Hide Notes 

Slide 1: S ove reign B a n c o rp, I nc. 2 0 0 0 A n n u a l R e p o r t Striving to Increase Shareholder Value 300% Within the Next 5 Ye a rs
Slide 2: Company Profile Vision When consumers and businesses think of a World Class financial services provider, they choose Sovereign Bank. Sovereign Bancorp, Inc. is a $33 billion financial services holding company whose principal subsidiary is Sovereign Bank. Sovereign Bank’s franchise includes 556 community banking offices reaching from north of Boston to south of Philadelphia. Sovereign Bank is among the 30 largest financial institutions in the country, the third largest bank headquartered in Pennsylvania and one of the largest lenders to small and medium sized businesses in the Northeastern United States. TA BL E O F C O N T E N T S Mission Sovereign Bank is a World Class financial services provider, committed to helping our customers succeed by understanding and anticipating their individual financial needs and providing customized solutions, resulting in an average customer having four plus services with the Bank. FORWARD-LOOKING STATEMENTS Financial Highlights Sovereign Bank Market Area Letter to Fellow Shareholders Building a Solid Foundation for the Future Five-Year Financial Summary Management’s Discussion and Analysis Financial Statements and Supplementary Data Officers and Boards of Directors Corporate Information 1 2 4 6 11 12 40 76 Inside Back Cover The following discussion and other portions of this Annual Report contain various forward-looking statements. Please refer to page 12 for a discussion of the various factors that could adversely affect the actual results-causing them to differ materially from those expressed herein.
Slide 3: Financial Highlights (dollars in millions, except per share data) 2000 1999 %Change CASH EARNINGS (in millions of dollars) FOR THE YEAR Cash Earnings (1) Operating Earnings (1) $ 308.6 239.9 (30.2) 854.8 3.19% $ 231.5 202.3 179.3 614.7 2.88% 33% 19% (117%) 39% 11% Net Income/(Loss) (includes special charges) Net Interest Income Net Interest Margin (2) PER SHARE Cash Earnings Per Share(1) Core Revenue Per Diluted Share(3) Operating Earnings Per Share(1) Net Income/(Loss) Per Share (includes special charges) Book Valueat End of Period (4) $ 1.48 5.26 1.15 (0.13) 8.60 8.13 $ 1.34 4.31 1.18 1.01 8.08 7.45 10% 22% (3%) (113%) 6% 9% OPERATING EARNINGS (in millions of dollars) Common Stock Price at End of Period AT YEAR-END Total Assets Demand Deposits Total Deposits Total Loans Stockholders’ Equity FINANCIAL RAT I O S Cash Return on Average Assets(1) Operating Return on Average Assets(1) Cash Return on Average Equity Efficiency Ratio(5) Non-Performing Assets to Total Assets Allowance for Loan Losses to Total Loans (1) $ 33,458 7,723 24,499 21,912 1,949 $ 26,607 2,961 12,013 14,288 1,821 26% 161% 104% 53% 7% ASSETS 0.99% 0.77% 18.32% 14.24% 54.31% 0.56% 1.17% 0.97% 0.85% 17.73% 15.51% 48.64% 0.32% 0.93% 2% (9%) 4% (8%) 12% 75% 26% (in billions of dollars) Operating Return on Average Equity(1) (1) Cash earnings are operating earnings excluding amortization of intangible assets and ESOP-related expense. Operating earnings include certain one-time tax benefits and exclude the following special charges for 2000: merger-related, restructuring and integration charges related to recent acquisitions, as well as the impact on net interest income and shares outstanding from the early issuance of certain debt and equity instruments issued to finance Sovereign’s New England retail banking and middle market lending acquisition. (2) Net interest margin is on an operating basis and excludes negative carry from escrowed financing proceeds and reduced reinvestment income from net proceeds of equity offerings. (3) Core Revenue is net interest income after provision for loan losses plus non-interest income, excluding securities transactions. (4) Book value equals equity divided by common shares outstanding. (5) Efficiency Ratio equals operating expenses e xcluding merger-related and other integration charges as a percentage of total revenue, defined as the sum of net interest income excluding the negative carry from escrowed financing proceeds plus non-interest income excluding securities transactions. 1
Slide 4: Geographic Market Area Sovereign Bank Among the 30 largest financial institutions in US Among the largest Lenders to Small Businesses in the Northeast 3rd largest bank headquartered in PA 3rd largest banking franchise in New England Dominant Market Share: New England #3 Massachusetts #3 Rhode Island #3 Hartford, Connecticut #5 New Hampshire Mid Atlantic #3 Southeastern Pennsylvania #4 Central and Northern New Jersey 2
Slide 5: One Bank Multiple Markets S ove reign Bank Locations (1) BankingOffices • • • • Pennsylvania(1) New Jersey(1) Delaware(1) New York MID ATLANTIC TOTAL Connecticut Massachusetts New Hampshire Rhode Island Vermont NEW ENGLAND TOTAL GRAND TOTAL 135 136 6 0 277 37 180 13 49 0 279 556 ATMs 259 169 15 9 452 75 369 21 90 20 575 1,027 “A large Regional Bank with a small Community Bank touch” • • • • • (1) Includes one office in Pennsylvania, eleven offices in New Jersey and six offices in Delaware expected to be sold in 2001. 3
Slide 6: L et te r to Fellow Sh areholders Jay S. Sidhu, President and Chief Executive Officer, Sovereign Bancorp, Inc. and Sovereign Bank Two thousand was another monumental year for Sovereign. Cash earnings per share increased 10%, while cash return on average equity was 18.3% and cash return on average assets was .99%. We more than doubled our deposit franchise, increased our net interest margin and completely transformed our balance sheet into a diversified commercial bank model. We are proud to highlight just a few of our team’s main accomplishments during 2000, which have created new opportunities for our customers and shareholders, as well as exciting challenges for our team members. We are committed to achieving above average annual increases in shareholder value Financial Results Sovereign achieved cash earnings per share of $1.48, an increase of 10% over 1999. Our 2000 core revenue (operating net interest income plus non-interest income, excluding securities transactions) was $1.1 billion, an increase of 48.0% over 1999. Core revenue was $5.26 per diluted share, up 22.0% from $4.31 per diluted share in 1999. Sovereign’s operating net interest margin improved 31 basis points to 3.19%. Our balance sheet repositioning continued with overall borrowing levels reduced by $6.1 billion or a reduction of 50% for the year. On an operating basis, our earnings for 2000 were $239.9 million, up from $202.3 million for the same period last year. Operating earnings per share was $1.15 versus $1.18 in 1999. The net impact of tax benefits plus merger related and restructuring of balance sheet special charges for the year were $243.8 million after-tax. Sovereign’s 2000 net loss, which includes the special charges noted above, was $30.2 million, or $.13 per share. Non-interest income excluding securities transactions for the year was $229.7 million, an 82% increase from $126.1 million in 1999, and Sovereign Bank’s deposit fees were $91.3 million, an increase of 86% for 2000 as compared to $49.2 million reported in 1999. Business Line Gains Sovereign Bank’s commercial loan originations for the year were $2.3 billion with commercial loans totaling $7.8 billion, representing 36% of the loan portfolio, compared to $4.1 billion and 29% of the loan portfolio at year end 1999. Consumer loans originated during 2000 totaled $2.1 billion with the consumer loan portfolio increasing to $6.1 billion from $4.5 billion in 1999. Consumer loans comprised 28% of Sovereign Bank’s loan portfolio in 2000 compared to 31% in 1999. Sovereign Bank’s retail-banking group finished the year posting solid sales results. As a result of Sovereign Bank’s Customer CASH EPS 4
Slide 7: Acquisition Strategy intitatives, checking and money market deposit growth for the year, excluding the New England acquisition and branch sales, was a net increase of $684 million, a growth rate of 16.4% over 1999. The deposit generation initiatives coupled with the successful deposit retention efforts in New England, resulted in an increase of $12.5 billion in total deposit balances for the year. Core deposits, which include checking, savings, and money market accounts, increased $8.8 billion for the year. Sovereign Bank exceeded its own internal goals by successfully integrating the largest branch divestiture in U.S. banking history with virtually no net deposit or loan run off. At the outset of the New England acquisition, we recognized the importance of customer retention, and team member efforts in this area have been tremendous—contributing to a 99.8% net deposit retention rate through year-end—well ahead of our expectations. Highly Focused Growth Strategy Sovereign’s goal remains to achieve, over the long-term, above average financial results and shareholder returns by implementing our clearly defined corporate strategy. Over the past ten years, operating earnings have increased an average of 19% a year and the total return to shareholders has averaged 25% a year. Our corporate strategy has been to achieve a dominant market position in high growth markets and differentiate ourselves on the basis of quality of service provided, while closely monitoring asset quality, interest rate risk, efficiency ratios plus retaining and developing a highly motivated, well trained team. We are focusing on the middle income consumer market and businesses with less than $100 million in sales, and combining the personal touch of a small community bank with the sophistication of a large commercial bank. Building a Solid Foundation for the Future During 2000, Sovereign successfully integrated a large, very strategic acquisition that has dramatically improved the quality of our franchise and balance sheet. We believe we have built a solid foundation and a strong management team that can deliver, on average, a double-digit growth rate in cash and operating earnings. We believe our game plan will result in above average growth in revenues. We expect to increase our tangible equity base by over $500 million by year end 2002, without any new capital offerings. We are very clear about consistently focusing on our critical success factors, as we look toward achieving a 300% increase in shareholder value within the next five years. There is a lot of optimism and excitement at Sovereign as we look to build upon our stronger foundation. We are greatly indebted to the dedication of our team members, and the support from our customers and shareholders as we continue to build a world class financial services company in the Northeast United States. Richard E. Mohn, Chairman of the Board, Sovereign Bancorp, Inc. and Sovereign Bank Over the past 10 years, operating earnings have increased an average of 19% a year and the total return to shareholders has averaged 25% a year CORE REVENUE PER DILUTED SHARE Richard E. Mohn Chairman of the Board Jay S. Sidhu President and Chief Executive Officer 5
Slide 8: Building a Solid Foun Sovereign’s CEO, Jay Sidhu, answers some of the most frequently asked questions from shareholders We believe the transformation Sovereign has undergone in recent years has been instrumental in building a solid foundation for the future. We believe Sovereign is now positioned to achieve its vision of “when consumers and businesses think of a World Class financial services provider, they choose Sovereign”. We believe this vision will result in above average returns to our shareholders. Our goal is to increase shareholder value 300% within five years. Q. What should shareholders expect from Sovereign over the next few years? A. Sovereign continually strives to outperform the market in terms of quality of earnings, growth in cash and GAAP earnings, return on equity and, hence, above average returns for shareholders. Although growth in operating earnings has been consistent over the years, we have had bumps in share price increases at certain times. However, the total return to shareholders has averaged 25% a year over the past ten years. And now, Sovereign has set a goal to increase shareholder value 300% or an average of over 50% a year over the next five years. risk, which resulted in a significantly lower P/E and, hence, a lower stock price. Now that we have proven to the marketplace that our team has successfully completed the entire integration, that capital levels are being restored very quickly, and a solid foundation has been built, we believe Sovereign is poised to achieve higher average returns for shareholders. How does tangible capital build so fast after October 2001? Q. A. Sovereign negotiated with FleetBoston to defer about $340 million of the purchase price for the acquisition through October 2001. When the U.S. Government had ordered FleetBoston to divest this franchise, they were prohibited from directly soliciting customers or employees of the acquirer for two years. If FleetBoston violates this agreement, Sovereign can withhold payments. This negotiated agreement with FleetBoston decreased the goodwill recorded by approximately $340 million, and gave Sovereign the ability to pay for the acquisition from current profits rather than additional borrowings or equity issuances. This payment is expected to be completed by October 2001. After that date, we expect generation of internal tangible equity to increase to approximately $40 million a month or over $430 million in 2002, after making dividend payments. Therefore, going forward, we believe capital should not be a problem for Sovereign. Q. Why did Sovereign do the FleetBoston deal? A. In 1997, we had articulated our goal of becoming a high performing commercial bank that has a diversified loan portfolio, a low-cost deposit base, higher margins and a dominant market position. The FleetBoston acquisition accelerated this transformation at a very reasonable price of under seven times earnings. We acquired 100% of the Fleet Bank franchise in eastern Massachusetts, 100% of the Bank Boston franchise in Rhode Island, and parts of the Bank Boston franchise in western Massachusetts and Connecticut. This franchise included the entire small business and middle market lending groups and no non-performing assets. In the short run, we took on a significant integration and capital 6
Slide 9: dation the Future What do you see as the company’s top three weaknesses? Our top three weaknesses are a below average holding company tangible capital ratio, facing a probable slowdown in the economy which could put short term pressures on asset quality, and a need to continue to build the infrastructure for a solid commercial bank which may result in a higher than desired efficiency ratio. Our holding company Tier 1 capital ratio is about 3.50%, which is expected to increase to about 5% by year-end 2002. At the bank level, we have a goal of keeping a minimum Tier 1 leverage ratio of 6.75% and risk based capital ratio of 10.25%. This gives our bank significant strength, especially during these uncertain economic times. Asset quality continues to receive high priority among top management. Over the long haul, we expect our efficiency ratios to be in the low 50’s or high 40’s. What is Sovereign’s strategy to achieve above average financial results and shareholder value over the next few years? Q. A. business plans. In consumer banking, we are implementing our strategies to increase noninterest revenues by over 50% within two years through superior sales efforts, and to increase our lower cost core deposits by 10% a year, which will result in an improved efficiency ratio. In the corporate banking area, our primary focus is on maintaining superior asset quality during these uncertain times and on increasing our market share among small to medium sized businesses with less than $100 million in sales. In addition, we expect to build in excess of $500 million in internally generated tangible common equity by year end 2002, that will allow us to strengthen our equity capital while we pay off our holding company debt. As a result of this focused and differentiated strategy of combining the best of a smaller community-oriented commercial bank with the best of a large bank, while paying attention to our four critical success factors, we will be striving to achieve $2.00 per share in earnings by 2005, hopefully resulting in a stock price between $24 and $30. Our management short-term and long-term bonus plans are aligned with these financial goals. OPERATING EARNINGS PER SHARE e= projected estimate Q. A. Now that we have built a strong foundation for the future, we are totally focused on executing our financial and Striving to increase shareholder value 300% within the next 5 years Our Beliefs and Principles We achieve our mission and practice our values in an ethical, moral and legal atmosphere, where mutual trust and understanding are practiced. We keep our promises, admit our mistakes and abide by these basic principles in decision making and the way we do business: • We encourage all team members to have a Business Plan and a Personal Development Plan, suggesting and supporting stretch goals. • We give individuals the authority to use their capabilities to the fullest to provide solutions for our customers’ needs. • We communicate frequently with candor, listening to each other, regardless of level or position or tenure. • We focus on situation, issue or behavior, not on the person. • We acknowledge problems openly and honestly and deal with conflicts as they arise. • We believe in maintaining the self-confidence and self-esteem of others. • We always strive to make things better, while maintaining constructive relationships and leading by example. 7
Slide 10: Building for the Future FOCUS ON CLEARLY DEFINED CRITICAL SUCCESS FA C T O R S In 1987, Sovereign defined its four critical success factors as superior asset quality, low interest rate risk, low overhead, and a strong sales and service culture supported through growth and development of team members. We will always strive to achieve our critical success factors and adhere to these enduring themes. S o v e re i g n ’ s G r o w t h 1986(1) Assets . . . . . . . . . . . . . . . . . . . . Branches . . . . . . . . . . . . . . . . . . $660 million 19 20th in PA 2000 $33 billion 556 30th largest in US Dennis S. Marlo, CPA, Chief Financial Officer and Treasurer, Sovereign Bancorp, Inc. and Sovereign Bank Asset quality overall remains solid and in-line with regional bank peers Market Position . . . . . . . . . . . . . . (1) As originally reported. Superior Asset Quality Superior asset quality remains a high priority at Sovereign Bank. Sovereign Bank has quality control procedures to ensure that commercial credits are approved and independently reviewed by teams of credit and loan review officers. Sovereign Bank’s team of commercial and consumer relationship officers and credit risk officers work closely with our customers to ensure personalized service and to ensure Sovereign Bank to better understand the customer’s business and financial needs which, in turn, helps to maintain strong, healthy loan relationships. As Sovereign continues with the transformation of its balance sheet, Sovereign will continue to actively manage the quality of its loan portfolios. ALLOWANCE FOR LOAN LOSSES (in millions of dollars) As set Qual it y Ratios Non-Performing Assets to Total Assets . . . . . Non-Performing Loans to Total Loans . . . . . Allowance for Loan Losses to Total Loans . . . Net Charge-Offs to Average Loans . . . . . . . . Allowance to Non-Performing Loans . . . . . . 1996 .78% 1.05% .76% .19% 73% 1999 .32% .55% .93% .29% 168% 2000 .56% .82% 1.17% .35% 143% 8
Slide 11: Low Interest Rate Risk Interest rate risk management will always be an important focus at Sovereign. Sovereign believes in consistency of earnings and that the stability of earnings must not be materially affected by changes in interest rates. To this end, Sovereign’s primary strategy is to maintain a neutral gap position and minimize interest rate risk through active management of its earning assets and funding sources. Tra n s formed to a Higher Pe r f o r m ing Dive rsified Loan Mix December 1997 Commercial December 2000 John P. Hamill, Chairman and Chief Executive Officer of the Sovereign Bank New England Division, Sovereign Bank 27% Residential 28% 61% 36% 36% 12% Consumer Yield Size 7.8% $11.6 billion 8.3% $21.9 billion Transformed to a Stable Low Cost Deposit Mix December 1997 Checking December 2000 As a result of the New England acquisition completed in 2000, Sovereign Bank truly became one bank in multiple markets 30% Time Deposits 56% 14% 31% 38% 31% Other Core Cost Size Loan to Deposit Ratio 4.2% $9.5 billion 122% 3.8% $24.5 billion 89% Low Overhead Providing quality service in a low-cost and efficient manner continues to be a cornerstone of Sovereign Bank’s success, with all team members being acutely aware of the importance of having a highly productive company. For the year ended December 31, 2000, Sovereign’s efficiency ratio (all operating expenses as a percentage of net interest income and recurring non-interest income) was 54.3%. Sovereign believes long-term performance belongs to growth companies that have a clear cut, highly focused, disciplined strategy providing efficiency ratios in the low 50’s or high 40’s. Joseph P. Campanelli, President, Sovereign Bank New England Division and President, Business Banking Division, Sovereign Bank Our personalized service allows Sovereign Bank to better understand the customer’s business 9
Slide 12: Strong Sales and Service Culture The Sovereign Way is our company culture and is the foundation from which Sovereign Bank grows. We understand the way we perform our jobs has a direct correlation with the view a customer has of Sovereign Bank. We believe that team member performance is a major determining force to the success of Sovereign Bank. Our goal is to stand out among our competitors and to become the bank with whom people want to do business. When consumers and businesses think of a World Class financial services provider, we want them to think of Sovereign Bank first. "The Sovereign Way" process is helping us to build upon our corporate culture. It’s not a way to deliver customer service, but a way of life. The program is comprised of five modules with each module building upon the other, layering skills and strategies for providing World Class service. These modules include Customer Relationship, Listening and Communication Skills, Accuracy and Productivity, Customized Solutions, and Customer Satisfaction. Each module is studied for a minimum of four weeks during which time the team members are observed by leaders to ensure that the concepts are absorbed and implemented. Upon completion of each module, certification is given. The Sovereign Way is all about layering skills and strategies for providing World Class Service. The next phase, which builds upon the foundation of the Sovereign Way is Sovereign’s Team Involvement Program. The Team Involvement Program, known to team members as "TIP", adds to the corporate culture by encouraging every team member to become an active participant in the business of the Company. The Team Involvement Program is an on-going process at Sovereign Bank that provides a set of values which supports team members to ask critical questions about their jobs and investigate and implement continuous process improvements. This program encourages and empowers every team member to analyze current workflow, identify redundancies and inefficiencies and actively pursue process improvements. Therefore, the Team Involvement Program is part of our corporate culture that promotes productivity and bashes bureaucracy. This program is a catalyst for change, not an end in itself. The main focus of the Team Involvement Program is on the process not the program. The Sovereign Way and the Team Involvement Program incorporate bank wide strategic initiatives to enhance Sovereign Bank’s corporate culture. These programs bring Sovereign Bank’s mission and corporate values to life and we believe these values are ultimately responsible for producing growth in shareholder wealth. With Sovereign Bank expanding into new regions, these values are more important than ever before. Sovereign Bank believes that continued success is dependent upon World Class team members providing World Class service. Lawrence M. Thompson, Jr., Esq., Chief Administrative Officer and Secretary, Sovereign Bancorp, Inc. Chief Operating Officer and Division President of Consumer Banking Division, Sovereign Bank Sovereign Bank believes that continued success is dependent upon World Class team members providing World Class service DEPOSIT FEES (in millions of dollars) 10
Slide 13: F i v e – Y e a r F i n a n c i a l S u m m a r y (1) BALANCE SHEET DATA (dollars in millions) At December 31, 2000 ___________ $ 33,458 21,912 24,499 1,949 1999 ___________ $ 26,607 14,288 12,013 1,821 1998 ___________ $ 21,914 11,583 12,460 1,204 1997 ___________ $ 17,655 11,635 9,537 1,048 1996 ___________ $ 15,299 9,734 8,661 890 Total assets Loans Deposits Stockholders’ equity STOCK STATISTICS(2) (shares in millions, except per share data) At or For the Year Ended December 31, 2000 ___________ $ 226.5 8.13 8.60 0.10 1999 ___________ $ 225.5 7.45 8.08 0.10 1998 ___________ $ 159.7 14.25 7.54 0.08 1997 ___________ $ 141.2 17.31 7.42 0.11 1996 ___________ $ 134.0 9.13 6.64 0.14 Common shares outstanding Common share price Book value per share(3) Dividends declared per common share(4) SUMMARY STATEMENT OF OPERATIONS (dollars in millions, except per share data) Year Ended December 31, 2000 ___________ 2,270 1,415 ___________ 855 57 ___________ 798 ___________ 109 731 282 ___________ (106) (65) 11 ___________ $ (30) ___________ $ 240 ___________ $ (0.13) 1.15 1.48 $ 1999 ___________ 1,607 992 ___________ 615 30 ___________ 585 ___________ 130 393 54 ___________ 268 89 ___________ $ 179 ___________ $ 202 ___________ $ 1.01 1.18 1.34 $ 1998 ___________ 1,355 862 ___________ 493 28 ___________ 465 ___________ 105 327 32 ___________ 211 75 ___________ $ 136 ___________ $ 170 ___________ $ 0.85 1.06 1.17 $ 1997 ___________ 1,179 747 ___________ 432 41 ___________ 391 ___________ 49 244 26 ___________ 170 67 ___________ $ 103 ___________ $ 139 ___________ $ 0.66 0.89 0.99 $ 1996 ___________ 1,017 630 ___________ 387 23 ___________ 364 ___________ 63 228 61 ___________ 138 48 ___________ $ 90 ___________ $ 115 ___________ $ 0.59 0.76 0.87 $ Total interest income Total interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Other income General and administrative expense(5) Other expenses Income/(loss) before taxes Income tax provision/(benefit) Gain on sale of FHLB advances(6) Net income/(loss)(7) Operating earnings(8) Diluted earnings/(loss) per share Operating earnings per share Cash earnings per share(9) (1) (2) (3) (4) (5) (6) (7) (8) (9) All financial highlights have been restated to reflect all acquisitions which have been accounted for under the pooling-of-interests method of accounting. All per share data have been adjusted to reflect all stock dividends and stock splits. Book value is calculated using equity divided by common shares outstanding at end of period. The higher dividend rate in prior periods is the result of acquisitions which were accounted for as a pooling-of-interests. General and Administrative expenses for the year ended December 31, 2000 and 1999 include special charges of $149 million and $50 million, respectively, related to merger and other integration expenses, restucturing charges, and non-solicitation expense. See Reconciliation of Net Income to Operating Earnings in “Management’s Discussion and Analysis” hereof. Net of tax of $5.2 million. The results for the years ended 2000, 1999, 1998 and 1997 include merger related and other integration charges of $270 million, $23 million, $34 million, and $37 million, after tax, respectively. See a “Reconciliation of Net Income to Operating Earnings” in Management’s Discussion and Analysis for explanation of special charges excluded from operating earnings. Cash earnings are operating earnings e xcluding amortization of intangible assets and ESOP–related expense. 11
Slide 14: Management’s Discussion and Analysis FORWARD-LOOKING STATEMENTS Sovereign Bancorp, Inc. ("Sovereign" or “the Company”) may from time to time make "forward-looking statements," including statements contained in Sovereign's filings with the Securities and Exchange Commission (including its Annual Report on Form 10-K and the Exhibits thereto), in its reports to shareholders (including this 2000 Annual Report) and in other communications by Sovereign, which are made in good faith by Sovereign, pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements with respect to Sovereign's vision, mission, strategies, goals, beliefs, plans, objectives, expectations, anticipations, estimates, intentions, financial condition, results of operations, future performance and business of Sovereign, including: (i) statements relating to Sovereign’s expectations and goals with respect to (a) growth in cash earnings, operating earnings, net income, shareholder value and internal tangible equity generation; (b) growth in earnings per share; (c) return on equity; (d) return on assets; (e) efficiency ratio; (f) tier 1 leverage ratio; (g) annualized net charge-offs and other asset quality measures; (h) fee income as a percentage of total revenue; (i) tangible equity to assets; (j) book value and tangible book value per share; (k) loan and deposit portfolio compositions, employee retention, deposit retention, asset quality, reserve adequacy; and (ii) statements preceded by, followed by or that include the words “may,” “could,” “should,” “pro forma,” “looking forward,” “would,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “strive,” “hopefully,” “try,” or similar expressions. Although we believe that the expectations reflected in our forward-looking statements are reasonable, these forward-looking statements involve risks and uncertainties which are subject to change based on various important factors (some of which, in whole or in part, are beyond Sovereign’s control). The following factors, among others, could cause Sovereign’s financial performance to differ materially from the goals, plans, objectives, intentions and expectations, forecasts and projections (and underlying assumptions) expressed in such forwardlooking statements: (1) the strength of the United States economy in general and the strength of the regional and local economies in which Sovereign conducts operations, (2) the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; (3) inflation, interest rate, market and monetary fluctuations; (4) the ability of Sovereign and Sovereign Bank to successfully integrate the assets, liabilities, customers, systems and management we acquire into our operations; (5) the timely development of competitive new products and services by Sovereign Bank and the acceptance of such products and services by customers; (6) the willingness of customers to substitute competitors’ products and services and vice versa; (7) the success of Sovereign and Sovereign Bank in meeting the post-closing regulatory requirements with respect to the FleetBoston acquisition, and the ability to pay installments on a timely basis related to the non-solicitation agreement in connection with the acquisition; (8) the impact of changes in financial services’ laws and regulations and the application of such laws and regulations (including laws concerning taxes, capital, liquidity, proper accounting treatment, securities and insurance) and the impact of changes in generally accepted accounting principles; (9) technological changes; (10) changes in consumer spending and savings habits; (11) unanticipated regulatory or judicial proceedings; (12) changes in asset quality; and (13) the success of Sovereign at managing the risks involved in the foregoing. Operating earnings, cash earnings, and core revenue, as defined, and the related ratios using these measures are not a substitute for other financial measures determined in accordance with generally accepted accounting principles (“GAAP”). Because all companies do not calculate these non-GAAP measures in the same fashion, these measures as presented may not be comparable to other similarly titled measures of other companies. Sovereign cautions that the foregoing list of important factors is not exclusive, and neither such list nor any such forward-looking statement takes into account the impact that any future acquisition may have on Sovereign and any such forward-looking statement. Sovereign does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of Sovereign. 12
Slide 15: MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION General. Sovereign Bancorp, Inc., (“Sovereign” or “the Company”), with assets of $33.5 billion at December 31, 2000, was the 30th largest banking company in the United States, with over 550 offices covering a geographic region stretching from north of Boston to south of Philadelphia. The growth of Sovereign in 2000 was mainly due to the acquisition of $12.3 billion of deposits, $8.0 billion of loans, and over 280 community banking offices from FleetBoston Financial (the “SBNE acquisition”). Sovereign successfully completed the SBNE acquisition in three phases on March 24, June 16, and July 21, 2000. The acquisition, which became Sovereign Bank New England (SBNE), amounted to the largest branch acquisition in banking history as detailed below. (For more details on the SBNE acquisition, and other acquisitions, see Note 2– Business Combinations in the "Notes to Consolidated Financial Statements") SUMMARY OF COMPLETED SBNE ACQUISITION (Dollars in billions) Summary of Operations. Sovereign reported cash earnings for 2000 of $309 million, or $1.48 per share, up from $231 million and $1.34 per share in 1999. This represents an increase in cash earnings of 33% and a 10% increase in cash earnings per share. Cash earnings are operating earnings excluding amortization of intangible assets and ESOP-related expense. Operating earnings for 2000 were $240 million, an increase of 19% from 1999 operating earnings of $202 million. Operating earnings per share for 2000 was $1.15, as compared to operating earnings per share of $1.18 in 1999 (for more information related to operating and cash earnings, see the Reconciliation of Net Income to Operating Earnings on page 14). Net loss for 2000 was $30 million or $.13 per share. Net income for 1999 was $179 million or $1.01 per share. This represents a decrease in net income of $209 million, which is due to increased merger-related and other unusual charges recorded in 2000, primarily directly or indirectly related to the SBNE acquisition, and certain securities transactions. On an operating basis, return on average equity and return on average assets were 14.24% and .77%, respectively, for 2000 compared to 15.51% and .85%, respectively, for 1999. Sovereign analyzes its performance on a net income basis determined in accordance with generally accepted accounting principles, as well as on an operating and a cash operating basis before special charges referred to in this analysis as “operating earnings” and “cash earnings”. Operating and cash earnings and related discussions are presented as supplementary information in this analysis to enhance the readers’ understanding of, and highlight trends in, its core financial results excluding the nonrecurring effects of discreet business acquisitions and other transactions. The Company has included these additional disclosures of operations before special charges because this information is both relevant and useful in understanding performance of the Company. Operating and cash earnings should not be viewed as a substitute for net income and earnings per share as determined in accordance with generally accepted accounting principles. Mergerrelated charges and other items excluded from net income used to derive operating and cash earnings and the effect of certain non-recurring tax benefits included in operating earnings may be significant and may not be comparable to other companies. Special charges were $270.1 million after-tax for the year ended December 31, 2000 and $23.0 million after-tax for the year ended 1999. Restructuring Charges. In November 2000, the Company announced the results of a restructuring initiative called “Shaping Sovereign’s Future” (SSF). In addition to realigning the Office of the Chief Executive Officer and the Company around customer segments, Sovereign analyzed front and back office operations and computer operating platforms and eliminated approximately 500 positions. In total, Sovereign recorded $18.5 million in restructuring costs, which was comprised of $14 million of severance and outplacement costs, and a $4.5 million write-off of a redundant computer-operating platform. DATE DIVESTED UNITS DEPOSITS LOANS BRANCHES March 24, 2000 . . Rhode Island, Connecticut (BankBoston) June 16, 2000 . . . Eastern Mass (Fleet) July 21, 2000 . . . Central Mass, New Hampshire (Fleet) $ 4.2 3.8 $ 2.5 3.5 2.0 _____ $ 8.0 90 86 105 _______ 281 _____4.3 ___ $ 12.3 As a result of the SBNE acquisition, 2000 was a year of repositioning Sovereign for the future—more than doubling our deposit base, changing the mix of loans to be more similar to that of a commercial bank, adding experienced banking professionals to senior management and over 3,000 staff to the organization. Sovereign successfully integrated over 280 community banking branches, accounting and computer systems and achieved net retention equal to 99.8% of the $12.3 billion deposits acquired in the SBNE acquisition at December 31, 2000. Sovereign’s financial results for 2000 reflect the SBNE acquisition from the dates noted above. Additionally, the results reflect mergerrelated and integration charges related to all of Sovereign’s recent acquisitions, restructuring charges, and non-solicitation expenses (for more information related to these expenses see the Reconciliation of Net Income to Operating Earnings on page 14). All per share amounts presented in Management’s Discussion and Analysis of Financial Condition and Results of Operations have been adjusted to reflect all stock dividends and stock splits. 13
Slide 16: Management’s Discussion and Analysis Operating earnings include certain tax benefits related to the sale of minority interests and exclude special charges related to restructuring and merger-related costs as more fully described in the footnotes below. The net impact of the tax benefits and special charges for the year ended December 31, 2000 were $243.8 million after-tax. A reconciliation of net income to operating earnings is presented below: RECONCILIATION OF NET INCOME TO OPERATING EARNINGS (Dollars in thousands, except per share data – all amounts are after-tax) TOTAL _______________________________ 1999 _ _____20______ __00 ____________ Net income/(loss) as reported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (30,242) Net negative carry on escrowed bond proceeds(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,589 Merger-related and integration costs related to recent acquisitions(2) . . . . . . . . . . . . . . . 97,063 Expense on convertible trust preferred securities ("PIERS")(1) . . . . . . . . . . . . . . . . . . . . 6,502 Loss on securities due to restructuring of the balance sheet(3) . . . . . . . . . . . . . . . . . . . . 66,956 Restructuring(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,025 Non-solicitation expense(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78,039 Assumed income from reinvestment of net proceeds of common equity and PIERS(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (9,051) Impact of additional shares outstanding for 2000 common and PIERS securities offerings(6). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ____________– _ Operating earnings(6)(7) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $____________ 239,881 _ $ ____________________YEAR_ENDED ____________31,___________________ _____ _______ DECEMBER __ PER ______ _______________SHARE_________ 179,299 3,123 20,576 2,125 – – – (2,827) ___________– _ $ 202,__6 _________29_ 2000 ____________ $ (0.13) 0.08 0.43 0.03 0.29 0.05 0.35 (0.04) 0.__ __________09 $ 1.15 ____________ ____19______ __99 $ 1.01 0.02 0.12 0.01 – – – (0.02) 0.04 ____________ $ 1.18 ____________ Cash earnings(6)(7) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ _____3___564 _ _08, ___ $ 231,46_ ___________7 $ 1.__ __________48 $ 1.__ __________34 (1) In connection with the SBNE acquisition, Sovereign raised $1.8 billion of debt and equity capital in November and December 1999 of which $1.3 billion of debt proceeds were in escrow with limited ability to reinvest the proceeds until the acquisition was completed on July 21, 2000. Consequently, the excess of negative carry and trust preferred expense over interest expense reduction realized on the raised capital resulted in a net reduction in pretax income of $24.7 million ($16.0 million after-tax) and $3.7 million ($2.4 million after-tax) comprised of the following components for the years ended December 31, 2000 and 1999: a) a reduction of net interest income of $28.6 million ($18.6 million after-tax) and $4.7 million ($3.1 million after-tax); b) expense of $10.0 million ($6.5 million after-tax) and $3.1 million ($2.1 million after-tax) associated with PIERS issued in November 1999; c) an assumed $13.9 million ($9.1 million after-tax) and $4.4 million ($2.8 million after-tax) of interest expense reduction from the assumed paydown of other borrowings with the proceeds of the Trust Preferred Securities and common stock offerings. (2) Merger-related and integration charges related to recent acquisitions include direct costs associated with the SBNE acquisition, including investment banking and debt commitment fees, indirect costs incurred to integrate recent acquisitions into Sovereign’s back-office systems, costs of training, relocation and associated travel, and management’s estimate of the carrying costs of certain facilities and personnel acquired in the first closing on March 24, 2000 that were not fully operational until July 21, 2000, the date of the final closing. Also included in merger-related and integration costs are expenses paid related to a structured real-estate transaction involving certain real estate related to SBNE. (3) In June and September 2000, Sovereign sold $2.1 billion of investment securities as part of a balance sheet deleveraging strategy and incurred a $103 million loss ($67.0 million after-tax). Sovereign used the proceeds from such sales primarily to repay short-term borrowings. (4) As more fully discussed in “Restructuring Charges”, Sovereign recorded $18.5 million ($12.0 million after-tax) primarily related to severance and outplacement related expenses. (5) As more fully discussed in Note 2 to the Financial Statements, Sovereign is required to pay to FleetBoston, subject to FleetBoston’s compliance with a non-solicitation agreement, $333 million over a 19 month period. Sovereign is expensing such payments ratably from the completion of the acquisition to the completion of the payment period. (6) Operating earnings per share and cash earnings per share are calculated using a weighted average number of shares which include for the years ended December 31, 2000 and 1999, a pro rata portion of the shares issued in November, 1999 in proportion to deposits acquired on March 24, 2000, June 16, 2000, and July 21, 2000 over total estimated SBNE deposits acquired in each phase of the SBNE acquisition. ( 7 )O p e rating earnings and cash earnings represent alternative measures of performance and do not represent earnings available to stockholders. 14
Slide 17: RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999 Net Interest Income. Net interest income for 2000 was $855 million compared to $615 million for 1999, or an increase of 39%. The increase in net interest income in 2000 was due primarily to the increases in interest-earning assets from the SBNE acquisition and internal asset growth, offset slightly by the deleveraging of the balance sheet in the second and third quarters of 2000. The SBNE acquisition added $8.0 billion to average loans and $6.9 billion to average deposits (replacing higher cost FHLB borrowings) in 2000. Net interest margin – operating basis (net interest income adjusted to eliminate the negative impact from escrowed financing proceeds related to the SBNE acquisition, divided by average interest-earning assets) was 3.19% for 2000 compared to 2.88% for 1999. Interest on interest-earning deposits was $22.2 million for 2000 compared to $4.7 million for 1999. The average balance of interestearning deposits was $138 million with an average yield of 16.08% for 2000 compared to an average balance of $15.2 million with an average yield of 31.12% for 1999. The increase in average interestearning deposits was due to $200 million placed on deposit with FleetBoston in March 2000 until the acquisition was completed in July 2000. The high yields were the result of an outsourced accounts payable process whereby a third-party vendor performs check processing and reconcilement functions for Sovereign's disbursement accounts and pays Sovereign interest on disbursed funds during the two-tothree day float period, effectively producing interest income with no corresponding asset balance. The decrease in rates was due primarily to the lower relative interest rate earned on the $200 million deposit mentioned above as compared to the implied rate earned on the accounts payable process. Interest on investment securities available-for-sale was $487 million for 2000 compared to $544 million for 1999. The decrease in interest income was due to the decrease in average investment securities available for sale from $8.1 billion in 1999 to $6.8 billion in 2000, which resulted from the sale of approximately $2.1 billion in investment securities in June and September. Interest on investment securities held-to-maturity was $132 million for 2000 compared to $99.8 million for 1999. The average balance of investment securities held-to-maturity was $2.0 billion with an average yield of 6.80% for 2000 compared to an average balance of $1.4 billion with an average yield of 6.94% for 1999. The increase in the average balance was primarily due to the creation of a $1.3 billion escrow fund in the fourth quarter 1999, which was used to fund the SBNE transaction. The escrow funds were invested in commercial paper which matured in conjunction with the escrow break on the final closing of the acquisition on July 21, 2000. Interest and fees on loans were $1.6 billion for 2000 compared to $959 million for 1999. The average balance of net loans was $19.4 billion with an average yield of 8.40% for 2000 compared to an average balance of $12.4 billion with an average yield of 7.77% for 1999. The increase in average loan volume was primarily the result of the SBNE acquisition and internal loan growth. The acquisition added $8.0 billion to average loans. The increase in the rate was due to a higher mix of higher yielding commercial and consumer loans, and rate increases reflected in the adjustable rate loans. Interest on total deposits was $735 million for 2000 compared to $441 million for 1999. The average balance of total deposits was $19.2 billion with an average cost of 3.83% for 2000 compared to an average balance of $12.2 billion with an average cost of 3.61% for 1999. The increase in the average balance was due primarily to the acquisition of deposits in the SBNE acquisition, which added over $6.9 billion to average deposits during 2000. The increase in rates in 2000 mainly reflects the increase in time deposit and money market account rates due to market conditions. Interest on borrowings and long-term debt was $680 million for 2000 compared to $552 million for 1999. The average balance of total borrowings was $10.3 billion with an average cost of 6.54% for 2000 compared to an average balance of $10.1 billion with an average cost of 5.46% for 1999. Although the average balance was consistent between 2000 and 1999, borrowings and debt decreased approximately $6 billion on an absolute basis. Average non-interest earning assets were $3.6 billion for 2000, as compared to $2.0 billion for 1999, an increase of $1.6 billion. The increase was due primarily to additions of non-earning assets during 2000 including $1.1 billion in goodwill from the SBNE acquisition, an additional investment in bank owned life insurance (BOLI) of $200 million, and the addition of the precious metals business and equipment of $171 million, also related to the SBNE acquisition. 15
Slide 18: Management’s Discussion and Analysis Table 1 presents a summary on a tax equivalent basis of Sovereign's average balances, the yields earned on average assets and the cost of average liabilities and stockholders' equity for the years indicated (in thousands): TABLE 1: NET INTEREST MARGIN _______________ __2000_________________ _ ____ AVERAGE YIELD/ BA __ N __ I_ T __ EST R___E ____LA__CE_ _ __N__ER____ _ _ _ AT_ Interest-earning assets: Interest-earning deposits . . . . . $ 137,826 Investment securities(1): available-for-sale . . . . . 6,840,799 held-to-maturity . . . . . . 1,950,093 Net loans(1)(2) . . . . . . . . . . . __19,411_854 _____ , ___ Total interest-earning assets . . . . . . . . . . . . . 28,340,572 Non-interest-earning assets . . . . . . . . . . . . . ________109 3,607, ___ Total assets . . . . . . . . . $_______681 _ 31,947, ___ ___________ Interest-bearing liabilities: Deposits: Demand deposit and NOW accounts . . . . . $ 5,468,164 Savings accounts . . . . . 2,741,867 Money market accounts . 3,059,568 Certificates of deposit . . ________94_ 7,935, __3 Total deposits . . . . . . . . 19,205,542 Total borrowings . . . . . . . . . . ________648 10,338, ___ Total interest-bearing liabilities . . . . . . . . . . . 29,544,190 Non-interest-bearing liabilities . . . . . . . . . . . ________035 541,___ Total liabilities . . . . . . . 30,085,225 Stockholders' equity . . . . . . . . ________45_ 1,862, __6 Total liabilities and stockholders' equity . . . __31,____6__ $ __ 947,_81 Net interest spread(3) . . . . . . . Taxable equivalent interest income/net interest margin(4) . . . . . Tax equivalent basis adjustment . . . . . Net interest income . . . Net interest margin-operating basis(5) . . . . . . . . . . . . Ratio of interest-earning assets to interest-bearing liabilities . . . . . . . . . . . $ 22,158 YEAR ENDED ___________ __ _______________________________________________________________DECEMBER_31,________ __________________________________________ _ _________________1_____ _______________ _999 _ _________________1998_________________ ____ AVERAGE _BALA___E _____ NC _ _ $ 15,170 I _ TE _____ __N___REST _ $ 4,721 YIELD/ RATE ______ 31.12% 6.85 6.94 7._7 ____7_ 7.39 – ______ 6.7 _ _____6% AVERAGE BA __ N __ ____LA__CE_ $ 56,389 INT ______ _____EREST_ $ 7,397 YIELD/ R___E _ AT_ 13.12% 6.75 7.22 7.__ ___94 7.57 ____– _ 6.96 _____ % 16.08% 7.26 6.80 8. __ ___40 8.06 ____– _ 7. __ ___15% 496,922 132,537 1,___ , ___ _____631_240 2,282,857 ___________– _ $ 2, __2, ___ _____28__857 8,079,731 1,440,894 12,379,295 ___________ 21,915,090 2,__7,003 ____02_____ $2_________ 3,_42,093 ____9______ __ 553,167 99,949 961,___ _________635 1,619,472 – ____________ $ _____472 ____1,619,___ 4,336,872 2,530,143 __11,____400 __ 105,___ 18,028,804 ___1,____937 _ 589,___ $___,____ ___ __19_618,___ _ __ ___ 741 292,531 182,594 882, ___ _________229 1,364,751 – ____________ $___________ _ 1,364,751 $ 81,842 67,880 132,131 _____453_234 ___, ___ 735,087 _____67__837 __9, ___ 1,414,924 – ____________ 1,414,924 – ____________ 1.50% 2.48 4.32 5.71 _____ 3.83 6. __ ___58 4.79 ____– _ 4.70 ____– _ $ 2,835,152 2,246,127 1,288,581 5, ___ 785 ____836,___ _ 12,206,645 10, ___, ___ ____101_973 22,308,618 ____274,___ ___ 858 _ 22,583,476 1, ___ 617 ____358,___ _ 34,622 58,333 50,246 297,___ _________625 440,826 551,847 ____________ 992,673 ___________– _ 992,673 ___________– _ $ 1.22% 2.60 3.90 5.10 ______ 3.61 5.__ ____46 4.45 _____– _ 4.40 _____– _ $ 1,774,514 2,126,149 1,173,889 ___5,____568 _ 688, ___ 10,763,120 ___7,____402 _ 342,___ 18,105,522 414,___ ________719 18,520,241 ___1,____500 _ 098, ___ $ 19,920 62,694 45,055 316, ___ _________164 443,833 417, ___ _________926 861,759 1.12% 2.95 3.84 5.56 _____ 4.12 5. __ ___69 4.76 ____– _ 4.65 ____– _ ___________– _ 861,759 ___________– _ $____414_924 _ 1, ___, ___ 4. __ ___43 2. __ ___72% _____ $ ___942,___ _ 23, ___ 093 _ $___________ 992,673 _ 4._5 ____1_ 2. __ ____61% ______ $_19,618,___ _ ______ 741 $___________ 861,759 _ 4.__ ___39 2.57 _____ % _____ 867,933 (_3, ___ ______1__122) $___________ 854,811 ____________ _ 3. __ ___06% _____ 626,799 (12, ___ _________143) $__________6 614,___ _________65_ _ 2. __ ____86% ______ 502,992 ( _____ _______9,380) $________612 493, ___ ____________ _ __2.__ % _____ _ 79 _3_19% _. __ 2. __ ____88% __2.__ % _ 79 .96 _____ x .98 ______ x 1.00 _____ x (1) Tax equivalent adjustments to interest on investment securities available for sale for the years ended December 31, 2000, 1999 and 1998 were $9.5 million, $9.5 million and $8.1 million, respectively. Tax equivalent adjustments to interest loans for the years ended December 31, 2000, 1999 and 1998, were $3.6 million, $2.5 million and $1.1 million, respectively. Tax equivalent interest income is based upon an effective tax rate of 35%. (2) Amortization of net fees of $14.4 million, $10.4 million and $2.6 million for the years ended December 31, 2000, 1999 and 1998, respectively, are included in interest income. Average loan balances include non-accrual loans and loans held for sale. (3) Represents the difference between the yield on total assets and the cost of total liabilities and stockholders' equity. (4) Represents taxable equivalent net interest income divided by average interest-earning assets. Excluding the taxable equivalent adjustment, net interest income divided by average interest-earning assets was 3.02%, 2.80%, and 2.74% for the years ended December 31, 2000, 1999, and 1998, respectively. (5) Represents net interest margin adjusted to eliminate the negative impact from escrowed financing proceeds relating to the acquisition of SBNE. Sovereign was required to raise $1.8 billion of debt and equity capital by December 15, 1999. Substantially all of the proceeds were required to be escrowed with limited ability to reinvest between closing of the financings and the assumption of the FleetBoston branches. The funds were released from escrow on the final closing of the acquisition on July 21, 2000. 16
Slide 19: Table 2 presents, on a tax equivalent basis, 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 ____________31,___________________________________ _____ _______DECEMBER __ 2000 VS. 1999 1999 VS. 1998 INC _ EA __/ __ EC __ A ___ _______________R___SE_(D___RE__SE) ____________ ___________INC___A_______C___A_______________ ___ RE _ SE/(DE _RE _SE) VOLU ___ ________ME __ Interest-earning assets: Interest-earning deposits . . . . . . . . . . . Investment securities available-for-sale . . . . . . . . . . . . . . Investment securities held-to-maturity . . . . . . . . . . . . . . . Net loans(1) . . . . . . . . . . . . . . . . . . . . Total interest-earning assets . . . . . . . . . . . . . . Interest-bearing liabilities: Deposits . . . . . . . . . . . . . . . . . . . . . . . Borrowings . . . . . . . . . . . . . . . . . . . . . Total interest-bearing liabilities . . . . . . . . . . . . Net change in net interest income . . . . . . . . . (1) Includes non-accrual loans and loans held for sale. R ____ _____ATE ___ $ (20,734) 28,577 (2,733) 123,309 ___TOTAL___ ______ $ 17,437 (56,245) 32,588 _____66__605 __9, ___ _____66__385 __3, ___ __VOLU__E__ _____M _ $ (5,407) 252,464 (78,608) 101,200 ____RATE ___ _____ $ 2,731 8,172 (4,037) (21,794) TOTAL ____________ $ (2,676) 260,636 (82,645) 79,406 ____________ 254,721 ____________ $ 38,171 (84,822) 35,321 546,296 252,755 12,929 $ _________282 269, ___ _ 41,506 115,061 $ ________148) (28, ___ _ 294,261 127, ___ _________990 42 _ 251 ________2,___ $ ________134 241, ___ _ 59,526 157,073 $ ________050 53, ___ _ (62,533) (23,152) $ _____70,757 _ ______ (3,007) 133,921 ____________ _____130,914 _______ $ ____12__807 _ __3, ___ Provision for Loan Losses. The provision for loan loss is based upon credit loss experience and an estimation of losses arising in the current loan portfolio. The provision for loan losses for 2000 was $56.5 million compared to $30.0 million for 1999. The higher provisioning was required because of an increase in net charge-offs during the year, and management’s desire to raise the overall level of the allowance, from .93% at 1999 to 1.17% in 2000, given increased levels of non-performing and potential problem loans, and current economic conditions. As Sovereign continues to place emphasis on commercial and consumer lending, management will regularly evaluate the risk inherent in its loan portfolio and increase its loan loss provision as is necessary. Historically, Sovereign's additions to its loan loss allowance (through income statement charges and acquisition accounting) have been sufficient to absorb the incremental credit risk in its loan portfolio. During 2000, Sovereign established an initial allowance of $134.7 million in connection with the SBNE acquisition. This initial allowance for SBNE, together with the provision of $56.5 million exceeded net charge-offs, and thereby increased the loan loss allowance by $123.4 million over 1999 levels. Sovereign's net charge-offs for 2000 were $67.8 million and consisted of charge-offs of $92.9 million and recoveries of $25.1 million. This compares to 1999 net charge-offs of $35.6 million consisting of charge-offs of $55.0 million and recoveries of $19.4 million. Sovereign’s increased level of commercial charge-offs in 2000 was related primarily to deterioration in a segment of the portfolio concentrated in cash flow, or enterprise lending in syndicated multi-bank credits that were originated by other banks and participated in by Sovereign, as well as direct loans made to Sovereign customers. The ratio of net loan charge-offs to average loans, including loans held for sale, was .35% for 2000, compared to .29% for 1999 and .30% for 1998. Commercial loan net charge-offs as a percentage of average commercial loans were .50% for 2000, compared to .11% for 1999 and .14% for 1998. Excluding charge-offs related to large corporate credits, commercial loan net charge-offs were .26% for 2000. Consumer loan net charge-offs as a percentage of average consumer loans were .49% for 2000, compared to .49% for 1999 and .80% for 1998. Residential real estate mortgage loan net charge-offs as a percentage of average residential mortgage loans, including loans held for sale, were .09% for 2000, .23% for 1999, and .08% for 1998. The increased level of residential mortgage loan net charge-offs in 1999 was the result of $7.0 million net charge-offs incurred as part of a bulk sale of non-performing residential loans. 17
Slide 20: Management’s Discussion and Analysis Table 3 presents the activity in the allowance for loan losses for the years indicated (in thousands): TABLE 3: RECONCILIATION OF THE ALLOWANCE FOR LOAN LOSSES 2 ___ _____000 ____ Allowance, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . Charge-offs: Residential(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total charge-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . Recoveries: Residential . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total recoveries . . . . . . . . . . . . . . . . . . . . . . . . . . . . Charge-offs, net of recoveries . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Acquired allowance and other additions(2) . . . . . . . . . . . . . . . . . Allowance, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Charge-offs, net of recoveries, to average total loans . . . . . . . . . . . $ 132,986 DECEMBER 31, _____________________________________________________________________________________ ____199_____ ___9 ____1998____ ____ ____1_______ _997 ____1996 __ ______ $ 133,802 $ 116,823 $ 73,847 $ 67,515 8,293 41,071 ______43,528 ______ ______92,892 ______ 1,433 8,729 ______14,894 ______ ______25,056 ______ 67,836 56,500 _____134,706 _______ $____256,356 _ _______ . ___ _________346% 14,038 4,659 36, ___ _________326 55, ___ _________023 1,629 1,429 16, ___ _________350 ______19_408 __, ___ 35,615 30,000 4, ___ _________799 $____1___986 _ _32, ___ . ___ _________285% 6,223 3,220 ______3__887 _6, ___ 46, ___ _________330 1,134 839 10, ___ _________715 ______1__688 _2, ___ 33,642 27,961 ______2__660 _2, ___ $ ____1___802 _ _33, ___ ________.300% ____ 8,869 3,687 11, ___ _________628 24, ___ _________184 1,040 2,264 2, ___ _________079 5, ___ _________383 18,801 41,125 20, ___ _________652 $________823 116, ___ _ ________.184% ____ 11,016 5,846 2,__9 _________07_ 18,941 ____________ 1,376 133 _________3__ _63 1,__2 _________87_ 17,069 22,685 716 ____________ $ 73,847 ____________ .___ _________193% (1) The 1999 residential charge-offs include $7.0 million of charge-offs incurred as part of accelerated dispositions of non-performing residential loans sold during the second and fourth quarters of 1999. (2) For 2000, amount represents initial allowance established in connection with SBNE acquisition. For 1999, amount represents Sovereign's June 1999 acquisition of Peoples Bancorp, Inc. For 1998, amount includes $20.5 million of loan loss allowance established in connection with the CoreStates branch acquisition. For 1997, amount includes $22.0 million of loan loss allowance established as part of the Fleet Auto acquisition, partially off-set by net charge-offs of $2.7 million related to First State for the three-month period ended December 31, 1996 resulting from the differing fiscal year end of First State. Sovereign's policy for charging off loans varies with respect to the category of loans and specific circumstances surrounding each loan under consideration. Consumer loans and residential real estate mortgage loans are generally charged off when deemed to be uncollectible or 180 days past due, whichever comes first. Charge-offs of commercial loans are made on the basis of management's ongoing evaluation of non-performing loans. Other Income. Total other income was $109 million for 2000 compared to $130 million for 1999. Several factors contributed to the decrease in other income as discussed below. Deposit fees were $91.3 million for 2000 compared to $49.2 million for 1999. This increase was primarily due to a favorable shift into core and corporate deposit products over the last year and the impact of the SBNE acquisition. Mortgage banking revenues were $25.2 million for 2000 compared to $29.9 million for 1999. At December 31, 2000, Sovereign serviced $4.2 billion of residential loans for others as compared to $5.7 billion at December 31, 1999. Sovereign sold mortgage servicing rights related to $2.5 billion of loans during 2000. Loan fees and service charges were $16.9 million for 2000 compared to $8.9 million for 1999. This increase was due primarily to the SBNE acquisition which added $8 billion in loans. Net losses on sales of loans and investment securities were $121 million for 2000, compared to a net gain of $4.3 million for 1999, which included net investment security gains/(losses) of $(120.9) million and $3.7 million, and net gains/(losses) on sales of loans of $.2 million and $.6 million in 2000 and 1999, respectively. This decrease was due primarily to the balance sheet deleveraging transactions. During the second and third quarters of 2000, Sovereign sold $2.1 billion of available-for-sale mortgage-backed securities, resulting in losses of $103 million. The net impact of the sales on equity was minimal as these losses were previously reflected as unrealized losses included as a reduction of stockholders’ equity in accordance with SFAS 115. During 2000, Sovereign created a Capital Markets Group. The group was built in three phases. The first phase provided risk management services for corporate clients including foreign exchange, investments and derivatives. The first phase also included securitization expertise for Sovereign’s balance sheet assets. The second phase added merger and acquisitions expertise to assist clients. The third phase, in process at December 31, 2000, includes the formation of a broker dealer. The Capital Markets Group generated revenue of $11.1 million in 2000. Income from bank-owned life insurance ("BOLI") was $33.3 million for 2000 compared to $22.8 million for 1999. This increase was primarily due to an additional investment in BOLI of $200 million which was made during the year. 18
Slide 21: General and Administrative Expenses. Total general and administrative expenses were $731 million for 2000 compared to $393 million in 1999. Included in 2000 total general and administrative expenses were $149 million of merger-related, integration and other charges related to recent acquisitions. These special charges include charges directly attributable to the acquired SBNE branches, indirect costs incurred to integrate recent acquisitions into Sovereign’s back office systems, costs that management considered redundant due to separating the SBNE acquisition from a single closing into three separate closings, and expenses related to the structured real estate transaction that involved properties utilized by SBNE. Included in 1999 general and administrative expenses were $30.8 million of merger and integration charges. Excluding the special charges, general and administrative expenses were $582.2 million and $362.1 million, for 2000 and 1999 respectively, or an increase of 61%. This increase was due primarily to the SBNE acquisition which increased compensation and benefits expense for the approximately 3,700 staff and management personnel which were added, increased occupancy and equipment expenses for the additional 281 community banking offices acquired, and increased other administrative expenses resulting from the acquisition. These expenses were reflected in 2000 results from each of the respective three closing dates. See Note 2 - Business Combinations for more details on the SBNE acquisition. Sovereign's efficiency ratio (all operating general and administrative expenses as a percentage of net interest income and recurring non-interest income) for 2000 was 54.3% compared to 48.6% for 1999. Other Operating Expenses. Total other operating expenses were $282 million for 2000 compared to $53.5 million for 1999. Other operating expenses included amortization of goodwill and other intangible assets of $98.9 million for 2000 compared to $38.0 million for 1999 and trust preferred securities expense of $44.3 million for 2000 compared to $15.4 million for 1999. The increase in amortization expense is due to the SBNE acquisition which added $1.1 billion to Sovereign’s intangible assets. Trust preferred securities expense increased due to the issuance of additional securities in November 1999. Income Tax Provision. The income tax benefit was $65.2 million for 2000 compared to a provision of $89.3 million for 1999. The effective tax rate for 2000 was 66.5% compared to 33.2% for 1999. The effective tax rate for year 2000 is not meaningful due to the high proportion of permanent tax differences, including certain one-time tax benefits included in operating earnings, in relation to the recorded pretax loss. For additional information with respect to Sovereign's income taxes, see Note 18 in the "Notes to Consolidated Financial Statements" hereof. Extraordinary Item. During the first quarter of 2000, Sovereign sold FHLB advances which resulted in a pretax gain of $16.0 million ($10.8 million after-tax) and is treated as an early extinguishment of debt under generally accepted accounting principles. FINANCIAL CONDITION Loan Portfolio. Sovereign's loan portfolio at December 31, 2000 was $21.9 billion compared to $14.3 billion at December 31, 1999. The increase in net loans was due to the SBNE acquisition which added $8.0 billion in loans and strong originations in Sovereign’s existing franchise offset by the securitization of commercial and consumer loans and the conversion of residential loans to mortgage-backed securities. As a result of the SBNE acquisition and a continued focus on nonresidential lending in its existing franchise portfolio, Sovereign's loan portfolio included $7.8 billion of commercial loans and $6.1 billion of consumer loans. This compares to $4.1 billion of commercial loans and $4.5 billion of consumer loans, at December 31, 1999. In addition to the $3.1 billion of commercial loans acquired in the SBNE acquisition, there were $2.3 billion of commercial loans originated during 2000, compared to $3.2 billion of commercial loans originated during 1999. This decrease was due to a high level of originations in 1999 in the Specialty Lending Group including the syndicated cash flow loan participations and other portfolios. Cash flow lending was curtailed in 2000 due to credit risk considerations. In addition to the $1.7 billion of consumer loans acquired in the SBNE acquisition, Sovereign originated $2.1 billion of consumer loans during 2000 compared to $2.3 billion of consumer loans for 1999. At December 31, 2000, Sovereign's total loan portfolio included $8.0 billion of first mortgage loans secured primarily by liens on owneroccupied one-to-four-family residential properties compared to $5.7 billion at December 31, 1999. Total production of first mortgage loans was $2.3 billion in 2000 of which $.7 billion were sold in the secondary market. This compares to first mortgage loan closings of $2.9 billion and $1.6 billion of loans sold for 1999. In addition, Sovereign acquired and retained $3.2 billion of residential mortgages from FleetBoston, excluding $1.1 billion of residential mortgages which were not relationship assets and were subsequently sold as part of Sovereign’s asset liability management strategy to reduce interest rate risk. During 2000, Sovereign securitized commercial automotive floor plan loans of $579 million and consumer home equity loans of $369 million. See Note 22 Asset Securitizations in the Notes to Consolidated Financial Statements for more details. Sovereign also converted $1.2 billion of residential mortgages to FHLMC mortgage backed securities which are included in Sovereign’s investment securities held-tomaturity portfolio at December 31, 2000. Federal law limits the amount of non-residential mortgage loans a savings institution, such as Sovereign Bank, may make. The law limits a savings institution to a maximum of 10% of its assets in large commercial loans, with another 10% of assets permissible in “small business loans.” Commercial loans secured by real estate, however, are in addition to the above amounts, and can be made in an amount up to four times an institution’s capital. An institution can also have commercial leases in addition to the above, up to 10% of its assets. Commercial loans and small business loans, as defined, totaled $2.9 billion and $1.3 billion, respectively, as compared to the 10% of assets limitation of $3.3 billion at December 31, 2000. 19
Slide 22: Management’s Discussion and Analysis Table 4 presents the composition of Sovereign's loan portfolio by type of loan and by fixed and variable rates at the dates indicated (in thousands): TABLE 4: COMPOSITION OF LOAN PORTFOLIO _________ ____________________________________________AT_DECEMBER _______________________________________________________ _ __ ___________ 31, 1999 1998 _ 199 _ 1996 _ __________2000 ______ ___ _____________________ __ _______________ _____ __ _____________7 _______ __ ____________________ _ ____ _ _ _ _ _ Residential real estate loans . . . . . . . . . . . . Residential construction loans . . . . . . . . . . Total Residential Loans . . . . . . . . . . . Commercial real estate loans . . . . . . . . . . . Commercial loans. . . . . . . . . . . . . . . . . . . . Automotive floor plan loans. . . . . . . . . . . . Multi-family loans . . . . . . . . . . . . . . . . . . . Total Commercial Loans . . . . . . . . . . Home equity loans . . . . . . . . . . . . . . . . . . Auto loans . . . . . . . . . . . . . . . . . . . . . . . . Loans to automotive lessors . . . . . . . . . . . . Student loans . . . . . . . . . . . . . . . . . . . . . . Credit cards . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Consumer Loans . . . . . . . . . . . Total Loans . . . . . . . . . . . . . . . . . . . Total Loans with: Fixed rates . . . . . . . . . . . . . . . . . . . Variable rates . . . . . . . . . . . . . . . . . Total Loans . . . . . . . . . . . . . . . . . . . _BALANC__ _PERC___T_ __ _____ E _ __ __ EN_ _ $ 7,927,442 36.2% 0. _ ___ ____415 _ 51, ___ ____2 __7_978,857 _, _______ 2,793,616 4,397,009 513,641 ,_ ____127_141 ____ __ __7_831,__ _ _, ___ 407 _ 3,256,598 2,309,025 317,281 26,283 – 19 __ __ ______2,794 _ 6,_____81 ____101,9__ $21_912,245 ___, _______ $14,165,535 7, _______ ____746,710 $21_912,245 ___, _______ 36. _ ____4 12.7 20.1 2.4 0. _ ____6 35. _ ____8 14.9 10.5 1.4 0.1 – 0. _ ____9 27. _ ____8 10_. _ __0_0% 64.6% 35. _ ____4 100.0 _____ % _BAL___C__ _PERC___T_ _BAL___C__ _PERC___T_ _BALANC__ _PERC___T_ _BAL___C__ __ _AN_ E _ __ __ EN_ _ __ _AN _ E __ __ EN_ _ _ __ _____ E _ __ __ EN_ _ __ _AN_ E _ $ 5,685,220 39.8% $ 5,410,467 46.7% $ 6,944,949 59.7% $ 7,520,159 .4 6_ , ___ 2 ._ 13_ ,___ 7 1.2 ___ ____2__ _ 59,_64 _____ ______ _536 ____5 _______367 ______ ___136_43_ ___ ,__6 5 744, ___ ___,____484 _ 1,516,953 1,690,744 730,623 ___ ____01_ _ 137,__9 4 075,___ ___,____339 _ 1,957,945 1,936,980 288,636 249,279 – ___ ____802 _ 35,___ 4 468,___ ___,____642 _ $14,____4__ ___ 288,_65 _ $ 8,769,876 5 ____589 ___ ,518,___ _ $14,____465 ___ 288,___ _ 40.2 _____ 10.6 11.8 5.1 1.0 _____ 28.5 _____ 13.7 13.6 2.0 1.7 – .3 _____ 31.3 _____ _100._ % ___ 0 61.4% 38.6 _____ 100.0 _____% 3 __5,___ _003 _ 47_ , ___ 887,938 717,440 578,147 5 ____11__195 __ , ___ 8 __2,___ _720 _ 29_ , ___ 1,750,883 1,510,676 252,856 256,744 – 3_ , ___ 9 ______ _888 3, __ , ___ ____811_047 _ $11,58__770 2 ______ , ___ $ 6,095,088 7 __5,48__682 ____ , ___ $11,58__770 ______2,___ 47._ ____2 7.7 6.2 5.0 1._ ____0 19._ ____9 15.1 13.0 2.2 2.2 – ._ ____4 32._ ____9 100.0 _____% 52.6% 47._ ____4 10___ __0.0% 2 __7,____316 _ 08_ ,___ 664,943 356,517 279,757 5 ____11__5__ __ ,_70 6 __1,____787 _ 41_ ,___ 1,050,304 1,553,318 267,033 190,440 54,887 19,__5 _______71_ _ 5 __3,____6__ _ 13_ ,_97 $ 11,____80_ 4 ___ 63_ ,__0 $ 4,859,629 __6,_______ _ 775,171 _ $11,____80_ 4 ___ 63_ ,__0 60.9 ______ 5.6 3.1 2.4 1.0 ______ 12.1 ______ 9.0 13.4 2.3 1.6 .5 .2 ______ 27.0 ______ _100.0% _____ 41.8% 58.2 ______ 100._ _____0% 7, ___ , ___ ___656_595 511,071 262,840 – 109,__4 _______77_ ___883_685 ___ , ___ 800,559 73,393 – 211,358 82,798 25,___ _______446 1, ___ , ___ ___193_554 $9, ___ , ___ ___733_834 $ 2,318,695 7,___ ,___ ___415_139 $9_733_834 __ , ___ , ___ P_______T _ ERCEN _ 77.3% 13 ____._ 78.6 _____ 5.3 2.7 – ___1._ _1 91 ____._ 8.1 .8 – 2.2 .9 .3 _____ 12.3 _____ 100.0 ______% 23.8% 76._ ____2 100._ _____0% Table 5 presents the contractual maturity of Sovereign's commercial loans at December 31, 2000 (in thousands): TABLE 5: LOAN MATURITY SCHEDULE AT DECEMBER __ _____ MAT _ R N _ ___________________________________31,_2000, _____U__I__G________ ____________ _ IN ONE YEAR ONE TO AFTER OR _____ FIVE YEARS FIVE YEARS TOTA_ ______LESS __ ____________ ____________ _______L__ Commercial real estate loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Automotive floor plans loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Multi-family loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loans with: Fixed rates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Variable rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total .. .. .. ..... .. ... .. .. ... .... ... .. .. ... .. ..... .. .. ... .. .. ... .. .. 128,641 1,774,557 233,115 13 _ ____________2 $ _________ ____2,136,445 $ $ 1,408,945 1,772,561 193,196 21,5 __ __________60 $____396,26_ _ 3,______2 $ 1,256,030 849,891 87,330 105 ___ ______ ,449 ___ $__2,2___700 9 _ ___ 8, ___ $ 2,793,616 4,397,009 513,641 127,___ _______141 $ _7,_______ _ _ 831,407 $ 87,718 ____2_048,727 _, _______ $ _________ ____2,136,445 $ 1,937,439 1, _______ _____458,823 $ 1,361,862 9______ 3 ______ 6,838 $ ___ 8, ___ 9 ___2,2___700 $ 3,387,019 4 444, ___ ___,____388 $ _7,____407 _ _ 831,___ $ ____396,262 _ 3, _______ 20
Slide 23: Credit Risk Management. Extending credit exposes Sovereign to credit risk, which is the risk that the principal balance of a loan and any related interest will not be collected due to the inability of the borrower to repay the loan. Sovereign manages credit risk in the loan portfolio through adherence to consistent standards, guidelines and limitations established by the Board of Directors. Written loan policies establish underwriting standards, lending limits and other standards or limits as deemed necessary and prudent. Various approval levels, based on the amount of the loan and whether the loan is secured or unsecured, have also been established. Loan approval authority ranges from the individual loan officer to the Board of Directors' Loan Committee. In addition to being subjected to the judgement of experienced loan officers and their managers, loans over a certain dollar size also require the co-approval of credit officers independent of the loan officer to ensure consistency and quality in accordance with Sovereign’s credit standards. The Loan Review Group conducts ongoing, independent reviews of the lending process to ensure adherence to established policies and procedures, monitors compliance with applicable laws and regulations, provides objective measurement of the risk inherent in the loan portfolio, and ensures that proper documentation exists. The results of these periodic reviews are reported to the Asset Review Committee, and to the Board of Directors of both Sovereign and Sovereign Bank. In response to Sovereign's increased emphasis on commercial and consumer lending, Sovereign has added to its loan review group by hiring loan review officers with significant commercial and consumer experience. Sovereign also maintains a watch list for certain loans identified as requiring a higher level of monitoring by management because of one or more factors, such as economic conditions, industry trends, nature of collateral, collateral margin, payment history, or other factors. Commercial loan credit quality is strong but due to questions on the strength of the economy, is under a high level of scrutiny by both line management and the independent Loan Review Group. The following discussion summarizes the underwriting policies and procedures for the major categories within the loan portfolio and addresses Sovereign's strategies for managing the related credit risk. Commercial Loans. Credit risk associated with commercial loans is primarily influenced by prevailing and expected economic conditions and the level of underwriting risk Sovereign is willing to assume. To manage credit risk when extending commercial credit, Sovereign focuses on both assessing the borrower's capacity and willingness to repay and on obtaining sufficient collateral. Commercial and industrial loans are generally secured by the borrower's assets and by personal guarantees. Commercial real estate loans are originated primarily within the Pennsylvania, New Jersey, and New England market areas and are secured by developed real estate at conservative loan-to-values and often by a guarantee of the borrower. Management closely monitors the composition and quality of the total commercial loan portfolio to ensure that significant credit concentrations by borrower or industry do not exist. Consumer Loans. Credit risk in the direct consumer loan portfolio is controlled by strict adherence to conservative underwriting standards that consider debt-to-income levels and the creditworthiness of the borrower and, if secured, collateral values. In the home equity loan portfolio, combined loan-to-value ratios are generally limited to 80% or credit insurance is purchased to limit exposure. Other credit considerations may warrant higher combined loan-to-value ratios for approved loans. The portion of the consumer portfolio which is secured by real estate, vehicles, deposit accounts or government guarantees comprises 96.8% of the entire portfolio. Residential Loans. Sovereign originates fixed rate and adjustable rate residential mortgage loans which are secured by the underlying 1-4 family residential property. At December 31, 2000 and 1999, residential loans accounted for 37% and 40%, respectively, of the total loan portfolio. This decrease was the outcome of Sovereign's increased emphasis on commercial and consumer lending. Credit risk exposure in this area of lending is minimized by the evaluation of the creditworthiness of the borrower, including debt-to-equity ratios, credit scores, and adherence to underwriting policies that emphasize conservative loan-to-value ratios of generally no more than 80%. Residential mortgage loans granted in excess of the 80% loan-to-value ratio criterion are generally insured by private mortgage insurance, unless otherwise guaranteed or insured by the Federal, state or local government. Sovereign also utilizes underwriting standards which comply with those of the Federal Home Loan Mortgage Corporation ("FHLMC") or the Federal National Mortgage Association ("FNMA"). Credit risk is further reduced since a portion of Sovereign's fixed rate mortgage loan production is sold to investors in the secondary market without recourse. Collections. Sovereign closely monitors delinquencies as another means of maintaining high asset quality. Collection efforts begin within 15 days after a loan payment is missed by attempting to contact all borrowers and to offer a variety of loss mitigation alternatives. If these attempts fail, Sovereign will proceed to gain control of any and all collateral in a timely manner in order to minimize losses. While liquidation and recovery efforts continue, officers continue to work with the borrowers, if appropriate, to recover all monies owed to Sovereign. Sovereign monitors delinquency trends at 30, 60, and 90 days past due. These trends are discussed at the monthly Asset Review Committee meetings. Minutes from these meetings are submitted to the Board of Directors of Sovereign Bank. 21
Slide 24: Management’s Discussion and Analysis Non-performing Assets. At December 31, 2000, Sovereign's non-performing assets were $187 million compared to $84 million at December 31, 1999. Non-performing assets as a percentage of total assets was .56% at December 31, 2000 compared to .32% at December 31, 1999. This increase was caused by each segment of the portfolio, but notably in residential and commercial portfolios. Commercial nonperforming loans are higher due to deterioration in a segment of the portfolio concentrated in cash flow, or enterprise lending in syndicated, multi-bank credits that were originated by other banks and participated in by Sovereign, as well as direct loans made to Sovereign customers. At December 31, 2000, 46% of non-performing assets consisted of loans related to real estate or OREO. Another 7% of non-performing assets consist of indirect auto loans and other repossessed assets. Indirect auto loans delinquent in excess of 120 days carry an allowance allocation of 100%. Repossessed autos carry an allowance allocation of 50%. Sovereign places all loans 90 days or more delinquent (except auto loans and loans guaranteed by the government or secured by deposit accounts) on non-performing status. Sovereign's auto loans continue to accrue interest until they are 120 days delinquent, at which time they are placed on non-accrual status and a 100% allowance allocation is assigned. Effective January 1, 2001, Sovereign will extend the auto loans accrual policy to other consumer loans. Table 6 presents the composition of non-performing assets at the dates indicated (in thousands): TABLE 6: NON-PERFORMING ASSETS ____2000____ ____ Non-accrual loans: Residential . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consumer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total non-accrual loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Restructured loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total non-performing loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other real estate owned and other repossessed assets: Residential real estate owned . . . . . . . . . . . . . . . . . . . . . . Commercial real estate owned . . . . . . . . . . . . . . . . . . . . . Other repossessed assets . . . . . . . . . . . . . . . . . . . . . . . . . Total other real estate owned and other repossessed assets . . . . . . Total non-performing assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . Past due 90 days or more as to interest or principal and accruing interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-performing assets as a percentage of total assets . . . . . . . . . Non-performing loans as a percentage of total loans . . . . . . . . . . Non-performing assets as a percentage of total loans and other real estate owned . . . . . . . . . . . . . . . . . . . . . . . Allowance for loan losses as a percentage of total non-performing assets . . . . . . . . . . . . . . . . . . . . . . . . . . . Allowance for loan losses as a percentage of total non-performing loans . . . . . . . . . . . . . . . . . . . . . . . . . . . $ _________________________________AT_DECEMBER ____________________________________ __ ___________ 31, ____1999 __ ______ ____199_____ ___8 ____1997____ ____ ____1996____ ____ 32,374 4,110 12,668 26, ___ _________259 75,411 3,__5 _________75_ 79,166 2,344 1,223 1,__2 _________76_ 5,__9 _________32_ $ 84,___ _________495 $ 60,582 6,108 7,305 25, ___ _________964 99,959 141 ____________ 100,100 12,147 665 2,___ _________772 15, ___ _________584 $ 115, ___ _________684 $ 65,930 2,785 942 25,___ _________720 95,377 _________327 ___ 95,704 11,299 710 – ____________ 12, ___ _________009 $ 107,___ _________713 $ 78,463 8,136 3,332 9,__4 _________25_ 99,185 1,561 ____________ 100,746 13,669 4,380 ___________– _ 18, ___ _________049 $ 118, ___ _________795 $ 60,322 12,403 64,485 38, ___ _________239 175,449 3, ___ _________755 179,204 4,425 – 3, ___ _________758 8, ___ _________183 $ 187, ___ _________387 $ 16,733 .56% .82 .85 136.8 143.1 $ 10,238 .32% .55 .59 157.4 168.0 $ 9,975 .53% .86 1.00 115.7 133.7 $ 7,053 .61% .82 .92 108.5 122.1 $ 16,722 .78% 1.05 1.22 62.2 73.3 22
Slide 25: Gross interest income for the years ended December 31, 2000, 1999 and 1998 would have increased by approximately $7.0 million, $5.0 million and $9.5 million, respectively, had Sovereign's period-end nonaccruing and restructured loans been current in accordance with their original terms and outstanding throughout the period. Interest income recorded on these loans for the years ended December 31, 2000, 1999, and 1998 was $3.8 million, $2.1 million and $3.3 million, respectively. Potential Problem Loans. Potential problem loans (consisting of loans for which management has doubts as to the ability of such borrowers to comply with present repayment terms, although not currently classified as non-performing loans) amounted to approximately $97 million and $13 million at December 31, 2000 and 1999. Allowance for Loan Loss. The adequacy of Sovereign's allowance for loan losses is regularly evaluated. Management's evaluation of the adequacy of the allowance to absorb potential loan losses takes into consideration the risks inherent in the loan portfolio, past loan loss experience, specific loans which have loss potential, geographic and industry concentrations, delinquency trends, economic conditions, the level of originations and other relevant factors. Management also considers loan quality, changes in the size and character of the loan portfolio, amount of non-performing loans, delinquency trends, economic conditions, industry trends and consultation with regulatory authorities when determining the allowance. The Company’s last regulatory examination was as of September 30, 2000. At December 31, 2000, Sovereign's loan delinquencies (all performing loans greater than 30 days delinquent) as a percentage of total loans was 2.29% compared to 1.94% at December 31, 1999. This increase was evident in each segment of the portfolio. Overall, management believes that delinquencies, charge-offs, and non-performing statistics have evidenced deterioration because of certain specific factors and not weakness throughout the entire portfolio. Nonetheless, the allowance has been increased from .93% to 1.17% of total loans reflecting these trends and the shift in portfolio composition throughout the year, and credit risk management processes continue to identify deterioration as soon as possible. At December 31, 1999, Sovereign's loan portfolio was 40% residential, 31% consumer and 29% commercial. At December 31, 2000, Sovereign's loan portfolio was 36% residential, 28% consumer and 36% commercial. Along with higher yields, management believes this shift in loan composition brings higher inherent risk. Sovereign maintains an allowance for loan losses sufficient to absorb inherent losses in the loan portfolio. As discussed in Credit Management, Sovereign believes the current allowance to be at a level adequate to cover such inherent losses. At December 31, 2000, the Company's total allowance was $256 million. The Company's total allowance at year-end equated to approximately 4.0 times the average charge-offs for the last three years and 5.6 times the average net charge-offs for the same three-year period. Because historical chargeoffs are not necessarily indicative of future charge-off levels, the Company also gives consideration to other risk indicators when determining the appropriate allowance level. Sovereign applies similar methods of determining the loan loss allowance for purchased loan portfolios as it does in establishing allowances for originated loans. Sovereign established $135 million of allowance for loan losses for the loans acquired in the SBNE acquisition. In establishing this allowance, Sovereign utilized its methodology, adjusted for increased uncertainty regarding the quality of the acquired loans. Sovereign performed specific reviews of large non-homogeneous loans, and established specific allowances accordingly. For homogenous loans, Sovereign established the loan loss allowance based on limited available performance history,industry statistics and similar experiences with other acquired portfolios. The allowance for loan losses consists of two elements: (i) an allocated allowance, which for non-homogeneous loans is comprised of allowances established on specific classified loans, and class allowances for both homogeneous and non-homogeneous loans based on historical loss experience and current trends, and (ii) unallocated allowances based on both general economic conditions and other risk factors in the Company’s individual markets and portfolios, and to account for a level of imprecision in management’s estimation process. The allowance recorded for consumer and residential portfolios is based on an analysis of product mix, credit scoring and risk composition of the portfolio, fraud loss and bankruptcy experiences, economic conditions and historical and expected delinquency and charge-off statistics for each homogeneous category or group of loans. Based on this information and analysis, an allowance is established approximating a rolling twelve-month estimate of net-charge-offs. The allowance recorded for commercial loans is based on an analysis of the individual credits and relationships and is separated into two parts, the specific allowance and the class allowance. The specific allowance element of the commercial loan allowance is based on a regular analysis of criticized commercial loans where internal credit ratings are below a predetermined classification. This analysis is performed by the Managed Asset Division, where loans with recognized deficiencies are administered, and periodically reviewed by the Loan Review Department. The specific allowance established for these criticized loans is based on a careful analysis of related collateral value, cash flow considerations and, if applicable, guarantor capacity. The class allowance element of the commercial loan allowance is determined by an internal loan grading process in conjunction with associated allowance factors. These class allowance factors are updated annually and are based primarily on actual historical loss experience, consultation with regulatory authorities, and peer groups loss experience. While this analysis is conducted annually, the Company has the ability to revise the class allowance factors whenever necessary in order to address improving or deteriorating credit quality trends or specific risks associated with a given loan pool classification. Regardless of the extent of the Company analysis of customer performance, portfolio evaluations, trends or risk management processes established, certain inherent but undetected losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer's financial condition or changes in their unique business conditions; the judgmental 23
Slide 26: Management’s Discussion and Analysis Table 7 summarizes Sovereign's allocation of the allowance for loan losses for allocated and unallocated allowances by loan type, and the percentage of each loan type of total portfolio loans (in thousands): TABLE 7: ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES ________200_____ __ _ ___0 _ _ % OF LOANS TO TOTAL AMOUNT LOANS Allocated allowances: Commercial loans. . . . Residential real estate mortgage loans. . . . Consumer loans. . . . . Unallocated allowances. . . . . Total allowance for loan losses. . . . . . . $149,828 34,629 48,053 __2____6 _3,84_ $256,356 ________ 36% 36 28 n/a __100% ___ AT DECEMBER __ ______________________________________________________________________31,____________________________________________________ __ _ __ 1 ___ _ _ ________19______ __ _ __99 _ _ ________1_______ __ _ _998 _ _ ________1997____ __ _ ____ _ _ _________996 ____ __ _ % OF LOANS TO TOTAL AMOUNT LOANS $ 58,784 19,535 43,455 ___11_212 _ ,___ $132, ___ _____986 29% 40 31 n/a 100 _____% % OF LOANS TO TOTAL AMOUNT LOANS $ 38,354 22,427 48,083 24,93_ _______8 $1______ __ 33,802 20% 47 33 n/a 100 _____% % OF LOANS TO TOTAL AMOUNT LOANS $ 30,793 36,351 24,300 __2__379 _5, ___ $116_823 ____, ___ ____ 12% 61 27 n/a 100 _____ % % OF LOANS TO TOTAL AMOUNT LOANS $ 21,091 25,835 10,274 16, ___ _____647 $ 73, ___ _____847 9% 79 12 n/a 100 _____ % nature of individual loan evaluations, collateral assessments and the interpretation of economic trends; volatility of economic or customer conditions and the sensitivity of assumptions utilized to establish allocated allowances for homogeneous groups of loans among other factors. The Company maintains an unallocated allowance to recognize the existence of these exposures. These other risk factors are continuously reviewed and revised by management where conditions indicate that the estimates initially applied are different from actual results. A comprehensive analysis of the allowance for loan losses is performed by the Company on a quarterly basis. In addition, a review of allowance levels based on nationally published statistics is conducted on an annual basis. The Company has an Asset Review Committee, which has the responsibility of affirming allowance methodology and assessing the general and specific allowance factors in relation to estimated and actual net charge-off trends. This Committee is also responsible for assessing the appropriateness of the allowance for loan losses for each loan pool classification at Sovereign. Although the Company determines the amount of each element of the allowance separately and this process is an important credit management tool, the entire allowance for credit losses is available for the entire loan portfolio. The actual amount of losses incurred can vary significantly from the estimated amounts. The Company’s methodology includes several factors intended to minimize the differences between estimated and actual losses. These factors allow the Company to adjust its estimate of losses based on the most recent information available. During 2000, management analysis of historical losses of the residential and consumer portfolios enabled the Company to reduce reserves for these portfolios to a level that is more comparable to the portfolio’s performance history, as discussed below. Residential Portfolio. The allowance for the residential mortgage portfolio increased from $19.5 million at December 31, 1999 to $34.6 million at December 31, 2000. The increase was due primarily to reserves established in connection with the SBNE acquisition of $15.6 million offset somewhat by a reduction of $14.3 million of reserves allocated to the originated portion of the portfolio due to a change in estimate. The increase between years represents an increase in absolute levels, from .34% at December 31, 1999, to .41% at December 31, 2000, reflecting some increased levels of delinquencies and non-performing assets. Delinquencies, stated on a consistent basis to reflect the FFIEC classification guidelines implemented in 2000, increased slightly from 3.22% at December 31, 1999 to 3.78% at December 31, 2000. Consumer Portfolio. The allowance for the consumer loan portfolio increased from $43.5 million at December 31, 1999 to $48.1 million at December 31, 2000 due to reserves established in connection with the SBNE acquisition of $18.6 million offset by a change in estimate of $16.8 million related to management’s analysis of portfolio performance over the past several years. Specifically, since its acquisition of the portfolio from FleetBoston Financial in 1997, the Company enhanced its underwriting and credit monitoring processes related to its indirect auto portfolio and purchased indirect auto portfolio, which has resulted in a decrease in historical net chargeoffs in the auto portfolio from 1.23% for 1998 to .53% for 2000. Commercial Portfolio. The allowance for loan losses for the commercial portfolio increased $91 million to $149.8 million at December 31, 2000. This increase is due to reserves established in connection with the SBNE acquisition of $80 million and management’s evaluation of general economic conditions and trends in the performance of this portfolio which resulted in an increased allocation of $31.1 million due to deterioration of certain asset based and cash flow loans in the Specialty 24
Slide 27: Lending Group. The allowance allocated to the commercial portfolio was increased by $7.6 million due to rating changes in the Company’s general commercial credits. Although Sovereign experienced deterioration in credit quality in selected portfolios, seasoning and improved performance enabled the Company to release $6.7 million and $12.6 million, respectively, from its small business portfolio and commercial real estate portfolio. Total commercial non-accrual loans as a percentage of total commercial loans increased from .41% at December 31, 1999 to .98% at December 31, 2000 primarily in the aforementioned Specialty Lending Group, and resulted in the allowance allocated to commercial loans as a percentage of total commercial loans increasing from 1.44% at December 31, 1999 to 1.91% at December 31, 2000. In addition to the increase in nonaccruals noted above, this increase was due to management’s belief that economic conditions are showing signs of slowing from periods of earlier robust growth and markets are mixed. Unallocated Allowance. The unallocated allowance increased $12.6 million to $23.8 million at December 31, 2000. The increase in the unallocated allowance is related to management’s evaluation of current economic conditions, loan portfolio trends, and recently acquired portfolios. The increase raises the unallocated allowance as a percentage of the total allowance for loan losses from 8.4% at December 31, 1999 to 9.3% at December 31, 2000. This is a result of increased uncertainty with respect to current economic conditions, along with the shift in the Company’s loan composition, which brings higher inherent risk. 25
Slide 28: Management’s Discussion and Analysis Investment Securities. Sovereign's investment portfolio is concentrated in mortgage-backed securities and collateralized mortgage obligations issued by federal agencies or private label issues. The private label issues have ratings of "AAA" by Standard and Poor's and Fitch at the date of issuance. The classes are backed by single-family residential loans which are primary residences geographically dispersed throughout the United States. Sovereign purchases classes which are senior positions backed by subordinate classes. The subordinate classes absorb the losses and must be completely eliminated before any losses flow through the senior positions. Sovereign's strategy is to purchase classes which have an average life of four years or less. The effective duration of the total investment portfolio at December 31, 2000 was 3.6 years. Investment Securities Available-for-Sale. Securities expected to be held for an indefinite period of time are classified as available-for-sale and are carried at fair value, with unrealized gains and losses reported as a separate component of stockholders' equity, net of estimated income taxes. Decisions to purchase or sell these securities are based on economic conditions including changes in interest rates, liquidity, and asset/liability management strategies. For additional information with respect to the amortized cost and estimated fair value of Sovereign's investment securities available-for-sale, see Note 4 in the "Notes to Consolidated Financial Statements" hereof. The actual maturities of mortgage-backed securities available-for-sale will differ from contractual maturities because borrowers may have the right to prepay obligations without prepayment penalties. During 2000, Sovereign sold $2.1 billion of investment securities available for sale and incurred a $103 million loss as part of a balance sheet deleveraging strategy. Investment Securities Held-to-Maturity. Securities that Sovereign has the intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. This portfolio is primarily comprised of U.S. Treasury and government agency securities; corporate debt securities; mortgage-backed securities issued by FHLMC, FNMA, the Government National Mortgage Association ("GNMA"), and private issuers; and collateralized mortgage obligations. For additional information with respect to the amortized cost and estimated fair value of Sovereign's investment securities held-to-maturity, see Note 4 in the "Notes to Consolidated Financial Statements" hereof. The actual maturities of the mortgage-backed securities held-tomaturity will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties. In the third and fourth quarters of 2000, $1.2 billion of owned mortgage loans were securitized. Sovereign retained the resulting securities and classified them as held-to-maturity. Table 8 presents the book value of investment securities by obligation and Table 9 presents the securities of single issuers (other than obligations of the United States and its political subdivisions, agencies and corporations) having an aggregate book value in excess of 10% of Sovereign's stockholders' equity which were held by Sovereign at December 31, 2000 (dollars in thousands): TABLE 8: INVESTMENT SECURITIES BY OBLIGOR ____AT___________________ __ DECEMBER 31, 1 ___ ___2000___ ____ ____999 ___ Investment securities available-for-sale: U.S. Treasury and government agency securities. . . . . . . . . . . . . . . . . . . . . . . State and municipal securities . . . . . . . . . . . . . Other securities. . . . . . . . . . . . . . . . . . . . . . . . Total investment securities available-for-sale. . . . . . . . . . . . . . . . . . . . . . . Investment securities held-to-maturity: U.S. Treasury and government agency securities. . . . . . . . . . . . . . . . . . . . . . . State and municipal securities. . . . . . . . . . . . . . Other securities. . . . . . . . . . . . . . . . . . . . . . . . Total investment securities held-to-maturity. . . . . . . . . . . . . . . . . . . . . . . . TABLE 9: INVESTMENT SECURITIES OF SINGLE ISSUERS __________AT_DECEMBER ________________ __ ___________ 31, 2000 A __________ _____ FAIR VA_ U _ __MORTIZED_COST ___________L__E ___ Cendant Mortgage . . . . . . . . . . . . . . . . . Countrywide Home Loans, Inc. . . . . . . . First Nationwide Trust . . . . . . . . . . . . . . Norwest Asset Securities Corporation . . . PNC Mortgage Securities Corporation . . . Residential Asset Securitization Trust . . . Residential Funding Corporation . . . . . . . Structured Asset Securities Corporation . . Total . . . . . . . . . . . . . . . . . . . . . 402,939 253,919 263,202 272,596 420,346 305,521 424,247 __________386,___ ___ 216 $ ________2,_______ _ 728,986 $ $ 396,348 249,104 250,915 262,823 418,592 301,034 425,998 378, ___ _____________054 $ 1,417,553 6,815 __3,____216 _ 891,___ $ ______584 _ 5,315, ___ $ 964,016 32,179 __7,____017 _ 034,___ $ _8,____212 _ _ 030,___ $ 1,568,908 739 408, ___ _______621 $__9___268 _ 1,_78, ___ $ 504,673 3,275 __1,____103 _ 854,___ $ ________,____868 2 682, ___ _ $ _2,362,___ _ _____ 051 26
Slide 29: Table 10 presents the book value, expected maturities and yields of Sovereign's investment securities available-for-sale at December 31, 2000 (in thousands): TABLE 10: INVESTMENT AND MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE AT DECEMBER 31, 2000, ____ _______________________________________________________________________DUE ________________________________________ AFTER 10 IN ONE YEAR ONE YEAR/ FIVE YEARS/ YEARS/ OR LESS FIVE YEARS NO _____U__I__Y ______________ ______________ __TEN_________ ___ YEARS ___ MAT _ R T _ ____TOTAL____ ______ Investment Securities: U.S. Treasury and government agency securities. . Corporate securities. . . . . . . . . . . . . . . . . . . . . . Asset-backed securities . . . . . . . . . . . . . . . . . . . Equities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FHLB stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . Agency preferred stock. . . . . . . . . . . . . . . . . . . . Municipal securities. . . . . . . . . . . . . . . . . . . . . . Mortgage-backed Securities: U.S. government agency passthroughs. . . . . . . . . Non-agency passthroughs . . . . . . . . . . . . . . . . . Collateralized mortgage obligations . . . . . . . . . . . . . . . Total investment and mortgage-backed securities available-for-sale . . . . . . . . . . . . . . . . . Weighted average yield. . . . . . . . . . . . . . . . . . . . . . . . . $ 80,831 6.42% – – 96,084 6.82% – – – – – – 355 5.81% $ 11,109 6.18% 604 8.60% 264,600 6.83% – – – – – – 364 5.84% $ – – 180,693 8.84% 119,469 6.70% – – – – – – 1,122 6.02% $ – – 124,512 9.00% 31,443 6.40% 51,660 – 225,797 7.25% 425,877 7.94% 4,974 6.00% $ 91,940 6.39% 305,809 8.91% 511,596 6.77% 51,660 – 225,797 7.25% 425,877 7.94% 6,815 5.98% 88,284 7.11% 438,876 6.65% 50,360 7. __ ________30% $ 754, ___ _______790 ______6.75% ____ 281,417 7.08% 1,122,386 6.66% 278,287 ______7.30% ____ $______767 _ 1,958, ___ 6. __ ________83% 163,137 6.99% 418,209 6.67% 155,402 7.36 __________ % $_1,____032 _ _ 038, ___ 7.__ ________20% 141,101 6.86% 534,097 7.26% 24,534 6.__ ________80% $_1,____9__ _ _ 563,_95 7. __ ________28% 673,939 7.02% 2,513,568 6.78% 508,583 7. __ ________29% $_5,____584 _ _ 315, ___ 7.02 __________ % 27
Slide 30: Management’s Discussion and Analysis Table 11 presents the book value, expected maturity and yields of Sovereign’s investment securities held-to-maturity at December 31, 2000 (in thousands): TABLE 11: INVESTMENT AND MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY AT DECEMBER __ _____ DUE _______________________________________________________________31,_2000, ____________________________________________ IN ONE YEAR ONE YEAR/ FIVE YEARS/ AFTER FIVE YEARS ___OR ________ ___ LESS ______________ __TEN ________ ____ YEARS __TEN ________ ____YEARS ____TOTAL____ ______ Investment Securities: U.S. Treasury and government agency securities. . $ 4,704 6.89% – – 406 5.01% 258,512 7.29% 9,539 7.42% 80,947 ______6_23% _. __ $ ___ , __ 8 ___354_10_ ______7.04% ____ $ 1,525 7.19% 2,525 10.21% 333 5.83% 732,721 7.17% $ 153 7.20% 33,259 10.27% – – 343,538 6.85% $ – – – – – – 227,755 6.26% $ 6,382 6.97% 35,784 10.27% 739 5.38% Corporate securities . . . . . . . . . . . . . . . . . . . . . . Municipal securities. . . . . . . . . . . . . . . . . . . . . . Mortgage-backed Securities: U.S. government agency passthroughs. . . . . . . . . 1,562,526 6.99% 39,118 7.67% 333,719 ______6.55% ____ $1,978 2 __ _______,__68 _______6_9_ % _ . _9 ___________ Non-agency passthroughs . . . . . . . . . . . . . . . . . Collateralized mortgage obligations . . . . . . . . . . . . . . . Total investment and mortgage-backed securities held-to-maturity . . . . . . . . . . . . . . . . . Weighted average yield(1). . . . . . . . . . . . . . . . . . . . . . (1) Weighted average yield calculated using amortized cost. 23,029 7.69% 222,672 ________.__7% 6 5_ $__9___,____ _ _ 82 805 7 0_ ________.__6% 5,690 7.96% 17,176 ________.___% 7 18 $__3______6 _ _99,81 _ 7 ___ ________.16% 860 7.93% 12,924 ______7_41% _. __ $ 241____ ______,539 ______6.32% ____ Other Assets. Premises and equipment increased from 1999 due to the acquisition of various assets in the SBNE franchise aggregating $68 million and the growth of the existing franchise. Accrued interest receivable increased $66 million due to the increase in the loan portfolio and the increased yield on such loans. BOLI increased due to an additional investment of $200 million during the year. Other assets at December 31, 2000 was $951.2 million compared to $530.2 million at December 31, 1999. The increase primarily relates to $180 million of precious metals inventory, and other assets, acquired in the SBNE transaction. Goodwill and other intangible assets increased $1.0 billion to $1.5 billion which represented 4.3% of total assets and 74.7% of stockholders’ equity at December 31, 2000. This increase was primarily due to additional goodwill of $726 million and core deposit intangible of $429 million related to the Fleet acquisition offset by goodwill and intangible asset amortization of $99 million. The goodwill arose from the purchase of $12.3 billion of deposits at a premium of 12% (9% net of adjustments) and purchase accounting adjustments related primary to marking the loans to market value and establishing an initial loan loss allowance. Deposits. Deposits are attracted from within Sovereign's primary market area through the offering of various deposit instruments including demand and NOW accounts, money market accounts, savings accounts, certificates of deposit and retirement savings plans. Total deposits at December 31, 2000 were $24.5 billion compared to $12.0 billion at December 31, 1999. The increase in deposits is attributable to $12.3 billion of deposits acquired in the SBNE acquisition, of which net retention was 99.8%, and growth in our existing deposit base of approximately $800 million, offset by $315 million of deposits divested in the sale of 20 branches in northern Pennsylvania. 28
Slide 31: Table 12 presents the composition of Sovereign's average deposits and yield rates for the periods indicated (in thousands): TABLE 12: AVERAGE DEPOSITS AND YIELD RATES FOR THE _____ ______ DECEMBER 31, ___________________________________________YEAR_ENDED_____________________________________________ ____________2_______________ _000 AVERAGE BALA _CE R __ E _______N____ _____AT_____ Demand deposit and NOW accounts . . . . . . . . . . . . . . . . . . . . . . . . $ 5,468,164 Savings accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,741,867 Money market accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,059,568 Retail certificates of deposit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . _________743 7,073, ___ Total retail deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,343,342 Jumbo certificates of deposit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . _____8___200 _62, ___ _$ _______542 _ 19,205, ___ 1.50% 2.48% 4.32% 5.65% 3.72% 6.27% 3.83% ____________199_____________ ___9 AVERAGE BALA _ CE R ____ _______N____ _____ATE ___ $ 2,835,152 2,246,127 1,288,581 ____4,____452 _ 945,___ 11,315,312 891,___ _________333 $__12,____6__ _ __ 206,_45 1.22% 2.60% 3.90% 5.05% 3.47% 5.36% 3.61% 1998 _____________________________ AVERAGE RAT_ __BALA___E _____NC _ _______E___ $ 1,774,514 2,126,149 1,173,889 4,903, ___ _________742 9,978,294 784, ___ _________826 $__10,____120 _ __ 763, ___ 1.12% 2.95% 3.84% 5.56% 4.01% 5.59% 4.12% Borrowings. Sovereign utilizes borrowings as a source of funds for its asset growth and its asset/liability management. Collateralized advances are available from the Federal Home Loan Bank of Pittsburgh ("FHLB") provided certain standards related to creditworthiness have been met. Another source of funds for Sovereign is reverse repurchase agreements. Reverse repurchase agreements are short-term obligations collateralized by investment securities. Total borrowings at December 31, 2000 were $1.3 billion, compared to total borrowings of $6.2 billion at December 31, 1999. Through the use of interest rate swaps, $400 million of the FHLB advances at December 31, 2000 have been effectively converted from variable rate obligations to fixed rate obligations. An additional $500 million of borrowings have been protected from upward repricing through the use of interest rate caps. Table 14 summarizes information regarding short-term securities sold under repurchase agreements and short-term FHLB advances (in thousands): TABLE 14: DETAILS OF BORROWINGS DECEMBER 31, __________________________________ 2000 1999 _____________ _____________ Short-term securities sold under repurchase agreement: Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . Weighted average interest rate . . . . . . . . . . . . Maximum amount outstanding at any month-end during the year . . . . . . . . . Average amount outstanding during the year . . . . . . . . . . . . . . . . . Weighted average interest rate during the year . . . . . . . . . . . . . . . . . Short-term FHLB advances: Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . Weighted average interest rate . . . . . . . . . . . . Maximum amount outstanding at any month-end during the year . . . . . . . . . . . . . . . . . Average amount outstanding during the year . . . . . . . . . . . . . . . . . Weighted average interest rate during the year . . . . . . . . . . . . . . . . . $ 230,900 6.58% 1,426,828 811,601 6.57% $ 102,944 5.85% 2,461,914 1,145,454 5.46% $ $ $ $ Table 13 presents information regarding Sovereign's borrowings and the related weighted average rate at the dates indicated (in thousands): $ 970,000 6.62% $ 6,054,995 5.67% $ 8,753,000 $ $ 6,054,995 3,442,512 5.57% TABLE 13: BORROWINGS ______________AT_____________________________ __ DECEMBER 31, 2000 1999 _____________________ _____________________ B _ an __ Ra __ ___al___ce _ _____te __ Federal funds purchased . . . . . . . Securities sold under repurchase agreements . . . . Federal Home Loan Bank advances . . . . . . . . . Total borrowings . . . . . . . . $ 130,000 230,900 970, ___ ______000 $1, __0, ___ ___33__900 5.23% 6.58% 6._2 ___6_ % 6._8 ___4_ % B _ an __ ___al___ce _ $ – 102,944 __6,____99_ _ 054,__5 $ _ 157,___ __________ __6,____939 Ra __ _____te __ – 5.85% 5. __ ___67% 5.__ ___67% $ 4,267,647 6.59% 29
Slide 32: Management’s Discussion and Analysis Long-Term Debt. Total long-term debt at December 31, 2000 was $4.9 billion compared to $6.2 billion at December 31, 1999. The decrease in long-term debt was due to the maturity of the 6.75% subordinated notes, the early repayment of a portion of the senior credit facility, the sale of FHLB advances which resulted in an extraordinary gain, and the maturity of long-term FHLB advances. On March 1, 2001, Sovereign refinanced the $500 million senior secured credit facility with a variable rate $400 million senior secured credit facility consisting of a $350 million revolving line and a $50 million term note. On February 20, 2001, Sovereign issued $175 million of senior unsecured notes at 8.625% which will mature on March 15, 2004. The proceeds of this issuance, along with the proceeds of $150 million from the 20 million shares of common stock issued on February 9, 2001, were used to repay $240 million of 6.625% senior notes which matured on March 15, 2001 and for additional liquidity. Table 15 presents the capital ratios of Sovereign Bank and the current regulatory requirements at December 31, 2000. TABLE 15: REGULATORY CAPITAL WELL CAPITALIZED R___U_R______T _EQ _ I _ EMEN _ None 5.00% 6.00 10.00 SOVEREIGN MINIMUM ___BA__K___ R___U_R______T __ N _ _ EQ _ I_ EMEN_ Tangible capital to tangible assets . . . . . Tier 1 leverage ratio . . . . . . . . . . . . . . . Tier 1 risk–based capital ratio . . . . . . . . Total risk–based capital ratio . . . . . . . . 6.92% 6.92 9.20 10.31 2.00% 3.00 4.00 8.00 BANK REGULATORY CAPITAL Federal law requires institutions regulated by the Office of Thrift Supervision to have a minimum leverage capital ratio equal to 3% of tangible assets and 4% of risk-adjusted assets, and a risk-based capital ratio equal to 8%. Federal law also requires OTS regulated institutions to have a minimum tangible capital equal to 2% of total tangible assets. The OTS Order, as amended, applicable to the approval of the SBNE acquisition (the “OTS Order”) requires Sovereign Bank to be “Well Capitalized” and also to meet certain additional requirements and other conditions. Various agreements with our lenders also require Sovereign Bank to be “Well Capitalized” at all times and in compliance with all regulatory requirements. To be “well capitalized”, a thrift institution must maintain a Tier 1 Leverage ratio of at least 5%, a Tier 1 risk-based capital ratio of 6% and total risk-based capital of 10%. Management believes, as of December 31, 2000 and 1999, that Sovereign Bank met all capital adequacy requirements to which they are subject in order to be “Well Capitalized”. Management expects that Sovereign Bank will continue to be classified as well-capitalized and in compliance with such capital requirements and conditions. Although OTS capital regulations do not apply to savings and loan holding companies, the OTS Order requires us to maintain certain Tier 1 capital levels. We are presently in compliance with this requirement and expect to remain as such. For a detailed discussion on regulatory capital requirements, see Note 15 in the "Notes to Consolidated Financial Statements" hereof. LIQUIDITY AND CAPITAL RESOURCES Liquidity represents the ability of Sovereign to obtain cost effective funding to meet the needs of customers, as well as Sovereign’s financial obligations. Sovereign’s primary sources of liquidity include retail deposit gathering, Federal Home Loan Bank (FHLB) borrowings, reverse repurchase agreements and wholesale deposit purchases. Other sources of liquidity include federal funds purchased, asset securitizations, liquid investment portfolio securities and debt issuances. Sovereign is required under applicable federal regulations to maintain specified levels of liquid investments in cash and other qualifying investments. Current regulations require Sovereign Bank to maintain liquid assets of not less than 4% of its net withdrawable accounts plus short-term borrowings. As of December 2000, the Bank’s liquidity ratio was 48.38%. Factors which impact the liquidity position of Sovereign include loan origination volumes, loan prepayment rates, maturity structure of existing loans, core deposit growth levels, CD maturity structure and retention, Sovereign’s credit ratings, investment portfolio cash flows, maturity structure of wholesale funding, etc. These risks are monitored and centrally managed. This process includes reviewing all available wholesale liquidity sources. As of December 31, 2000, Sovereign had $5.4 billion in available overnight liquidity in the form of unused federal funds purchased lines, unused FHLB borrowing capacity and unencumbered investment portfolio securities. Sovereign also forecasts future liquidity needs and develops strategies to ensure that adequate liquidity is available at all times. 30
Slide 33: During 2000, the Company completed the following transactions to provide either additional capital and/or increased liquidity: Securitizations: In December 2000, the Company securitized and sold approximately $369 million of home equity loans. In October 2000, Sovereign securitized and sold $579 million of automotive floor plan commercial loans. Branch Sale: In the fourth quarter 2000, Sovereign sold certain non-strategic branches with deposits of $315 million. The securitizations and branch sales resulted in a net gain of $9 million, recorded as other income in the Financial Statements. REIT Preferred Stock: In August 2000, the Company raised $140 million from issuance of preferred stock of a subsidiary, Sovereign REIT. Structured Real Estate Transaction: In the second quarter, 2000, Sovereign executed a structured real estate transaction that involved the sale and subsequent leaseback of its own real estate and entered into a long-term lease arrangement for certain real estate used in the SBNE franchise. The total transaction was valued at $308 million. Total expenses related to the transaction were approximately $17 million pretax and were recorded as merger-related charges. During 1999, the Company raised $1.8 billion of debt and equity to finance its acquisition of Sovereign Bank New England. Components of these financings were as follows: Common Stock: 43.8 million shares of common stock were issued on November 15, 1999 resulting in net proceeds to Sovereign of $331.5 million. Piers Units: 5.75 million units of Trust Preferred Income Equity Redeemable Securities (PIERS) were issued on November 15, 1999, resulting in net proceeds to Sovereign of $278.3 million, $91.5 million of which has been allocated to the value of the warrants and is treated as original issue discount. The original issue discount is accreted into Trust Preferred Securities expense over the life of the unit resulting in an effective yield of 11.74%. Each PIERS unit consists of: A preferred security issued by Sovereign Capital Trust II (the Trust), having a stated liquidation amount of $50, representing an undivided beneficial ownership interest in the Trust, which assets consist solely of debentures issued by Sovereign. Distributions are payable quarterly beginning February 15, 2000 at an annual rate of 7.5% of the stated liquidation value; and A warrant to purchase, subject to antidilution adjustments, 5.3355 shares of Sovereign common stock at any time prior to November 20, 2029. Senior Notes: $200 million of 10.25% notes due May 15, 2004, and $500 million of 10.50% notes due November 15, 2006, on November 15, 1999 resulting in net proceeds to Sovereign of $681.3 million. The senior notes are unsecured senior obligations of Sovereign and rank equally with all existing and future senior indebtedness. Senior Secured Credit Facility: $500 million floating rate senior secured credit facility resulting in net proceeds to Sovereign of $485.5 million on December 16, 1999. The senior secured credit facility is secured primarily by the stock of Sovereign Bank, which is wholly owned by Sovereign Bancorp. The senior facility will mature on the date six months prior to the maturity date of the 10.25% senior notes, but in no event later than June 30, 2003. The facility’s original amortization schedule was as follows: 2000-5%, $25 million; 2001-15%, $75 million; 2002-40%, $200 million; and 2003-40%, $200 million with mandatory prepayments occurring if Sovereign's cash flow exceeds predetermined levels. During year 2000, Sovereign made its required $25 million payment on the Senior Credit Facility, and made additional payments of $125 million. These prepayments were made voluntarily, and not due to Sovereign’s cash flow exceeding the predefined levels proscribed. On March 1, 2001, Sovereign repaid this senior credit facility with the proceeds from another debt issuance as described below. 2001 Activities: Subsequent to December 31, 2000, Sovereign entered into the following transactions: Common Stock: On February 9, 2001, Sovereign issued $150 million of common equity consisting of 20 million shares sold at $7.50 per common stock share. The proceeds of the issuance were used to repay a portion of the $240 million of 6.625% senior notes which matured on March 15, 2001. Senior Notes: On February 20, 2001, Sovereign issued $175 million of senior unsecured notes at 8.625% which will mature on March 15, 2004. The proceeds of this issuance were used to repay the remaining portion of the $240 million of 6.625% senior notes which matured on March 15, 2001 and for additional liquidity. Senior Secured Credit Facility: On March 1, 2001, Sovereign refinanced the $500 million senior secured credit facility described above (outstanding balance at December 31, 2000 of $350 million) with a variable principal rate $400 million senior secured credit facility consisting of a $350 million revolving line of credit and a $50 million term note. For the first two years, the interest rates on both the line of credit and term loan is calculated using one of five methods at the option of Sovereign as: (1) 1 month Eurodollar rate plus 250 bp, (2) 3 month Eurodollar rate plus 250 bp, (3) 6 month Eurodollar rate plus 250 bp, (4) 12 month Eurodollar rate plus 250 bp, (5) the greater of the prime rate, plus 75 bp, or Fed Funds rate plus 125 bp. The interest rates for years 3-6 are structured based upon a rate table beginning with the Eurodollar rate plus 275 bp or the greater of the prime rate plus 100 bp or the federal funds rate plus 150 bp, and are decreased based upon each level of Sovereign’s senior unsecured long-term debt credit rating exceeding certain levels. The revolving line matures $100 million in 2005, $200 million in 2006, and $50 million in 2007, and the term note matures in 2005. 31
Slide 34: Management’s Discussion and Analysis Cash and cash equivalents increased $566 million for 2000. Net cash used by operating activities was $189 million for 2000. Net cash provided by investing activities for 2000 was $6.5 billion primarily due to the maturity of $1.3 billion securities held in escrow to finance the SBNE acquisition, and the sale of $2.1 billion of investment securities as a part of the strategy to deleverage the balance sheet, and the cash received from the SBNE acquisition Net cash used by financing activities for 2000 was $5.8 billion which was primarily attributable to repayment of short-term borrowings. Sovereign’s debt agreements impose customary limitations on dividends, other payments and transactions. These limits are not expected to affect dividend payments at current levels, and reasonably anticipated increases. mix and the increase in the mix of shorter duration consumer and commercial loans. Net interest income sensitivity is used to gauge the short-term interest rate risk of the bank. Sovereign also monitors the relative repricing sensitivities of its assets versus its liabilities. As of December 31, 2000, the one year cumulative gap was 1% versus (19)% one year earlier. This improvement is due to the same factors listed above. A neutral gap position indicates that the bank’s margin will be stable across various interest rate scenarios. Finally, Sovereign monitors the market value sensitivity of its assets versus the market value sensitivity of its liabilities. The analysis calculates the market value of assets, subtracts the market value of liabilities and adds any off-balance sheet items to come up with its Net Portfolio Value (NPV). This NPV is then calculated in numerous interest rate scenarios. Imbalances in this analysis indicate that the bank has sensitivity to changes in interest rates. At December 31, 2000, Sovereign has a very balanced profile, in correlation to the Gap Analysis and Net Interest Income simulation results discussed above. When measuring Net Portfolio Value (NPV), Sovereign monitors closely two specific interest rate environments as measured by standard industry practice, an instantaneous rate shock of up and down 200 basis points. If rates move up or down in parallel by 200 basis points, Sovereign’s NPV remains remarkably constant with a loss of less than 1.55% in the worst scenario of rates falling 200 basis points. The worst case scenario is used as a benchmark by regulators and Sovereign to measure and monitor the interest rate risk sensitivity of an institution. NPV is used as a gauge of long term interest rate risk. Because the assumptions used are inherently uncertain, the model cannot precisely predict the effect of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to the timing, magnitude and frequency of interest rate changes, the difference between actual experience and the assumed volume and characteristics of new business and behavior of existing positions, and changes in market conditions and management strategies, among other factors. ASSET AND LIABILITY MANAGEMENT Interest rate risk arises primarily through Sovereign’s traditional business activities of extending loans and accepting deposits. Many factors, including economic and financial conditions, movements in market interest rates and consumer preferences, affect the spread between interest earned on assets and interest paid on liabilities. In managing its interest rate risk, the bank seeks to minimize the variability of net interest income across various likely scenarios while at the same time maximizing its net interest income and net interest margin. To achieve these objectives, the bank works closely with each business line in the company and guides new business flows. The bank also uses various other tools to manage interest rate risk including wholesale funding maturity targeting, investment portfolio purchase strategies, asset securitization/sale, and financial derivatives. Interest rate risk is managed centrally by the Asset and Liability Committee. Management reviews various forms of analysis to monitor interest rate risk including net interest income sensitivity, market value sensitivity, repricing frequency of assets versus liabilities and scenario analysis. Numerous assumptions are made to produce these analyses including assumptions on new business volumes, loan and investment prepayment rates, deposit flows, interest rate curves, economic conditions, competitor pricing, etc. Sovereign reviews nine instantaneous rate shock scenarios to assess the sensitivity of Net Interest Income due to changes in interest rates including parallel shocks, curve steepening scenarios and curve flattening scenarios. At December 31, 2000, if interest rates moved in parallel 200 basis points up or down, or if the yield curve steepened or flattened by 200 basis points, Sovereign estimates the loss to Net Interest Income to remain under 2.4%. This has improved significantly from December 31, 1999 when the sensitivity in the worst scenario exceeded 10%. This improvement is due to the following factors: addition of $12 billion of deposits from the SBNE acquisition, wholesale funding paydown of over $5 billion, investment deleveraging of over $2 billion, increase in the core deposit 32
Slide 35: Pursuant to its interest rate risk management strategy, Sovereign enters into off-balance sheet transactions which involve interest rate exchange agreements (swaps, caps, and floors) for interest rate risk management purposes. Sovereign’s objective in managing its interest rate risk is to provide sustainable levels of net interest income while limiting the impact that changes in interest rates have on net interest income. Interest rate swaps are generally used to convert fixed rate assets and liabilities to variable rate assets and liabilities and vice versa. Sovereign utilizes interest rate swaps that have a high degree of correlation to the related financial instrument. At December 31, 2000, Sovereign’s principal off-balance sheet transactions were to convert liabilities from fixed rate to floating rate to reduce the cost of funds. Interest rate caps are generally used to limit the exposure from the repricing and maturity of liabilities and interest rate floors are generally used to limit the exposure from the repricing and maturity of assets. Interest rate caps and floors are also used to limit the exposure created by other interest rate swaps. In certain cases, interest rate caps and floors are simultaneously bought and sold to create a range of protection against changing interest rates while limiting the cost of that protection. As part of its mortgage banking strategy, Sovereign originates fixed rate residential mortgages. It sells the majority of these loans to FHLMC, FNMA, and private investors. The loans are exchanged for cash or marketable fixed rate mortgage-backed securities which are generally sold. This helps insulate Sovereign from the interest rate risk associated with these fixed rate assets. Sovereign uses forward sales, cash sales and options on mortgage-backed securities as a means of hedging loans in the mortgage pipeline which are originated for sale. To accommodate customer needs, Sovereign enters into customerrelated financial derivative transactions primarily consisting of interest rate swaps, caps, and floors. Risk exposure from customer positions is managed through transactions with other dealers. 33
Slide 36: Management’s Discussion and Analysis Table 16 presents the amounts of interest-earning assets and interest-bearing liabilities that are assumed to mature or reprice during the periods indicated at December 31, 2000 and their related average yields and costs. Adjustable and floating rate loans and securities are included in the period in which interest rates are next scheduled to adjust rather than the period in which they mature (in thousands): TABLE 16: GAP ANALYSIS AT DECEMBER 31, 2000 REPRICING ________________________________________________________________________________________________________________________ YEAR ____ ________ONE__ Interest earning assets: Investment securities(1)(2) . . . . . . . . . . . . . . . Loans(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . Total interest earning assets . . . . . . . . . . . . . . . . Non-interest earning assets . . . . . . . . . . . . . . Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest bearing liabilities: Deposits(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total interest bearing liabilities . . . . . . . . . . . . . . Non-interest bearing liabilities . . . . . . . . . . . . . . Stockholders’ equity . . . . . . . . . . . . . . . . . . . . . Total liabilities and stockholders’ equity . . . . . . . Excess assets (liabilities) before effect of off-balance sheet positions . . . . . . . . . . . . . . To total assets Cumulative excess assets (liabilities) before effect of off-balance sheet positions . . . . . . . . . . . . $ 2,831,369 6.92% 11,346,502 _________9.__ % _ 02 14,177,871 8.60% – ____________ $ 14,177,871 8.60 ____________ % $ 11,457,089 5.46% 2,484,393 6.55 ____________ % 13,941,482 5.65% – – ____________ $ 13,941,482 5.65% $___________ 236,389 _ _________0.__ % _ 71 $___________ 236,389 _ 0.71% $___________ 47,551 _ $___________ 283,940 _ 0.85% __YEAR_TWO__ _____ ____ $ 1,163,271 7.14% 3,163,161 8.65 ____________ % 4,326,432 8.24% – ____________ $ 4,326,432 _________8.__ % _ 24 2,812,408 4.02% 169,979 6 15 __________.__ % 2,982,387 4.14% – – ____________ $ 2,982,387 4.14% YEAR_THREE _____ ______ $ 626,477 7.23% 1,930,388 _________8.__ % _ 51 _YEAR_FO__R_ _____ __ U _ $ 406,746 7.26% 1,193,130 8._8 __________2_% 1,599,876 8.02% ___________– _ $ 1,599,876 8.__ __________02% 1,675,735 2.55% 3,035,941 5. __ __________92% __YEAR_FIVE__ _____ ____ $ 199,847 7.24% 945,031 7.87 ____________ % 1,144,878 7.76% – ____________ $ 1,144,878 7.76 ____________% T _ ER _AF __R __H___E___TE__ $ 2,066,142 6.88% 3,334,033 ________7.__ % _71 5,400,175 7.39% ___4,251,___ _____700 $ 9,651,875 4.14 ___________ % $ 5,133,867 1.54% 500,000 10.50 ___________ % 5,633,867 2.34% 769,688 ___1,____8__ _ 948,_84 $ 8,352,439 1.58% $__1,____43_ _ _ 299,__6 3.88 ___________ % $__________ – _ – $_______000 60, ___ _ $__1,____4__ _ _ 359,_36 4.06% ___TOTAL___ ______ $ 7,293,852 7.00% 21,912,245 8.63 ___________ % 29,206,097 8.23% ___4,____700 _ 251,___ $ 33,457,797 7._8 _________1_% $ 24,498,917 3.86% 6,240,308 6._6 _________5_% 30,739,225 4.41% 769,688 1,948, ___ ________884 $ 33,457,797 4.05% 2,556,865 8.20% ___________– _ $ 2,556,865 8.20 ____________ % 1,831,613 2.62% 49,995 8.00 ____________ % $ $ $ $ 1,588,205 2.40% – –% ____________ 1,588,205 2.40% – – ____________ 1,881,608 2.76% – – ____________ $ 1,881,608 2.76% 4,711,676 4.72% – ___________– _ $ 4,711,676 4.72% $ 1,588,205 2.40% $___1,344,___ _ _____ 045 _________4.__ % _ 02 $___1,580,___ _ _____ 434 4.72% $___________ 92,449 _ $___1,436,___ _ _____ 494 4.29% $________25_ 675,__7 _ 2.02 ____________ % $___2,_______ _ _ 255,691 6.74% $____(_______ ) 200,000 _ $________25_ 475,__7 _ 1.42% $_____111_80_) _ (3, __ ,__0 9.__ ________(__30)% $________109) (856, ___ _ (2.74)% $__________– _ _ $_____111,___ ) _ (3,___ 800 (9.30)% $ ____(_______ ) 443,327 _ ________(1.__ )% __33 $ __(1,____4__ ) _ __ 299,_36 (3.88)% $ __________– _ _ $____(_______ ) 443,327 _ (1.33)% To total assets Effect of off-balance sheet positions on assets and liabilities Excess assets (liabilities) after effect of off-balance sheet positions . . . . . . . . . . . . . . To total assets Cumulative excess assets (liabilities) after off-balance sheet positions . . . . . . . . . . . . . . To total assets (1) Include interest-earning deposits. $___________ 283,940 _ 0.85% $___1,720,___ _ _____ 434 5.14% $___2,195,___ _ _____ 691 6.56% $____(916,___) _ ____109 (2.74)% $__(1,_______ ) _ __ 359,436 (4.06)% $__________ – _ – (2) Investment securities include market rate payment and repayment assumptions. (3) Loan balances include annual prepayment and repayment assumptions between 12% and 40%. Loan balances are presented net of deferred loan fees and include loans held for sale. (4) Saving, NOW, money market and demand deposit accounts have been assumed to decay at an annual rate of 14.6%. 34
Slide 37: Table 17 presents selected quarterly consolidated financial data (in thousands, except per share data): TABLE 17: SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA THREE MONTHS ______ _______________________________________________________________ENDED___________________________________________ DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31, __20____ __00 __2_____ _000 __20____ __00 __20____ __00 __1999__ ____ __1_____ _999 __19____ __99 __199___ ___9 Total interest income . . . . . . . . . . . . . . Total interest expense . . . . . . . . . . . . . Net interest income . . . . . . . . . . . . . . Provision for loan losses . . . . . . . . . . . Net interest income after provision. . . . . . . . . . . . . . . . . . Gain/(loss) on sale of loans and investment securities . . . . . . . . . Other income . . . . . . . . . . . . . . . . . . . Other expenses . . . . . . . . . . . . . . . . . . Income/(loss)before income taxes . . . . Income tax provision . . . . . . . . . . . . . Income/(loss) before extraordinary item . . . . . . . . . . Extraordinary item . . . . . . . . . . . . . . . Net income/(loss) . . . . . . . . . . . . . . . Operating earnings . . . . . . . . . . . . . . . Net income/(loss) applicable to common stock. . . . . . . . . . . . Earnings/(loss) per share: Basic Income/(loss) before extraordinary item . . . . . . . . . . Extraordinary item . . . . . . . . . . Net income/(loss) . . . . . . . . . . . Diluted Income/(loss) before extraordinary item . . . . . . . . . . Extraordinary item . . . . . . . . . . Net income/(loss) . . . . . . . . . . . Operating(1) Income/(loss) before extraordinary item . . . . . . . . . . Extraordinary item . . . . . . . . . . Net income/(loss) . . . . . . . . . . . . . . . . Market prices High . . . . . . . . . . . . . . . . . . . . Low . . . . . . . . . . . . . . . . . . . . . Dividends declared per common share . . . . . . . . . . . . . . . . . . . . $ 605,507 351 171 ______,___ 254,336 28,__0 ______50_ 225, ___ ______836 5,026 79,438 327,__4 ______21_ (16,914) 13,590 ___(______ ) (3,324) ________– _ $ 3,_24 ____(__3__) $ 55,_32 ______6__ $_____324) _ (3, ___ $ 634,754 380,__5 ______34_ 254,409 10, ___ ______000 244, ___ ______409 (45,052) 59,614 315,__5 ______74_ (56,774) (40,__9 ______85_) (15,915) ________– _ $__(___915) _ 15,___ $ 7 _ 121 _____4,___ $__(15,___ ) _ ___915 $ 557,593 370,___ ______779 186,814 10, ___ ______000 176,___ ______814 (58,216) 46,494 237,810 _________ (72,718) ___(24,___ ___ 016) (48,702) ________– _ $__(______) _ 48,702 _________ $ 57,298 _________ $__(______) _ 48,702 $ 471,881 312, ___ ______629 159,252 8,__0 ______00_ 151,___ ______252 (22,872) 44,130 132,__5 ______33_ 40,175 13,___ ______250 26,925 10, ___ ______775 $ 37, ___ ______700 $ 52,831 _________ $ 37,___ ______700 $ 445,902 280,___ ______315 165,587 7,__0 ______50_ 158,__7 ______08_ (2,196) 31,993 148, ___ ______722 39,162 9,_39 ______9__ 29,223 – _________ $ 29, ___ ______223 $ 52,220 _________ $ 29, ___ ______223 $ 415,954 254,__6 ______08_ 161,868 7,__0 ______50_ 154, ___ ______368 (299) 35,250 103,843 _________ 85,476 29, ___ ______488 55,988 ________– _ $ 55, ___ ______988 $ 55, ___ ______988 $ 55, ___ ______988 $ 377,444 230, ___ ______036 147,408 7,__0 ______50_ 139,__8 ______90_ 3,362 29,928 98, ___ ______445 74,753 25, ___ ______974 48,779 ________– _ $ 48, ___ ______779 $ 48,___ ______779 $ 48, ___ ______779 $ 368,028 228,_36 ______2__ 139,792 7,___ ______500 132, ___ ______292 3,408 28,896 95, ___ ______369 69,227 23,___ ______914 45,313 ________– _ $ 45,___ ______313 $ 45,___ ______313 $ 45,___ ______313 $ (0.01) $ (0.07) $ (0.22) $ 0.12 $ 0.14 $ 0.31 $ 0.31 $ 0.28 ________– _ $ _____(0.__ ) __ 01 ________– _ $____(__07) 0.__ _ ________– _ $ (0.__ _______22) 0. __ _______05 $______17 0. __ _ – _________ $ 0.14 _________ ________– _ $ 0.31 _________ ________– _ $ 0.31 _________ ________– _ $ 0.__ _______28 $ (0.01) $ (0.07) $ (0.22) $ 0.12 $ 0.14 $ 0.31 $ 0.30 $ 0.28 ________– _ $____(0.__ ) _ __ 01 ________– _ $ 0.__ _____(__07) ________– _ $ 0.__ _____(__22) 0. __ _______05 $ 0.__ _______17 – _________ $ 0.14 _________ ________– _ $ 0.31 _________ ________– _ $ 0.__ _______30 ________– _ $ 0.__ _______28 0.25 – _________ $ 0.25 _________ $ 9 8/17 6 39/50 0.025 $ $ 0.33 ________– _ $______33 0. __ _ $ 9 7/8 7 1/32 0.025 0.29 ________– _ $ 0.29 _________ $ 8 6 7/16 0.025 $ $ 0.29 0.__ _______05 $ 0. __ _______34 $ 7 29/32 6 11/16 0.025 $ 0.29 – _________ $ 0.29 _________ $ 9 23/64 7 3/16 0.025 $ 0.31 ________– _ $ 0.31 _________ $ 12 7/8 9 3/32 0.025 $ 0.31 ________– _ $ 0.31 _________ $ 17 1/2 11 5/8 0.025 $ 0.28 ________– _ $ 0.__ _______28 $ 14 9/16 11 15/16 0.020 (1) Operating earnings exclude special charges of $90.7 million, $94.9 million, $90.1 million and $12.2 million for the three-month periods ended December 31, September 30, June 30 and March 31, 2000, respectively and 000$30.8 million for the three-month period ended December 31, 1999. See "Reconciliation of Net Income to Operating Earnings" on page 14 of Management's Discussion and Analysis. 35
Slide 38: Management’s Discussion and Analysis PENDING ACCOUNTING PRONOUNCEMENTS. In June 1999, The Financial Accounting Standards Board ("FASB") issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities – Deferral of the Effective Date of FASB Statement No. 133", which delays the effective date of SFAS No. 133. Accordingly SFAS No. 133, shall be effective for all fiscal years beginning after June 15, 2000. SFAS No. 133 requires the recognition of all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value as a component of income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be off-set against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value will be immediately recognized in earnings. The fair value of Sovereign’s derivative instruments is currently not on the balance sheet. On January 1, 2001, Sovereign adopted SFAS No. 133, and at that time, designated anew the derivative instruments used for risk management into hedging relationships in accordance with the requirements of the new standard. Derivative instruments used to hedge changes in the fair value of assets and liabilities due to changes in interest rates or other factors were designated in fair value hedge relationships. Derivative instruments used to hedge the variability of forcasted cash flows attributable to a specific risk, generally interest rate risk, were designated in cash flow hedge relationships. Also on January 1, 2001, after-tax transition amounts associated with establishing the fair values of the derivative instruments and hedged items on the balance sheet of $1.1 million and $7.1 million were recorded as a reduction of net income and an increase in other comprehensive income, respectively. The transition adjustments will be presented as cumulative effect adjustments as described in Accounting Principles Board Opinion No. 20, Accounting Changes, in the 2001 Consolidated Financial Statements. The transition amounts were determined based on the interpretive guidance issued by the Financial Accounting Standards Board to date. The FASB continues to issue interpretive guidance which could require changes in Sovereign’s application of the standard and adjustments to the transition amounts. SFAS No. 133, as applied to Sovereign’s risk management strategies, may increase or decrease reported net income and stockholders’ equity prospectively, depending on future levels of interest rates and other variables affecting the fair values of derivative instruments and hedged items, but will have no effect on cash flows or economic risk. eliminate the negative impact from escrowed financing proceeds relating to the pending acquisition of Sovereign Bank New England, divided by average interest-earning assets – see Reconciliation of Net Income to Operating Earnings) was 2.88% for 1999 compared to 2.79% for 1998. Interest on interest-earning deposits was $4.7 million for 1999 compared to $7.4 million for 1998. The average balance of interest-earning deposits was $15.2 million with an average yield of 31.12% for 1999 compared to an average balance of $56.4 million with an average yield of 13.12% for 1998. The high yields on interest-earning deposits were the result of a contractual arrangement whereby a third-party vendor performed check processing and reconcilement functions for Sovereign’s disbursement accounts. Under the agreement, the vendor is required to pay Sovereign interest on disbursed funds during the two to three day float period, effectively producing interest income with no corresponding asset balance. This agreement will continue to favorably impact the yield on Sovereign’s interest-earning deposits in future years. Interest on investment securities available-for-sale was $544 million for 1999 compared to $284 million for 1998. The average balance of investment securities available-for-sale was $8.1 billion with an average yield of 6.85% for 1999 compared to an average balance of $4.3 billion with an average yield of 6.75% for 1998. The increase in the average balance of investment securities available-for-sale was due to Sovereign’s realignment of its investment portfolio, and an active decision by management to increase balance sheet flexibility by placing more investments into available-for-sale. Interest on investment securities held-to-maturity was $99.8 million for 1999 compared to $182 million for 1998. The average balance of investment securities held-to-maturity was $1.4 billion with an average yield of 6.94% for 1999 compared to an average balance of $2.5 billion with an average yield of 7.22% for 1998. The decrease in the yield at year end, and the majority of the year-end balance, is associated with the escrowed proceeds from the November offerings related to the Fleet Boston acquisition. Interest and fees on loans were $959 million for 1999 compared to $881 million for 1998. The average balance of net loans was $12.4 billion with an average yield of 7.77% for 1999 compared to an average balance of $11.1 billion with an average yield of 7.94% for 1998. The increase in average loan volume was primarily the result of Sovereign’s significant progress during the year in increasing its emphasis in commercial and consumer lending. The increase in volume was offset slightly by an overall decrease in rates.Interest on total deposits was $441 million for 1999 compared to $444 million for 1998. The average balance of total deposits was $12.2 billion with an average cost of 3.61% for 1999 compared to an average balance of $10.8 billion with an average cost of 4.76% for 1998. The increase in the average balance and the decrease in the average cost of deposits was primarily the result of Sovereign’s emphasis on attracting lower-cost core deposits from small and medium size corporations, governmental units and consumers, and the CoreStates branch acquisition in September 1998. RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998 Net Interest Income. Net interest income for 1999 was $615 million compared to $494 million for 1998. This growth represents an increase of 24% and was primarily due to internal commercial and consumer loan growth, recent acquisitions, an increase in average balances in investment securities available for sale and growth in core deposits. Net interest margin - operating basis (net interest income adjusted to 36
Slide 39: Interest on total borrowings was $552 million for 1999 compared to $418 million for 1998. The average balance of total borrowings was $10.1 billion with an average cost of 5.46% for 1999 compared to an average balance of $7.3 billion with an average cost of 5.69% for 1998. The increase in the average balance was the result of both balance sheet growth and funding requirements needed in anticipation of the pending acquisition of assets and liabilities from Fleet Boston. The decrease in the average cost of borrowings was due to a higher proportion of short-term borrowings in the current year versus prior year, and a slight overall decrease in interest rates. Provision for Loan Losses. The provision for loan losses was $30.0 million for 1999 compared to $28.0 million for 1998. Sovereign's net charge-offs for 1999 were $35.6 million and consisted of charge-offs of $55.0 million and recoveries of $19.4 million. This compares to 1998 net charge-offs of $33.6 million consisting of charge-offs of $46.3 million and recoveries of $12.7 million. The ratio of net loan chargeoffs to average loans, including loans held for sale, was .29% for 1999 as compared to .30% for 1998. Commercial loan net charge-offs as a percentage of average commercial loans were .11% for 1999 as compared to .14% for 1998. Consumer loan net charge-offs as a percentage of average consumer loans were .49% for 1999, compared to .80% for 1998. Residential real estate mortgage loan net charge-offs as a percentage of average residential mortgage loans, including loans held for sale, were .23% for 1999, and .08% for 1998. The increase was due to a $7.0 million accelerated disposition of non-performing residential loan in 1999. Sovereign's increased level of consumer and commercial loan charge-offs in 1999 and 1998 was primarily related to Sovereign's acquisition activity during 1999 and 1998. Although commercial and consumer lending will typically result in higher net charge-off levels than residential lending, historically, it has also resulted in higher income potential. Other Income. Total other income was $130 million for 1999 compared to $105 million for 1998. Several factors contributed to the increase in other income as discussed below. Deposit fees were $49.2 million for 1999 compared to $31.1 million for 1998. This increase was primarily due to an increase in the number of Sovereign’s transaction accounts and active fee collection efforts due in part to customer relationships acquired in the CoreStates and Peoples’ acquisitions. Mortgage banking revenues were $29.9 million for 1999 compared to $28.2 million for 1998. At December 31, 1999, Sovereign serviced $10.2 billion of its own loans and $5.7 billion of loans for others. This compares to $9.2 billion of its own loans and $6.7 billion of loans for others at December 31, 1998. Loan fees and service charges were $8.9 million for 1999 compared to $7.1 million for 1998. Loan fees and service charges relate primarily to Sovereign’s non-residential loan portfolios, and the growth period to period is the result of growth in the commercial and consumer loan portfolios due to internal growth and acquisitions. Net gains on sales of loans and investment securities were $4.3 million for 1999 compared to $19.8 million for 1998, which included net investment security gains of $3.7 million and $15.8 million, and net gains on sales of loans of $0.6 million and $4.0 million in 1999 and 1998, respectively. This decrease was in part due to a net gain of $2.8 million resulting from the sale of Sovereign’s credit card portfolio during the second quarter of 1998, and gains on sales of investment securities available-for-sale during 1998. Income from bank-owned life insurance (“BOLI”) was $22.8 million for 1999 compared to $12.6 million for 1998. This increase was primarily due to an additional investment in BOLI, which was made during the first quarter of 1999. General and Administrative Expenses. Total general and administrative expenses were $393 million for 1999 compared to $327 million. Included in 1998 total general and administrative expenses were $49.9 million of merger-related charges. The increase in general and administrative expenses for 1999 was primarily due to Sovereign’s overall franchise growth (including the full year impact of the CoreStates branch acquisition completed September 4, 1998, and inclusion of the Peoples acquisition from June 30, 1999), $30.8 million of merger, integration and other charges related to Sovereign’s recent and pending acquisitions, and start-up costs related to the formation of Sovereign’s Capital Markets Group and 1stwebbankdirect.com during the fourth quarter of 1999. The remaining increase in expenses are related to Sovereign’s Year 2000 and other technology initiatives, and expansion in its corporate banking business line during the year. Sovereign’s efficiency ratio (all operating general and administrative expenses as a percentage of net interest income and recurring noninterest income) for 1999 was 48.6% compared to 46.6% for 1998. Other Operating Expenses. Total other operating expenses were $53.5 million for 1999 compared to $32.3 million for 1998. Other operating expenses included amortization of goodwill and other intangible assets of $38.0 million for 1999 compared to $20.6 million for 1998, Trust Preferred Securities expense of $15.4 million for 1999 compared to $12.5 million for 1998, and other net real estate owned (“OREO”) losses of $95,000 for 1999 compared to net OREO gains of $804,000 for 1998. This increase in amortization expense for goodwill and other intangible assets is due to Sovereign’s September 1998 CoreStates branch acquisition. Trust Preferred Securities expense increased due to the issuance of additional securities in November. Income Tax Provision. The income tax provision was $89.3 million for 1999 compared to $74.8 million for 1998. The effective tax rate for 1999 was 33.2% compared to 35.4% for 1998. The effective tax rate for 1999 includes the effect of Sovereign’s increased investment in BOLI during the first quarter of 1999. For additional information with respect to Sovereign’s income taxes, see Note 18 in the “Notes to Consolidated Financial Statements” hereof. 37
Slide 40: Report of Management TO OUR STOCKHOLDERS: FINANCIAL STATEMENTS Sovereign Bancorp, Inc. ("Sovereign") is responsible for the preparation, integrity, and fair presentation of its published financial statements as of December 31, 2000, and the year then ended. The consolidated financial statements of Sovereign have been prepared in accordance with generally accepted accounting principles and, as such, include some amounts that are based on judgments and estimates of management. INTERNAL CONTROL OVER FINANCIAL REPORTING Management is responsible for establishing and maintaining effective internal control over financial reporting. The system contains monitoring mechanisms and actions are taken to correct deficiencies identified. There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time. Management assessed Sovereign’s internal control over financial reporting as of December 31, 2000. This assessment was based on criteria for effective internal control over financial reporting described in "Internal Control—Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that Sovereign maintained effective internal control over financial reporting as of December 31, 2000. Jay S. Sidhu President and Chief Executive Officer Dennis S. Marlo Treasurer and Chief Financial Officer Mark R. McCollom Chief Accounting Officer 38
Slide 41: Report of Independent Auditors The Board of Directors and Stockholders, Sovereign Bancorp, Inc. We have audited the accompanying consolidated balance sheets of Sovereign Bancorp, Inc. as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the management of Sovereign. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sovereign Bancorp, Inc. at December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Philadelphia, Pennsylvania February 5, 2001, except for Note 26, as to which the date is March 1, 2001 39
Slide 42: Consolidated Balance Sheets (in thousands, except share data) 2000 _____________ Assets Cash and amounts due from depository institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest-earning deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment securities available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment securities held-to-maturity (fair value approximates $1,971,896 and $2,367,025) . . . . . . . . . . . . . . . . . . . . Loans (including loans held for sale of $59,993 and $61,925) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allowance for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Premises and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other real estate owned (including other repossessed assets of $3,758 and $1,762) . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued interest receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill and other intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bank owned life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liabilities Deposits and other customer accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Long-term debt: Repurchase agreements and FHLB advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Senior secured credit facility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Senior notes and subordinated debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Advance payments by borrowers for taxes and insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mandatorily redeemable capital securities (“Trust Preferred Securities”) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Minority interest-preferred securities of subsidiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stockholders' Equity Preferred stock; no par value; $50 liquidation preference; 7,500,000 shares authorized; 0 shares issued and outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Common stock; no par value; 400,000,000 shares authorized; issued 231,465,030 and 230,647,896 . . . . . . . . . . . . . . . Warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unallocated common stock held by the Employee Stock Ownership Plan (4,565,924 shares and 4,856,254 shares at cost) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Treasury stock (397,756 shares and 383,875 shares at cost) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Stockholders' Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Liabilities and Stockholders' Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . See accompanying notes to consolidated financial statements. ______YEAR_ENDED ____________________ _____ _______ DECEMBER 31, 1999 _____________ $ 945,196 14,447 5,315,584 1,978,268 21,912,245 (256,356) 290,134 8,183 230,514 1,455,331 612,580 951,_71 _________6__ $ 373,996 19,238 8,030,212 2,362,051 14,288,465 (132,986) 119,201 5,329 164,720 434,078 412,580 530,___ __________228 $________797 _ 33,457, ___ $ 24,498,917 1,330,900 3,544,984 350,792 1,013,632 24,009 _____2___464 _87, ___ 31,050, ___ _________698 319,959 138,256 $ ___26,____112 _ __ 607,___ $ 12,012,675 6,157,939 4,618,489 500,000 1,093,681 28,222 58, ___ __________265 ____24,_______ __ 469,271 316,346 – – 1,259,374 91,500 (33,230) (3,789) (38,521) 673, ___ _________550 1,948, __4 _________88_ $________797 _ 33,457, ___ – 1,254,037 91,500 (36,295) (3,595) (210,932) 726,__0 __________78_ _____1,____49_ _ 821,__5 $___26,____112 _ __ 607,___ 40
Slide 43: Consolidated Statements of Operations (in thousands, except per share data) Interest Income: Interest on interest-earning deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest and dividends on investment securities: available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest and fees on loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest Expense: Interest on deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest on borrowings and long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net interest income after provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other Income: Deposit fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage banking fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loan fees and service charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gain/(loss) on sale of loans and investment securities . . . . . . . . . . . . . . . . . . . . . . . . . . Capital markets revenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bank owned life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Miscellaneous income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . General and Administrative Expenses: Compensation and benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Occupancy and equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Outside services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other administrative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total general and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other Operating Expenses: Amortization of goodwill and other intangibles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trust Preferred Securities and other minority interest expense . . . . . . . . . . . . . . . . . . . . . Other real estate owned (gains)/losses, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Restructuring . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-solicitation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total other operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income/(loss) before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax provision/(benefit). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . INCOME/(LOSS) BEFORE EXTRAORDINARY ITEM. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gain on the sale of FHLB advances (net of tax of $5,225) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . NET INCOME/(LOSS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . NET INCOME/(LOSS) APPLICABLE TO COMMON STOCK . . . . . . . . . . . . . . . . . . . . . . . . . . . Earnings/(loss) per share: Basic Income/(loss) before extraordinary item . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Extraordinary item. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income/(loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted Income/(loss) before extraordinary item . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Extraordinary item. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income/(loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends Declared Per Common Share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . See accompanying notes to consolidated financial statements. __________________YEAR_ENDED ____________31,____________________ _____ _______ DECEMBER __ 2000 1999 199 _ ___________ ___________ _______8 ___ $ 22,158 $ 4,721 $ 7,397 487,448 132,442 1,627, ___ ________687 2,269, ___ ________735 735,087 679, ___ ________837 1,414, ___ ________924 854,811 56, ___ ________500 798 311 ________,___ 91,304 25,207 16,854 (121,114) 11,090 33,269 51,_51 ________9__ 108,___ ________561 270,799 158,629 166,188 135, ___ ________875 731,491 ___________ 98,940 44,293 (180) 18,500 120, ___ ________060 281,___ ________613 (106,232) (65,__5 ________21_ ) (41,017) 10, ___ ________775 $_______242) _ (30, ___ $_______242) _ (30, ___ 543,631 99,813 959,___ ________164 ___1,_______ _ 607,329 440,826 551,___ ________847 992,_73 ________6__ 614,656 30,___ ________000 584,_56 ________6__ 49,177 29,926 8,856 4,275 – 22,813 15, ___ ________295 130,___ ________342 154,880 67,564 93,340 77,___ ________145 392,__9 ________92_ 37,967 15,393 95 – – ___________ 53,___ ________455 268,614 89,315 ___________ 179,299 __________– _ $ _______2__ _ 179,_99 $ _______299 _ 179,___ 284,392 182,499 881,_83 ________0__ ___1,_______ _ 355,371 443,833 417,___ ________926 861,_59 ________7__ 493,612 27,961 ___________ 465 651 ________,___ 31,078 28,209 7,075 19,844 – 12,572 6,___ ________403 _____105,___ ___ 181 146,614 70,272 52,830 57, ___ ________577 327,__3 ________29_ 20,609 12,528 (804) – – ___________ 32,___ ________333 211,206 74,751 ___________ 136,455 – ___________ $_______45_ _ 136,__5 $_______95_ _ 134,__9 $ (0.18) 0. __ _________05 $________13) (0.__ _ 1.02 ___________ $ __________ 1.02 _ $ 1.01 ___________ $ __________ 1.01 _ $ $ 0.88 ___________ $__________ 0.88 _ $ (0.18) 0. __ _________05 $________13) (0. __ _ 0.85 ___________ $ __________ 0.85 _ $ _______0__ ._80 _ $ $_______100 . ___ _ $ _______100 .___ _ 41
Slide 44: Consolidated Statements of Stockholders’ Equity (in thousands) COMMON SHARES OU __ TA_ D N _ ___TS___N__I__G Balance, December 31, 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Comprehensive income: Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in unrecognized income on investment securities available-for-sale, net of tax . . . . . . . . . . . . . . . . . Total comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exercise of stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash in lieu of fractional shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sale of stock under Dividend Reinvestment and Employee Stock Purchase Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends paid on common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends paid on preferred stock . . . . . . . . . . . . . . . . . . . . . . . . . . . Treasury stock repurchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Treasury stock sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Conversion of preferred stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Redemption of preferred stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allocation of shares under Employee Stock Ownership Plan . . . . . . . . Adjustment for ML Bancorp's different fiscal year end . . . . . . . . . . . . . Balance, December 31, 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Comprehensive income: Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in unrecognized loss on investment securities available-for-sale, net of tax . . . . . . . . . . . . . . . . . . . . . . . . . . Total comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuance of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuance of warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exercise of stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash in lieu of fractional shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sale of stock under Dividend Reinvestment and Employee Stock Purchase Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends paid on common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . Treasury stock repurchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Treasury stock sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allocation of shares under Employee Stock Ownership Plan . . . . . . . . Acquisition of Network Companies . . . . . . . . . . . . . . . . . . . . . . . . . . Acquisition of People's Bancorp, Inc . . . . . . . . . . . . . . . . . . . . . . . . . Balance, December 31, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Comprehensive income: Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in unrecognized loss on investment securities available-for-sale, net of tax . . . . . . . . . . . . . . . . . . . . . . . . Total comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exercise of stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash in lieu of fractional shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sale of stock under Dividend Reinvestment and Employee Stock Purchase Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends paid on common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . Treasury stock repurchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Treasury stock sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allocation of shares under Employee Stock Ownership Plan, net . . . . . Balance, December 31, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . See accompanying notes to consolidated financial statements. PREFERRED SHARES O__TS___N__I__G _ U __ TA _ D N _ 1,996 COMMON STOCK ___________ $ 523,327 WA__RA__TS ___ R __ N __ $ – PREFERRED ___STOCK___ ______ $ 96,276 141,218 – – 2,296 – 296 – – (86) 18 14,342 – 1,581 __________– _ 159,___ ________665 – – – – – – – – – (1,996) – – – ___________ __________– _ – – 15,910 (68) 4,609 – – – – 96,270 – 11,760 – ___________ 651,808 ___________ – – – – – – – – – – – – __________– _ __________– _ – – – – – – – – – (96,270) (6) – __________– _ __________– _ – – 43,810 – 721 – 408 – (3,351) 26 270 235 23, ___ ________624 225,__8 ________40_ – – 196 – 621 – (62) 48 ________290 ___ 226,___ ________501 – – – – – – – – – – – – __________– _ __________– _ – – – – – – – – __________– _ __________– _ – – 331,478 – 6,919 (6) 4,412 – – – 1,255 3,000 255,171 ___________ ___1,____037 _ 254,___ – – 678 (3) 4,569 – – – _________93 __ $ _______37_ _ 1,259, __4 – – – 91,500 – – – – – – – – __________– _ 91, ___ ________500 – – – – – – – – __________– _ $ _______500 91,___ _ – – – – – – – – – – – – __________– _ __________– _ – – – – – – – – __________– _ $ _________– _ _ 42
Slide 45: RETAINED EA _ N N _S ____R__I__G__ $ 446,644 TREASURY ___STOCK___ ______ $ (185) UNALLOCATED STOCK HELD BY ESOP ________________ $ (37,211) ACCUMULATED OTHER COMPREHENSIVE I _ CO ___ ______N___ME_____ $ 18,944 TOTAL STOCKHOLDERS' _____E___ITY_____ _QU___ $ 1,047,795 136,455 – – – – (12,790) (1,496) – – – – – (_____ _______4,228) 564, ___ _________585 – – – – – – – (1,258) 357 – – – ___________– _ (1, ___ _________086) – – – – – – – – – – – 7,852 ___________– _ (29, ___ _________359) – (824) – – – – – – – – – – ___________– _ 18, ___ _________120 136,455 (824 ___________) 135,631 15,910 (68) 4,609 (12,790) (1,496) (1,258) 357 – (6) 19,612 (4,__8 ________22_) 1,__4, ___ _____20__068 179,299 – – – – – – (17,104) – – – – ___________– _ _____7___780 _26, ___ (30,242) – – (79) – (22,420) – – ________(489) ____ $ _____673,550 _______ – – – – – – – – (47,152) 285 – – ______4__358 _4, ___ (3, ___ _________595) – – – – – – (473) 279 ___________– _ $ (_____ _______3,789) – – – – – – – – – – 1,834 – (8, ___ _________770) (36, ___ _________295) – – – – – – – – _______3,065 _____ $____(33,230) _ _______ – (229,052) – – – – – – – – – – ___________– _ (210,932 ____________) – 172,411 – – – – – – ___________– _ $_____38,521) (______ ____________ _ 179,299 (229,052 ____________) (49,753) 331,478 91,500 6,919 (6) 4,412 (17,104) (47,152) 285 3,089 3,000 _____29__759 __0, ___ 1,821, ___ _________495 (30,242) 172,411 ____________ 142,169 678 (82) 4,569 (22,420) (473) 279 _______2_669 _, ___ $____948,884 _ 1, _______ 43
Slide 46: Consolidated Statements of Cash Flows (in thousands) Cash Flows From Operating Activities: Net income/(loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjustments to reconcile net income/(loss) to net cash provided by operating activities: Provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization/accretion of investment securities and loan discounts . . . . . . . . . . . . . . . . . . . . Gain/loss on sale of loans, investment securities and real estate owned . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gain/loss on sale of fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gain/loss on sale of FHLB advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allocation of Employee Stock Ownership Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net change in: Loans held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued interest receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prepaid expenses and other costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net cash (used) by operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash Flows From Investing Activities: Proceeds from sales of investment securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from repayments and maturities of investment securities: Available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchases of investment securities: Available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from sales of loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchase of loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net change in loans other than purchases and sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from sales of premises and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchases of premises and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from sales of real estate owned . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net cash received from/(paid for) business combinations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net cash provided (used) by investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash Flows From Financing Activities: Assumption of deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net increase/(decrease) in deposits and other customer accounts . . . . . . . . . . . . . . . . . . . . . . . . . Net increase/(decrease) in short-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from long-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repayments of long-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sale of FHLB advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net increase/(decrease) in advance payments by borrowers for taxes and insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from the issuance of preferred stock by subsidiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from issuance of Trust Preferred Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash dividends paid to stockholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Redemption of preferred stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from issuance of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from issuance of warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Advance to the Employee Stock Ownership Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (Purchase)/issuance of treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net cash provided (used) by financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net change in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash and cash equivalents at beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash and cash equivalents at end of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ____________________YEAR_ENDED ____________31,____________________ _____ _______ DECEMBER __ 2000 1999 ______________ ______________ _____1998____ ____ $ (30,242) 56,500 (50,930) 128,587 (34,747) 117,897 (165) (16,000) 3,065 8,811 (11,829) (656,202) ______296,326 _______ _____(188,929) ________ 8,248,463 836,465 4,255,897 (6,157,701) (2,704,498) 2,385,619 (2,572,063) 463,389 46,490 (178,106) 3,624 1,916,345 – _____________ ____6_543,____ _, ___ 924 – 210,550 (5,449,523) 813,068 (569,982) (911,037) (4,213) 140,396 – (22,988) – 5,337 – – _________(194) ____ (_, ___ 586 ____5_788,____) 566,409 ______393,234 _______ $ ______959,643 _______ $ 179,299 30,000 18,852 18,802 58,830 (4,484) – – 3,089 235,005 (9,262) (273,033) (280,___ __________706) (23, ___ __________608) 5,553,469 1,644,019 793,031 (8,024,026) (1,312,372) 1,188,173 (2,022,695) (1,561,471) 5,757 (39,844) 17,081 112,998 ____________– _ ____(3,____880) __ 645, ___ – (1,117,500) 2,023,868 2,500,894 (455,959) – 568 – 187,231 (17,104) – 342,803 91,500 (436) (46, ___ __________867) 3 508, ___ ______,____998 (160,490) 553,___ __________724 $_________2__ 393,_34 _ $ 136,455 27,961 (18,681) 13,434 18,204 (20,076) – – 19,612 13,748 (39,560) (467,329) ______301,217 ______ 15,__5 ______(___01_) 2,157,904 1,109,075 2,062,628 (7,996,541) (471,326) 1,422,279 (1,966,864) 464,382 18,437 (32,872) 19,069 (302,808) (4, ___ _________228) ___(3,____8__) __ 520,_65 2,231,149 576,982 (2,135,369) 3,169,839 – – (14,192) – – (14,286) (6) 20,451 – – (9__ __________01) ____3,____667 _ 833,___ 297,787 255,___ _________937 $________72_ 553,__4 _ Supplemental Disclosures: Income tax payments totaled $6.2 million in 2000, $101 million in 1999, and $77.4 million in 1998. Interest payments totaled $1.4 billion in 2000, $963 million in 1999, and $848 million in 1998. Noncash activity consisted of acquisitions which included $9.1 billion of loans and assumption of $12.3 billion of deposits in 2000, $551 million of loans and assumption of $515 million in deposits in 1999, and $3.9 billion of loans and assumption of $2.4 billion of deposits in 1998. Other noncash activity consisted of mortgage loan securitization of $1.2 billion in 2000, $1.0 billion in 1999, and $1.2 billion in 1998; reclassification of long-term borrowings to short-term borrowings of $950 million in 2000, $536 million in 1999, and $613 million in 1998; and reclassification of mortgage loans to real estate owned of $6.2 million in 2000, $11.7 million in 1999, and $18.8 million in 1998. See accompanying notes to consolidated financial statements. 44
Slide 47: Notes to Consolidated Financial Statements NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Sovereign Bancorp, Inc. and subsidiaries ("Sovereign") is a Pennsylvania business corporation and is the holding company of Sovereign Bank. Sovereign is headquartered in Philadelphia, Pennsylvania and Sovereign Bank is headquartered in Wyomissing, Pennsylvania. Sovereign's primary business consists of attracting deposits from its network of community banking offices, located throughout eastern Pennsylvania, New Jersey, New Hampshire, Massachusetts, Connecticut, Rhode Island, and northern Delaware, and originating commercial, consumer and residential mortgage loans in those communities. Sovereign also serves customers throughout New York. The following is a description of the significant accounting policies of Sovereign. Such accounting policies are in accordance with accounting principles generally accepted in the United States and have been followed on a consistent basis. a. Principles of Consolidation – The accompanying financial statements include the accounts of the parent company, Sovereign Bancorp, Inc. and its wholly-owned subsidiaries: Sovereign Bank, Sovereign Delaware Investment Corporation, Sovereign Capital Trust I, Sovereign Capital Trust II, and ML Capital Trust I. All material intercompany balances and transactions have been eliminated in consolidation. b. Use of Estimates – The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. c. Per Share Information – All per share data has been restated to reflect the effect of the 6-for-5 stock split which was authorized on January 22, 1998 with a record date of March 31, 1998. Basic earnings per share is calculated by dividing income available to common stockholders by the weighted average common shares outstanding, excluding options, warrants, and convertible securities from the calculation. In calculating diluted earnings per share, the dilutive effect of options and warrants is calculated using the treasury stock method using the average market price of the period. The dilutive effect of preferred stock is calculated using the if-converted method. See Note 23 for computation of earnings per share. d. Interest-earning Deposits – Interest-earning deposits consist of deposit accounts with other financial institutions generally having maturities of three months or less. e. Investment Securities – Investment securities that the Company has the intent and ability to hold to maturity are classified as held-tomaturity and reported at amortized cost. Securities expected to be held for an indefinite period of time are classified as available-for-sale and are carried at fair value with unrealized gains and losses reported as a component of comprehensive income within stockholders' equity, net of estimated income taxes. Gains or losses on the sales of securities are recognized at trade date utilizing the specific identification method. f. Forward Commitments and Options – Sovereign utilizes forward commitments and options to hedge interest rate risk associated with loans held for sale. Gains and losses on these transactions are included in the net gain or loss when the asset is sold. g. Loans Held for Sale – Loans held for sale are recorded at the lower of cost or estimated fair value on an aggregate basis. Gains and losses are included in the consolidated statements of operations. h. Mortgage Banking Activity – Sovereign recognizes, as separate assets, the rights to service mortgage loans, whether those rights are acquired through loan purchase or loan origination activities. The initial recognition of originated mortgage servicing assets is predicated upon an allocation of the total cost of the related loans between the loans and the loan servicing rights based on their relative estimated fair values. Purchased mortgage servicing assets are recorded at cost. Excess servicing fees are computed as the present value of the difference between the estimated future net revenues and normal servicing net revenues as established by the federally sponsored secondary market makers. Resultant premiums are deferred and amortized over the estimated life of the related mortgages using the constant yield method. Mortgage servicing rights are amortized against loan servicing fee income on an accelerated basis in proportion to, and over the period of, estimated net future loan servicing fee income, which periods initially do not exceed eight years. For purposes of measuring impairment of capitalized mortgage servicing rights and minimizing the impact of risk, Sovereign conservatively evaluates the loans underlying these rights by stratifying them into certain homogeneous categories which include, but are not limited to, residential real estate 30-year and 15-year fixed rate mortgage loans, adjustable rate mortgage loans and balloon loans. See Note 6 for details of mortgage banking activity. i. Allowance for Loan Losses – An allowance for loan losses is maintained at a level that management considers adequate to provide for losses based upon an evaluation of known and inherent risks in the loan portfolio. Management's evaluation takes into consideration the risks inherent in the loan portfolio, past loan loss experience, specific loans which have losses, geographic and industry concentrations, delinquency trends, economic conditions, the level of originations and other relevant factors. While management uses the best information available to make such evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. 45
Slide 48: Notes to Consolidated Financial Statements NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (CONTINUED) The allowance for loan losses consists of two elements: (i) an allocated allowance, which is comprised of allowances established on specific loans, and class allowances based on historical loan loss experience and current trends, and (ii) unallocated allowances based on both general economic conditions and other risk factors in the Company's individual markets and portfolios, and to account for a level of imprecision in management's estimation process. The specific allowance element is based on a regular analysis of criticized commercial loans where internal credit ratings are below a predetermined classification. This analysis is performed at the relationship manager level, and periodically reviewed by the loan review department. The specific allowance established for these criticized loans is based on a careful analysis of related collateral value, cash flow considerations and, if applicable, guarantor capacity. The class allowance element is determined by an internal loan grading process in conjunction with associated allowance factors. These class allowance factors are updated at least annually and are based primarily on actual historical loss experience projected loss experience based on current conditions, consultation with regulatory authorities, and peer group loss experience. While this analysis is conducted at least annually, the Company has the ability to revise the class allowance factors whenever necessary in order to address improving or deteriorating credit quality trends or specific risks associated with a given loan pool classification. Regardless of the extent of the Company analysis of customer performance, portfolio evaluations, trends or risk management processes established, certain inherent, but undetected losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer's financial condition or changes in their unique business conditions; the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends; and the sensitivity of assumptions utilized to establish allocated allowances for homogeneous groups of loans among other factors. The Company maintains an unallocated allowance to recognize the existence of these exposures. These other risk factors are continuously reviewed and revised by management where conditions indicate that the estimates initially applied are different from actual results. A comprehensive analysis of the allowance for loan losses is performed by the Company on a quarterly basis. In addition, a review of allowance levels based on nationally published statistics is conducted on an annual basis. The Company also has an asset review committee, which has the responsibility of affirming allowance methodology and assessing the general and specific allowance factors in relation to estimated and actual net charge-off trends. This committee is also responsible for assessing the appropriateness of the allowance for loan losses for each loan pool classification at Sovereign. j. Loans – Loans are reported net of unearned income. Interest on loans is credited to income as it is earned. Loan origination fees and certain direct loan origination costs are deferred and recognized as adjustments to interest income in the consolidated statement of operations over the contractual life of the loan utilizing the level yield method, except in the case of certain discounted loans in which a portion of the net deferred fee may be amortized over the discount period. Interest income is not recognized on loans when the loan payment is 90 days or more delinquent (except auto loans, government-guaranteed loans or loans secured by deposit accounts) or sooner if management believes the loan has become impaired. A non-accrual loan is a loan in which it is probable that scheduled payments of principal and interest will not be paid when due according to the contractual terms of the loan agreement. When a loan is placed on non-accrual status, all accrued yet uncollected interest is reversed from income. Payments received on non-accrual loans are generally applied to the outstanding principal balance. In order for a non-accrual loan to revert to accruing status, all delinquent interest must be paid and Sovereign must approve a repayment plan. Loans delinquent 180 days or more (120 days for auto loans) are charged-off unless it can be clearly demonstrated that repayment will occur regardless of the delinquency status. Examples of this would include: a loan which is secured by collateral and is in the process of collection; a loan supported by a valid guarantee or insurance; or a loan supported by a valid claim against a solvent estate. For purposes of measuring impairment as set forth by the provisions of SFAS No. 114 “Accounting by Creditors for Impairment of a Loan” and SFAS No. 118 “Accounting by Creditors for Impairment of a Loan – Income Recognition and Disclosure”, Sovereign defines impaired loans as non-accrual, non-homogeneous loans and certain other loans which are still accruing, which management has specifically identified as being impaired. 46
Slide 49: NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (CONTINUED) k. Premises and Equipment – Premises and equipment are carried at cost, less accumulated depreciation. Depreciation is calculated utilizing the straight-line method. Estimated useful lives are as follows: Office buildings . . . . . . . . . . . . . . . . . . . Leasehold improvements . . . . . . . . . . . . Furniture, fixtures and equipment . . . . . . Automobiles . . . . . . . . . . . . . . . . . . . . . 10 to 30 years Remaining lease term* 3 to 10 years 5 years o. Foreign Exchange – The company enters into forward exchange contracts to provide for the needs of its customers. Forward exchange contracts are valued at current exchange rates. All gains or losses on forward exchange contracts are included in capital markets revenue. p. Consolidated Statement of Cash Flows – For purposes of reporting cash flows, cash and cash equivalents include cash and amounts due from depository institutions, interest-earning deposits and securities purchased under resale agreements with an original maturity of three months or less. q. Reclassifications – Certain amounts in the financial statements of prior periods have been reclassified to conform with the presentation used in current period financial statements. These reclassifications have no effect on net income. r. Goodwill and Other Intangibles – Core deposit intangibles are a measure of the value of checking and savings deposits acquired in business combinations accounted for as purchases. Core deposit intangibles are generally amortized using an accelerated method over the estimated lives of the existing deposit relationships acquired, but not exceeding 10 years. Goodwill is the excess of the purchase price over the fair value of net tangible and identifiable intangible assets of companies acquired through business combinations accounted for as purchases. In finalizing a purchase allocation, the Company considers all the facts that come to its attention during the allocation period, not to exceed 12 months, and, if necessary, will adjust the purchase price allocation accordingly based on such facts. Goodwill is amortized using the straight line method over various periods not exceeding 25 years. The carrying amount of the goodwill is reviewed if facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as determined based on the loss of economic value, the carrying amount of the goodwill is reduced by the estimated loss of value. In addition, goodwill associated with impaired long-lived assets is included in the impairment evaluation which Sovereign assesses under the rules of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." s. Segment Reporting – SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" requires that public companies report certain information about operating segments. It also requires that public companies report certain information about their products and services, the geographic areas in which they operate, and their major customers. Sovereign is a large regional bank which offers a wide array of products and services to its customers. Pursuant to its banking strategy, emphasis is placed on building relationships with its customers, as opposed to building specific lines of business. As a result, at December 31, 2000 and 1999 Sovereign is not organized around discernable lines of business and prefers to work as an integrated unit to customize solutions for its customers, with business line emphasis and product offerings changing over time as needs and demands change. Thus, all necessary requirements of SFAS No. 131 have been met by Sovereign as of December 31, 2000. t. Asset Securitizations – When the Company sells home equity loans, automobile and recreational vehicle loans, and residential mortgage loans, it may retain interest only strips, one or Expenditures for maintenance and repairs are charged to expense as incurred. *Including option periods, if applicable. l. Other Real Estate Owned – Other real estate owned ("OREO") consists of properties acquired by or in lieu of foreclosure. OREO is stated at the lower of cost or estimated fair value minus estimated costs to sell. Write-downs of OREO which occur after the initial transfer from the loan portfolio and costs of holding the property are recorded as other operating expenses, except for significant property improvements which are capitalized to the extent that carrying value does not exceed estimated fair value. m. Income Taxes – Deferred income taxes are provided on temporary differences between amounts reported for financial statement and tax purposes. n. Derivative Instruments and Hedging Activity – Sovereign has entered into certain interest rate exchange agreements in connection with its asset/liability management program which are designated as hedges. Derivatives used as hedges must be effective at reducing the risk associated with the exposure being hedged and must be designated as a hedge at the inception of the derivative contract. To ensure effectiveness, Sovereign performs an analysis to ensure that changes in fair value or cash flow of the derivative correlates to the equivalent changes in the asset or liability being hedged. Related fees are deferred and amortized on a straight line basis over the life of the interest rate exchange agreement, which corresponds to the estimated life of the asset or liability item being hedged. Net interest payments/receipts are accrued as an adjustment of interest expense/income on the hedged assets or liabilities. Gains or losses resulting from early termination of interest rate exchange agreements are deferred and amortized over the remaining term of the original exchange agreements. In the event the related asset/liability is disposed of, such deferred gains or losses are recognized as an adjustment to the respective gain or loss on disposition and are reflected in other income. Changes in the value of interest rate exchange agreements are not recorded in the financial statements because the interest rate exchange agreements are designated as hedges. Sovereign enters into interest rate swap contracts to provide for the needs of its customers. Contracts held or issued for customers are valued at fair market value with gains or losses included in capital markets revenue. 47
Slide 50: Notes to Consolidated Financial Statements NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (CONTINUED) more subordinated tranches, servicing rights, and in some cases a cash reserve account, all of which are retained interests in the securitized receivables. Gain or loss on sale of the receivables depends in part on the previous carrying amount of the financial assets involved in the transfer, allocated between the assets sold and the retained interests based on their relative fair value at the date of the transfer. The Company generally estimates fair value based on the present value of expected future cash flows estimated using management’s best estimates of the key assumptions-credit losses, pre-payment speeds, forward yield curves, and discount rates commensurate with the risks involved. u. Pending Accounting Pronouncements – In June 1999, The Financial Accounting Standards Board (“FASB”) issued SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities–Deferral of the Effective Date of FASB Statement No. 133”, which delays the effective date of SFAS No. 133. Accordingly, SFAS No. 133, shall be effective for all fiscal years beginning after June 15, 2000. SFAS No. 133 requires the recognition of all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value as a component of income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be off-set against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value will be immediately recognized in earnings. The fair value of Sovereign’s derivative instruments is currently not on the balance sheet. On January 1, 2001, Sovereign adopted SFAS No. 133, and at that time, designated anew the derivative instruments used for risk management into hedging relationships in accordance with the requirements of the new standard. Derivative instuments used to hedge changes in the fair value of assets and liabilities due to changes in interest rates or other factors were designated in fair value hedge relationships. Derivative instruments used to hedge the variability of forecasted cash flows attributable to a specific risk, generally interest rate risk, were designated in cash flow hedge relationships. Also on January 1, 2001, after-tax transition amounts associated with establishing the fair values of the derivative instruments and hedged items on the balance sheet of $1.1 million and $7.1 million were recorded as a reduction of net income and an increase in other comprehensive income, respectively. The transition adjustments will be presented as cumulative effect adjustments as described in Accounting Principles Board Opinion No. 20, Accounting Changes, in the 2001 Consolidated Financial Statements. The transition amounts were determined based on the interpretive guidance issued by the Financial Accounting Standards Board to date. The FASB continues to issue interpretive guidance which could require changes in Sovereign’s application of the standard and adjustments to the transition amounts. SFAS No. 133, as applied to Sovereign’s risk management strategies, may increase or decrease reported net income and stockholders’ equity prospectively, depending on future levels of interest rates and other variables affecting the fair values of derivative instruments and hedged items, but will have no effect on cash flows or economic risk. 48 NOTE 2 – BUSINESS COMBINATIONS On September 3, 1999 and amended February 28, 2000, Sovereign entered into a purchase and assumption agreement with FleetBoston Financial to acquire branch banking offices located in Connecticut, Massachusetts, New Hampshire and Rhode Island, and related deposit liabilities, loans and other assets associated with the business of those branches. In total, Sovereign purchased 281 community banking offices (exclusive of 4 locations which were resold to a third party) as detailed in the chart below. The acquisition, which resulted in the creation of Sovereign Bank New England ("SBNE") included the former Fleet Bank community banking franchise in eastern Massachusetts; the entire former BankBoston community banking franchise in Rhode Island; and select community banking offices of Fleet Bank in Southern New Hampshire and BankBoston in Connecticut. In addition, Sovereign acquired a substantial portion of the middle market and small business-lending group from Fleet Bank in Massachusetts and New Hampshire, and from BankBoston in Rhode Island and Connecticut. The acquisition included the purchase of fully functioning business units, with the necessary management, relationship officers, support staff and other infrastructure for the acquired loans and deposits to be fully serviced. During 2000, Sovereign completed each of the three phases of the purchase and assumption agreement of SBNE. Sovereign’s results include the operations of these acquired SBNE branches, assets and liabilities from their respective acquisition dates, and thereafter. Total deposits transferred through the acquisition were $12.3 billion. Additionally, loan balances transferred to Sovereign approximated $8.0 billion, which included $3.1 billion of commercial loans and leases, $1.7 billion of consumer loans and $3.2 billion of residential mortgages, inclusive of $1.1 billion of residential mortgage loans which were not relationship assets which were subsequently sold as part of Sovereign’s asset-liability management strategy to reduce interest-rate risk. Other assets acquired included $85 million of currency, $68 million of premises and equipment, $180 million of precious metals inventory and $213 million of prepaid and other miscellaneous assets. Cash received, net of the premium paid, was $85 million. Summary of Completed SBNE Acquisition (dollars in billions): Date _________ D vested _____ D ____ t_ _____Completed _____i_______Units ___ __eposi_s March 24, 2000 RI, CT (BankBoston) $ 4.2 June 16, 2000 Eastern MA (Fleet) 3.8 July 21, 2000 Central MA, NH (Fleet) ____4._ _3 $ 12.3 Loa __ ____ns $ 2.5 3.5 2._ _____0 $ 8.0 B__n____ _ra_ ches 90 86 105 ____ 281
Slide 51: NOTE 2 – BUSINESS COMBINATIONS (CONTINUED) Total potential consideration for the SBNE acquisition is 12% of acquired deposits less agreed upon reductions. Included in the 12% premium, Sovereign will pay up to $333 million in periodic installments between January 2001 and October 2001 if FleetBoston complies with its non-solicitation obligations under the agreement and certain other conditions are met. These payments are recorded as expense ratably from the completion of the acquisition on July 21, 2000 through the completion of the payments. As of the final closing on July 21, 2000, Sovereign paid a net premium of $848 million, recorded a fair value reduction on acquired loans of $79 million and established an initial allowance for loan losses of $135 million, $17 million of which was recorded in the fourth quarter 2000. These items result in total intangibles of $1.1 billion including goodwill of $685 million and core deposit intangible of $428 million to be amortized over 25 years and 10 years, respectively. Additionally, Sovereign expensed $120 million during 2000 as part of its non-solicitation agreement with FleetBoston. In November, 2000, the Company announced the results of a restructuring initiative in which management analyzed front and back office operations and computer operating platforms which were duplicated as a result of the acquisition and eliminated approximately 500 positions. In total, Sovereign recorded $18.5 million in restructuring costs, which was comprised of $14 million of severance and outplacement costs, and $4.5 million write-off of a redundant computer-operating platform. As of December 31, 2000, $13.0 million of liability remained. On June 30, 1999, Sovereign acquired Peoples Bancorp, Inc. ("Peoples"), a $1.4 billion bank holding company headquartered in Lawrenceville, New Jersey whose principal operating subsidiary operated 14 community banking offices in Mercer, Burlington and Ocean counties, New Jersey. The transaction added investments, loans and deposits to Sovereign of approximately $922 million, $503 million and $515 million, respectively. Sovereign issued approximately 23.6 million shares or .80 shares of Sovereign common stock for each outstanding share of Peoples common stock in connection with the transaction, which was accounted for as a purchase. Sovereign recorded total intangibles of $39.5 million, of which $9.8 million was allocated to a core deposit intangible and $29.7 million was allocated to goodwill. The goodwill and core deposit intangible are being amortized over 25 years and 10 years, respectively. Sovereign's results of operations include the operations of Peoples from June, 30 1999 and thereafter. On June 15, 1999, Sovereign acquired The Network Companies ("Network"), a privately held specialty leasing company headquartered in Commack, New York. Network provides financing for the purchase or lease of equipment and specialty vehicles plus other specialty products for businesses throughout the United States, with transactions ranging from $15,000 to $250,000. The purchase price of $6 million consisted of $4 million of stock and $2 million of cash. Sovereign's results of operations include the operations of Network from June 15, 1999 and thereafter. On September 4, 1998, Sovereign acquired 93 former CoreStates Financial Corp. ("CoreStates") branch offices from First Union Corporation ("First Union"). The former CoreStates offices, located throughout Pennsylvania and New Jersey, added approximately $2.2 billion of commercial bank deposits and $725 million of commercial and consumer loans to Sovereign's balance sheet. This transaction was accounted for as a purchase. Sovereign paid a premium of $325 million for the CoreStates branches which was allocated to core deposit intangible and goodwill. Additionally, Sovereign established an initial loan loss reserve of $20.5 million. The goodwill and core deposit intangible are being amortized over 25 years and 10 years, respectively. In October and November of 2000, Sovereign sold 20 of these branches, representing $315 million of deposits. On July 31, 1998, Sovereign acquired Carnegie Bancorp ("Carnegie"), a $414 million commercial bank holding company headquartered in Princeton, New Jersey which operated seven branch offices throughout central New Jersey and one in Pennsylvania, and First Home Bancorp Inc. ("First Home"), a $510 million savings bank holding company headquartered in Pennsville, New Jersey. First Home had one principal operating subsidiary which operated ten branch offices in Salem, Gloucester and Camden counties, New Jersey and New Castle County, Delaware. As a result of the Carnegie and First Home transactions, Sovereign issued approximately 10.9 million new shares of common stock during the third quarter of 1998. These transactions were accounted for as pooling of interests. On February 28, 1998, Sovereign acquired ML Bancorp, Inc. ("ML Bancorp"), a $2.4 billion bank holding company headquartered in Villanova, Pennsylvania. ML Bancorp's principal operating subsidiary, Main Line Bank, operated 29 branch offices located in the suburbs of Philadelphia, Pennsylvania. Approximately 20.5 million adjusted new shares of Sovereign common stock were issued in connection with the transaction. This transaction was accounted for as a pooling-of-interests. Prior to the combination, ML Bancorp's fiscal year end was March 31, and accordingly, Sovereign's consolidated results of operations for the twelve-month period ended December 31, 1998 include ML Bancorp's results of operations for the two-month period ended February 28, 1998, Sovereign's consolidated results of operations for the twelvemonth period ended December 31, 1997 include ML Bancorp's results of operations for the eleven-month period ended February 28, 1998 and a net decrease to Sovereign's stockholders' equity of $5.0 million has been made to reflect ML Bancorp's activity for the two-month period ended February 28, 1998. That activity consisted of net income of $4.2 million and net unrealized gains on investment securities available-for-sale of $792,000. 49
Slide 52: Notes to Consolidated Financial Statements NOTE 2 – BUSINESS COMBINATIONS – (CONTINUED) The pre-merger results of operations for Sovereign, ML Bancorp, Carnegie and First Home (which were acquired pursuant to transactions accounted for as a pooling-of-interests) were as follows (in thousands): SOVER_ I _ N _______E_G__ Year Ended December 31, 1998 Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,284,933 821,529 27,467 100,962 332,710 ______71,539 ______ $ _____132,650 _______ ML _____ OR_ (_) ____BANC___P_1_ 27,935 16,295 – 3,441 8,534 2, ___ _________319 $________228 4, ___ _ $ CA_ N __ I_ (_) ___R__EG_E_2_ 19,517 9,848 260 427 10,180 _________390 ___ $_______(734) _ ____ $ FI ____ HOME(2) __RST _________ $ 22,986 14,087 234 808 8,659 _________503 ___ _CO_______D_ __ MBINE _ 1,355,371 861,759 27,961 105,638 360,083 74, ___ _________751 $ 136, ___ _________455 $ $ 311 ____________ (1) Reflects ML Bancorp's results of operations for the two-month period ended February 28, 1998. (2) Reflects Carnegie and First Home results of operations for the seven-month period ended July 31, 1998. During 1998, Sovereign recorded pre-tax merger-related charges of $49.9 million, ($33.5 million after-tax) or $.21 per share, primarily related to costs incurred in connection with its acquisitions of ML Bancorp, Inc., Carnegie Bancorp and First Home Bancorp, Inc. The components of the merger-related charges were as follows (in thousands): REQUIRING _____ __________________CASH______ CASH _PROVISION_ __________ Severance and employee-related costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Merger transaction costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Writedowns of assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Office closing costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 22,257 5,307 13,350 3,085 _______5,933 _____ OU_ FLOW ____T_______ $ 22,257 5,307 – 1,274 _______5,____ _ 933 OUTFLOW __TO ____E__ ___ DAT_ $ 22,257 5,307 – 1,274 5,___ _________933 $ ______49,932 ______ $ ______34,771 ______ $ 34,771 ____________ Severance and employee-related costs relate primarily to severance costs and related taxes for employees of the three companies who were displaced as a result of merger, as well as the termination and distribution of ML Bancorp's ESOP and restricted stock plans in connection with the merger. Writedowns of assets include obsolescence of data processing equipment at all three companies as well as writedowns of servicing-related assets at ML Bancorp. The entire provision of $49.9 million was used in 1998. 50
Slide 53: NOTE 3 – RESTRICTIONS ON CASH AND AMOUNTS DUE FROM DEPOSITORY INSTITUTIONS Sovereign Bank is required to maintain certain average reserve balances as established by the Federal Reserve Board. The amounts of those reserve balances for the reserve computation periods which included December 31, 2000 and 1999 were $243 million and $72 million, respectively. NOTE 4 – INVESTMENT SECURITIES The amortized cost and estimated fair value of investment securities are as follows (in thousands): __________ AT DECEMBER 31, _______________________________1__________________________________ _999 AMORTIZED UNREALIZED UNREALIZED C _ ST A___RE_____ION __EP___CIAT_O__ FAIR VA_UE _____O______ _ PP __ CIAT ___ D __RE ____ I_ N ________L___ _______________________________20_________________________________ __00 AMORTIZED UNREALIZED UNREALIZED A____E_____ION __EP___CIAT_O__ FAIR VA_UE ____C__ST____ _ O __ _ PPR_ CIAT ___ D __RE ____ I_ N ________L___ Investment Securities Available-for-Sale: Investment Securities: U.S. Treasury and government agency securities . . . . . . . Corporate securities/Trust preferred . . . . . . . . Asset-backed securities Equities . . . . . . . . . . . FHLB stock . . . . . . . . Agency preferred stock Municipal securities . . Mortgage-backed Securities: Passthroughs: U.S. government agencies . . . . . . Non-agencies . . . . Collateralized mortgage obligations . . . . Total investment securities available-for-sale . . . . $ 92,341 300,206 523,466 25,196 225,797 425,888 36,549 $ 55 11,333 248 126 – 267 2,693 $ 455 5,727 12,118 3,427 – 2,472 473 $ 91,941 305,812 511,596 21,895 225,797 423,683 38,769 $ 77,229 243,915 685,274 32,142 524,397 425,888 32,813 $ 2 650 – 31 – 4,135 745 $ 1,210 14,231 21,149 11,420 – 395 1,379 $ 76,021 230,334 664,125 20,753 524,397 429,628 32,179 676,593 2,553,289 _____515,852 _______ 3,025 556 _________535 ___ 5,679 40,275 _______7_805 _, ___ 673,939 2,513,570 _____508,____ ___ 582 478,462 2,688,315 3, _______ _____166,472 909 – _______2_564 _, ___ 21,004 132,333 1 __ 610 ______30,___ 458,367 2,555,982 3, _______ _____038,426 $________177 _ 5,375, ___ $________838 18, ___ _ $_____78_431 _ __, ___ $____315,584 _ 5, _______ $____35__907 _ 8,__4, ___ $________036 9, ___ _ $__________ _ 333,731 $__________2 _ 8,030,21 _ 51
Slide 54: Notes to Consolidated Financial Statements NOTE 4 – INVESTMENT SECURITIES – (CONTINUED) AT DECEMBER 31, ________________________________________________________________________________________________________________________________________ _______________________________2__________________________________ _000 _______________________________19_________________________________ __99 AMORTIZED CO __ _______ST____ Investment Securities Held-to-Maturity: Investment Securities: U.S. Treasury and government agency securities Corporate securities Municipal securities Mortgage-backed securities: Passthroughs: U.S. government agencies Non-agency Collateralized mortgage obligations Total investment securities held-to-maturity UNREALIZED A___R______ION _ PP _ECIAT ___ UNREALIZED D___RE_____ION _ EP __ CIAT ___ FAIR VA_UE ________L___ AMORTIZED ____C__ST____ _ O __ UNREALIZED A___RE_____ION _ PP __ CIAT ___ UNREALIZED D___RE_____ION _ EP __CIAT ___ FAIR VA_UE ________L___ $ 6,382 35,785 739 $ – 2,282 135 $ 138 6 6 $ 6,244 38,061 868 $ 4,807 1,326,827 3,275 $ – 9,852 96 $ 109 165 22 $ 4,698 1,336,514 3,349 1,562,525 39,117 _____333,720 _______ $____978_268 _ 1, ___, ___ 14,780 378 _________505 ___ $_____1__080 _ _8, ___ 16,502 234 _______7,566 _____ $_____24,452 _ ______ 1,560,803 39,261 _____326,____ ___ 659 $____971,896 _ 1, _______ 499,866 52,319 _____474,957 _______ $________051 _ 2,362, ___ 2,516 377 2, ___ _________520 $________361 15, ___ _ 2,365 224 7,___ ________502 $_______387 10, ___ _ 500,017 52,472 _____469,975 _______ $____367,025 _ 2, _______ 52
Slide 55: NOTE 4 – INVESTMENT SECURITIES – (CONTINUED) The amortized cost and estimated fair value of investment securities at December 31, 2000 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (in thousands): AMORTIZED ______C__ST______ _ O __ Investment Securities Available-for-Sale: Due in one year or less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Due after one year through five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Due after five years through ten years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Due after ten years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total investment securities available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 773,882 1,991,715 1,055,179 878,061 676,___ ______________340 ___FAIR_VALU____ ____ _____E $ 754,790 1,958,767 1,038,032 860,661 703, ___ ______________334 $________5,____177 _ _ 375, ___ AMORTIZED ______C__ST______ _ O __ $________5,____584 _ _ 315,___ ___FAIR_VA_______ ____ __ LUE $ 350,083 961,177 394,765 265,_71 ______________8__ Investment Securities Held-to-Maturity: Due in one year or less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Due after one year through five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Due after five years through ten years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Due after ten years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total investment securities held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 354,108 982,805 399,816 241,___ ______________539 $________1,____2__ _ _ 978,_68 $________1,971,___ _ _____896 Proceeds from sales of investment securities available for sale and the realized gross gains and losses from those sales are as follows (in thousands): AVAILABLE-FOR-SALE __________YEAR_ENDED ____________31,__________ _____ _______ DECEMBER __ 2 ___ _____000 ____ ____199_____ ___9 ____199_____ ___8 Proceeds from sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross realized gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross realized losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net realized gains/(losses) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 8, _______ _____248,463 3,039 ( _______ _____123,916) $ ________ ____(120,877) $____55__469 _ 5,__3, ___ 8,335 (4, ___ _________603) $________732 3, ___ _ $____1___929 _ 2,_45, ___ 27,729 (11,___ _________449) $________280 16, ___ _ Tax-exempt income included in interest and dividends on investment securities for the years ended December 31, 2000, 1999 and 1998 was $27.1 million, $27.1 million and $17.9 million, respectively. Tax expense/(benefit) related to net realized gains and losses from sales of investment securities for the years ended December 31, 2000, 1999 and 1998 were $(42.3) million, $1.2 million and $5.7 million, respectively. Investment securities with an estimated fair value of $2.3 billion and $2.7 billion were pledged as collateral for borrowings, interest rate agreements and public deposits at December 31, 2000 and 1999, respectively. 53
Slide 56: Notes to Consolidated Financial Statements NOTE 5 – LOANS A summary of loans included in the consolidated balance sheets (in thousands): Loans to related parties include loans made to certain officers, directors and their affiliated interests. At December 31, 2000 and 1999, loans to related parties totaled $14.6 million and $9.2 million, respectively. The activity in the allowance for loan losses is as follows (in thousands): _______AT_DECEMBER _________ __ ___________ 31, ____200_____ ___0 ____199_____ ___9 Residential real estate loans . . . . . . . . . $ 7,927,442 Residential construction loans . . . . . . . . . . ._________415 51, ___ Total Residential Loans. . . . . . . . Commercial real estate loans. . . . . . . . Commercial loans. . . . . . . . . . . . . . . . Automotive floor plan loans . . . . . . . . Multi-family loans. . . . . . . . . . . . . . . . Total Commercial Loans . . . . . . Home equity loans . . . . . . . . . . . . . . . Auto loans. . . . . . . . . . . . . . . . . . . . . Loans to automotive lessors . . . . . . . . . Student loans . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . Total Consumer Loans . . . . . . . . Total Loans(1)(2) . . . . . . . . . . . Total Loans with: Fixed rate. . . . . . . . . . . . . . . . . Variable rate . . . . . . . . . . . . . . . Total Loans(1) . . . . . . . . . . . . . 7,_78, ___ _____9___857 2,793,616 4,397,009 513,641 127,_41 _________1__ 7,831, ___ _________407 3,256,598 2,309,025 317,281 26,283 _____1___794 _92, ___ ____6,____981 _ 101, ___ $________245 _ 21,912, ___ $ 5,685,220 ______5__264 _9, ___ 5,_44, ___ _____7___484 1,516,953 1,690,744 730,623 137, ___ _________019 4,075, ___ _________339 1,957,945 1,936,980 288,636 249,279 35, ___ _________802 4,___, ___ _____468_642 $____288_465 _ 14,___, ___ Balance, beginning of period. Allowance established/acquired in acquisitions . . . . . . Provision for loan losses. . . . Charge-offs. . . . . . . . . . . . . . Recoveries . . . . . . . . . . . . . Balance, end of period . . . . . ____200_____ ___0 $ 132,986 __________YEAR_ENDED ____________31,__________ _____ _______ DECEMBER __ 1998 ____19______ __99 ___________ $ 133,802 $ 116,823 134,706 56,500 92,892 ______25,056 ______ $____256,356 _ _______ 4,799 30,000 55,023 19, ___ _________408 $________986 132, ___ _ 22,660 27,961 46,330 12, ___ ________688 $_______802 _ 133,___ Impaired loans are summarized as follows (in thousands): AT __________ 31, __________DECEMBER__________ ____200_____ ___0 ___1_______ _999 Impaired loans without a related allowance . . . . . Impaired loans with a related allowance . . . . . . . Total impaired loans . . . . . . . . . . . . . . . . Allowance for impaired loans . . . . . . . . . . . . . . . $ – $ – 232, ___ _________817 $________817 232, ___ _ $ 5 _ 311 ________6,___ 108,__5 ________21_ $ _______21_ 108,__5 _ $_______033 23, ___ _ $ 14,165,535 7 746,___ _____,____710 $________245 _ 21,912, ___ $ 8,769,876 5,518, ___ _________589 $____288,465 _ 14, _______ (1) Loan totals are net of deferred loan fees of $33 million for 2000 and $24 million for 1999. (2) Loan totals are net of unamortized premium/(discount) of ($65) million and ($3) million for 2000 and 1999. Maturities of residential real estate loans are presented as follows (in thousands): If Sovereign's non-accruing and restructured loans had been current in accordance with their original terms and had been outstanding throughout the period, gross interest income for the years ended December 31, 2000, 1999 and 1998 would have increased by approximately $7.0 million, $5.0 million and $9.8 million, respectively. Interest income recorded on these loans for the years ended December 31, 2000, 1999 and 1998 was $3.8 million, $2.1 million and $3.3 million, respectively. AT DECEMBER 31, 2000 _______________________ Maturing: In one year or less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . One to five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . After five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 142,517 513,599 7, ___, ___ _____322_741 $____978,857 _ 7, _______ 54
Slide 57: NOTE 6 – MORTGAGE BANKING ACTIVITY At December 31, 2000, 1999, and 1998, Sovereign serviced loans for the benefit of others totaling $5.5 billion, $5.7 billion, and $6.7 billion, respectively. The following table presents the activity of Sovereign's mortgage servicing rights for the years indicated. This activity does not reflect the reduction from the activity in Sovereign's valuation allowance for mortgage servicing rights presented in the table below (in thousands): NOTE 7 – PREMISES AND EQUIPMENT A summary of premises and equipment, less accumulated depreciation and amortization, follows (in thousands): AT __________ 31_ __________DECEMBER___, ______ ____200_____ ___0 ___1_______ _999 Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Office buildings . . . . . . . . . . . . . . . . . . . . . . . . Furniture, fixtures, and equipment . . . . . . . . . . . Leasehold improvements . . . . . . . . . . . . . . . . . . Automobiles. . . . . . . . . . . . . . . . . . . . . . . . . . . Less accumulated depreciation. . . . . . . . . . . . . . 13,200 108,890 214,106 57,723 _________605 ___ 394,524 (104, ___ _________390) $____29__134 _ __0, ___ $ $ 15,790 84,130 116,163 22,154 ________883 ___ 239,120 ____(119,___) ____919 Balance, beginning of year. . . Servicing assets sold . . . . . . Net servicing assets recognized . . . . . . . . Amortization and other. . . . . Balance, end of year. . . . . . . ____200_____ ___0 $ 77,349 (34,842) 7,971 (_, ___ _______8_937) $________541 41, ___ _ ____199_____ ___9 $ 75,627 – 14,605 (12, ___ _________883) $_____77,349 _ ______ 1998 ___________ $ 68,063 – 19,439 _____(11,___) ___875 $ 75, ___ ________627 Total premises and equipment . . . . . . . . . $____11_____ _ _ 9,201 For valuation purposes, at December 31, 2000, a weighted average discount rate of 9.6% was assumed and assumed prepayment speeds were consistent with published secondary market rates for Sovereign's market area. Sovereign also takes into consideration any inherent risks, as well as other relevant factors associated with each portfolio. Prices are obtained in the secondary market and are based upon current market prices of similarly traded loans and/or comparable secondary market instruments. Activity in the valuation allowance for mortgage servicing rights for the years indicated consisted of the following (in thousands): Included in occupancy and equipment expense for 2000, 1999 and 1998 was depreciation expense of $36.6 million, $15.1 million, and $11.8 million respectively. Sovereign also recorded rental expense of $52.0 million, $16.5 million and $10.6 million, net of $5.2 million $1.2 million, and $1.1 million of sublease income in 2000, 1999 and 1998, respectively. On June 30, 2000, Sovereign was party to a structured real estate transaction pursuant to which 127 commercial properties, including 104 commercial properties that were owned by FleetBoston and 23 commercial properties of Sovereign’s existing franchise, were sold to the Sovereign Bank Lease Pass-Through Trust, a non-affiliated third party. The Company simultaneously entered into 127 separate operating leases, each of which had an initial lease term of approximately 20 years. Sovereign recorded a gain on the sale of $11.9 million, which was deferred and will be amortized over the lease term of the 23 properties sold and subsequently leased back. YEAR ENDED ___________ 31, ________________________DECEMBER _____________ 1998 ____200_____ ___0 ____199_____ ___9 ___________ Balance, beginning of year . . Change in valuation allowance for mortgage servicing rights . . . . . Balance, end of year . . . . . . $ 4,858 $ 13,295 $ 3,295 NOTE 8 – ACCRUED INTEREST RECEIVABLE Accrued interest receivable is summarized as follows (in thousands): ( _____ _______2,675) $ _______2,183 _____ (8, ___ _________437) $________858 4,___ _ ______10,____ __ 000 $______3,____ 1 _ 295 _ _______AT _____________________ ___DECEMBER 31, ____20______ __00 ___19______ __99 Accrued interest receivable on: Investment securities. . . . . . . . . . . . . . . . Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . Total interest receivable . . . . . . . . . . . $ 55,465 $ 58,749 _____1___049 _75, ___ $________514 230, ___ _ 105,_71 ________9__ $ __________ _ 164,720 55
Slide 58: Notes to Consolidated Financial Statements NOTE 9 – DEPOSITS Deposits are summarized as follows (in thousands): 200 _ _________________________0 _____________________ BALA _CE PERCEN _ R ____ _______N____ ________T ___ATE _ Demand deposit accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . NOW accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Savings accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Money market accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retail certificates of deposit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Jumbo certificates of deposit . . . . . . . . . . . . . . . . . . . . . . . . . . . Total deposits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,475,994 4,247,194 2,952,960 4,553,020 8,371,936 _____897,813 _______ $____498,917 _ 24, _______ 14% 17 12 19 34 _______4 _ 100 ________ % AT __________ 31_ _____________________________________________DECEMBER___, _________________________________________ _____________________19_______________________ __99 –% 2.67 2.38 4.44 5.91 6.55 3. __ ______83% BA_ A _CE ____L__N___ $ 1,089,472 1,871,288 2,142,708 1,345,325 4,708,057 855, ___ _________825 $________675 _ 12,012, ___ PERCEN _ ________T 9% 16 18 11 39 7 ________ 10_ _______0% R ____ ___ATE _ –% 2.44 2.69 4.17 5.00 5.56 3. __ ______68% Deposits of related parties include deposits made by certain officers, directors and their affiliated interests. At December 31, 2000 and 1999, deposits of related parties totaled $1.2 million and $2.4 million, respectively. Interest expense on deposits is summarized as follows (in thousands): AT __________ __, _____________________________DECEMBER_31__________________________ 200 _ 1998 _________0 _____ _____1_________ _999 ______________ Demand deposit and NOW accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Savings accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Money market accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Certificates of deposit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total interest expense on deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81,842 67,880 132,131 ________453,234 _______ $ ________735,087 _______ $ 34,622 58,333 50,246 ________2___625 _97, ___ $ 440, ___ ____________826 $ 19,920 62,694 45,055 316, ___ ____________164 $ ________443,833 _______ $ The following table sets forth the maturity of Sovereign's certificates of deposit of $100,000 or more as scheduled to mature contractually at December 31, 2000 (in thousands): The following table sets forth the maturity of Sovereign's certificates of deposit as scheduled to mature contractually at December 31, 2000 (in thousands): AT ______________ ___ DECEMBER 31, 2000 ____________ Three months or less . . . . . . . . . . . . . . . . . . . . . . . . . . . . Over three through six months. . . . . . . . . . . . . . . . . . . . . . Over six through twelve months . . . . . . . . . . . . . . . . . . . . Over twelve months . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 539,437 499,845 360,013 169, ___ ________361 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $___5___656 _ 1,_68, ___ AT ______________ ___ DECEMBER 31, ____20______ __00 $ 7,491,297 1,172,202 144,637 76,856 76,256 _____308,501 _______ $ _, _______ ___9_269,749 56
Slide 59: NOTE 10 – BORROWINGS Borrowings. Short-term borrowings included in the consolidated balance sheets are as follows (in thousands): AT DECEMBER ___ ____________________________31, ______________ 2000 199 _ _____________________ ____________9 ________ B _ ance B _ an __ __al_______ W.A.____e ___al___ce _ W.A._____ ____ Rat_ ____ Rate $ 130,000 5.23% $ – – 230,900 970, ___ ______000 $1_330,900 __, ______ 6.58% 6.62% 6.48% 102,944 6,054, ___ _______995 $______939 _ 6,157, ___ 5.85% 5.67% 5.67% NOTE 11 – LONG-TERM DEBT Long-term Debt. Long-term debt (borrowings with original maturities of more than one year) at December 31 consisted of the following (in thousands): AT __________ 31, __________DECEMBER__________ 19 __ ______99 ___ $ 188,580 Federal funds purchased . . . . . Securities sold under repurchase agreements . Federal Home Loan Bank advances . . . . . . Total borrowings . . . . . Included in borrowings are sales of securities under repurchase agreements. Securities underlying sales of securities under repurchase agreements consisted of investment securities which had an amortized cost of $243 million and $141 million and a market value of $239 million and $139 million at December 31, 2000 and 1999, respectively. Short-term FHLB advances are collateralized by qualifying mortgagerelated assets as defined by the FHLB. Short-term FHLB advances had weighted average interest rates of 6.62% and 5.67% at December 31, 2000 and 1999, respectively. Qualifying repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as a liability in the balance sheet. The dollar amount of securities underlying the agreements remains in the asset accounts, although the securities underlying the agreements are delivered to the brokers who arranged the transactions. In certain instances, the broker may have sold, loaned, or disposed of the securities to other parties in the normal course of their operations, and have agreed to resell to Sovereign substantially similar securities at the maturity of the agreements. The broker/dealers who participate with Sovereign in these agreements are primarily broker/dealers reporting to the Federal Reserve Bank of New York. Through the use of interest rate swaps, $400 million of FHLB advances at December 31, 2000 have been effectively converted from variable rate obligations to fixed rate obligations. An additional $500 million of borrowings have been protected from upward repricing through the use of interest rate caps. Securities sold under repurchase agreements FHLB advances, maturing January 2001 to April 2012 . . . . . . . . . . . . . . . . . . . . . . . . Senior secured credit facility, due November 15, 2003 6.625% senior notes, due March 15, 2001 . . . . . . 10.25% senior notes, due May 15, 2004. . . . . . . . 10.50% senior notes, due November 15, 2006 . . . 6.75% subordinated debentures, due 2000. . . . . . 8.50% subordinated debentures, due 2002. . . . . . 8.00% subordinated debentures, due 2003. . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ____200_____ ___0 $ – 3,544,984 350,792 239,973 200,000 500,000 19,992 49,960 3, ___ _________707 $____90__408 _ 4,__9, ___ 4,429,909 500,000 239,843 200,000 500,000 77,892 19,987 49,943 _______6,____ _ 016 $____212,____ _ 6, ___ 170 Long-term debt includes sales of securities under repurchase agreements with weighted average interest rates of 5.84%at December 31, 1999. Securities underlying these repurchase agreements consist of investment securities which had a book value of $195 million, and a market value of $192 million at December 31, 1999. Long-term FHLB advances are collateralized by qualifying mortgagerelated assets as defined by the FHLB. Long-term FHLB advances had weighted average interest rates of 5.47% and 5.09% at December 31, 2000 and 1999, respectively. The Senior Secured Credit Facility will mature November 15, 2003. The facility’s original amortization schedule was as follows: 2000 – 5%, $25 million; 2001 – 15%, $75 million; 2002 – 40%, $200 million; and 2003 – 40%, $200 million with mandatory prepayments occurring if Sovereign's cash flow exceeds predetermined levels. Interest is calculated, at the option of the borrower, at LIBOR plus 3.5%, or the sum of a) the highest of (i) lender's base rate, (ii) .50% over lender's three month CD rate, or (iii) .50% over the Federal Funds Effective Rate, plus b) 2.50%. Interest was calculated under the LIBOR option (9.96%) at December 31, 2000. The Senior Secured Credit Facility is secured primarily by first perfected security interest in the stock of Sovereign Bank owned by Sovereign Bancorp. The Senior Secured Credit Facility subjects Sovereign to a number of affirmative and negative covenants. On March 1, 2001, Sovereign refinanced this facility as described in Note 26. The 6.625%, 10.25% and 10.50% senior notes are non-amortizing and are redeemable, at a significant premium, at any time prior to maturity. The 8.00% subordinated debentures are non-amortizing and are not redeemable prior to maturity. The 8.50% subordinated debentures are non-amortizing and are redeemable at the option of Sovereign in whole or in part. 57
Slide 60: Notes to Consolidated Financial Statements NOTE 11 – LONG TERM DEBT – (CONTINUED) The following table sets forth the maturity of Sovereign's long-term debt as scheduled to mature contractually at December 31, 2000 (in thousands): AT DECEMBER 31, 20 __ ______00 ___ 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 582,722 519,992 350,753 300,700 12,750 ___3,____,___ _ 142 491 In the event of certain changes or amendments to regulatory requirements or federal tax rules, Sovereign may elect to redeem the Trust Preferred II securities at 100% of accreted value and to redeem the warrants at their value (combined value $50). Sovereign may elect to redeem the Trust Preferred II securities and the warrants at $50, if the value of Sovereign's common stock on 20 trading days out of the preceding 30 consecutive trading days and on the day the election is made exceeds $14.99 after November 20, 2002; $13.12 after November 15, 2003; or $11.25 after November 15, 2004. The Trust Preferred offerings are classified as and are similar to a minority interest and are presented as "Mandatorily redeemable capital securities (or “Trust Preferred”)." The Trust Preferred offerings qualify for Tier I capital treatment for Sovereign and the loan payments from Sovereign to the Trust are fully tax deductible. The warrants, included in the PIERS units, are classified as additional capital within stockholders' equity. $__4,_______ _ _ 909,408 NOTE 13 – MINORITY INTEREST NOTE 12 – TRUST PREFERRED SECURITIES On November 15, 1999, Sovereign issued 5,750,000 units of Trust Preferred Income Equity Redeemable Securities (PIERS) resulting in net proceeds to Sovereign of $278.3 million with a stated maturity of January 15, 2030, of which $91.5 million has been allocated to the value of the warrants and is treated as original issue discount. The original issue discount is accreted into Trust Preferred Securities expense over the life of the unit resulting in an effective yield of 11.74%. Each PIERS unit consists of: A preferred capital security (Trust Preferred II) issued by Sovereign Capital Trust II (Trust II), valued at $32.50, having a stated liquidation amount of $50, representing an undivided beneficial ownership interest in Trust II, which assets consist solely of debentures issued by Sovereign. Distributions are payable quarterly beginning February 15, 2000 at an annual rate of 7.5% of the stated liquidation value; and A warrant to purchase, subject to antidilution adjustments, 5.3355 shares of Sovereign common stock at any time prior to November 20, 2029. The warrants were valued at $17.50 per unit. The Trust Preferred II securities were issued by a special-purpose statutory trust created expressly for the issuance of these securities. Distributions on Trust II will be payable at an annual rate of 7.5% of the stated liquidation amount of $50 per capital security, payable quarterly. After original issue discount and issuance costs, proceeds of $186.8 million were invested in Junior Subordinated Debentures of Sovereign, at terms identical to the Trust Preferred II offering. Cash distributions on Trust Preferred II will be made to the extent interest on the debentures is received by Trust II. Sovereign may defer interest payments on the debentures for a period not exceeding 20 consecutive quarters or beyond the original maturity date. Holders may require Sovereign to repurchase the Trust Preferred II securities at accreted value following exercise of the warrants. On August 21, 2000 Sovereign received approximately $140 million of net proceeds from the issuance of $161.8 million of 12% Series A Noncumulative Preferred Interests in Sovereign Real Estate Investment Trust (“SREIT”), a subsidiary of Sovereign Bank which holds primarily residential real estate loans. The preferred stock was issued at a discount, which is being amortized over the life of the preferred shares. The preferred shares may be redeemed at any time on or after May 16, 2020, at the option of Sovereign subject to the approval of the OTS. Under certain circumstances, the preferred shares are automatically exchangeable into preferred stock of Sovereign Bank. The offering was made exclusively to institutional investors; however, by mid-2001 these SREIT preferred shares are expected to be registered so that they may be offered to other investors. The proceeds of this offering were principally used to repay corporate debt. NOTE 14 – STOCKHOLDERS’ EQUITY Sovereign maintains a Dividend Reinvestment and Stock Purchase Plan which permits holders of record of Sovereign common stock to purchase additional shares of common stock directly from Sovereign via reinvestment of cash dividends and optional cash purchases. At December 31, 2000, purchases of common stock with reinvested dividends are made at a 5% discount from the current market price as defined and optional cash purchases are limited to a maximum of $5,000 per quarter. Sovereign maintains a Stockholder Rights Plan (the "Rights Plan"). The Rights Plan is designed to protect stockholders from attempts to acquire control of Sovereign at an inadequate price. Under the Rights Plan, Sovereign distributed a dividend of one right to purchase a unit of preferred stock on each outstanding share of Sovereign's common stock. The rights are not currently exercisable or transferable and no separate certificates evidencing such rights will be distributed, unless certain events occur. The rights attach to shares of common stock outstanding on October 2, 1989 and will expire on September 27, 2004 as stated in the amendment to the Rights Plan dated September 27, 1995. The rights will entitle the holders to purchase either Sovereign's common stock or the common stock of the potential acquiree at a substantially reduced price. 58
Slide 61: On November 15, 1999, Sovereign raised $1.3 billion of debt and equity. This included issuance of 43.8 million shares of common stock resulting in net proceeds of $331.5 million. In connection with the PIERS offering as described in Note 12, Sovereign issued 5.75 million warrants with a fair value, net of offering expenses, of $91.5 million, classified as stockholders' equity. The conversion of all warrants would result in an additional 30.7 million shares outstanding before the effect of repurchase of shares assumed under the treasury stock method used for fully diluted EPS calculations. On May 15, 1998, Sovereign redeemed all outstanding shares of its 6 1/4% Cumulative Convertible Preferred Stock, Series B and issued 14.3 million shares of common stock in connection with this redemption. Retained earnings at December 31, 2000 included $79.6 million in bad debt reserves, for which no deferred taxes have been provided due to the indefinite nature of the recapture provisions. Our debt agreements impose customary limitations on dividends, other payments and transactions. These limits are not expected to affect dividend payments at current levels and reasonably anticipated increases. as well-capitalized or adequately-capitalized are subject to various restrictions regarding capital distributions, payment of management fees, acceptance of brokered deposits and other operating activities. As of December 31, 2000, Sovereign was “well-capitalized” under the regulatory framework for FDICIA. The OTS order, as amended, applicable to the approval of the SBNE acquisition (the “OTS order”) requires Sovereign Bank to be “Well Capitalized”, and also to meet certain additional capital ratio requirements and other conditions. Various agreements with our lenders also require us to cause Sovereign Bank to be “Well Capitalized” at all times and in compliance with all regulatory requirements. To be “well capitalized”, a thrift institution must maintain a Tier 1 Leverage ratio of at least 5%, a Tier 1 risk-based capital ratio of 6% and total riskbased capital of 10%. Although OTS capital regulations do not apply to savings and loan holding companies, the OTS Order requires Sovereign to maintain certain Tier 1 capital levels. At December 31, 2000, Sovereign had met all quantitative thresholds necessary to be classified as well-capitalized under regulatory guidelines. Federal banking laws, regulations and policies also limit Sovereign Bank’s ability to pay dividends and make other distributions to Sovereign Bancorp. Sovereign Bank must obtain prior OTS approval to declare a dividend or make any other capital distribution if, after such dividend or distribution, Sovereign Bank’s total distributions to us within that calendar year would exceed 100% of its net income during the year plus retained net income for the prior two years, Sovereign Bank would not meet capital levels imposed by the OTS in connection with any order, including the OTS order applicable to the New England Acquisition, as amended, or if Sovereign Bank is not adequately capitalized at the time. In addition, OTS prior approval would be required if Sovereign Bank’s examination or CRA ratings fall below certain levels or Sovereign Bank is notified by the OTS that it is a problem association or an association in troubled condition. NOTE 15 – REGULATORY MATTERS The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA") requires institutions regulated by the Office of Thrift Supervision (OTS) to have a minimum leverage capital ratio equal to 3% of tangible assets, and 4% of risk-adjusted assets, and a risk-based capital ratio equal to 8% as defined. The Federal Deposit Insurance Corporation Improvement Act ("FDICIA") requires OTS regulated institutions to have a minimum tangible capital equal to 2% of total tangible assets. Management believes, as of December 31, 2000 and 1999, that Sovereign Bank met all capital adequacy requirements to which they are subject in order to be well-capitalized. The FDICIA established five capital tiers: well-capitalized, adequatelycapitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. A depository institution's capital tier depends upon its capital levels in relation to various relevant capital measures, which include leverage and risk-based capital measures and certain other factors. Depository institutions that are not classified The following schedule summarizes the actual capital balances of Sovereign Bank at December 31, 2000 (in thousands): TIER 1 TOTAL RISK-BASED RISK-BASED CAPITAL TO CAPITAL TO RISK-ADJUSTED RISK-ADJUSTED A ___ TS __A____TS___ _ SSE __ ____SSE_____ $ 2,097,654 ___1,280,____ _____ 869 $ _____816,____ ___ 785 9.20% $ 2,348,935 1, _______ _____823,347 $____525_588 _ ___, ___ 10.31% REGULATORY CAPITAL TANGIBLE CAPITAL TO TANGIBLE A _____ ____SSETS___ $ 2,216,886 LEVERAGE CAPITAL TO TANGIBLE __A____TS___ _ SSE __ $ 2,216,886 ___1,280,____ _____ 869 $ _____936,____ ___ 017 6.92% Sovereign Bank: Regulatory capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Minimum capital requirement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Excess . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital ratio. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ____1,____869 _ 280, ___ $ ________017 936,___ _ 6.92% 59
Slide 62: Notes to Consolidated Financial Statements NOTE 16 – STOCK OPTION PLANS Beginning in 1990, Sovereign initiated its stock option plan. This plan grants stock options for a fixed number of shares to key officers, certain employees and directors with an exercise price equal to the fair market value of the shares at the date of grant. Sovereign's stock options expire not more than ten years and one month after the date of grant and become fully vested and exercisable within a one to five year period after the date of grant. Sovereign accounts for stock option grants in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees," and accordingly, recognizes no compensation expense for the stock option grants. There are 14.2 million shares of common stock reserved for issuance under the plans. These shares, along with the per share data in the following summary of option transactions, have been adjusted to reflect all stock dividends and stock splits. The following table provides a summary of Sovereign's stock option activity for the years ended December 31, 2000, 1999 and 1998 and stock options exercisable at the end of each of those years (number of options in thousands). PRICE PER Options outstanding December 31, 1997 (4,351,317 shares exercisable) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Granted. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exercised. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Forfeited. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options outstanding December 31, 1998 (3,371,038 shares exercisable) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .` Options exchanged in conjunction with Peoples acquisition... Granted. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exercised. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Forfeited. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options outstanding December 31, 1999 (4,154,213 shares exercisable) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Granted. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exercised. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Forfeited. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options outstanding December 31, 2000 (6,031,898 shares exercisable) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SH_ R __ ____A__ES__ $ 6,033,453 934,070 (2,295,265) ___(172,____ ____ 550) __4,____70__ _ 499,__8 473,531 2,216,479 (720,811) (110 015) _______,____ __6,________ _ 358,892 1,762,744 (195,873) ___(306,____ ____ 430) $ _7,619,____ _ _____ 333 ___SH__R____ __ A _E $ .96 - 16.77 13.38 - 20.25 .97 - 10.54 8.22 - 20.25 .96 - 20.25 4.41 - 6.86 8.28 - 12.44 .96 - 8.83 3.78 - 16.35 1.30 - 20.25 6.69 - 7.81 1.30 - 6.53 4.11 - 16.35 $ 1.30 - 20.25 The following table summarizes Sovereign's stock options outstanding at December 31, 2000: _________________OPTIONS_OUTS___N__I__G_________________ ________ _____TA _ D N _ WEIGHTED WEIGHTED AVERAGE AVERAGE EXERCISE REMAINING CO_ T _AC _UAL ____ _SH__R___ __ A _ES ___PR_C____ __ I_ E ___N__R___T_____LIFE 2,291,227 2,274,864 _3,____242 _ 053,___ _7,____333 _ 619,___ $ 4.41 $ 7.37 $ 13.11 $ _. __ ____8_78 3.91 8.49 7.84 6.__ ___85 ____OPTIONS________SABLE____ ________ EXERCI______ WEIGHTED AVERAGE EXERCISE PR ___ _SH__R___ __ A _ES _____ICE__ 2,155,477 823,179 _3,____242 _ 053, ___ _6,031_898 ____ , ___ $ 4.26 $ 8.15 $ 13.11 $ 9. __ _____27 E___RCISE_PRICES _ XE _____ _______ $1.30 - $6.69 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $6.72 - $10.57 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11.80 - $20.25 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Companies have a choice either to expense the fair value of employee stock options over the vesting period (recognition method) or to continue the previous practice but disclose the pro forma effects on net income and earnings per share had the fair value method been used (disclosure only method). Sovereign follows the disclosure only method. 60
Slide 63: NOTE 16 – STOCK OPTION PLANS – (CONTINUED) Pro forma information regarding net income and earnings per share is required by SFAS No. 123 and has been determined as if Sovereign had accounted for its employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions: Grant date year Expected volatility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expected life in years. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock price on date of grant. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exercise price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Weighted average exercise price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Weighted average fair value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expected dividend yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Risk-free interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vesting period in years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 __ _________00 ____ .325 6.00 $ 6.69 - $7.81 $ 6.69 - $7.81 $ 6.90 $ 2.73 1.21% 6.67%-6.85% 1-5 1999 _______________ .296 6.00 $ 8.28 - $12.44 $ 8.28 - $12.44 $ 11.34 $ 3.98 1.40% 5.17% - 6.75% 1-5 199 _ _________8 ____ .278 6.00 $ 13.38 - $20.25 $ 13.38 - $20.25 $ 15.41 $ 5.45 .67% 4.65% - 5.72% 1 The Black-Scholes option valuation model was developed for use in estimating the fair market value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because Sovereign's employee stock options have characteristics significantly different from those traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide reliable single measure of fair value of its employee stock options. The pro forma reduction to net income for 2000, 1999 and 1998, was $3.5 million, $3.2 million and $2.8 million, respectively. The pro forma reduction to diluted earnings per share was $.02, each year. NOTE 17 – EMPLOYEE BENEFIT PLANS Sovereign sponsored several non-contributory defined benefit pension plan which covered substantially all employees, and former employees of certain institutions acquired by Sovereign. Benefits were frozen effective March 31, 1999. Sovereign recorded a curtailment gain of $1.6 million in 1999 and a settlement gain of $1.3 million (net of excise tax expense of $1.2 million) in 2000. $2.0 million of plan assets were transferred to Sovereign’s 401(k) plan and $6.2 million was returned to Sovereign in 2000 after settlement of benefit obligations was completed. Sovereign also sponsors a supplemental executive retirement plan (“SERP”) and several postemployment benefit plans of several institutions acquired by Sovereign. Increasing or decreasing the assumed health care cost trend rate would not have a significant impact on the accumulated post retirement benefit obligation at December 31, 2000, and the aggregate of the service and interest components of net benefit expense for the year ended December 31, 2000. 61
Slide 64: Notes to Consolidated Financial Statements NOTE 17 – EMPLOYEE BENEFIT PLANS – (CONTINUED) The following tables present net periodic expense, change in benefit obligation and change in plan assets and funded status at or for the periods indicated (in thousands of dollars): NET _________ _________FOR ____ YEAR ENDED _____________, ____________________________________PERIODIC_EXPENSE _____THE ______________DECEMBER 31________________________ 20 __ ________00 _____ $ 332 2,076 (1,703) 50 – _________(1,____ __ 330) $______________ (575) _ PENSION AND SERP ______ ___________________________________PLANS_______________ ______1999_____ ____ ______1998_____ ____ 348 2,507 (224) (2,297) (1,564) – _______________ $_________1,230) ( _____ _ $ 2,245 2,444 (7,028) 3,772 – ______________– _ $ __________1,433 _____ $ ____________PO___EMPL___________________________ __ ST _____OYMENT PLANS ___20_____ __00 ____1999 ___ ____ ___1998__ ____ $ – 74 – – – _________– _ $_______74 _ __ $ 3 61 – (11) – __________– _ $________5_ _ _3 $ 3 54 – (11) – ________– _ $_______6 4_ _ Service cost Interest on benefit obligation Actual return on assets Amortization and deferrals Curtailment gain Settlement gain (net of excise tax expense $1,233) Net periodic expense BENEFIT OBLIGATION, PLAN ASSETS AND FUNDED STATUS AT DECEMBER 31, ______________________________________________________________________________________________ PENSION AND SERP ______ __________________________PLANS______ _____PO___EMPL____________________ __ ST _____OYMENT PLANS Change in benefit obligation: Benefit obligation at beginning of year Service cost Interest cost Actuarial (gains) losses Benefits paid and annuity purchases Acquisitions Curtailment Assumption changes 2000 _______________ $ 42,950 332 2,076 (2,123) (39,402) – – – _______________ 1999 _______________ $ 37,176 348 2,507 4,093 (5,868) 4,509 (4,174) 4,359 _______________ 2000 _______________ 1,131 – 74 39 (129) – – – _______________ $ __________1,____ _______________ _ 115 $ _____1_______ _999 $ 983 3 61 (244) (104) 432 – – _____________ Benefit obligation at end of year $_________3,____ _______________ _ _ 833 $______________ 42,_50 ____________9__ _ $____________ 1,131 _____________ _ Change in plan assets: Fair value of assets at beginning of year Actual return on assets Company contributions Benefits paid and annuity purchases Acquisitions Assets transferred to 401K plan or reverted to Sovereign upon settlement $ 45,942 1,703 – (39,418) – (8,227) $ 46,901 213 – (5,878) 4,706 – $ – – 129 (129) – – $ – – 104 (104) – – _______________ Fair value of assets at end of year $______________ – _ _______________ $ (3,833) 1,313 – 605 _______________ _______________ $___________94_ 45,___ _ ______________2 $ 2,992 871 – 660 _______________ _______________ $______________ – _ _______________ $ (1,115) 197 – (97) _______________ $________(1,____ _ __015) _______________ _____________ $___________– _____________ _ _ $ (1,131) 60 – – _____________ Funded status of the plan Unrecognized net actuarial (gain) loss Unrecognized net transition asset Unrecognized prior service cost (Accrued) prepaid benefit cost $_________1,915) ( _____ _______________ _ $___________52_ 4,___ _ ______________3 $_______(__071) 1,___ _ _____________ Weighted average assumptions as of December 31: Discount rate Rate of compensation increase Expected return on plan assets Medical benefits rate of increase 6.75% 4.50% n/a n/a 6.30% 4.50% 5.13% n/a 6.75% 4.50% n/a 6.00% 6.75% 4.50% n/a 5.20% 62
Slide 65: NOTE 17 – EMPLOYEE BENEFIT PLANS (CONTINUED) Substantially all employees of Sovereign are eligible to participate in the 401(k) retirement plan following their completion of six months service and attaining age 21. Sovereign recognized expense for contributions to this plan of $5.2 million, $2.1 million and $1.5 million during 2000, 1999 and 1998, respectively. Pursuant to this plan, employees can contribute up to 12% of their compensation to the plan. Sovereign contributes 100% of the employee contribution up to 3% of compensation and 50% of the employee contribution from 3% to 5% of compensation in the form of Sovereign common stock. Sovereign maintains an Employee Stock Ownership Plan ("Sovereign ESOP"), and substantially all employees of Sovereign are eligible to participate following completion of one year of service and attaining age 21. Peoples also sponsored a leveraged ESOP that Sovereign assumed upon acquisition in 1999 (collectively, “the ESOPs”). The Sovereign ESOPs are defined contribution plans which provide retirement benefits for participants and beneficiaries in the form of Sovereign common stock purchased in the open market. On November 21, 1994, Sovereign's Board of Directors authorized an amendment to the Sovereign ESOP to add a leverage feature to purchase up to 6.7 million shares of Sovereign's outstanding common stock in the open market or in negotiated transactions. The Sovereign ESOP is funded through direct loans from Sovereign. The proceeds from these loans were used to purchase outstanding shares of Sovereign's common stock. As the debt on these loans is repaid, shares of Sovereign common stock are released and become eligible for allocation to employee accounts. In addition, dividends are paid on all shares of Sovereign common stock, including unallocated shares held by the Sovereign ESOP. Dividends on the unallocated shares are allocated on a pro-rata basis when purchased shares are released. Compensation expense is recognized based on the fair value of the shares committed to be released to employees and the shares then become outstanding for earnings per share computations. Sovereign has committed to make contributions sufficient to provide for the debt requirements of the ESOPs. Sovereign recognized as expense $2.6 million, $3.4 million and $4.0 million for the ESOPs in 2000, 1999 and 1998, respectively. At December 31, 2000, the ESOPs held 6.4 million shares of Sovereign stock of which 1.9 million shares were allocated to participant accounts. The unallocated ESOP shares are presented as a reduction of stockholders' equity in the consolidated financial statements. At December 31, 2000, the unallocated ESOP shares had a fair market value of $37.1 million and the ESOPs had $44.1 million of loans outstanding from Sovereign. Sovereign maintains several bonus deferral plans for selected management and executive employees. These plans allow employees to defer 50% or more of their bonus to purchase Sovereign stock. The deferred amount is placed in a grantor trust and invested in Sovereign common stock. Matching contributions ranging from 25% to 100% are made by Sovereign into the trust and are also invested in Sovereign stock. Earnings on the deferral and matching contributions are also invested in Sovereign stock. Expense is recognized ratably over the vesting periods of the plans. Benefits vest ratably over three years under the management plan and after five years under the executive plan. Benefits also vest under the plans in the event of termination by reason of death, disability, retirement, involuntary termination or the occurrence of a change of control as defined by the plans. Voluntary termination or termination for cause (as defined) generally result in forfeiture of the unvested balance including employee deferrals. Sovereign recognized as expense $1.9 million, $1.0 million, and $285,000 for these plans in 2000, 1999 and 1998, respectively. 63
Slide 66: Notes to Consolidated Financial Statements NOTE 18 – INCOME TAXES The provision for income taxes in the consolidated statement of operations is comprised of the following components (in thousands): YEAR ENDED __________ 31, ________________________DECEMBER_____________ 1999 1998 ____2000____ ____ ____________ ___________ Current: Federal . . . . . . . . . . . . . . . State . . . . . . . . . . . . . . . . . Deferred . . . . . . . . . . . . . . . . . . Total income tax expense (benefit) . . . . . . . . . . . $ (9,796) $ 69,656 $ 92,311 The following is a reconciliation of the actual tax provisions with taxes computed at the federal statutory rate of 35% for each of the years indicated: YEAR ENDED DECEMBER ___ _______________________________31, _______ _200__ ___0 _19___ __99 _1____ _998 Statutory federal tax rate . . . . . . . . . . . Increase/(decrease) in taxes resulting from: Tax-exempt income. . . . . . . . Bank owned life insurance State income taxes, net of federal tax benefit . . . . Amortization of intangible assets and other purchase accounting adjustments. Sale of minority interest . . . . Non-deductible, merger-related costs . . . . . Other . . . . . . . . . . . . . . . . . Effective federal tax rate . . . . . . . . . . . (35.0)% 35.0% 35.0% _________736 ___ (9,060) ( __, ___ ______50_930) $____(59,990) _ _______ _________8__ _07 70,463 18, ___ _________852 $________315 89,___ _ 1,121 ___________ 93,432 (18,___ ________681) $ 74,751 ___________ (5.4) (12.9) 6.0 (2.8) (3.0) 0.2 (3.2) (2.0) 0.3 3.5 (26.0) – 3._ _____3 (66._ _____5)% 0.9 – – 2.9 ______ 33. _ _____2% 0.8 – 3.1 1._ _____4 35._ _____4 % The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below (in thousands): YEAR ENDED ___________ 31, _______________________DECEMBER _____________ 1999 1998 ___200_____ ___0 ___________ ___________ Deferred tax assets: Allowance for possible loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchased mortgage servicing rights. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employee benefits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Merger-related liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchase accounting adjustments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrealized loss on available-for-sale portfolio. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net operating loss carry forwards, net of valuation allowance of $5,340 in 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-solicitation covenant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total gross deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred tax liabilities: Purchase accounting adjustments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred loan fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax bad debt reserve recapture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Originated mortgage servicing rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Option premiums. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrealized gain on available-for-sale portfolio. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total gross deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net deferred tax asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 42,031 (1,076) 736 14,384 6,982 29,300 4,542 33,383 34, ___ ________168 $ 43,766 3,532 1,344 6,339 8,765 113,764 8,630 – 5,__2 ________47_ $ 37,849 4,356 888 2,313 370 – 1,393 – ________84_ __7 $_______450 _ 164, ___ $__________ 191,612 _ $ _______016 48,___ _ $ 7,077 16,433 5,354 (2,654) – – 27, ___ ________399 $ 8,177 10,505 4,393 8,269 2,716 – 11,__5 ________14_ $ 5,402 7,144 2,406 3,843 2,716 9,757 4, ___ ________163 $_______609 53, ___ _ $____110_8__ _ __ ,_41 $__________ 45,205 _ $__________ _ 146,407 $______5,___ 3 _ 431 _ $_______585 12,___ _ 64
Slide 67: NOTE 18 – INCOME TAXES – (CONTINUED) During 2000, Sovereign established a $5 million valuation allowance related to previously recognized state tax net operating losses. The valuation allowance was necessary due to structural changes at Sovereign resulting from the SBNE acquisition. For the remainder of Sovereign’s deferred tax assets, no valuation allowance is necessary due to Sovereign's conclusion that it is "more likely than not" that the deferred tax assets will be realized is based on a history of growth in earnings, the prospects for continued growth including an analysis of potential uncertainties that may affect future operating results and potential tax planning strategies that could be employed in the future. Sovereign will continue to review the criteria related to the recognition of deferred tax assets on a quarterly basis. The following schedule summarizes Sovereign's off-balance sheet financial instruments (in thousands): CONTRACT OR NOTIONAL AMOUNT ____2_______ _000 Financial instruments whose contract amounts represent credit risk: Commitments to extend credit . . . . . . . . . Standby letters of credit. . . . . . . . . . . . . . . Loans sold with recourse . . . . . . . . . . . . . Financial instruments whose notional or contract amounts exceed the amount of credit risk: Forward contracts. . . . . . . . . . . . . . . . . . . Interest rate swaps. . . . . . . . . . . . . . . . . . Interest rate caps . . . . . . . . . . . . . . . . . . . AT DECEMBER __ _____________________31,______ 19 __ ______99 ___ $ 5,812,328 564,226 20,647 $ 2,189,743 76,775 25,214 NOTE 19 – COMMITMENTS AND CONTINGENCIES FINANCIAL INSTRUMENTS Sovereign is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to manage its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit, loans sold with recourse, forward contracts and interest rate swaps, caps and floors. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The contract or notional amounts of these financial instruments reflect the extent of involvement Sovereign has in particular classes of financial instruments. Sovereign's exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and loans sold with recourse is represented by the contractual amount of those instruments. Sovereign uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. For interest rate swaps, caps and floors and forward contracts, the contract or notional amounts do not represent exposure to credit loss. Sovereign controls the credit risk of its interest rate swaps, caps and floors and forward contracts through credit approvals, limits and monitoring procedures. Unless noted otherwise, Sovereign does not require and is not required to pledge collateral or other security to support financial instruments with credit risk. 115,914 1,258,294 500,000 75,639 452,300 1,200,000 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Sovereign evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management's credit evaluation of the counterparty. Collateral held usually consists of real estate but may include securities, accounts receivable, inventory and property, plant and equipment. Standby letters of credit are conditional commitments issued by Sovereign to guarantee the performance of a customer to a third party. The guarantees are primarily issued to support public and private borrowing arrangements. Most guarantees expire by June 2003. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Sovereign holds various collateral to support the commitments. Loans sold with recourse primarily represent single-family residential loans. These are seasoned loans with decreasing balances and historical loss experience has been minimal. The forward contracts used by Sovereign in its mortgage banking activities are contracts for delayed delivery of securities in which Sovereign agrees to make delivery of a specified instrument, at a specified future date, at a specified price or yield. Risks arise from the possible inability of counter parties to meet the terms of their contracts and from movements in securities' values and interest rates. 65
Slide 68: Notes to Consolidated Financial Statements NOTE 19 – COMMITMENTS AND CONTINGENCIES (CONTINUED) Interest rate swaps, caps and floors enable Sovereign to transfer, modify or reduce its interest rate risk and are used as part of asset and liability management. Sovereign may become a principal in the exchange of interest payments with another party and therefore, is exposed to loss should one of the counter parties default. Sovereign minimizes this risk by performing credit reviews on counter parties. Notional principal amounts often are used to express the volume of these transactions, but the amounts potentially subject to credit risk are significantly smaller. LEASES Sovereign is committed under various non-cancelable operating leases relating to branch facilities having initial or remaining terms in excess of one year. Future minimum annual rentals under non-cancelable leases, net of sublease income at December 31, 2000, are summarized as follows (in thousands): LITIGATION At December 31, 2000, Sovereign was party to a number of lawsuits, which arise during the normal course of business. While any litigation has an element of uncertainty, management, after reviewing these actions with legal counsel, is of the opinion that the liability, if any, resulting from these actions will not have a material effect on the financial condition or results of operations of Sovereign. 2001 . . . . . . . . . . . . . . . . . 2002 . . . . . . . . . . . . . . . . . 2003 . . . . . . . . . . . . . . . . . 2004 . . . . . . . . . . . . . . . . . 2005 . . . . . . . . . . . . . . . . . Thereafter . . . . . . . . . . . . . . Total . . . . . . . . . . . . . _____________AT _______________2000_____________ ___DECEMBER 31, ____ Future Minimum ________________________________________________ Lease Sublease Net nco _ e Payments __Payments _ _________ ___I____m____ ___________ $ 85,422 $ (7,481) $ 77,941 82,093 (6,820) 75,273 78,299 (3,323) 74,976 73,167 (1,815) 71,352 148,217 (1,045) 147,172 (2, ___ _____2___745 _28, ___ _________194) _____226,551_ ______ $ _____69__943 __5, ___ $ ( ______ ______22,678) $ 673 265 ________,____ Total rental expense for all leases for the years ended December 31, 2000, 1999, and 1998 was $51.9 million, $16.5 million and $10.6 million, respectively. 66
Slide 69: NOTE 20 – FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents disclosures about the fair value of financial instruments as defined by SFAS No. 107, "Fair Value of Financial Instruments." These fair values are presented based upon subjective estimates of relevant market conditions at a specific point in time and information about each financial instrument. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. These techniques involve uncertainties resulting in variability in estimates affected by changes in assumptions and risks of the financial instruments at a certain point in time. Therefore, the derived fair value estimates presented below cannot be substantiated by comparison to independent markets. In addition, the fair values do not reflect any premium or discount that could result from offering for sale at one time an entity's entire holdings of a particular financial instrument nor does it reflect potential taxes and the expenses that would be incurred in an actual sale or settlement. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of Sovereign (in thousands): 2000 ___________________________________ CARRYING VALU _ FAIR VA __ E _________E____ _________LU___ Financial Assets: Cash and amounts due from depository institutions . . . . . . . . . . . . . . . . . . . . . . . . . Interest-earning deposits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loans held for sale. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment securities: available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loans, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage servicing rights. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Financial Liabilities: Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Borrowings(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrecognized Financial Instruments:(2) Commitments to extend credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loans sold with recourse . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest rate swaps, caps and floors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exchange traded futures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 945,196 14,447 59,993 5,315,584 1,978,268 21,655,889 41,541 24,498,917 6,240,308 44,432 20,647 957 38,849 $ 945,196 14,447 60,148 AT DECEMBER ___ ____________________________________________31, _____________________________ 1999 ___________________________________ CARRYING VA __ E _______LU______ $ 373,996 19,238 61,925 8,030,212 2,362,051 14,093,554 72,491 12,012,675 12,370,109 16,003 126 4,463 – __FAIR_VALU___ ____ _____ E $ 373,996 19,238 62,439 8,030,212 2,367,025 13,955,482 76,606 11,979,123 12,149,668 16,086 50 1,198 – 5,315,584 1,971,896 21,604,291 44,618 22,428,033 6,202,987 44,306 – 5,167 38,849 (1) Borrowings are shown without unamortized cap premiums, as cap premiums are reflected separately below in "Interest rate swaps, caps and floors." (2) The amounts shown under "carrying value" represent accruals or deferred income arising from those unrecognized financial instruments. 67
Slide 70: Notes to Consolidated Financial Statements NOTE 20 – FAIR VALUE OF FINANCIAL INSTRUMENTS – (CONTINUED) The following methods and assumptions were used to estimate the fair value of each class of financial instruments: Cash and amounts due from depository institutions and interestearning deposits. For these short-term instruments, the carrying amount is a reasonable estimate of fair value. Loans held for sale. Fair values are estimated using quoted rates based upon secondary market sources for securities backed by similar loans. Fair value estimates include consideration of all open positions (including forward contracts), outstanding commitments and related fees paid. Investment securities available-for-sale. The fair value of investment securities available-for-sale are based on quoted market prices as of the balance sheet date. In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," changes in fair value are reflected in the carrying value of the asset and are shown as a separate component of stockholders' equity. Investment securities held-to-maturity. The carrying amounts for short-term investment securities held-to-maturity approximate fair value because of the short maturity of these instruments and they do not present unanticipated credit concerns. The fair value of long-term investment securities held-to-maturity is estimated based upon bid quotations received from securities dealers and an independent pricing servicing bureau. Loans. Fair value is estimated by discounting cash flows using estimated market discount rates at which similar loans would be made to borrowers and reflect similar credit ratings and interest rate risk for the same remaining maturities. Mortgage servicing rights. The fair value of mortgage servicing rights are estimated using quoted rates based upon secondary market sources. The estimated fair value approximates the amount for which the servicing could currently be sold. Deposits. The fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, NOW accounts, savings accounts and certain money market accounts, is equal to the amount payable on demand as of the balance sheet date. The fair value of fixed-maturity certificates of deposit is estimated by discounting cash flows using currently offered rates for deposits of similar remaining maturities. Borrowings. Fair value is estimated by discounting cash flows using rates currently available to Sovereign for other borrowings with similar terms and remaining maturities. Commitments to extend credit. The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. Loans sold with recourse. The fair value of loans sold with recourse is estimated based upon the cost to terminate Sovereign's obligations under the recourse provisions. Interest rate swaps, caps and floors. The fair value of interest rate swaps, caps and floors which represent the estimated amount Sovereign would receive or pay to terminate the contracts or agreements, taking into account current interest rates and when appropriate, the current creditworthiness of the counter parties are obtained from dealer quotes. 68
Slide 71: NOTE 21 – FINANCIAL DERIVATIVES Sovereign uses a variety of off-balance-sheet financial derivatives as part of its overall interest rate risk management process and to manage risk associated with mortgage banking activities. Interest rate swaps are generally used to convert fixed rate assets and liabilities to variable rate assets and liabilities and vice versa. Interest rate caps are generally used to limit the exposure from repricing of liabilities. Interest rate floors are generally used to limit the exposure from repricing of assets. In certain cases, interest rate caps and floors are simultaneously bought and sold to create a range of protection against changing interest rates while limiting the cost of that protection. Forward contracts are used to manage risk positions associated with mortgage origination. Substantially all forward contracts mature within 90 days of origination. Forward contracts are traded in over-the-counter markets and do not have standardized terms. Counterparties to Sovereign’s forward contracts are primarily U.S. government agencies and brokers and dealers in mortgage-backed securities. Sovereign’s Capital Markets Group provides risk management services for its customers. Sovereign purchases and sells certain derivatives including interest rate swaps, caps and floors. Customer related derivative financial instrument transactions are generally marked to market and any gains or losses are recorded in the income statement. Sovereign also holds derivatives in connection with its securities trading activities and, at times, takes minimal positions in the expectation of profiting from favorable movements in interest rates. The following table presents information regarding financial derivatives at the dates indicated (in thousands): ________________________AT_DECEMBER ______________________________ __ ___________ 31, 2000 NET NOTIONAL POSITIVE NEGATIVE ASSET AMO _ N _ FAIR VA_UE FAIR VA_UE (LI___ LITY _ _______U__T__ ________L___ ________L___ ___ABI_____) Interest Rate Risk Management: Interest rate swaps: Pay variable-receive fixed(1) Pay fixed-receive variable(2) Interest ratecaps/floors/collars(3) Mortgage banking risk management Forward commitments: To buy loans To sell loans Total interest rate risk management Customer Related: Interest rate swaps: Pay variable-receive fixed Pay fixed-receive variable Interest rate caps/floors/collars Exchange traded futures(4) Total customer related Total derivatives AT DECEMBER __ ____ ___________________________________31,_1999_________________ NET NOTIONAL POSITIVE NEGATIVE ASSET A _ O_ N _ FAIR_VALU_ FAIR_VA____ ___A__I_____) ____M__U__T__ ____ _____E ____ __ LUE (LI_ B LITY _ $ 858,294 400,000 500,000 $ 16,395 – – $ (975) (10,087) (166) $ 15,420 (10,087) (166) $ 252,300 200,000 1,200,000 $ 637 8,853 – $ (7,483) – (809) $ (6,846) 8,853 (809) 34,000 149, ___ ________914 1,_42, ___ ____9___208 115 _______77 __ 16, ___ ______587 (27) (1, ___ ______333) (12, __8 ______58_ ) 88 1,256 ____(_____ ) 3, ___ ______999 – 75, ___ _______639 1,727, ___ _______939 – 116 __________ 9,__6 ______60__ – (_78 ______1__) 8,___ ____(__470) – (62) ________ 1, ___ _____136 502,532 512,390 105,701 38,849 ___________ 1,159, __2 ________47_ $___,____680 _ 3 101, ___ 496 13,008 105 – _________ 13, ___ ______609 $_____196 _ 30, ___ (11,320) (404) (105) – _________ ___(11,___ ) ___ 829 $__(___41_ ) _ 24,__ 7 (10,824) 12,604 – – _________ 1, ___ ______780 $ _____779 _ 5, ___ – – – – __________ _________– _ $______939 _ 1,727, ___ – – – – __________ – __________ $_________ _ 9,606 – – – – _________ ________– _ $ ___(8,___ ) _ __470 – – – – ________ _______– _ $ ____136 _ 1, ___ (1) The weighted average pay rate was 6.48% and 7.24% and the weighted average receive rate was 7.31% and 7.00% at December 31, 2000 and 1999. (2) The weighted average pay rate was 7.12% and 5.41% and the weighted average receive rate was 6.49% and 6.13% at December 31, 2000, and 1999 respectively. (3) The weighted average strike price range was 6.00% - 6.55% at December 31, 2000 and 5.25% - 9.00% at December 31, 1999. (4) Represents futures to sell metal forward which are related to Sovereign’s precious metals business. Net interest income resulting from interest rate exchange agreements included $6.4 million of income and $.1 million of expense for 2000, $.5 million of income and $8.9 million of expense for 1999 and $6.8 million of income and $4.5 million of expense for 1998. At December 31, 2000, $9.4 million of net gains resulting from terminations of interest rate contracts were reflected in other liabilities on the statement of financial condition. 69
Slide 72: Notes to Consolidated Financial Statements NOTE 22 – ASSET SECURITIZATIONS During 2000, the Company sold home equity loans and automotive floor plan loans in securitization transactions. In all those securitizations, the Company retained servicing responsibilities. The Company retained a subordinated interest in the automotive floor plan loans. In addition, during 2000 the Company acquired the servicing responsibilities, and retained interest only strips, related to home equity and recreational vehicle loans which were previously securitized, as part of the SBNE acquisition. The Company receives annual servicing fees approximating .50 percent for home equity loans, and for boat and recreational vehicle loans, and 1.00 percent (for automotive floor plan loans) of the outstanding balance and rights to future cashflows arising after the investors in the securitization trust have received the return for which they contracted. The investors and securitization trusts have no recourse to the Company’s other assets for failure of debtors to pay when due. The Company’s retained interests are subordinate to investors interests. Their value is subject to credit, prepayment, and interest rate risks on the transferred financial assets. In 2000, the Company recognized a pretax gain of $2.5 million on the securitization of home equity loans and a pretax loss of $(2.3) million on the securitization of automotive floor plan loans. The components of securitized financial assets and the related average balances, delinquencies, and net credit losses are as follows: At _________ ___ 2000 _______________December_31, ___________________ Principal 90 Days Total Principal Past Due ______________ ______________ Loans Securitized: Home Equity Loans Boat Loans Recreational Vehicle Loans Automotive Floor Plan Loans Total Securitized Loans Held in Portfolios: Home Equity Loans Boat Loans (1) Recreational Vehicle Loans Automotive Floor Plan Loans Total Held in Portfolio Total Loans Managed (1) Boat loans are included in other consumer loans. For the Year Ended December ____2000 _________ 31, ____ Net Credit Lo _ es _____ss________ $ 3,492 698 2,175 – ______________ $ __________365 6, ___ _ $ 1,167,879 153,708 315,840 579,___ ___________000 ______2,____427 _ 216,___ 40,193 13 835 _____________– _ $ 41,041 ______________ $ 3,256,598 6,521 – 317,281 ______________ 3,580, ___ ___________400 $ _____5,____827 _ _ 796,___ The components of retained interest and key economic assumptions used in measuring the retained interest at the date of securitization resulting from securitizations completed during the year were as follows (in thousands): Recreational _Home_Equity _ _____ ______ Components of Retained Interest: Subordinated interest retained Servicing rights Excess servicing Cash reserve Total Retained Interest Key economic assumptions: Prepayment speed Weighted average life (in years) Expected credit losses Residual cashflows discount rate – 9,195 55,496 _____________– _ $ _____________ 64,691 _ $ B ___ ______oat _____ $ 519 1,066 17,099 _____________– _ $__________68_ 18,__4 _ Veh cl__ _______i__es ___ $ 511 1,950 17,844 _____________– _ $_____________ 20,305 _ Automotive Floor ____ ________Plan __ $ 21,085 – 657 4,___ ___________947 $__________68_ 26,__9 _ 15% 17.99 0.75% 12.00% 22% 15.00 0.40% 11.00% 22% 11.75 0.40% 11.00% – .17 0.25% 10.00% 70
Slide 73: NOTE 22 – ASSET SECURITIZATIONS – (CONTINUED) The table below summarizes certain cash flows received from and paid to securitization trusts or special purpose entities (in thousands): Proceeds from new securitizations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Servicing fees received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other cash flows received on retained interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchases of delinquent or foreclosed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Servicing advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repayments of servicing advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . For the Year Ended _December_31,_2000_ _________ __ ____ $ 948,456 1,577 22,581 262 1,916 856 At December 31, 2000, key economic assumptions and the sensitivity of the current fair value of residual cashflows to immediate 10 percent and 20 percent adverse changes in those assumptions are as follows (in thousands): Home Equity Carrying amount/fair value of retained interests . . . . . . . . . . . . . . . . . . . . . Weighted-average life (in years) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prepayment speed assumption (annual rate) . . . . . . . . . . . . . . . . . . . . . . Impact on fair value of 10% adverse change . . . . . . . . . . . . . . . . . . . . . Impact on fair value of 20% adverse change . . . . . . . . . . . . . . . . . . . . . Expected credit losses (annual rate) . . . . . . . . . . . . . . . . . . . . . . . . . . . . Impact on fair value of 10% adverse change . . . . . . . . . . . . . . . . . . . . . Impact on fair value of 20% adverse change . . . . . . . . . . . . . . . . . . . . . Residual cash flows discount rate (annual) . . . . . . . . . . . . . . . . . . . . . . . Impact on fair value of 10% adverse change . . . . . . . . . . . . . . . . . . . . . Impact on fair value of 20% adverse change . . . . . . . . . . . . . . . . . . . . . Lo ___ _________ans ______ $ 64,691 17.99 27.0% (1,900) (4,700) 0.75% (2,100) (3,500) 12.0% (3,000) (5,700) Boat Loan _ ___________s ______ $ 18,684 15.00 2.0% (200) (300) 0.26% (100) (100) 11.0% (500) (900) Recreational ___Vehicle_Loans___ ______ _____ $ 20,305 11.75 1.8% (200) (300) 0.45% (100) (100) 11.0% (400) (1,500) Automotive Floor Plan Lo ___ _________ans ______ $ 26,689 .17 – (26) (47) 0.25% (18) (36) 10.0% (220) (428) $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another (for example, increased in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities. Expected static pool credit losses as a % of the original pool balance are as follows: Actual and Projected Credit Losses as of December 31, 2000: Home Equity Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Boat Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recreational Vehicle Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Automotive Floor Plan Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2000 0.29% 0.17% 0.26% – 2001 0.75% 0.40% 0.40% 0.25% 2002 0.75% 0.40% 0.40% 0.25% 71
Slide 74: Notes to Consolidated Financial Statements NOTE 23 – EARNINGS PER SHARE The following table presents the computation of earnings per share based on the provisions of SFAS No. 128 for the years indicated (in thousands, except per share data): 2 ___ ____000 ___ Calculation of income/(loss) for EPS: Income/(loss) before extraordinary item . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less preferred dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income /(loss) before extraordinary item for basic EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Extraordinary item, after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income for basic EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income/(loss) before extraordinary item for fully diluted EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Extraordinary item, after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income/(loss) for fully diluted EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Calculation of shares: Weighted average basic shares. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Assumed conversion of preferred shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dilutive effect of average stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Weighted average fully diluted shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Earnings/(loss) per share: Basic Income/(loss) before extraordinary item . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Extraordinary item . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income/(loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted Income/(loss) before extraordinary item . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Extraordinary item . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income/(loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (41,017) 1999 __________ $ 179,299 ___199____ ___8 $ 136,455 _________– _ (41,017) 10,__5 _______77_ $______24_ ) _ (30,__2 $ (41,017) _________– _ $ 179,299 _________– _ _____(1,___ ) __ 496 $ 134,959 – __________ $ ______29_ _ 179,__9 $ 179,299 $_____4,___ _ 13 _ 959 $ 136,455 10, ___ _______775 $ ______242) _ (30, ___ _________– _ $ ______299 _ 179, ___ – __________ $ ____36,___ _ 1 __ 455 225,881 – _________– _ 225,_81 _______8__ 176,021 – 2, ___ _______146 178,___ _______167 152,910 5,262 3,039 __________ 161, __ ________211 $ (0.18) $ 1.02 $ 0.88 0.__ ________05 $_______1_ ) (0._3 _ _________– _ $ _______02 1.__ _ – __________ $ ______0.__ _ _ 88 (0.18) 0.__ ________05 $ _______13) (0.__ _ $ 1.01 _________– _ $ _________ 1.01 _ $ $ 0.85 – __________ $ ______0.__ _ _ 85 72
Slide 75: NOTE 24 – COMPREHENSIVE INCOME/(LOSS) The following table presents the components of comprehensive income, net of related tax, based on the provisions of SFAS No. 130 for the years indicated (in thousands): __________YEAR_ENDED_________________________ _____ ______ DECEMBER 31, 20 __ 1 ___ ______00 ____ ____199_____ ___9 _____998 ____ Net income/(loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrealized (losses) gains on securities arising during the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less reclassification adjustment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net unrealized (losses) gains recognized in other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Comprehensive income/(loss). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ _____(30,____ ___ 242) 93,841 _____(78,____ ___ 570) $ _____1___299 _79, ___ (227,550) 1, ___ _________502 $ _____1___455 _36, ___ 10,647 11, ___ _________471 _____17__411 __2, ___ $_______,____ _ 142 169 (229, ___ _________052) $ (49, ___ _________753) ________(824) ____ $________631 135, ___ _ 73
Slide 76: Notes to Consolidated Financial Statements NOTE 25 – PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for Sovereign Bancorp is as follows (in thousands): BALANCE SHEETS Assets Cash and due from banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment securities: Available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment in subsidiaries: Bank subsidiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-bank subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liabilities and Stockholders' Equity Borrowings: Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Borrowings from non-bank subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stockholders' Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Liabilities and Stockholders' Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . _______AT_DECEMBER _________ __ ___________ 31, 2000 1999 ____________ ____________ $ – 1,075 – 3,497,002 131,199 _____135,283 _______ $____764,559 _ 3, _______ $ 2 278 765,458 2,299,508 664,908 51, ___ _________189 $ ________343 _ 3,781, ___ $ 1,359,925 365,970 ______89,780 ______ 1, __5, ___ _____81__675 1, _______ _____948,884 $____764,559 _ 3, _______ $ 1,587,667 347,605 ______24,576 ______ 1,_59, ___ _____9___848 ____1,____495 _ 821, ___ $ ___3,____343 _ _ 781, ___ STATEMENTS OF OPERATIONS Dividends from: Bank subsidiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-bank subsidiaries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loss before income taxes and equity in earnings of subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income/(loss) before equity in earnings of subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equity in undistributed earnings/(loss) of: Bank subsidiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-bank subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income/(loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . YEAR ENDED ___________ 31, ________________________DECEMBER _____________ 2000 ____________ ____1999____ ____ ____199_____ ___8 $ 100,000 16,828 35,016 (2, __8 _________38_ ) $ – – 6,847 _________149 ___ $ – – 12,222 5, ___ _________749 149,_56 _________4__ 180,761 8,___ _________317 189, ___ _________078 (39,622) (81,__2) _________28_ 41,660 (68,336) (3, ___ _________566) $________24_) (30, __2 _ 6, ___ _________996 56,668 28, ___ _________976 85, ___ _________644 (78,648) (_6, ___ ______2__058) (52,590) 226,219 5, ___ _________670 $________299 179, ___ _ 17, ___ _________971 29,556 8, ___ _________122 ______3__678 _7, ___ (19,707) (6, ___ _________461) (13,246) 149,442 _________259 ___ $____1___455 _ _36, ___ 74
Slide 77: NOTE 25 – PARENT COMPANY FINANCIAL INFORMATION – (CONTINUED) STATEMENTS OF CASH FLOWS ___________YEAR_ENDED_________________________ _____ ______ DECEMBER 31, 2000 1 ___ ____________ ____199_____ ___9 _____998 ____ Cash Flows from Operating Activities: Net income/(loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjustments to reconcile net income/(loss) to net cash provided by operating activities: Undistributed (earnings)/loss of: Bank subsidiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-bank subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net cash provided (used) by operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash Flows from Investing Activities: Net capital contributed to subsidiaries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment securities: Maturity and repayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net purchase and sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net cash received from business combinations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net change in other assets and other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net cash provided (used) by investing activities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash Flows from Financing Activities: Net change in borrowings: Repayment of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net proceeds received from long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net change in borrowings from non-bank subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sale (acquisition) of treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash dividends paid to stockholders. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net proceeds from issuance of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net proceeds from issuance of warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net cash provided (used) by financing activities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (Decrease) increase in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash and cash equivalents at beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash and cash equivalents at end of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (30,242) $ 179,299 $ 136,455 68,336 3,566 (16, __2 _________22_ ) 25, __8 _________43_ (226,219) (5,670) (__, ___ ______25_969) (__, ___ ______78_559) (149,442) (259) 29, ___ _________117 15, ___ _________871 (563,275) 764,661 – – ___________– _ 201,__6 _________38_ (739,777) – (994,788) 51 ___________– _ 1,__4, ___ ___(__73__514) (346,648) 6,183 97,084 – ( _____ _______4,228) ( _______ _____247,609) (227,742) – 18,365 (194) (22,499) 5,244 ___________– _ (226, ___ _________826) (2) 2 ____________ $__________– _ _ – 1,239,894 202,735 (46,867) (17,104) 342,803 91, ___ _________500 ____1,____961 _ 812,___ (112) _________114 ___ $ __________2 _ _ – 167,076 52,139 (901) (14,286) 20,451 ___________– _ _____2___479 _24, ___ (7,259) 7, ___ _________373 $ ________114 _ ___ NOTE 26 – SUBSEQUENT EVENTS On February 9, 2001, Sovereign issued $150 million of common equity consisting of 20 million shares sold at $7.50 per share. On February 20, 2001, Sovereign issued $175 million of senior unsecured notes at 8.625% which will mature on March 15, 2004. On March 1, 2001, Sovereign refinanced the $500 million senior secured credit facility described in Note 11 (outstanding balance at December 31, 2000 of $350 million) with a variable rate $400 million senior secured credit facility consisting of a $350 million revolving line and a $50 million term note. The revolving line matures in 2007 and the term note matures in 2005. 75
Slide 78: Officers & Boards of Directors S o v e reign Bancorp, Inc., Board of Dire c t o r s John A. Fry(1) Executive Vice President University of Pennsylvania Brian Hard President, Penske Truck Leasing Richard E. Mohn Chairman of the Board, Sovereign Bancorp, Inc. and Sovereign Bank Rhoda S. Oberholtzer Community Leader and Retired Executive, Stauffer's of Kissel Hill Daniel K. Rothermel Chief Executive Officer, Cumru Associates, Inc. Jay S. Sidhu President and Chief Executive Officer, Sovereign Bancorp, Inc. Sovereign Bank Cameron C. Troilo President and Chief Executive Officer, Cameron C. Troilo, Inc. S o v e reign Bancorp, Inc., Off i c e r s Richard E. Mohn Chairman of the Board Jay S. Sidhu President and Chief Executive Officer Dennis S. Marlo, CPA Chief Financial Officer and Treasurer Mark R. McCollom, CPA Chief Accounting Officer Lawrence M. Thompson, Jr., Esq. Chief Administrative Officer and Secretary S o v e re ig n Ba nk , B o ard o f Di re c t o r s John M. Arnold(1) Chairman, Petroleum Products Corp. P. Michael Ehlerman(1) Chairman, President and Chief Executive Officer Yuasa Battery, Inc. John A. Fry Executive Vice President, University of Pennsylvania Brian Hard President, Penske Truck Leasing Stewart B. Kean President, Sergeantsville Corporation Chairman of the Board, KCS Richard E. Mohn Chairman of the Board, Sovereign Bank and Sovereign Bancorp, Inc. Rhoda S. Oberholtzer Community Leader and Retired Executive, Stauffer's of Kissel Hill George W. Reinhard(1) Chairman, Lester Fellows Co. Daniel K. Rothermel Chief Executive Officer, Cumru Associates, Inc. Elizabeth B. Rothermel Homemaker and Community Leader Robert A. Sadler Executive Vice-President of Operations, Cadmus Communications Jay S. Sidhu President and Chief Executive Officer, Sovereign Bank and Sovereign Bancorp, Inc. Cameron C. Troilo President and Chief Executive Officer, Cameron C. Troilo, Inc. S o v e reign Bank Office of the CEO Jay S. Sidhu President and Chief Executive Officer Joseph P. Campanelli President, Sovereign Bank New England and President, Business Banking Division (1) Appointed January 18, 2001. John P. Hamill Chairman and Chief Executive Officer of the Sovereign Bank New England Division Dennis S. Marlo, CPA Chief Financial Officer and Treasurer Lawrence M. Thompson, Jr., Esq. Chief Operating Officer and Division President of Consumer Banking Division 76
Slide 79: Corporate Information Investor Inform a t i o n Copies of the Annual Report, 10-K, interim reports, press releases and other communications sent to shareholders are available at no charge by contacting: Linda A. Hagginbothom Assistant Vice President Investor Relations 610-320-8498 voice mail: 800-628-2673 e-mail: Lhagginb@sovereignbank.com Counsel Stevens & Lee Philadelphia and Reading, PA Dividends Cash dividends on common stock and PIERS Units are customarily paid on a quarterly basis on or about the 15th of February, May, August and November. Common Stock Dividend Reinvestment and Stock P u rchase Plan Sovereign Bancorp maintains a Dividend Reinvestment and Stock Purchase Plan for its shareholders on record of Common Stock. This Plan provides a convenient method of investing cash dividends and voluntary cash payments in additional shares of Sovereign’s Common Stock without payment of brokerage commissions or service charges. For a copy of the Prospectus and enrollment card, please contact Mellon Investor Services at 800-685-4524. Financial Inform a t i o n Investors, brokers, security analysts and others desiring financial information should contact: Dennis S. Marlo Chief Financial Officer 610-320-8443 e-mail:Dmarlo@sovereignbank.com Mark R. McCollom Chief Accounting Officer 610-736-1335 e-mail:Mmccollo@sovereignbank.com Robert E. Bond Senior Vice President Investor Relations 610-988-0300 e-mail:Rbond@sovereignbank.com Registrar and Transfer Agent Shareholders who wish to change the name, address or ownership of stock, report lost stock certificates, or consolidate stock accounts should contact: Common Stock Mellon Investor Services One Mellon Bank Center 500 Grant Street, Room 2122 Pittsburgh, PA 15258 800-685-4524 PIERS Units The Bank of New York 101 Barclay Street - 21W New York, NY 10286 212-815-2568 Bancorp Headquart e r s 2000 Market Street Philadelphia, PA 19103 Bank Headquart e r s Mid-Atlantic Division 1130 Berkshire Boulevard Wyomissing, PA 19610 N ew England Division 75 State Street Boston, MA 02109 Contact Inform a t i o n Mailing Address P.O. Box 12646 Reading, PA 19612 Operator 610-320-8400 fax: 610-320-8448 Internet www.sovereignbank.com e-mail:Investor@sovereignbank.com Stock Listing Sovereign’s Common Stock is traded and listed on the NASDAQ Stock Market under the symbol “SVRN”. Sovereign’s Trust Preferred Income Equity Redeemable Securities, PIERS Units, are traded on the NASDAQ Stock Market under the symbol “SVRNU”. Options on Sovereign Common Stock are traded on the American Stock (AMEX), Chicago Board Options (VIX), Philadelphia Stock (PHLX) and Pacific (PCX) under the symbol “SVRN” or “SQV”. Sovereign Common Stock high, low and closing prices are reported in most major newspapers as “Sovrgn Bcorp”, “Sovereign” or “SovBcp. At December 31, ” 2000, the total number of holders of record of Sovereign’s Common Stock was 17,460. Auditors Ernst & Young LLP Two Commerce Square, Suite 4000 2001 Market Street Philadelphia, PA 19103 VIEW YOUR COMMON STOCK ACCOUNT ONLINE The Transfer agent for Sovereign’s Common Stock has introduced a new Internet Service. Investor ServiceDirect http:vault.chasemellon.com/isd Investor ServiceDirect is a Web-enabled real-time service, available 24 hours a day, 7 days per week. This service provides shareholders of record with the ability to: • View account status • Issue certificates from book-entry • Request duplicate statements • Perform address changes • View, print or request form 1099 • Sell shares • View certificate, book-entry and payment history First time users will need to establish a PIN. Establishing a PIN is easy, just enter your social security number and click on the ESTABLISH PIN button. For technical assistance call 1.877.978.7778. For questions about your account call 1.800.685.4524. 77