of AMTI over $150,000 and is
completely eliminated when AMTI equals $310,000). The excess, if
any, of the bad debt deduction using the "percentage of taxable
income" method over the bad debt deduction calculated on the
basis of actual experience method is treated as a preference item
for determining AMTI. Although there are other applicable
adjustment and preference items (e.g., the adjustment for
depreciation) for determining AMTI of a savings institution, this
particular preference item is significant in determining AMTI.
If a savings institution is subject to AMT, then all or a portion
of the amount of such preference will effectively be subject to a
20% surtax.
Sovereign's consolidated federal income tax return, as well
as certain prior year separate returns of Jersey Shore and
Harmonia, for the tax years beginning after 1991 are open under
the statute of limitations.
State Taxation. Sovereign and its nonthrift Pennsylvania
subsidiaries are subject to the Pennsylvania Corporate Net Income
Tax and Capital Stock Tax. The Corporate Net Income Tax rate for
1995 and thereafter is 9.99% and is imposed on a corporate
taxpayer's unconsolidated taxable income for federal purposes
with certain adjustments. In general, the Capital Stock Tax is a
property tax imposed on a corporate taxpayer's capital stock
value apportionable to the Commonwealth of Pennsylvania, which is
determined in accordance with a fixed formula based upon average
book income and net worth. In the case of a holding company, an
optional elective method permits the corporate taxpayer to be
taxed on only 10% of such capital stock value. The Capital Stock
Tax rate is presently 1.275%.
Sovereign Bank is taxed under the Pennsylvania Mutual Thrift
Institutions Tax Act (the "Mutual Tax Act"). The Mutual Tax Act
exempts Sovereign Bank from all other corporate taxes imposed by
the Commonwealth of Pennsylvania for Pennsylvania purposes and
from all local taxation imposed by political subdivisions of
Pennsylvania, except taxes on real estate and real estate
transfers. The Mutual Tax Act is a tax upon net income
apportioned to Pennsylvania, determined in accordance with
generally accepted accounting principles ("GAAP"), with certain
modifications. The Mutual Tax Act, in computing GAAP income,
allows for the deduction of interest earned on Pennsylvania
governmental and federal securities, while disallowing a
percentage of a thrift's interest expense deduction in the
proportion of the interest income from those securities to the
overall interest income of the institution. Pursuant to the
Mutual Tax Act, Sovereign Bank's tax rate is presently 11.5% of
such net income.
Sovereign Bank and Colonial Bank are also taxed under the
New Jersey Savings Institution Tax. The Savings Institution Tax
rate is 3% and is imposed on the portion of the taxpayer's
modified federal taxable income (with certain adjustments) that
is properly attributable to New Jersey. Effective September 29,
1995, Sovereign Bank is subject to a Delaware Franchise Tax that
is imposed on federal savings banks not headquartered in
Delaware. The tax, which is imposed on taxable income properly
attributable to Delaware branches, varies from a rate of 8.7% on
taxable income up to $20 million to a rate of 2.7% on taxable
income over $30 million.
Item 2. PROPERTIES.
Sovereign Bank is the owner of a five-story office building
in Wyomissing, Berks County, Pennsylvania. The building is used
as Sovereign's and Sovereign Bank's executive offices and as
Sovereign Bank's operations center. Colonial Bank leases its
office building in Freehold, Monmouth County, New Jersey, from
its wholly-owned subsidiary, CSB Building Corporation. The
building is used as Colonial Bank's executive offices, retail
banking office and operations center.
Sovereign Bank has 120 branch offices, including 6 loan
production and personalized banking offices. Sovereign owns 65
of these offices and leases 55. Branch office leases are
generally long-term. Loan production and personalized banking
office leases generally have terms of two years or less.
Colonial Bank has no branch offices.
Item 3. LEGAL PROCEEDINGS.
Sovereign is not involved in any pending legal proceedings
other than nonmaterial legal proceedings occurring in the
ordinary course of business.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
Item 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.
Certain information, including principal occupation during
the past five years, relating to the principal executive officers
of Sovereign, as of March 4, 1996, is set forth below:
Richard E. Mohn - Age 65. Mr. Mohn was elected the Chairman
of the Board of Sovereign on April 24, 1995. Mr. Mohn became
Chairman of the Board of Sovereign Bank in November, 1989. He
is Chairman of Cloister Spring Water Company, Lancaster,
Pennsylvania, a bottler and distributor of spring water.
Jay S. Sidhu - Age 44. Mr. Sidhu has served as President
and Chief Executive Officer of Sovereign since November 21, 1989.
Prior thereto, Mr. Sidhu served as Treasurer and Chief Financial
Officer of Sovereign. Mr. Sidhu is also President and Chief
Executive Officer of Sovereign Bank and Colonial Bank. Prior to
becoming President and Chief Executive Officer of Sovereign Bank
on March 28, 1989, Mr. Sidhu served as Vice Chairman and Chief
Operating Officer of Sovereign Bank.
Lawrence M. Thompson, Jr. - Age 43. Mr. Thompson serves as
Chief Administrative Officer and Secretary of Sovereign and Chief
Administrative Officer and Secretary of Sovereign Bank. Upon
Sovereign's acquisition of Colonial Bank on November 15, 1995,
Mr. Thompson became Secretary of Colonial Bank. Mr. Thompson was
hired as Sovereign Bank's General Counsel and Secretary in 1984.
He was promoted to Vice President in 1985. In April 1986 he
became Sovereign Bank's Senior Vice President for legal affairs
and administration. In January, 1990, he became Group Executive
Officer - Lending and in June, 1995, he became Chief
Administrative Officer of Sovereign and Sovereign Bank.
Karl D. Gerhart - Age 43. Mr. Gerhart was elected Chief
Financial Officer and Treasurer of Sovereign on February 20,
1990. Mr. Gerhart is also Group Executive Officer, Treasurer and
Chief Financial Officer of Sovereign Bank and Treasurer and Chief
Financial Officer of Colonial Bank. Mr. Gerhart joined Sovereign
Bank in 1975 and in 1986 was promoted to Vice President-
Investments. In 1987, he became Sovereign Bank's Senior Vice
President, Treasurer and Chief Investment Officer, responsible
for managing Sovereign Bank's investment portfolio and interest
rate risk.
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
Sovereign's common stock is traded in the over-the-counter
market and is quoted on the National Association of Securities
Dealers Automated Quotation System ("NASDAQ") National Market
System under the symbol "SVRN." At March 4, 1996, the total
number of holders of record of Sovereign's common stock was
8,452.
The high and low bid prices reported on the NASDAQ National
Market System for Sovereign's common stock for 1994, adjusted to
reflect all stock dividends and splits, including a 5% stock
dividend declared on December 20, 1995, were $11.000 and $7.000
and for 1995 were $10.375 and $7.000, respectively.
During 1995, Sovereign paid a cash dividend of $.0209 per
share in the first quarter, $.0209 per share in the second
quarter, $.0209 per share in the third quarter and $.0210 per
share in the fourth quarter. During 1994, Sovereign paid a cash
dividend of $.0336 per share in the first quarter, $.0256 per
share in the second quarter, $.0258 per share in the third
quarter and $.0209 per share in the fourth quarter. During 1993,
Sovereign paid a cash dividend of $0.0250 per share in the first
quarter, $.0259 in the second quarter, $.0252 in the third
quarter and $.0231 in the fourth quarter. These per share
amounts have been adjusted to reflect all stock dividends and
stock splits and acquisitions accounted for as pooling-
of-interests.
For certain limitations on the ability of Sovereign Bank and
of Colonial Bank to pay dividends to Sovereign, see Note 10 to
Sovereign's consolidated financial statements, incorporated by
reference herein at Item 8 "Financial Statements and
Supplementary Data" and Item 1 "Business--Supervision and
Regulation--Restriction on Capital Distributions" hereof.
Item 6. SELECTED FINANCIAL DATA.
SELECTED FINANCIAL DATA(1)
BALANCE SHEET DATA
(IN THOUSANDS)
AT DECEMBER 31,
--------------------------------------------------------------
1995 1994 1993 1992(2) 1991
---------- ---------- ---------- ---------- ----------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,078,287 $6,564,082 $4,877,166 $3,699,084 $2,274,702
Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,674,364 4,350,898 2,898,014 2,337,382 1,437,247
Allowance for possible loan losses . . . . . . . . . . . . . . . . 34,856 36,289 33,099 26,562 13,198
Investment and mortgage-backed securities available-for-sale . . . 889,509 87,128 -- -- --
Investment and mortgage-backed securities held-to-maturity . . . . 2,077,212 1,816,840 1,689,304 1,001,356 644,061
Deposits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,039,143 4,027,119 3,183,107 2,961,058 1,815,679
Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,530,656 2,162,587 1,367,100 427,591 285,059
Stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . 427,025 303,900 259,121 220,419 137,259
SUMMARY STATEMENT OF OPERATIONS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1995 1994 1993 1992(2) 1991
---------- ---------- ---------- ---------- ----------
Total interest income . . . . . . . . . . . . . . . . . . . . . . $ 493,031 $ 354,141 $ 282,790 $ 199,431 $ 182,015
Total interest expense . . . . . . . . . . . . . . . . . . . . . 318,805 198,741 153,318 118,585 125,326
---------- ---------- ---------- ---------- ----------
Net interest income . . . . . . . . . . . . . . . . . . . . . . . 174,226 155,400 129,472 80,846 56,689
Provision for possible loan losses . . . . . . . . . . . . . . . 1,000 4,100 8,650 10,080 6,796
---------- ---------- ---------- ---------- ----------
Net interest income after provision for possible loan losses. . . 173,226 151,300 120,822 70,766 49,893
---------- ---------- ---------- ---------- ----------
Other income . . . . . . . . . . . . . . . . . . . . . . . . . . 25,829 14,554 15,167 10,965 5,083
Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . 113,108 90,989 77,377 47,036 33,460
---------- ---------- ---------- ---------- ----------
Income before income taxes and cumulative effect of change
in accounting principle . . . . . . . . . . . . . . . . . . . . 85,947 74,865 58,612 34,695 21,516
Income tax provision . . . . . . . . . . . . . . . . . . . . . . 29,539 28,467 22,998 15,057 9,534
---------- ---------- ---------- ---------- ----------
Income before cumulative effect of change in accounting principle 56,408 46,398 35,614 19,638 11,982
Cumulative effect of change in accounting principle . . . . . . . -- -- 4,800 -- --
---------- ---------- ---------- ---------- ----------
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 56,408 $ 46,398 $ 40,414 $ 19,638 $ 11,982
========== ========== ========== ========== ==========
Net income applicable to common stock . . . . . . . . . . . . . . $ 51,719 $ 46,398 $ 40,414 $ 19,638 $ 11,982
========== ========== ========== ========== ==========
SHARE DATA(3)
Common shares outstanding at end of period (in thousands) . . . . 45,465 45,567 41,357 40,682 23,898
Preferred shares outstanding at end of period (in thousands) . . . 2,000 -- -- -- --
Earnings per common and common equivalent share:
Before cumulative effect of change in accounting principle. . $ 1.00 $ .90 $ .70 $ .51 $ .37
After cumulative effect of change in accounting principle . . 1.00 .90 .80 .51 .37
Book value per common and common equivalent share at end of
period(4). . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.40 6.05 5.24 4.53 3.73
Common share price at end of period . . . . . . . . . . . . . . . 9 5/8 7 10 11/16 6 1/16 3 3/16
Dividends paid per common share . . . . . . . . . . . . . . . . . .084 .106 .099 .082 .058
Dividend payout ratio. . . . . . . . . . . . . . . . . . . . . . . 8.40% 11.78% 14.14% 16.08% 15.68%
(1) The acquisitions of Valley Federal and Charter were
accounted for as pooling-of-interests and accordingly, the
consolidated financial statements have been restated to
include the accounts of Valley Federal and Charter for all
periods presented.
(2) The acquisition of Harmonia was accounted for as a purchase
at the close of business on December 31, 1992. Sovereign's
consolidated balance sheet at December 31, 1992, includes
Harmonia. Sovereign's 1992 consolidated results of
operations do not include Harmonia's results.
(3) All per share data have been adjusted to reflect all stock
dividends and stock splits.
(4) Book value is calculated using equity divided by common
shares and, if converted, preferred shares.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
General. Sovereign and subsidiaries reported net income of
$56.4 million for the year ended December 31, 1995. This
represents an increase of 22% over net income of $46.4 million
reported for 1994. Earnings per share were $1.00 for 1995 which
represents an increase of 11% over 1994 earnings per share of
$.90. Return on average equity and return on average assets were
14.95% and .78%, respectively, for 1995 compared to 16.47% and
.84%, respectively, for 1994. Return on average risk-adjusted
assets was 1.68% for 1995 compared to 1.77% for 1994.
Sovereign's financial results include the following significant
events:
Interest Rate Environment. During 1995, the Board of
Governors of the Federal Reserve System lowered short-term
interest rates three times, resulting in a 1% reduction in
short-term rates. Long-term interest rates responded
dramatically to 1995's slowing economy and lower rate of
inflation by decreasing more than 2% during the year. This
tightening of interest rates resulted in a flat yield curve (a
shrinking of the difference between short-term rates and
long-term rates). The flat yield curve coupled with a low
interest rate environment caused a contraction of Sovereign's
interest rate spread (the difference between the yield on total
assets and the cost of total liabilities and stockholders'
equity) from 2.82% in 1994 to 2.42% in 1995. While the flat
yield curve compressed Sovereign's interest rate spread, it did
allow Sovereign the opportunity to extend the maturity and
repricing of its liabilities and shorten the maturity and
repricing of its assets. This repositioning shifted Sovereign's
one year gap position (the ratio representing the difference
between assets, liabilities and off-balance sheet positions which
will mature or reprice within one year expressed as a percentage
of average assets) from a negative 10.5% at December 31, 1994, to
a negative .29% at December 31, 1995.
Berkeley. On November 17, 1995, Sovereign acquired two
branch offices and related deposits from Berkeley Federal Bank &
Trust, FSB ("Berkeley"). Sovereign assumed approximately
$111.7 million of deposit liabilities and received approximately
$104.9 million of cash.
Colonial. On November 15, 1995, Sovereign acquired Colonial
Bank in a transaction accounted for as a purchase. Sovereign
acquired $46.5 million of assets consisting principally of loans
and investment securities. Sovereign also assumed approximately
$42.0 million of deposit liabilities. Sovereign acquired
Colonial Bank in exchange for $6.3 million in cash. Colonial
Bank operates as a separate banking subsidiary of Sovereign.
Colonial's results of operations from November 15, 1995,
and thereafter, have been included in Sovereign's consolidated
results of operations.
Northwest Savings Bank and Union National Bank & Trust
Company. On November 10, 1995, Sovereign completed the sale of
its Pottsville, Pennsylvania branch office with related deposits
totalling $23.9 million to Northwest Savings Bank ("Northwest")
and the sale of its English Village branch office in North Wales,
Pennsylvania with related deposits of $12.4 million to Union
National Bank & Trust Company ("Union National"). As a result of
these transactions, Sovereign recognized a pre-tax gain of
$1.1 million and reduced goodwill by $568,000, respectively.
Collective. On April 21, 1995, Sovereign completed the sale
of seven southern New Jersey offices with related deposits
totalling $106.7 million to Collective Bancorp, Inc.
("Collective"). Six of these offices had previously been
purchased from Berkeley as part of a transaction which occurred
on January 1, 1995. In addition, Sovereign acquired $7.0 million
of deposits from Collective's Wilmington, Delaware branch office.
As a result of this transaction, Sovereign recognized a pre-tax
gain of $1.5 million and reduced its existing core deposit
intangible by approximately $6.0 million.
Berkeley. On January 1, 1995, Sovereign acquired 23 branch
offices located in New Jersey and Delaware with $909.3 million of
deposit liabilities from Berkeley. In exchange for assuming the
deposits of the Berkeley offices, Sovereign acquired principally
cash and fixed assets, net of a deposit premium of $66.6 million.
Charter. On November 1, 1994, Sovereign acquired Charter
FSB Bancorp, Inc. ("Charter"). At September 30, 1994, Charter
had total assets, deposits and stockholders' equity of
approximately $405.8 million, $341.4 million and $41.7 million,
respectively. Sovereign exchanged a total of 7.0 million new
shares (7.7 million shares as adjusted for all subsequent stock
dividends) of Sovereign common stock with a value of
$62.7 million for all of the outstanding shares of Charter common
stock.
The acquisition of Charter was accounted for as a
pooling-of-interests and accordingly, the consolidated financial
statements have been restated to include the accounts of Charter
for all periods presented.
Second National. On September 16, 1994, Sovereign acquired
the Chadds Ford, Pennsylvania office and related deposits of
Second National Federal Savings Association ("Second National")
from the Resolution Trust Corporation ("RTC"), receiver for
Second National. Sovereign assumed approximately $14.4 million
of deposit liabilities and received approximately $13.7 million
of cash.
Shadow Lawn. On August 5, 1994, Sovereign acquired Shadow
Lawn Savings Bank ("Shadow Lawn") in a transaction accounted for
as a purchase. Sovereign acquired $787.5 million of assets
consisting principally of investment and mortgage-backed
securities and loans. Sovereign also assumed approximately
$730.6 million of deposit liabilities. Sovereign acquired Shadow
Lawn in exchange for $78.4 million of cash.
Shadow Lawn's results of operations from August 5, 1994, and
thereafter, have been included in Sovereign's consolidated
results of operations.
Valley Federal. On November 5, 1993, Sovereign acquired
Valley Federal Savings and Loan Association ("Valley Federal").
At September 30, 1993, Valley Federal had total assets, deposits
and stockholders' equity of $315.7 million, $256.4 million and
$18.6 million, respectively. Sovereign exchanged a total of
2.9 million new shares (3.5 million shares as adjusted for all
subsequent stock dividends) of Sovereign common stock with a
value of $32.3 million for all of the outstanding shares of
Valley Federal common stock.
The acquisition of Valley Federal was accounted for as a
pooling-of-interests and accordingly, the consolidated financial
statements have been restated to include the accounts of Valley
Federal for all periods presented.
Home Unity. On August 27, 1993, Sovereign assumed
$252.3 million of deposit liabilities and received $233.7 million
of cash from the RTC as receiver of nine branch offices of Home
Unity Federal Savings and Loan Association ("Home Unity").
Harmonia. On January 15, 1993, Sovereign formally acquired
Harmonia Bancorp, Inc. ("Harmonia") in a transaction which was
accounted for as a purchase. Pursuant to applicable accounting
guidance for business combinations, the Harmonia acquisition was
accounted for as having been completed at the close of business
on December 31, 1992, because control of Harmonia had been
transferred to Sovereign as of that date. Sovereign acquired
total assets of $621.0 million consisting principally of cash and
interest-earning deposits, federal funds sold, investment and
mortgage-backed securities and performing loans. Sovereign
assumed liabilities consisting principally of deposits.
Sovereign acquired Harmonia in exchange for $19.6 million of cash
and 9.6 million new shares (11.6 million shares as adjusted for
all subsequent stock dividends) of Sovereign common stock which
were issued at a value of $66.1 million.
Since the Harmonia acquisition was accounted for at the
close of business on December 31, 1992, Sovereign's consolidated
balance sheet at December 31, 1992, includes Harmonia.
Sovereign's consolidated results of operations include Harmonia's
results of operations from January 1, 1993, and thereafter.
Accounting Changes. In January 1994, Sovereign adopted
Statement of Financial Accounting Standards ("SFAS") No. 115
"Accounting for Certain Investments in Debt and Equity
Securities," which requires management to classify investments in
equity securities that have readily determinable fair values and
all investments in debt securities as either held-to-maturity and
reported at amortized cost, available-for-sale and reported at
fair value with unrealized gains and losses reported in a
separate component of stockholders' equity, or trading securities
and reported at fair value with unrealized gains and losses
included in earnings. Effective January 1, 1994, Sovereign
classified $1.29 billion of securities as held-to-maturity,
$391.0 million of securities as available-for-sale and
$6.5 million of securities as trading securities. The adoption
of SFAS No. 115 resulted in an $836,000 increase to stockholders'
equity accounted for as the cumulative effect of a change in
accounting principle in 1994. On November 15, 1995, the
Financial Accounting Standards Board ("FASB") issued a Special
Report, "A Guide to Implementation of Statement 115 on Accounting
for Certain Investments in Debt and Equity Securities". On
December 7, 1995, in accordance with provisions in that Special
Report, Sovereign reclassified $750.2 million of securities from
held-to-maturity to available-for-sale. This reclassification
resulted in a $1.7 million unrealized gain, net of tax, which is
included in Sovereign's stockholders' equity at December 31,
1995.
In October 1995, the FASB issued SFAS No. 123 "Accounting
for Stock-Based Compensation" which provides companies with a
choice either to expense the fair value of employee stock options
over the vesting period (recognition method) or to continue the
previous practice but disclose the pro forma effects on net
income and earnings per share had the fair value method been used
(disclosure only method). Companies electing the disclosure only
method will be required to include the pro forma effects of all
awards granted in fiscal years beginning after December 15, 1994.
Sovereign plans to adopt the disclosure only method during 1996.
Effective July 1, 1995, Sovereign prospectively adopted SFAS
No. 122 "Accounting for Mortgage Servicing Rights". SFAS No.
122 requires that management recognize as separate assets, rights
to service mortgage loans for others, however those servicing
rights are acquired. Management allocates the total cost of
mortgage loans, either purchased or originated, to the loans and
the mortgage servicing rights based on their relative fair value.
The Statement also requires that management assess its
capitalized mortgage servicing rights for impairment based on the
fair value of those rights, and that this impairment be
recognized through a valuation allowance. The adoption of SFAS
No. 122 will not have a material effect on Sovereign's
operations.
Sovereign adopted SFAS No. 109 in January 1993, and has
applied the provisions of the statement without restating prior
years' financial statements. The adoption of SFAS No. 109
resulted in a $4.8 million increase to net income ($.10 per
share) that was accounted for as the cumulative effect of a
change in accounting principle.
Subordinated Debentures. On July 18, 1995, Sovereign issued
$50.0 million of 6.75% non-amortizing subordinated debentures due
July 1, 2000, receiving net proceeds of approximately
$49.4 million. On September 1, 1993, Sovereign issued
$50.0 million of 6.75% non-amortizing subordinated debentures due
September 1, 2000, receiving net proceeds of approximately
$49.2 million. On April 7, 1993, Sovereign issued $50.0 million
of 8.00% non-amortizing subordinated debentures due March 15,
2003, receiving net proceeds of approximately $48.7 million. All
of the subordinated debentures qualify as supplementary capital
at Sovereign Bancorp. Approximately $100.0 million of the net
proceeds of Sovereign's subordinated debentures has been
contributed to the capital of Sovereign Bank and qualifies as
primary capital at Sovereign Bank.
Preferred Stock. On May 17, 1995, Sovereign completed the
sale of 2.0 million shares of Convertible Preferred Stock,
raising $96.7 million in capital. The 6 1/4%, non-voting,
Cumulative Convertible Preferred Stock is convertible at the
option of the holder at any time, unless previously redeemed, at
a conversion rate of 4.989 shares of common stock for each share
of preferred stock, equivalent to a conversion price of
$10.022 per share of common stock.
Stock Dividends. Sovereign declared a 5% stock dividend on
December 20, 1995 and on February 22, 1995, and a 10% stock
dividend on April 19, 1994. All per share information such as
earnings, book value, share price and dividends have been
restated to reflect all stock dividends and stock splits. See
Item 8, at Note 1(c) to Sovereign Consolidated Financial
Statements for a detailed discussion of Sovereign's stock
dividends and stock splits.
Federal Deposit Insurance Corporation. Sovereign Bank is
insured by the SAIF of the FDIC and pays insurance fees equal to
$.23 per $100.00 (23 basis points) of insured deposits annually,
the lowest rate permitted. The average SAIF premium is 24 basis
points. Colonial Bank is insured by the BIF of the FDIC. During
recent years, the FDIC's BIF, which insures commercial banks and
certain savings banks, has also charged an average premium to its
members of 24 basis points, and a minimum assessment of 23 basis
points.
Effective September 30, 1995, the average BIF premium was
reduced from 24 basis points to 4.4 basis points, with the
minimum assessment being reduced from 23 basis points to 4 basis
points. Subsequently, the minimum BIF assessment was reduced to
0 basis points effective January 1, 1996, subject to the minimum
FDIC annual assessment of $1,000. The average and minimum SAIF
premiums remain at 24 and 23 basis points, respectively, until
the SAIF reserves reach $1.25 per $100.00 in insured deposits.
In order to accelerate the recapitalization of the SAIF, it
has been proposed that SAIF-insured institutions such as
Sovereign Bank be assessed a one-time charge of between 85 and
90 basis points of their insured deposits as of March 31, 1995.
If enacted, this assessment would result in a pre-tax charge to
Sovereign Bank's earnings of approximately $36.0 million to
$38.1 million. This charge would have a significant negative
impact on earnings in the period enacted. In accordance with
FASB guidance on this specific issue, no liability or charge for
this assessment is included in the 1995 audited financial
statements.
While it cannot be determined at this time what the outcome
of these events and proposals will be, Sovereign Bank has been
placed at a significant competitive disadvantage which will
remain until the BIF and SAIF insurance premiums are again made
equal.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995 AND
1994
Net Interest Income. Net interest income for 1995 was
$174.2 million compared to $155.4 million in 1994. This
represents an increase of 12% and is primarily due to an increase
in the size of the balance sheet resulting from the recent
acquisitions and internal growth, partially offset by a decline
in Sovereign's interest rate spread.
Interest and fees on loans were $327.5 million for 1995
compared to $248.7 million for 1994. The average balance of
loans was $4.50 billion with an average yield of 7.29% for 1995
compared to an average balance of $3.58 billion with an average
yield of 6.95% for 1994. The increase in average balance was
primarily due to the origination of $1.06 billion of residential
mortgage loans of which $808.8 million (principally discounted
adjustable rate loans) were retained in Sovereign's loan
portfolio. The increase in yield was the result of the upward
repricing of discounted adjustable rate loans which Sovereign
originated in 1994.
Interest on investment and mortgage-backed securities
available-for-sale was $10.1 million for 1995 compared to
$6.2 million for 1994. The average balance of investment and
mortgage-backed securities available-for-sale was $147.7 million
with an average yield of 7.09% for 1995 compared to an average
balance of $104.3 million with an average yield of 6.27% in 1994.
The increase in average yield is the result of generally higher
interest rates.
Interest on investment and mortgage-backed securities
held-to-maturity was $151.6 million for 1995 compared to
$96.7 million for 1994. The average balance of investment and
mortgage-backed securities held-to-maturity was $2.19 billion
with an average yield of 6.92% for 1995 compared to an average
balance of $1.55 billion with an average yield of 6.24% for 1994.
Interest on interest-earning deposits was $3.8 million for
1995 compared to $2.5 million for 1994. The average balance of
interest-earning deposits was $23.9 million with an average yield
of 16.10% for 1995 compared to an average balance of
$43.5 million with an average yield of 5.77% for 1994.
Interest on total deposits was $210.3 million for 1995
compared to $121.8 million for 1994. The average balance of
total deposits was $4.95 billion with an average cost of 4.25%
for 1995 compared to an average balance of $3.58 billion with an
average cost of 3.40% for 1994. The increase in average balance
was primarily due to the Berkeley acquisition. The increase in
the average cost of deposits was a result of a general rise in
interest rates.
Interest on total borrowings was $108.5 million for 1995
compared to $76.9 million for 1994. The average balance of total
borrowings was $1.83 billion with an average cost of 5.92% for
1995 compared to an average balance of $1.59 billion with an
average cost of 4.84% for 1994. The increase in average cost of
borrowings is a result of the general rise in interest rates and
the cost of the subordinated debentures issued during 1995.
Table 1 presents a summary of Sovereign's average balances,
the yields earned on average assets and the cost of average
liabilities and stockholders' equity for the years ended
December 31, 1995, 1994 and 1993 (in thousands):
Table 1: Spread Analysis
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
1995 1994
---------------------------------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE
---------- -------- ------ ---------- -------- ------
Interest-earning assets:
Interest-earning deposits . . . . . . . . . . . . $ 23,868 $ 3,843 16.10% $ 43,503 $ 2,508 5.77%
Investment and mortgage-backed securities
available-for-sale(1) . . . . . . . . . . . . . 147,658 10,118 7.09 104,296 6,188 6.27
Investment and mortgage-backed securities
held-to-maturity(2)(3) . . . . . . . . . . . . 2,191,395 151,620 6.92 1,549,999 96,729 6.24
Net loans(4)(5) . . . . . . . . . . . . . . . . 4,496,756 327,450 7.29 3,581,685 248,716 6.95
---------- -------- ----- ---------- -------- ----
Total interest-earning assets . . . . . . . . . . 6,859,677 493,031 7.19 5,279,483 354,141 6.72
Non-interest-earning assets . . . . . . . . . . . 366,931 -- -- 250,836 -- --
---------- -------- ----- ---------- -------- ----
Total assets . . . . . . . . . . . . . . . . . $7,226,608 493,031 6.83 $5,530,319 354,141 6.41
========== -------- ----- ========== -------- ----
Interest-bearing liabilities:
Deposits:
Savings deposits . . . . . . . . . . . . . . . $2,017,194 53,059 2.63 $1,594,473 36,677 2.30
Certificates . . . . . . . . . . . . . . . . . 2,929,025 157,208 5.37 1,989,931 85,135 4.28
---------- -------- ----- ---------- -------- ----
Total deposits . . . . . . . . . . . . . . . . 4,946,219 210,267 4.25 3,584,404 121,812 3.40
Total borrowings . . . . . . . . . . . . . . . . 1,832,446 108,538 5.92 1,588,560 76,929 4.84
---------- -------- ----- ---------- -------- ----
Total interest-bearing liabilities 6,778,665 318,805 4.70 5,172,964 198,741 3.84
Non-interest-bearing liabilities 70,630 -- -- 75,694 -- --
---------- -------- ----- ---------- -------- ----
Total liabilities . . . . . . . . . . . . . . 6,849,295 318,805 4.65 5,248,658 198,741 3.79
Stockholders' equity . . . . . . . . . . . . . . 377,313 -- -- 281,661 -- --
---------- -------- ----- ---------- -------- ----
Total liabilities and stockholders' equity . . $7,226,608 318,805 4.41 $5,530,319 198,741 3.59
========== -------- ----- ========== -------- ----
Interest rate spread(6) . . . . . . . . . . . . 2.42% 2.82%
===== ====
Net interest income/net yield on total
interest-earning assets(7) $174,226 2.54% $155,400 2.96%
======== ===== ======== ====
Ratio of interest-earning assets to interest-
bearing liabilities . . . . . . . . . . . . . . 1.01x 1.02x
===== ====
YEAR ENDED DECEMBER 31,
------------------------------
1993
------------------------------
AVERAGE YIELD/
BALANCE INTEREST RATE
---------- -------- ------
Interest-earning assets:
Interest-earning deposits . . . . $ 82,980 $ 3,344 4.03%
Investment and
mortgage-backed securities
available-for-sale(1) . . . . . -- -- --
Investment and
mortgage-backed securities
held-to-maturity(2)(3) . . . . 1,530,073 92,534 6.06
Net loans(4)(5) . . . . . . . . 2,547,943 186,912 7.34
---------- -------- -----
Total interest-earning assets . 4,160,996 282,790 6.80
Non-interest-earning assets . . . 213,247 -- --
---------- -------- -----
Total assets . . . . . . . . . $4,374,243 282,790 6.47
========== -------- -----
Interest-bearing liabilities:
Deposits:
Savings deposits . . . . . . . $1,388,795 38,368 2.76
Certificates . . . . . . . . . 1,665,038 69,702 4.19
---------- -------- -----
Total deposits . . . . . . . . 3,053,833 108,070 3.54
Total borrowings . . . . . . . . 1,001,793 45,248 4.52
---------- -------- -----
Total interest-bearing liabilities 4,055,626 153,318 3.78
Non-interest-bearing liabilities 77,447 -- --
---------- -------- -----
Total liabilities . . . . . . 4,133,073 153,318 3.71
Stockholders' equity . . . . . . 241,170 -- --
---------- -------- -----
Total liabilities and
stockholders' equity . . . . $4,374,243 153,318 3.51
========== -------- -----
Interest rate spread(6) . . . . 2.96%
====
Net interest income/net yield on
total interest-earning assets(7) $129,472 3.11%
======== ====
Ratio of interest-earning
assets to interest-
bearing liabilities . . . . . . 1.03x
====
(1) The tax equivalent adjustments for the years ended
December 31, 1995 and 1994 were $344,000 and $346,000,
respectively, and are based on a tax rate of 38% in 1995 and
35% in 1994.
(2) The tax equivalent adjustment for the year ended
December 31, 1993 was $145,000 and is based on a tax rate of
35%, (none in 1994 or 1995).
(3) Amortization of fees of $52,000 pertaining to
mortgage-backed securities is included in interest income
for the year ended December 31, 1993, (none in 1994 or
1995).
(4) Amortization of net fees of $2,574,000, $476,000 and
$4,491,000 for the years ended December 31, 1995, 1994 and
1993, respectively, are included in interest income.
Average loan balances include non-accrual loans and loans
held for resale.
(5) The tax equivalent adjustments for the years ended
December 31, 1995, 1994 and 1993, were $144,000, $150,000
and $152,000, respectively, and are based on a tax rate of
38% in 1995 and 35% in 1994 and 1993.
(6) Represents the difference between the yield on total assets
and the cost of total liabilities and stockholders' equity.
(7) Represents tax equivalent net interest income divided by
interest-earning assets.
Table 2 presents, prior to any tax equivalent adjustments,
the relative contribution of changes in volumes and changes in
rates to changes in net interest income for the periods
indicated. The change in interest income and interest expense
attributable to the combined impact of both volume and rate has
been allocated proportionately to the change due to volume and
the change due to rate (in thousands):
Table 2: Volume/Rate Analysis
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------------
1995 VS. 1994 1994 VS. 1993
INCREASE/(DECREASE) INCREASE/(DECREASE)
------------------------------------- --------------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------- --------- -------- -------- -------- -------
Interest-earning assets:
Interest-earning deposits . . . . $ (449) $ 1,784 $ 1,335 $ (8,809) $ 7,973 $ (836)
Investment and mortgage-backed
securities available-for-sale 2,863 1,067 3,930 6,188 -- 6,188
Investment and mortgage-backed
securities held-to-maturity . 43,472 11,419 54,891 1,216 2,979 4,195
Net Loans(1) . . . . . . . . . . 66,140 12,594 78,734 72,255 (10,451) 61,804
======= ======== -------- ======== ======== --------
Total interest-earning assets . . 138,890 71,351
-------- --------
Interest-bearing liabilities:
Deposits . . . . . . . . . . . 53,273 35,182 88,455 18,169 (4,427) 13,742
Borrowings . . . . . . . . . . 12,885 18,724 31,609 28,205 3,476 31,681
======= ======== -------- ======== ======== --------
Total interest-bearing liabilities 120,064 45,423
-------- --------
Net change in net interest income $42,395 $(23,569) $ 18,826 $ 32,183 $ (6,255) $25,928
======= ======== ======== ======== ======== ========
(1) Includes non-accrual loans and loans held for resale.
Provision for Possible Loan Losses. The provision for
possible loan losses was $1.0 million for 1995 compared to
$4.1 million for 1994. This decreased provision was the result of
improved asset quality. See "Credit Quality" for a detailed
discussion of Sovereign's asset quality.
During 1995, Sovereign charged-off (net of recoveries)
$2.9 million of loans compared to $5.6 million during 1994. The
decreased level of charge-offs is primarily due to $2.4 million
of charge-offs in 1994 that did not recur in 1995. The
$2.4 million of charge-offs in 1994 were related to the
disposition of $40.4 million of non-performing assets acquired in
the Shadow Lawn acquisition. Sovereign also acquired a $485,000
allowance for possible loan losses in the Colonial acquisition.
Table 3 presents the activity in the allowance for possible
loan losses for the years indicated (in thousands):
Table 3: Reconciliation of the Allowance for Possible Loan
Losses
DECEMBER 31,
------------------------------------------------------------------------
1995 1994 1993 1992 1991
------- ------- ------- ------- -------
Allowance, beginning of year . . . . . . . . . . . . $36,289 $33,099 $26,562 $13,198 $ 8,823
Charge-offs:
Residential . . . . . . . . . . . . . . . . . . . . 2,679 2,563 1,077 905 2,216
Commercial real estate . . . . . . . . . . . . . . 498 2,932 292 618 133
Commercial . . . . . . . . . . . . . . . . . . . . -- -- 1 1,853 104
Consumer (including home equity lines of credit) . 403 933 894 740 5
------- ------- ------- ------- -------
Total charge-offs . . . . . . . . . . . . . . . 3,580 6,428 2,264 4,116 2,458
------- ------- ------- ------- -------
Recoveries:
Residential . . . . . . . . . . . . . . . . . . . 514 352 7 41 17
Commercial real estate . . . . . . . . . . . . . . 125 82 49 54 5
Commercial . . . . . . . . . . . . . . . . . . . . -- 75 45 3 12
Consumer (including home equity lines of credit) . 23 297 6 28 3
------- ------- ------- ------- -------
Total recoveries . . . . . . . . . . . . . . . . 662 806 107 126 37
------- ------- ------- ------- -------
Charge-offs, net of recoveries . . . . . . . . . . . 2,918 5,622 2,157 3,990 2,421
Provision for possible loan losses . . . . . . . . . 1,000 4,100 8,650 10,080 6,796
Acquired reserves and other additions . . . . . . . . 485 4,712 44 7,274 --
------- ------- ------- ------- -------
Allowance, end of year . . . . . . . . . . . . . . . $34,856 $36,289 $33,099 $26,562 $13,198
======= ======= ======= ======= =======
Charge-offs, net of recoveries to average loans . . . .064% .155% .084% .237% .179%
======= ======= ======= ======= =======
Other Income. Total other income was $25.8 million for 1995
compared to $14.6 million for 1994.
Other loan fees and service charges were $4.4 million for
1995 compared to $5.0 million for 1994. This decrease was
primarily due to a decrease in Sovereign's servicing portfolio.
At December 31, 1995, Sovereign serviced $4.04 billion of its own
loans and $947.1 million of loans for others. This compares to
$3.90 billion of its own loans and $1.11 billion of loans for
others at December 31, 1994.
Deposit fees were $9.4 million for 1995 compared to
$5.8 million for 1994. This increase was primarily the result of
the Berkeley acquisition and the full year effect of the Shadow
Lawn acquisition.
The gain on loans and investment and mortgage-backed
securities was $419,000 for 1995 compared to $494,000 for 1994.
Mortgage banking gains were $6.1 million for 1995 compared
to $1.5 million for 1994. The 1995 gain includes a $3.6 million
gain recognized on the sale of $238.5 million of mortgage
servicing rights. The 1994 gain includes a $1.1 million gain on
the sale of servicing rights related to $111.4 million of
residential mortgage loans.
Miscellaneous income was $5.5 million for 1995 compared to
$1.8 million for 1994. This increase includes a $2.6 million
gain on the sale of $130.6 million of deposits sold during 1995.
General and Administrative Expenses. Total general and
administrative expenses were $100.3 million for 1995 compared to
$84.4 million for 1994. The 19% increase in general and
administrative expenses from 1994 to 1995 compares to a 31%
increase in the average balance sheet over the same time period.
The ratio of general and administrative expenses to average
assets was 1.39% for 1995 compared to 1.53% for 1994. This
decrease in the expense ratio is the result of efficiencies
realized from recent acquisitions and an increase in average
balances without a corresponding increase in operating expenses.
Other operating expenses were $12.8 million for 1995
compared to $6.6 million for 1994. Included in other operating
expenses was amortization of goodwill and other intangible assets
of $12.2 million for 1995 compared to $6.5 million for 1994.
This increase was primarily the result of the Berkeley
acquisition and a full year of amortization of goodwill and core
deposit intangibles resulting from the Shadow Lawn acquisition.
Real estate owned ("REO") losses were $657,000 for 1995 compared
to $91,000 for 1994.
Income Tax Provision. The income tax provision was
$29.5 million for 1995 compared to $28.5 million for 1994. The
effective tax rate for 1995 was 34.4% compared to 38.0% for 1994.
FINANCIAL CONDITION
Loan Portfolio. Sovereign's primary loan products are
variable rate mortgage loans on owner occupied residential real
estate. Sovereign's focus on these products has resulted in
97.8% of Sovereign's total loan portfolio at December 31, 1995
being secured by residential real estate and $3.54 billion or
75.7% of the total loan portfolio being comprised of variable
rate loans. However, as a result of Sovereign's use of interest
rate swaps, $426.1 million of variable rate mortgage loans have
been effectively converted to fixed rate mortgage loans. Also,
$295.7 million of intermediate variable rate mortgage loans
(loans with a five-year fixed rate period) have effectively been
converted to a variable rate over the fixed rate period. At
December 31, 1995, Sovereign's total loan portfolio of
$4.67 billion included $4.00 billion of first mortgage loans
secured primarily by liens on owner occupied one-to-four family
residential properties and $456.9 million of outstanding home
equity loans ($293.1 million of additional unused commitments for
home equity lines of credit) secured primarily by second
mortgages on owner occupied one-to-four family residential
properties. At December 31, 1995, Sovereign's residential loan
portfolio also included $75.2 million of multi-family loans.
Table 4 presents the composition of Sovereign's loan
portfolio by type of loan and by fixed and adjustable rates at
the dates indicated (in thousands):
Table 4: Composition of Loan Portfolio
AT DECEMBER 31,
-----------------------------------------------------------------------------
1995 1994 1993
----------------------- ----------------------- ----------------------
BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT
---------- ------- ---------- -------- ---------- --------
Residential real estate
loans: . . . . . . . . . . . . . $3,998,048 85.53% $3,710,150 85.27% $2,434,520 84.01%
Real estate construction
loans:
Residential . . . . . . . . . . 38,151 .82 49,094 1.13 23,086 .80
Residential development . . . . 1,676 .04 3,226 .08 3,205 .11
Multi-family loans . . . . . . . . 75,218 1.61 95,216 2.19 117,257 4.04
Home equity loans . . . . . . . . . 456,922 9.77 413,037 9.49 270,471 9.33
---------- ------ ---------- ----- --------- ------
Total Residential
Loans . . . . . . . . . . . . . 4,570,015 97.77 4,270,723 98.16 2,848,539 98.29
Commercial real estate
loans . . . . . . . . . . . . . . 47,177 1.01 39,717 .91 18,259 .63
Commercial loans . . . . . . . . . 15,831 .34 5,730 .13 8,351 .29
Consumer loans . . . . . . . . . . 41,341 .88 34,728 .80 22,865 .79
---------- ------ ---------- ------ ---------- ------
Total Loans . . . . . . . . . . . $4,674,364 100.00% $4,350,898 100.00% $2,898,014 100.00%
========== ====== ========== ====== ========== ======
Total Loans with:
Fixed rates . . . . . . . . . . . $1,134,542 24.27% $1,097,469 25.22% $905,320 31.24%
Variable rates . . . . . . . . . 3,539,822 75.73 3,253,429 74.78 1,992,694 68.76
---------- ------ ---------- ------ ---------- ------
Total Loans . . . . . . . . . . $4,674,364 100.00% $4,350,898 100.00% $2,898,014 100.00%
========== ====== ========== ====== ========== ======
AT DECEMBER 31,
-------------------------------------------------
1992 1991
---------------------- ----------------------
BALANCE PERCENT BALANCE PERCENT
---------- ------- ---------- -------
Residential real estate
loans: . . . . . . . . . . . . . $1,830,629 78.32% $1,113,224 77.46%
Real estate construction
loans:
Residential . . . . . . . . . . 38,954 1.67 28,040 1.95
Residential development . . . . 2,029 .09 2,522 .18
Multi-family loans . . . . . . . . 125,443 5.37 6,748 .47
Home equity loans . . . . . . . . . 260,514 11.14 191,651 13.33
---------- ----- ---------- -----
Total Residential
Loans . . . . . . . . . . . . . 2,257,569 96.59 1,342,185 93.39
Commercial real estate
loans . . . . . . . . . . . . . . 31,214 1.34 42,455 2.95
Commercial loans . . . . . . . . . 7,565 .32 7,878 .55
Consumer loans . . . . . . . . . . 41,034 1.75 44,729 3.11
---------- ----- ---------- -----
Total Loans . . . . . . . . . . . $2,337,382 100.00% $1,437,247 100.00%
========== ====== ========== ======
Total Loans with:
Fixed rates . . . . . . . . . . . $ 737,339 31.55% $ 420,151 29.23%
Variable rates . . . . . . . . . 1,600,043 68.45 1,017,096 70.77
--------- ------ --------- ------
Total Loans . . . . . . . . . . $2,337,382 100.00% $1,437,247 100.00%
========== ====== ========== ======
Credit Quality. Since Sovereign's primary loan products are
residential loans, Sovereign has instituted various controls
specifically designed to improve the credit quality of
residential loans. For instance, Sovereign utilizes underwriting
standards which in some cases are more conservative than the
Federal Home Loan Mortgage Corporation ("FHLMC") or the Federal
National Mortgage Association ("FNMA"). Sovereign maintains an
independent Loan Review Department which each month reviews a
statistical sampling of all new originations for sound
underwriting practices and reviews and rates all mortgage loan
requests in excess of $300,000 with a loan-to-value ratio in
excess of 75% and all applications for home equity lines of
credit of $100,000 and over with a loan-to-value ratio in excess
of 70%, prior to submission of the loan for underwriting.
Results of these loan reviews are discussed at quarterly Loan
Review meetings. Criticized loans and deficiencies in those
loans are discussed and corrected.
Sovereign also closely monitors delinquencies as a means of
maintaining high asset quality. Collection efforts begin as
early as 15 days after a loan payment is due. All borrowers
whose loans are more than 30 days past due are contacted by a
collection officer in an effort to correct the delinquency. Once
a loan is more than 90 days past due, it is referred to the Asset
Recovery and Liquidation Department and the process of
liquidation begins. Sovereign monitors delinquency trends at 30,
60 and 90 days past due. These trends are discussed at the
quarterly Loan Review and monthly Asset Review meetings, and with
the Boards of Directors of Sovereign Bancorp and Sovereign Bank.
At December 31, 1995, Sovereign's non-performing assets were
$43.7 million compared to $40.5 million at December 31, 1994.
Non-performing assets as a percentage of total assets were .54%
at December 31, 1995 compared to .62% at December 31, 1994. At
December 31, 1995, 84% of non-performing assets consisted of
loans or REO related to one-to-four family residential real
estate. Historically, losses on the disposition of non-
performing residential real estate have been lower than non-
performing commercial and commercial real estate loans. The
remainder of Sovereign's non-performing assets consist
principally of commercial, residential development and multi-
family REO acquired in the Shadow Lawn acquisition. Non-
performing assets at December 31, 1995, included $4.5 million of
REO which is carried at lower of cost or estimated fair value
minus estimated costs to sell. Sovereign places all loans
90 days or more delinquent (except loans guaranteed by the
government) on non-performing status.
Table 5 presents the composition of non-performing assets at
the dates indicated (in thousands):
Table 5: Non-performing Assets
AT DECEMBER 31,
------------------------------------------------
1995 1994 1993 1992 1991
------- ------- ------- ------- -------
Non-accrual loans:
Past due 90 or more days as to interest or principal:
Residential . . . . . . . . . . . . . . . . . . . $33,580 $25,379 $20,740 $20,465 $14,327
Other . . . . . . . . . . . . . . . . . . . . . . 3,902 2,892 1,795 835 762
Past due less than 90 days as to interest or principal:
Residential . . . . . . . . . . . . . . . . . . . 644 2,980 1,056 -- --
Other . . . . . . . . . . . . . . . . . . . . . . 739 -- -- -- 81
------- ------- ------- ------- -------
Total non-accrual loans . . . . . . . . . . . . . . . . . . 38,865 31,251 23,591 21,300 15,170
Restructured loans . . . . . . . . . . . . . . . . . . . . 296 99 372 1,183 30
------- ------- ------- ------- -------
Total non-performing loans . . . . . . . . . . . . . . . . 39,161 31,350 23,963 22,483 15,200
Real estate owned:
Residential . . . . . . . . . . . . . . . . . . . . . 2,437 6,104 4,510 7,655 10,079
Other . . . . . . . . . . . . . . . . . . . . . . . . 2,076 3,087 8,306 12,247 1,148
------- ------- ------- ------- -------
Total real estate owned . . . . . . . . . . . . . . . . . . 4,513 9,191 12,816 19,902 11,227
------- ------- ------- ------- -------
Total non-performing assets . . . . . . . . . . . . . . . . 43,674 40,541 36,779 42,385 26,427
Past due 90 days or more as to interest or principal
and accruing interest . . . . . . . . . . . . . . . . -- -- 63 75 130
------- ------- ------- ------- -------
Non-performing assets and loans past due 90 days or more
and accruing . . . . . . . . . . . . . . . . . . . . $43,674 $40,541 $36,842 $42,460 $26,557
======= ======= ======= ======= =======
Non-performing assets as a percentage of total assets . . . .54% .62% .75% 1.15% 1.16%
Non-performing loans as a percentage of total loans . . . . .83 .72 .81 .94 1.03
Non-performing assets as a percentage of total loans
and real estate owned . . . . . . . . . . . . . . . . .92 .93 1.24 1.75 1.78
Allowance for possible loan losses as a percentage of total
non-performing assets . . . . . . . . . . . . . . . . 78.95 88.24 89.24 61.91 49.00
Allowance for possible loan losses as a percentage of total
non-performing loans . . . . . . . . . . . . . . . . . 88.05 114.11 136.97 116.72 85.18
In May 1993, the FASB issued SFAS No. 114 "Accounting by
Creditors for Impairment of a Loan." SFAS No. 114 requires that
certain impaired loans be measured based on the present value of
expected future cash flows discounted at the loan's effective
interest rate or, as a practical expedient, at the loan's
observable market price or the fair value of the collateral if
the loan is collateral dependent. In October 1994, the FASB
issued SFAS No. 118 "Accounting by Creditors for Impairment of a
Loan--Income Recognition and Disclosures," that amends SFAS
No. 114 and eliminates its provisions regarding how a creditor
should report income on an impaired loan. Originally, SFAS No.
114 would have required creditors to apply one of two allowable
methods. As a result of the amendment, creditors may now
continue to use existing methods for recognizing income on
impaired loans, including methods that are required by certain
industry regulators. SFAS No. 118 also clarified SFAS No. 114's
disclosure requirements. SFAS No. 114 and SFAS No. 118 were
adopted by Sovereign beginning January 1, 1995. The effect of
SFAS No. 114 and SFAS No. 118 on Sovereign was not significant.
Potential problem loans (consisting of loans which
management has serious doubts as to the ability of such borrowers
to comply with present repayment terms, although not currently
classified as non-performing loans) were comprised of 17 loans
which amounted to $5.7 million at December 31, 1995 and consisted
principally of multi-family loans.
At December 31, 1995, Sovereign serviced, with recourse, a
total of $78.2 million of single-family residential loans.
Substantially all of this recourse servicing was acquired in the
Jersey Shore acquisition. These are seasoned loans and
historical loss experience has been minimal.
The adequacy of Sovereign's allowance for possible loan
losses is constantly evaluated. Management's evaluation of the
adequacy of the allowance to absorb potential future loan losses
takes into consideration the risks inherent in the loan
portfolio, past loan loss experience, specific loans which have
loss potential, geographic and industry concentrations,
delinquency trends, economic conditions, the level of
originations and other relevant factors. Sovereign's loan
delinquencies (all loans greater than 30 days delinquent) as a
percentage of total loans was 1.32% at December 31, 1995, up
slightly from 1994 delinquencies of 1.16% of total loans.
These factors indicated to management that a provision for
possible loan losses of $1.0 million was necessary to maintain
the allowance for possible loan losses at a level which
management conservatively estimates is necessary to absorb
potential future losses in consideration of the factors noted
above.
Investment and Mortgage-backed Securities Available-For-
Sale. Securities expected to be held for an indefinite period of
time are classified as available-for-sale and are carried at fair
value, with unrealized gains and losses reported as a separate
component of stockholders' equity, net of estimated income taxes.
Decisions to purchase or sell these securities are based on
economic conditions including changes in interest rates,
liquidity, and asset liability management strategies.
Table 6 presents the amortized cost and estimated fair value
of investment and mortgage-backed securities available-for-sale
at the dates indicated (in thousands):
Table 6: Investment and Mortgage-backed Securities
Available-for-Sale
AT DECEM