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On October 14, 2008, Banco Santander Central Hispano, S.A. (STD), already a 25% owner in Sovereign, announced plans to purchase the remaining 75% of the company.^[1]

Sovereign Bancorp (NYSE: SOV) is a savings and loan bank that generates interest revenue by issuing consumer and commercial loans. In 2007, the company recorded a net loss of $1.35 billion, and for 3Q2008, the company recorded a loss of $982 million.^[2][3] Sovereign's primary business is that of the community bank with a network of local branches that hold deposits and originate a number of different types of small business, family, and mortgage loans. As of the end of 2007, the company held a $57.8 billion loan portfolio made up up 53.5% of commercial loans, 33.5% of consumer loans secured by real estate, and 12.7% consumer loans not secured by real estate.^[4]

The company has a history of expanding by acquisitions with 28 financial institutions acquired since 1990. In June 2006, Sovereign acquired Independence Community Bank; however, by early 2008, the company took a $1.6 billion write-down based on higher customer loan defaults from loans inherited from Independence.^[5] Sovereign originally paid $3.6 billion for Independence.^[6]

As of June 30, 2008, Sovereign held $622.6 million preferred shares from Fannie Mae (FNM) and Freddie Mac (FRE), but since the government bailout of the two organizations, these preferred shares are nearly worthless.^[2][7] Ties to these distressed entities have hurt every bank during the 2008 Financial Crisis and Sovereign is no different. On September 30, 2008, the company announced the appointment of a new CEO, Paul A. Perrault.^[8]

Contents 1 Company Overview 1.1 Business and Financial Metrics 1.2 Business Segments 2 Key Trends and Forces 2.1 Sovereign's low share price makes it an acquisition target 2.2 Exposure to Fannie Mae (FNM) and Freddie Mac (FRE) ties Sovereign to the most distressed portion of the financial sector 2.3 Declining value in CDO portfolio due to widespread mortgage defaults and the 2008 Financial Crisis 2.4 Uncertainty on the state of commercial loans could affect Sovereign's healthiest segment 3 Competitors 4 References

[edit] Company Overview

Sovereign Bancorp is the holding company for Sovereign Bank. Sovereign bank is largely a thrift bank, which means it takes on bank deposits in order to issue mortgage and other types of loans and doesn't engage in corporate banking, brokering, or underwriting. The company's 750 bank branches are largely located in the Northeast and Mid-Atlantic regions. Sovereign has developed its network of banks through a series of 28 acquisitions since 1990.^[9] Its most recent acquisition of Independence Community Bank in 2006 was funded thanks largely to the $2.4 billion equity offering to Banco Santander Central Hispano, S.A. (STD), which made Santander Sovereign's largest shareholder with a 25% stake in the bank.^[9]

[edit] Business and Financial Metrics

While Sovereign has raised revenue each of the past 5 years, its net income plummeted in 2007 to a loss of $1.3 billion.^[10] The loss was largely attributed to a $1.6 billion write-down related to their Shared Services Consumer segment and Metro New York Banking Division, which comes directly from the company's Independence Bank acquisition.^[10][12] As a result of this and an effort to sell off many of its distressed assets, the company's total assets under management decreased from $89.6 billion in 2006 to $84.7 billion in 2007.^[10]

	Net Income from Operations [10]
	2003	2004	2005	2006	2007
Net Interest Income	1,227.8	1,436.6	1,632.1	1,821.5	1,864.0
Non-Interest Income	499.4	450.5	602.7	285.6	354.4
General and administrative expenses	852.4	942.7	1,089.2	1,290.0	1,345.8
Other expenses	158.0	236.2	163.4	313.5	1,874.6
Net Income	401.9	453.6	676.2	136.9	(1,349.3)

In 2007, commercial loans made up 43% of the loan portfolio with a $25.4 billion balance.^[11] The company's consumer loans backed by real estate made up 37% ($21.4 billion), auto loans made up 8% ($6.2 billion), and multifamily loans made up 8% ($4.7 billion) of the loan portfolio.^[11] Sovereign's residential real estate loans of $13.3 billion suffered losses of $7.5 million in 2007. Sovereign does not offer adjustable rate mortgage loans, which have low, teaser interest rates before a jump at the end of their introductory period; however, they do originate Alt-A loans, which require less pre-screening and paperwork in return for higher interest rates. These types of loans have been central to the Mortgage Market Meltdown.

Sovereign appears to have a stable deposit base despite any panic felt during the 2008 Financial Crisis. Sovereign's uninsured deposit ratio, which measures the percentage of accounts with more than $100K deposited compared to total liabilities, was estimated at 20.9% at 2Q2008. The industry average is 19.1%.^[13] One of its competitors, Washington Mutual (WM), lost 10% of its deposits before its liquidation and sale to J P Morgan Chase (JPM).

[edit] Business Segments

The company's segments are largely based on where their customers and branches are located. Each of their branches offers a combination of deposit types including money market accounts, savings accounts, certificates of deposits, and retirement plans.

• Mid-Atlantic Banking Division - Net interest income declined to $305.8 million in 2007 for the Mid-Atlantic division, a decline a $12.8 million from the previous year.^[14] This division incorporates the company's branches located in Pennsylvania and Maryland.

• New England Banking Division - Net interest income declined to $630.4 million in 2007 for the New England division, a decline of $26.1 million from the previous year.^[14] This division incorporates locations located in Massachusetts, Rhode Island, Connecticut, and New Hampshire.

• Metro New York Banking Division - Net interest income increased $114.5 million to $568.6 million in 2007 compared to 2006, thanks largely to the Independence Bank acquisition.^[14] The Independence acquisition, however, hurt total net income with a $943 million goodwill impairment charge that resulted in a $707.5 million loss in 2007.^[14] This division incorporates the company's branches in New York and New Jersey.

• Shared Services Consumer - The Shared Services Consumer segment decreased net income $6.8 million to $317.0 million in 2007 compared to 2006.^[14] This segment was hit by losses in the auto loan portion of its portfolio, largely from loans in the Southeast and Southwest outside its geographic footprint. Losses in auto loans totaled $76.2 million in 2007 compared to $30.5 million in 2006.^[14] This division is made up of the mortgage banking group, the home equity business, and the automobile group.

• Shared Services Commercial - The Shared Services Commercial segment increased $25.7 million to $263.2 million in 2007 compared to 2006 thanks largely to a net increase in average commercial assets.^[15] This division provides cash management and capital markets services as well as asset backed lending products, commercial real estate loans, small business loans, etc.

• Other - The net income loss in the Other segment decreased from a $620.9 million in 2006 to $465.6 million in 2007.^[15] Included in this loss is a $180.5 impairment charge related to Fannie Mae (FNM) and Freddie Mac (FRE) preferred stock held by the company.^[15] The Other segment includes earnings from the company's investment portfolio, expenses from the company's loans, and other unallocated income and expenses.

[edit] Key Trends and Forces

[edit] Sovereign's low share price makes it an acquisition target

In October 2005, Banco Santander Central Hispano, S.A. (STD) took a 25% stake in Sovereign with the option to buy the company outright for $40 a share. Banco Santander has a history of acquiring distressed banks.^[16]

If not Banco Santander Central Hispano, S.A. (STD), there are other banks eyeing Sovereign for a possible acquisition. Sovereign's stock price is down 58% since the beginning of 2008 and, with Wachovia (WB)'s purchase of Citigroup (C), investors are looking for other distressed assets at these prices.^[13]

[edit] Exposure to Fannie Mae (FNM) and Freddie Mac (FRE) ties Sovereign to the most distressed portion of the financial sector

On September 8th, Sovereign Bancorp officially declared it had held $622.6 million in preferred stock with Fannie Mae (FNM) and Freddie Mac (FRE); however, since the government's bailout of these two organizations, the stock is nearly worthless.^[2][17] The value of Fannie Mae (FNM) and Freddie Mac (FRE) preferred stock is still subject to fluctuation, and it is possible that Sovereign will sustain further losses due to their holdings. During the 2008 Financial Crisis, banks tied to these two companies have seen their stock prices hit hardest. Each day, more companies report their exposure to Fannie Mae (FNM) and Freddie Mac (FRE). To see the entire list, see the Wall Street Journal's "Daily List of Companies Reporting Fannie/Freddie Exposure".

Fannie Mae (FNM) and Freddie Mac (FRE) have been central to the subprime mortgage crisis. These two entities own or securitized 70% of all residential mortgage loans in the U.S. and have felt the brunt of defaults on subprime loans.^[18]

[edit] Declining value in CDO portfolio due to widespread mortgage defaults and the 2008 Financial Crisis

In the 3Q2008, Sovereign recorded a loss of $982 million due to the loss on its Freddie Mac (FRE) and Fannie Mae (FNM) investments and the sale of its entire portfolio of collateralized debt obligations.^[2] The firm took a $602 million loss related to the sale of this portion of its portfolio.^[2]

[edit] Uncertainty on the state of commercial loans could affect Sovereign's healthiest segment

The percentage of U.S. commercial loans in default rose to a five-year high of 3.3% in August compared to .24% a year ago.^[19] For now, defaults in the U.S. have been concentrated in smaller loans with only 2% of the money lent.^[19] Sovereign's commercial loans represented 43% of its loan portfolio.^[19]

[edit] Competitors

Sovereign competes both as a collector of deposits and as an originator of loans. The company competes strictly in its geographic areas for deposits where its ATMs and local bank branches are located. For loans, the company has gone outside its geographic footprint as seen with its auto loans in the Southeast and Southwest. As a result, the company's the company competes with some of the largest banks in the country as well as small regional banks offering similar services.

• PNC Bank (PNC) - PNC bank is a diversified financial services company operating in Pennsylvania, New Jersey, Washington, District of Columbia, Maryland, Virgina, Ohio, Kentucky, and Delaware. The company provides both general banking services as well as fund processing products and services. In 2007, the company earned $6.78 billion in revenue with assets of $138.9 billion.^[20][21]
• Northwest Bancorp (NWSB) - Northwest Bancorp is a community-oriented bank with 166 branches in Pennsylvania, New York, Ohio, Maryland, and Floria. The company originates fixed rate and adjustable rate mortgage loans. In 2007, the company earned $233.89 million in revenue on $6.6 billion in assets.^[22][23]
• M&T Bank (MTB) - M&T Bank offers a range of commercial banking, trust, and investment services with branches in New York, Maryland, Pennsylvania, Delaware, New Jersey, Virginia, West Virginia, and District of Columbus. In 2007, the company earned $2.61 billion in revenue on $64.8 billion in assets.^[24][25]
• Bank of America (BAC) - Bank of America operates in both banking and non-banking financial services with segments in Consumer and Small Business Banking, Global Corporate and Investment Banking, and Global Wealther and Investment Management. The company operates in 32 states with 6,100 branches. In 2007, the company earned $48.62 billion in revenue on $1.7 trillion in assets.^[26][27]

Competitor Comparison[28][29]	Sovereign	PNC Bank (PNC)	Northwest Bancorp (NWSB)	M&T Bank (MTB)	Bank of America (BAC)
Revenue	1.83 B	24.01 B	233.89 M	2.61 B	48.62 B
Net Income	-1.33 B	1.47 B	52.56 M	626.58 M	8.11 B

[edit] References

1. ↑
2. ↑ ^{2.0 2.1 2.2 2.3 2.4} "Santander to buy Sovereign Bancorp for $1.9 billion", Philadelphia Business Journal, October 14, 2008
3. ↑ SOV, 2007, 10-K, page 15
4. ↑ SOV, 2007, 10-K, page 34
5. ↑ "Sovereign Bancorp takes $1.6bn writedown", FT.com Alphaville, January 15, 2008
6. ↑ "PA-based Sovereign Bancorp to buy Brooklyn's Independence Community", BNET, November 4, 2005
7. ↑ "Sovereign Bancorp (SOV) Sees Charge On $623M In Exposure To Fannie and Freddie Perpetual Preferred Stock", StreetInsider, September 8, 2008
8. ↑ Sovereign Bancorp soars as Perrault becomes CEO
9. ↑ ^{9.0 9.1} SOV, 2007, 10-K, Page 4
10. ↑ ^{10.0 10.1 10.2 10.3 10.4} SOV, 2007, 10-K, Page 12
11. ↑ ^{11.0 11.1 11.2} SOV, 2007, 10-K, Page 19
12. ↑ SOV, 2007, 10-K, Page 72
13. ↑ ^{13.0 13.1} "Looking for a run on the bank", WSJ Blogs: MarketBeat, October 2, 2008
14. ↑ ^{14.0 14.1 14.2 14.3 14.4 14.5 14.6} SOV, 2007, 10-K, Page 25
15. ↑ ^{15.0 15.1 15.2} SOV, 2007, 10-K, Page 26
16. ↑ "Banking on Santander", Barron's, October 6, 2008
17. ↑ "Daily List of Companies Reporting Fannie/Freddie Exposure", The Wall Street Journal, October 7, 2008
18. ↑ Wikipedia Mortgage GSE Controversy Page
19. ↑ ^{19.0 19.1 19.2} "Defaults could net bigger fish", The New York Times, September 5, 2008
20. ↑ Google Finance PNC Page
21. ↑ Yahoo Finance PNC Page
22. ↑ Google Finance NWSB Page
23. ↑ Yahoo Finance NWSB Page
24. ↑ Google Finance MTB Page
25. ↑ Yahoo Finance MTB Page
26. ↑ Google Finance BAC Page
27. ↑ Yahoo Finance BAC Page
28. ↑ Google Finance
29. ↑ Yahoo Finance
30. ↑ AF, 2007 10K, Item 7, PG 72
31. ↑ ^{31.0 31.1 31.2} AF, 2007 10K, Item 6, PG 39
32. ↑ AF, 2007 10K, Item 6, PG 40
33. ↑ ^{33.0 33.1 33.2} ISBC, 2007 10K, Item 6, PG 39
34. ↑ ISBC, 2007 10K, Item 6, PG 40
35. ↑ NWSB, 2007 10-K Item 1 PG 11
36. ↑ ^{36.0 36.1 36.2} NWSB, 2007 10-K Item 6 PG 28
37. ↑ NWSB, 2007 10-K Item 6 PG 29
38. ↑ SOV, 2007, 10-K, Item 7, PG 42
39. ↑ ^{39.0 39.1 39.2} SOV, 2007, 10-K, Item 6, PG 12
40. ↑ SOV, 2007, 10-K, Item 7,Table 1: Net Interest Margin, PG 19
41. ↑ WM, 2007 10K, Item 8, PG 131
42. ↑ WM, 2007 10K, Item 8, PG 102
43. ↑ ^{43.0 43.1} WM, 2007 10K, Item 6, PG 24
44. ↑ WM, 2007 10K, Item 6, PG 25

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