Santander Holdings USA, Inc. - Annual Report: 2005 (Form 10-K)

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934,

for the fiscal year ended December 31, 2005, or

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934,

for the transition period from N/A to                     .

SOVEREIGN BANCORP, INC.

(Exact name of Registrant as specified in its charter)

Pennsylvania (State or other Jurisdiction of Incorporation or Organization)		23-2453088 (I.R.S. Employer Identification No.)

1500 Market Street, Philadelphia, Pennsylvania		19102
(Address of Principal Executive Offices)		(Zip Code)

(215) 557-4630

Registrant’s Telephone Number

Title		Name of Exchange on Which Registered
Common stock, no par value 8.75% Preferred Capital Securities		NYSE NYSE
(Sovereign Capital Trust III)
Seacoast Capital Trust I		Nasdaq

(Sovereign Capital Trust IV) PIERS Units

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ  No  o

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
15(d) of the Securities Exchange Act of 1934. Yes  o No  þ

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Act):
Large accelerated filer þ Accelerated filer o Non-accelerated filer o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

The aggregate market value of the shares of Common Stock of the Registrant held by nonaffiliates of the Registrant was $8,061,811,472 at June 30, 2005. As of February 28, 2006, the Registrant had 358,810,392 shares of Common Stock outstanding.

 

 

Form 10-K Cross Reference Index

				Page
Forward-Looking Statements					3-4
PART I
Item 1		- Business			5-8
Item 1A		- Risk Factors			9
Item 1B		- Unresolved Staff Comments			10
Item 2		- Properties			10
Item 3		- Legal Proceedings			10
Item 4		- Submission of Matters to a Vote of Security Holders			11
Item 4A		- Executive Officers of the Registrant			11
PART II
Item 5		- Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			12
Item 6		- Selected Financial Data			13
Item 7		- Management’s Discussion and Analysis of Financial Condition and Results of Operations			14-48
Item 7A		- Quantitative and Qualitative Disclosures About Market Risk			48
Item 8		- Financial Statements and Supplementary Data			48-102
Item 9		- Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			103
Item 9A		- Controls and Procedures			103
Item 9B		- Other Information			103
PART III
Item 10		- Directors and Executive Officers of the Registrant			103
Item 11		- Executive Compensation			103
Item 12		- Security Ownership of Certain Beneficial Owners and Management			103
Item 13		- Certain Relationships and Related Transactions			103
Item 14		- Principal Accountant Fees and Services			103
PART IV
Item 15		- Exhibits and Financial Statement Schedules			104-107
Signatures					108
Subsidiaries of the Registrant
Consent of Ernst & Young LLP
Chief Executive Officer certification pursuant to Rule 13a-14(a) and Rule 15d-14(a)
Chief Financial Officer certification pursuant to Rule 13a-14(a) and Rule 15d-14(a)
Chief Executive Officer certification pursuant to 18 U.S.C. Section 1350
Chief Financial Officer certification pursuant to 18 U.S.C. Section 1350

Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements made by or on behalf of Sovereign Bancorp, Inc. (“Sovereign”). Sovereign may from time to time make forward-looking statements in Sovereign’s filings with the Securities and Exchange Commission (including this Annual Report on Form 10-K and the Exhibits hereto), in its reports to shareholders (including its 2005 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. Some of the disclosure communications by Sovereign, including any statements preceded by, followed by or which include the words “may,” “could,” “should,” “pro forma,” “looking forward,” “will,” “would,” “believe,” “expect,” “hope,” anticipate,” “estimate,” “intend,” “plan,” “strive,” “hopefully,” “try,” “assume” or similar expressions constitute forward-looking statements.

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 statements relating to:

	•		growth in net income, shareholder value and internal tangible equity generation;
	•		growth in earnings per share;
	•		return on equity;
	•		return on assets;
	•		efficiency ratio;
	•		Tier 1 leverage ratio;
	•		annualized net charge-offs and other asset quality measures;
	•		fee income as a percentage of total revenue;
	•		ratio of tangible equity to assets or other capital adequacy measures;
	•		book value and tangible book value per share; and
	•		loan and deposit portfolio compositions, employee retention, deposit retention, asset quality and reserve adequacy.

These forward-looking statements, implicitly and explicitly, include the assumptions underlying the statements. Although Sovereign believes that the expectations reflected in these forward-looking statements are reasonable, these statements involve risks and uncertainties which are subject to change based on various important factors (some of which are beyond Sovereign’s control). The following factors, among others, could cause Sovereign’s financial performance to differ materially from its goals, plans, objectives, intentions, expectations, forecasts and projections (and the underlying assumptions) expressed in the forward-looking statements:

	•		the strength of the United States economy in general and the strength of the regional and local economies in which Sovereign conducts operations;
	•		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;
	•		inflation, interest rate, market and monetary fluctuations;
	•		adverse changes that may occur in the securities markets, including those related to the financial condition of significant issuers in our investment portfolio;
	•		Sovereign’s ability to successfully integrate any assets, liabilities, customers, systems and management personnel Sovereign acquires into its operations and its ability to realize related revenue synergies and cost savings within expected time frames;
	•		the possibility that expected merger-related charges are materially greater than forecasted or that final purchase price allocations based on fair value of the acquired assets and liabilities at acquisition date and related adjustments to yield and/or amortization of the acquired assets and liabilities are materially different from those forecasted;
	•		deposit attrition, customer loss, revenue loss and business disruption following Sovereign’s acquisitions, including adverse effects on relationships with employees may be greater than expected;
	•		anticipated acquisitions may not close on the expected closing date or may not close at all;
	•		the conditions to closing anticipated acquisitions, including stockholder and regulatory approvals, may not be satisfied;
	•		Sovereign’s timely development of competitive new products and services in a changing environment and the acceptance of such products and services by customers;
	•		the willingness of customers to substitute competitors’ products and services and vice versa;

	•		the ability of Sovereign and its third party vendors to convert and maintain Sovereign’s data processing and related systems on a timely and acceptable basis and within projected cost estimates;
	•		the impact of changes in financial services policies, laws and regulations, including laws, regulations and policies concerning taxes, banking, capital, liquidity, proper accounting treatment, securities and insurance, and the application thereof by regulatory bodies and the impact of changes in and interpretation of generally accepted accounting principles;
	•		technological changes;
	•		competitors of Sovereign may have greater financial resources and develop products and technology that enable those competitors to compete more successfully than Sovereign;
	•		changes in consumer spending and savings habits;
	•		acts of terrorism or domestic or foreign military conflicts; and acts of God, including natural disasters;
	•		regulatory or judicial proceedings;
	•		changes in asset quality;
	•		if Sovereign acquires companies with weak internal controls, it will take time to get the acquired company up to the same level of operating effectiveness as Sovereign’s internal control structure. The Company’s inability to address these risks could negatively affect the Company’s operating results; and
	•		Sovereign’s success in managing the risks involved in the foregoing.

If one or more of the factors affecting Sovereign’s forward-looking information and statements proves incorrect, then its actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements. Therefore, Sovereign cautions you not to place undue reliance on any forward-looking information and statements. The effect of these factors are difficult to predict. New factors emerge from time to time and we cannot assess the impact of any such factor on our business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward looking statement. Any forward looking statements only speak as of the date of this document.

Sovereign does not intend to update any forward-looking information and statements, whether written or oral, to reflect any change. All forward-looking statements attributable to Sovereign are expressly qualified by these cautionary statements.

PART I

Item 1 — Business

General

Sovereign Bancorp, Inc. (“Sovereign” or “the Company”), is the parent company of Sovereign Bank (“Sovereign Bank” or “the Bank”), and is a $64 billion financial institution with more than 650 community banking offices, over 1,000 ATMs and about 10,000 team members with principal markets in the Northeastern United States. Sovereign’s primary business consists of attracting deposits from its network of community banking offices, and originating small business and middle market commercial loans, residential mortgage loans, home equity lines of credit, and auto and other consumer loans in the communities served by those offices. Sovereign also originates and purchases certain loans throughout the United States.

Sovereign Bank was created in 1984 under the name Penn Savings Bank, F.S.B. through the merger of two financial institutions with market areas primarily in Berks and Lancaster counties, Pennsylvania. Sovereign Bank assumed its current name on December 31, 1991. Sovereign was incorporated in 1987. Sovereign has acquired 27 financial institutions, branch networks and/or related businesses since 1990. Seventeen of these acquisitions, with assets totaling approximately $35 billion, have been completed since 1995. On October 24, 2005, Sovereign entered into an Agreement and Plan of Merger with Independence Community Bank Corp., a $19.1 billion financial institution headquartered in Brooklyn, New York (See Note 28 to the financial statements) This acquisition which is expected to close in 2006 and will allow Sovereign to enter the New York market and expand its presence in the Northeast.

Sovereign is a Pennsylvania business corporation and its principal executive offices are located at 1500 Market Street, Philadelphia, Pennsylvania. Sovereign Bank is headquartered in Wyomissing, Pennsylvania, a suburb of Reading, Pennsylvania.

Sovereign Bank is a federally chartered savings bank and operates in a heavily regulated environment. Changes in laws and regulations affecting Sovereign and its subsidiaries may have a significant impact on its operations. See “Business — Supervision and Regulation.”

Business Strategy

Sovereign believes that as a result of continuing consolidation in the financial services industry, there is an increasing need for a super-community bank in the Northeastern United States. Sovereign considers a super-community bank to be a bank with the size and range of commercial, business and consumer products to compete with larger institutions, but with the orientation to relationship banking and personalized service usually found at smaller community banks.

In response to this need, in 1996, Sovereign initiated a strategy to transform itself from a traditional mortgage lender into a super-community bank by:

	•		targeting small and medium size businesses through offering a broader array of commercial and business banking products and services;
	•		changing the mix of its deposits and, while endeavoring to preserve its credit quality, changing the mix of its assets to be more characteristic of a commercial bank;
	•		increasing its penetration into larger, more densely populated markets in the northeastern United States;
	•		preserving its orientation toward relationship banking and personalized service, as well as its sales-driven culture; and
	•		increasing its non-interest income as a percentage of net income.

During 2000, Sovereign substantially completed this transformation by acquiring $12.3 billion of deposits, $8.0 billion of loans (exclusive of $1.1 billion of non-relationship mortgage loans sold immediately after the acquisition), and 281 community banking offices located in Massachusetts, Rhode Island, Connecticut and New Hampshire from FleetBoston Financial Corporation (the “FleetBoston Acquisition”). As a result of the FleetBoston Acquisition, Sovereign doubled its deposit base, changed the mix of loans and deposits to be more characteristic of a commercial bank, and increased the breadth and depth of senior and middle management. Since that time, Sovereign has completed four additional acquisitions of community banks. Sovereign also believes that its pending acquisition with Independence and the expansion into New York further solidifies our strategy of being a super community bank. See Management’s Discussion and Analysis of Financial Condition and Results of Operations – Recent Acquisitions for further discussion.

Subsidiaries

Sovereign had two direct consolidated wholly-owned subsidiaries at December 31, 2005: Sovereign Bank is the only material subsidiary.

Employees

At December 31, 2005, Sovereign had 8,956 full-time and 1,218 part-time employees. None of these employees are represented by a collective bargaining agreement, and Sovereign believes it enjoys good relations with its personnel.

Competition

Sovereign is subject to substantial competition in attracting and retaining deposits and in lending funds. The primary factors in competing for deposits include the ability to offer attractive rates, the convenience of office locations, and the availability of alternate channels of distribution. Direct competition for deposits comes primarily from national and state banks, thrift institutions, and broker dealers. Competition for deposits also comes from money market mutual funds, corporate and government securities, and credit unions. The primary factors driving commercial and consumer competition for loans are interest rates, loan origination fees, service levels and the range of products and services offered. Competition for origination of loans normally comes from other thrift institutions, national and state banks, mortgage bankers, mortgage brokers, finance companies, and insurance companies.

Environmental Laws

Environmentally related hazards have become a source of high risk and potentially significant liability for financial institutions relative to their loans. Environmentally contaminated properties owned by an institution’s borrowers may result in a drastic reduction in the value of the collateral securing the institution’s loans to such borrowers, high environmental clean up costs to the borrower affecting its ability to repay the loans, the subordination of any lien in favor of the institution to a state or federal lien securing clean up costs, and liability to the institution for clean up costs if it forecloses on the contaminated property or becomes involved in the management of the borrower. To minimize this risk, Sovereign Bank may require an environmental examination of, and report with respect to, the property of any borrower or prospective borrower if circumstances affecting the property indicate a potential for contamination, taking into consideration the potential loss to the institution in relation to the burdens to the borrower. Such examination must be performed by an engineering firm experienced in environmental risk studies and acceptable to the institution, and the costs of such examinations and reports are the responsibility of the borrower. These costs may be substantial and may deter a prospective borrower from entering into a loan transaction with Sovereign Bank. Sovereign is not aware of any borrower who is currently subject to any environmental investigation or clean up proceeding that is likely to have a material adverse effect on the financial condition or results of operations of the Company.

Supervision and Regulation

     General. Sovereign is a “savings and loan holding company” registered with the Office of Thrift Supervision (“OTS”) under the Home Owners’ Loan Act (“HOLA”) and, as such, Sovereign is subject to OTS oversight and reporting with respect to certain matters. Sovereign Bank is chartered as a federal savings bank, and is highly regulated by the OTS as to all its activities, and subject to extensive OTS examination, supervision, and reporting.

Sovereign Bank is required to file reports with the OTS describing its activities and financial condition and is periodically examined to test compliance with various regulatory requirements. The deposits of Sovereign Bank are insured by the Federal Deposit Insurance Corporation (“FDIC”). Sovereign Bank is also subject to examination by the FDIC. Such examinations are conducted for the purpose of protecting depositors and the insurance fund and not for the purpose of protecting holders of equity or debt securities of Sovereign or Sovereign Bank. Sovereign Bank is a member of the Federal Home Loan Bank (“FHLB”) of Pittsburgh, which is one of the twelve regional banks comprising the FHLB system. Sovereign Bank is also subject to regulation by the Board of Governors of the Federal Reserve System with respect to reserves maintained against deposits and certain other matters.

     Holding Company Regulation. The HOLA prohibits a registered savings and loan holding company from directly or indirectly acquiring control, including through an acquisition by merger, consolidation or purchase of assets, of any savings association (as defined in HOLA to include a federal savings bank) or any other savings and loan holding company, without prior OTS approval. Generally, a savings and loan holding company may not acquire more than 5% of the voting shares of any savings association unless by merger, consolidation or purchase of assets.

Federal law empowers the Director of the OTS to take substantive action when the Director determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of any particular activity constitutes a serious risk to the financial safety, soundness or stability of a savings and loan holding company’s subsidiary savings institution. Specifically, the Director of the OTS may, as necessary, (i) limit the payment of dividends by the savings institution; (ii) limit transactions between the savings institution, the holding company and the subsidiaries or affiliates of either; (iii) limit any activities of the savings institution that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings institution. Any such limits could be issued in the form of a directive having the legal efficacy of a cease and desist order.

     Control of Sovereign. Under the Savings and Loan Holding Company Act and the related Change in Bank Control Act (the “Control Act”), individuals, corporations or other entities acquiring Sovereign common stock may, alone or together with other investors, be deemed to control Sovereign and thereby Sovereign Bank. If deemed to control Sovereign, such person or group will be required to obtain OTS approval to acquire Sovereign’s common stock and could be subject to certain ongoing reporting procedures and restrictions under federal law and regulations. Ownership of more than 10% of the capital stock may be deemed to constitute “control” if certain other control factors are present. As of December 31, 2005, no individual corporation or other entity owned more than 10% of Sovereign’s capital stock.

On October 24, 2005, Sovereign Bancorp, Inc. (“Sovereign”) and Banco Santander Central Hispano, S. A. (“Santander”) announced that they had entered into an Investment Agreement, dated as of October 24, 2005 (the “Investment Agreement”), which sets forth the terms and conditions pursuant to which, among other things, (i) Santander will purchase from Sovereign approximately 88 million shares of Sovereign’s common stock for $2.4 billion in cash, (ii) Santander can increase its ownership up to over the next two years subject to certain standstill restrictions and regulatory limitations, and (iii) Santander can after two years, subject to certain exceptions, acquire 100% of Sovereign in a negotiated transaction subject to shareholder approval. We expect this agreement to close in 2006. The proceeds of the investment will be used to acquire the common stock of Independence Community Bank Corp. (“Independence”) as discussed above. Additionally, Santander has also agreed to provide nonvoting equity and debt financing in an aggregate amount not to exceed $1.2 billion at prevailing market rates if requested by Sovereign in order to assist Sovereign with the funding of its acquisition of Independence. This investment agreement has been submitted to the OTS for their approval.

Santander is the ninth largest bank in the world by market capitalization. It has over 10,000 offices and a presence in over 40 countries. It is the largest financial group in Spain and Latin America, and has a significant presence elsewhere in Europe, including the United Kingdom through its Abbey subsidiary and Portugal, where it is the third largest banking group. It also operates a leading consumer finance franchise in Germany, Italy, Spain and nine other European countries.

     Regulatory Capital Requirements. OTS regulations require savings associations to maintain minimum capital ratios. These standards are the same as the capital standards that are applicable to other insured depository institutions, such as banks. OTS regulations do not require savings and loan holding companies to maintain minimum capital ratios.

Under the Federal Deposit Insurance Act (“FDIA”), insured depository institutions must be classified in one of five defined categories (well-capitalized, adequately-capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized). Under OTS regulations, an institution will be considered “well-capitalized” if it has (i) a total risk-based capital ratio of 10% or greater, (ii) a Tier 1 risk-based capital ratio of 6% or greater, (iii) a Tier 1 leverage ratio of 5% or greater and (iv) is not subject to any order or written directive to meet and maintain a specific capital level. A savings institution’s capital category is determined with respect to its most recent thrift financial report filed with the OTS. In the event an institution’s capital deteriorates to the undercapitalized category or below, the FDIA and OTS regulations prescribe an increasing amount of regulatory intervention, including the adoption by the institution of a capital restoration plan, a guarantee of the plan by its parent holding company and the placement of a hold on increases in assets, number of branches and lines of business.

If capital has reached the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and (in critically undercapitalized situations) appointment of a receiver or conservator. Critically undercapitalized institutions generally may not, beginning 60 days after becoming critically undercapitalized, make any payment of principal or interest on their subordinated debt. All but well-capitalized institutions are prohibited from accepting brokered deposits without prior regulatory approval. Pursuant to the FDIA and OTS regulations, savings associations which are not categorized as well capitalized or adequately-capitalized are restricted from making capital distributions which include cash dividends, stock redemptions or repurchases, cash-out mergers, interest payments on certain convertible debt and other transactions charged to the capital account of a savings association. At December 31, 2005, Sovereign Bank met the criteria to be classified as “well-capitalized.”

     Standards for Safety and Soundness. The federal banking agencies adopted certain operational and managerial standards for depository institutions, including internal audit system components, loan documentation requirements, asset growth parameters, information technology and data security practices, and compensation standards for officers, directors and employees. The implementation or enforcement of these guidelines has not had a material adverse effect on Sovereign’s results of operations.

     Insurance of Accounts and Regulation by the FDIC. Sovereign Bank is a member of the Savings Association Insurance Fund, which is administered by the FDIC. Deposits are insured up to the applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the Insurance Fund. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the Office of Thrift Supervision an opportunity to take such action, and may terminate an institution’s deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

The FDIC’s deposit insurance premiums are assessed through a risk-based system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their level of capital and supervisory evaluation. Under the system, institutions classified as well-capitalized and considered healthy pay no premium or reduced premiums while institutions that are less than adequately capitalized and considered of substantial supervisory concern pay higher premiums. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period. The current premium schedule for Savings Association Insurance Fund insured institutions ranges from 0 to 27 basis points per $100 of deposits. Sovereign Bank is in the category of institutions who pay zero in FDIC premiums. In addition, all insured institutions are required to pay a Financing Corporation assessment, in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. The current annual rate for all insured institutions is $0.132 for every $1,000 in domestic deposits. These assessments are revised quarterly and will continue until the bonds mature in the year 2017.

In February 2006, deposit insurance modernization legislation was enacted. The new law merges the BIF and SAIF into a single Deposit Insurance Fund, increases deposit insurance coverage for IRAs to $250,000, provides for the further increase of deposit insurance on all accounts by indexing the coverage to the rate of inflation, authorizes the FDIC to set the reserve ratio of the combined Deposit Insurance Fund at a level between 1.15% and 1.50%, and permits the FDIC to establish assessments to be paid by insured banks to maintain the minimum ratios. New deposit insurance assessment rates will not be known until the FDIC conducts extensive research and issues new assessment rates, expected in the fourth quarter of 2006. While the possible assessment rates are unknown, the FDIC has stated that it expects that all banks will be assessed some amount for deposit insurance based upon present expectations. Banks in existence prior to 1996 will receive a partial credit for past deposit insurance premiums paid, but the amount of credit for a specific bank will not be known until new regulations implementing the assessments and the credits are adopted.

     Federal Restrictions on Transactions with Affiliates. All banks and savings institutions are subject to affiliate and insider transaction rules applicable to member banks of the Federal Reserve System set forth in the Federal Reserve Act, as well as such additional limitations as the institutions’ primary federal regulator may adopt. These provisions prohibit or limit a savings institution from extending credit to, or entering into certain transactions with, affiliates, principal stockholders, directors and executive officers of the savings institution and its affiliates. For these purposes, the term “affiliate” generally includes a holding company such as Sovereign and any company under common control with the savings institution. In addition, the federal law governing unitary savings and loan holding companies prohibits Sovereign Bank from making any loan to any affiliate whose activity is not permitted for a subsidiary of a bank holding company. This law also prohibits Sovereign Bank from making any equity investment in any affiliate that is not its subsidiary.

     Restrictions on Subsidiary Savings Institution Capital Distributions. Sovereign’s principal sources of funds are cash dividends paid to it by Sovereign Bank, investment income and borrowings. OTS regulations limit the ability of savings associations such as Sovereign Bank to pay dividends and make other capital distributions. Associations that are subsidiaries of a savings and loan holding company must file a notice with the OTS at least 30 days before the proposed declaration of a dividend or approval of the proposed capital distribution by its board of directors. In addition, a savings association must obtain prior approval from the OTS if it fails to meet certain regulatory conditions, or if, after giving effect to the proposed distribution, the association’s capital distributions in a calendar year would exceed its year-to-date net income plus retained net income for the preceding two years or the association would not be at least adequately capitalized or if the distribution would violate a statute, regulation, regulatory agreement or a regulatory condition to which the association is subject.

     Qualified Thrift Lender. All savings institutions are required to meet a qualified thrift lender test to avoid certain restrictions on their operations. The test under the Home Owners Loan Act (HOLA) requires a savings institution to have at least 65% of its portfolio assets, as defined by regulation, in qualified thrift investments. As an alternative, the savings institution under HOLA may maintain 60% of its assets in those assets specified in Section 7701(a) (19) of the Internal Revenue Code. Under either test, such assets primarily consist of residential housing related loans, certain consumer and small business loans, as defined by the regulations and mortgage related investments. Sovereign Bank is currently in compliance with the qualified thrift lender regulations.

     Other Loan Limitations. Federal law limits the amount of non-residential mortgage loans a savings institution, such as Sovereign Bank, may make. Separate from the qualified thrift lender test, the law limits a savings institution to a maximum of 10% of its assets in large commercial loans (defined as loans in excess of $2 million), with another 10% of assets permissible in “small business loans.” Commercial loans secured by real estate 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 items, up to 10% of its assets. Commercial paper, corporate bonds, and consumer loans taken together cannot exceed 35% of an institution’s assets. For this purpose, however, residential mortgage loans and credit card loans are not considered consumer loans, and are both unlimited in amount. The foregoing limitations are established by statute, and cannot be waived by the OTS. Sovereign is currently in compliance with these statutes.

     Federal Reserve Regulation. Under Federal Reserve Board regulations, Sovereign Bank is required to maintain a reserve against its transaction accounts (primarily interest-bearing and non interest-bearing checking accounts). Because reserves must generally be maintained in cash or in non-interest-bearing accounts, the effect of the reserve requirements is to increase an institution’s cost of funds.

Numerous other regulations promulgated by the Federal Reserve Board affect the business operations of Sovereign Bank. These include regulations relating to equal credit opportunity, electronic fund transfers, collection of checks, truth in lending, truth in savings, availability of funds, home mortgage disclosure, and margin credit.

     Federal Home Loan Bank System. The FHLB System was created in 1932 and consists of twelve regional FHLBs. The FHLBs are federally chartered but privately owned institutions created by Congress. The Federal Housing Finance Board (“Finance Board”) is an agency of the federal government and is generally responsible for regulating the FHLB System. Each FHLB is owned by its member institutions. The primary purpose of the FHLBs is to provide funding to their members for making housing loans as well as for affordable housing and community development lending. FHLBs are generally able to make advances to their member institutions at interest rates that are lower than could otherwise be obtained by such institutions.

     Community Reinvestment Act. The Community Reinvestment Act (“CRA”) requires financial institutions regulated by the federal financial supervisory agencies to ascertain and help meet the credit needs of their delineated communities, including low to moderate-income neighborhoods within those communities, while maintaining safe and sound banking practices. A bank’s performance under the CRA is important in determining whether the bank may obtain approval for, or utilize streamlined procedures in, certain applications for acquisitions or to engage in new activities. Sovereign Bank’s lending activities are in compliance with applicable CRA requirements, and Sovereign Bank’s current CRA rating is “outstanding,” the highest category.

     Other Legislation. The Fair and Accurate Credit Transactions Act (“FACTA”) was signed into law on December 4, 2003. This law extends the previously existing Fair Credit Reporting Act. New provisions added by FACTA address the growing problem of identity theft. Consumers will be able to initiate a fraud alert when they are victims of identity theft, and credit reporting agencies will have additional duties. Consumers will also be entitled to obtain free credit reports, and will be granted certain additional privacy rights. The Check 21 Act was also enacted in late 2003. This Act affects the way checks are processed in the banking system, allowing payments to be processed electronically rather than as traditional paper checks.

On July 30, 2002, the Sarbanes-Oxley Act (“Sarbanes-Oxley”) was enacted. This act is not a banking law, but applies to all public companies, including Sovereign. Sarbanes-Oxley is designed to restore investor confidence by assuring proper corporate governance is applied to all publicly traded companies. Sarbanes-Oxley adopts new standards of corporate governance and imposes new requirements on the board and management of public companies. The chief executive officer and chief financial officer of a public company must now certify the financial statements of the company.

New definitions of “independent directors” have been adopted, and new responsibilities and duties have been established for the audit and other committees of the board of directors. In addition, the reporting requirements for insider stock transactions have been revised, requiring most transactions to be reported within two business days. While complying with Sarbanes-Oxley has resulted in increased costs to Sovereign, the additional costs did not have a material effect on results of operations.

In addition to the legislation discussed above, Congress is often considering some financial industry legislation, and the federal banking agencies routinely propose new regulations. New legislation and regulation may include dramatic changes to the federal deposit insurance system. Sovereign cannot predict how any new legislation, or new rules adopted by the federal banking agencies, may affect its business in the future.

     Corporate Information. All reports filed electronically by Sovereign Bancorp, Inc. with the United States Securities and Exchange Commission (SEC), including the annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, as well as any amendments to those reports, are accessible at no cost on the Corporation’s Web site at www.sovereignbank.com as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. These filings are also accessible on the SEC’s Web site at www.sec.gov. Also, copies of the company’s annual report will be made available, free of charge, upon written request.

Item 1A – Risk Factors

The following list describes several risk factors that are applicable to our company.

•

An Economic Downturn May Lead to a Deterioration in Our Asset Quality and Adversely Affect Our Earnings and Cash Flow.

     Our business faces various material risks, including credit risk and the risk that the demand for our products will decrease. In a recession or other economic downturn, these risks would probably become more acute. In an economic downturn, our credit risk and litigation expense will increase. Also, decreases in consumer confidence, real estate values, and interest rates, usually associated with a downturn, could combine to make the types of loans we originate less profitable.

•

The Preparation of Sovereign’s Financial Statements Requires the Use of Estimates That May Vary From Actual Results.

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make significant estimates that affect the financial statements. One example of a significant critical estimate is the level of allowance for credit losses. Due to the inherenent nature of this estimate, Sovereign cannot provide absolute assurance that it will not significantly increase the allowance for credit losses and/or sustain credit losses that are significantly higher than the provided allowance.

•

Changing Interest Rates May Adversely Affect Our Profits.

     To be profitable, we must earn more money from interest on loans and investments and fee-based revenues than the interest we pay to our depositors and creditors and the amount necessary to cover the cost of our operations. Rising interest rates may hurt our income because they may reduce the demand for loans and the value of our investment securities and our loans. If interest rates decrease, our net interest income could be negatively affected if interest earned on interest-earning assets, such as loans, mortgage-related securities, and other investment securities, decreases more quickly than interest paid on interest-bearing liabilities, such as deposits and borrowings. This would cause our net interest income to go down. In addition, if interest rates decline, our loans and investments may prepay earlier than expected, which may also lower our income. Interest rates do and will continue to fluctuate, and we cannot predict future Federal Reserve Board actions or other factors that will cause rates to change. If the yield curve steepens or flattens, it could impact our net interest income in ways management may not accurately predict.

•

We Experience Intense Competition for Loans and Deposits.

     Competition among financial institutions in attracting and retaining deposits and making loans is intense. Our most direct competition for deposits has come from commercial banks, savings and loan associations and credit unions doing business in our areas of operation, as well as from nonbanking sources, such as money market mutual funds and corporate and government debt securities. Competition for loans comes primarily from commercial banks, savings and loan associations, consumer finance companies, insurance companies and other institutional lenders. We compete primarily on the basis of products offered, customer service and price. A number of institutions with which we compete have greater assets and capital than we do and, thus, may have a competitive advantage.

•

We Are Subject to Substantial Regulation Which Could Adversely Affect Our Business and Operations.

     As a financial institution, we are subject to extensive regulation, which materially affects our business. Statutes, regulations and policies to which we and Sovereign Bank are subject may be changed at any time, and the interpretation and the application of those laws and regulations by our regulators is also subject to change. There can be no assurance that future changes in regulations or in their interpretation or application will not adversely affect us.

     The regulatory agencies having jurisdiction over banks and thrifts have under consideration a number of possible rulemaking initiatives which impact on bank and thrift and bank and thrift holding company capital requirements. Adoption of one or more of these proposed rules could have an adverse effect on us and Sovereign Bank.

     Existing federal regulations limit our ability to increase our commercial loans. We are required to maintain 65% of our assets in residential mortgage loans and certain other loans, including small business loans. We also cannot have more than 10% of our assets in large commercial loans that are not secured by real estate, more than 10% in small business loans, or more than four times our capital in commercial real estate loans. A small business loan is one with an original loan amount of less than $2 million, and a large commercial loan is a loan with an original loan amount of $2 million or more. Because commercial loans generally yield interest income which is higher than residential mortgage loans, the amount of our interest income could be adversely affected by these provisions. If the growth of our commercial loan portfolio continues at its current rate, we may exceed these regulatory limitations, requiring us to reduce the size of our commercial loan portfolio or take other actions which may adversely affect our net income.

•

Changes in Accounting Standards could Impact Reported Earnings.

The accounting standard setters, including the FASB, SEC and other regulatory bodies, periodically change the financial accounting and reporting standards that govern the preparation of Sovereign’s consolidated financial statements. These changes can be hard to predict and can materially impact how it records and reports its financial condition and results of operations. In some cases, Sovereign could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.

•

Difficulties in combining the operations of acquired entities with Sovereign’s own operations may prevent Sovereign from achieving the expected benefits from its acquisitions.

Sovereign may not be able to to achieve fully the strategic and operating efficiencies in an acquisition. Inherent uncertainities exist in the operations of an acquired entity. In addition, the market conditions where Sovereign and its potential acquisition targets operate are highly competitive. Although Sovereign has a strong track record in integrating acquired entities, it is possible that Sovereign may lose customers or the customers of acquired entities as a result of an acquisition. Sovereign may also lose key personnel, either from the acquired entity or from itself, as a result of an acquisition. These factors could contribute to Sovereign not achieving the expected benefits from its acquisitions within desired time frames, if at all.

Item 1B — Unresolved Staff Comments

None.

Item 2 — Properties

Sovereign Bank utilizes 743 buildings that occupy a total of 5.8 million square feet, including 202 owned properties with 1.6 million square feet and 541 leased properties with 4.2 million square feet. Seven major buildings contain 1.2 million square feet, which serve as the headquarters or house significant operational and administrative functions:

Columbia Park Operations Center – Dorchester, Massachusetts

East Providence Call Center and Operations and Loan Processing Center – East Providence, Rhode Island

75 State Street Regional Headquarters for Sovereign Bank of New England – Boston, Massachusetts

405 Penn Street Sovereign Plaza Call Center and Operations and Loan Processing Center - Reading, Pennsylvania

601 Penn Street Loan Processing Center – Reading, Pennsylvania

1130 Berkshire Boulevard Bank Headquarters and Administrative Offices – Wyomissing, Pennsylvania

1125 Berkshire Boulevard Operations Center – Wyomissing, Pennsylvania

The majority of the properties of Sovereign outlined above are utilized by the retail banking operations in the consumer bank segment and for general corporate purposes in the other segment.

Item 3 — Legal Proceedings

In December 2005, Sovereign commenced litigation in the United States District Court for the Southern District of New York against Relational Investors, LLC (“Relational”), seeking a declaratory judgment that, under Sovereign’s articles of incorporation and the Pennsylvania Business Corporation Law, directors of Sovereign may only be removed from office by shareholders for cause. In January 2006, this action was combined with certain outstanding claims by Relational, including claims seeking a declaratory judgment that shareholders can remove directors without cause, claims relating to the issuance of shares of Sovereign common stock in the pending transaction with Santander and claims relating to the timing of Sovereign’s 2006 annual meeting of shareholders. There is additional outstanding class action and derivative litigation which relates to Sovereign’s pending transactions with Santander and Independence Community Bank Corp. Sovereign’s management believes that all of these claims are without merit and intends to defend against the claims vigorously in court. Sovereign incurred $5.8 million of costs in the fourth quarter of 2005 to defend itself against the claims and the actions of Relational, and anticipates incurring additional costs in 2006. On March 2, 2006, the judge in the District Court action in the Southern District of New York issued a ruling that Sovereign’s directors may be removed without cause; Sovereign disagrees with the District Court’s ruling under Pennsylvania law and Sovereign’s articles of incorporation, and intends to seek prompt review of the ruling by the United States Court of Appeals for the Second Circuit. Sovereign cannot predict with reasonable certainty the eventual outcome of such appeal or, if the ruling is upheld, the extent of the adverse impact of the ruling on Sovereign’s financial condition or results of operations.

With the exception of the matters described above, Sovereign is not involved in any pending material legal proceeding other than routine litigation occurring in the ordinary course of business. Sovereign does not expect that any amounts that it may be required to pay in connection with these matters would have a material adverse effect on its financial position.

Item 4 — Submission of Matters to a Vote of Security Holders

None.

Item 4A — Executive Officers of the Registrant

Certain information, including principal occupation during the past five years, relating to the principal executive officers of Sovereign, as of February 28, 2006, is set forth below:

Jay S. Sidhu – Age 54. Mr. Sidhu became Chairman of Sovereign and Sovereign Bank in April 2002. He has been a director of Sovereign since September 1988 and a director of Sovereign Bank since 1987. In addition, Mr. Sidhu has served as President and Chief Executive Officer of Sovereign since November 1989. Prior thereto, Mr. Sidhu served as Treasurer and Chief Financial Officer of Sovereign. Mr. Sidhu is also President and Chief Executive Officer of Sovereign Bank. Prior to becoming President and Chief Executive Officer of Sovereign Bank in March 1989, Mr. Sidhu served as Vice Chairman and Chief Operating Officer of Sovereign Bank.

Lawrence M. Thompson, Jr. – Age 53. Mr. Thompson serves as Vice Chairman and Chief Administrative Officer of Sovereign. Mr. Thompson was appointed Vice Chairman in September 2002. Also, Mr. Thompson was appointed President and Chief Operating Officer of Sovereign Bank’s Consumer Banking Division in November 2000. Mr. Thompson was hired as Sovereign Bank’s General Counsel and Secretary in 1984. He was promoted to Vice President in 1985. In April 1986, he became Sovereign Bank’s Senior Vice President for legal affairs and administration. In January 1990, he became Group Executive Officer — Lending and in June 1995, he became Chief Administrative Officer of Sovereign and Sovereign Bank. Mr. Thompson became Chief Operating Officer of Sovereign Bank in November 1996.

Joseph P. Campanelli – Age 49. Mr. Campanelli was appointed Vice Chairman of Sovereign in September 2002. Mr. Campanelli was named President and Chief Executive Officer of SBNE effective January 1, 2005. In May 2002, Mr. Campanelli was appointed President and Chief Operating Officer of Sovereign Bank’s Commercial Markets Group. Prior to becoming President and Chief Operating Officer of Sovereign Bank’s Commercial and Business Banking Division in May 2001, Mr. Campanelli was appointed President and Chief Operating Officer of SBNE in January 2000. Mr. Campanelli joined Sovereign as Executive Vice President in September 1997 through Sovereign’s acquisition of the Fleet Automotive Finance Division and assumed the role of Managing Director of Sovereign’s Automotive Finance Division and the Asset Based Lending Group.

Mark R. McCollom – Age 42. In May 2005, Mr. McCollom was promoted to Chief Financial Officer of Sovereign Bancorp after the retirement of the previous company’s Chief Financial Officer. Mr. McCollom has been with Sovereign since 1996 holding several positions within the company including Managing Director of Corporate Planning, Chief Financial Officer of Sovereign Bank and Chief Accounting Officer.

James Lynch – Age 56. Mr. Lynch was appointed Vice Chairman of Sovereign in February 2006. Mr. Lynch joined Sovereign as Chairman and CEO of Sovereign Bank Mid-Atlantic Division in September 2002. Prior to Sovereign, in 1996, Mr. Lynch was President and CEO of Prime Bancorp, Inc. and Prime Bank. He also became Chairman of Prime Bancorp, Inc. in 1997 until it merged with Summit Bancorp, Inc. in 1999. At Summit, Mr. Lynch served as Senior Executive Vice President of Summit Bancorp and the Chairman and CEO of Summit Bank — Pennsylvania until it merged with FleetBoston Financial in March 2001, where he acted as the President and CEO of Fleet Bank — Pennsylvania until joining Sovereign.

PART II

Item 5 — Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Sovereign’s common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “SOV.” At February 28, 2006, the total number of record holders of Sovereign’s common stock was 22,703.

Market and dividend information for Sovereign’s common stock appear in Item 7 of this Form 10-K.

Sovereign expects to continue its policy of paying regular cash dividends, although there is no assurance as to future dividends because they depend on future earnings, capital requirements, and financial condition. In addition, for certain limitations on the ability of Sovereign Bank to pay dividends to Sovereign, see Part I, Item I, “Business Supervision and Regulation — Regulatory Capital Requirements” and Note 15 at Item 8, “Financial Statements and Supplementary Data.”

The table below summarizes the Company’s repurchases of common equity securities during the quarter ended December 31, 2005:

Average

Total Number of

Maximum Number of

Total

Price

Shares Purchased as

Shares that may be

Number of

Paid

Part of Publicly

Purchased Under

Shares

Per

Announced Plans or

the Plans or

Period

Purchased

Share

Programs (1)

Programs (1)

10/1/05 through 10/31/05

1,000,663

$

21.88

1,000,000

19,500,000

11/1/05 through 11/30/05

1,831

$

23.04

Not Applicable

19,500,000

12/1/05 through 12/31/05

200

$

21.77

Not Applicable

19,500,000

Sovereign does occasionally repurchase its common securities on the open market to fund equity compensation plans for its employees. Additionally, Sovereign repurchases its shares from employees who surrender a portion of their shares received through the Company’s stock based compensation plans to cover their associated minimum income tax liabilities. Sovereign repurchased 2,694 shares outside of publicly announced repurchase programs during the fourth quarter of 2005.

Item 6 — Selected Financial Data

		SELECTED FINANCIAL DATA
		AT OR FOR THE YEAR ENDED DECEMBER 31,
		2005				2004				2003				2002				2001
(Dollars in thousands, except per share data)
Balance Sheet Data
Total assets(1)		$	63,678,726			$	54,489,026			$	43,517,433			$	39,600,674			$	35,484,352
Loans, net of allowance(1)			43,384,248				36,240,076				25,832,869				22,905.056				20,144,431
Investment securities			12,557,328				11,546,877				12,618,971				11,366,077				10,465,116
Deposits and other customer accounts			37,977,706				32,555,518				27,344,008				26,851,089				23,348,004
Borrowings and other debt obligations			18,720,897				16,140,128				12,197,603				8,829,289				8,939,770
Company-obligated mandatorily redeemable preferred securities of subsidiary trusts holding junior subordinated debentures of Sovereign and minority interest-preferred securities of subsidiaries(2)			205,660				203,906				202,136				596,957				604,528
Stockholders’ equity		$	5,810,699			$	4,988,372			$	3,260,406			$	2,764,318			$	2,202,481
Summary Statement of Operations
Total interest income		$	2,918,779			$	2,224,144			$	1,929,751			$	2,059,540			$	2,222,475
Total interest expense(2)			1,330,498				819,327				724,123				899,924				1,168,193
Net interest income			1,588,281				1,404,817				1,205,628				1,159,616				1,054,282
Provision for credit losses			90,000				127,000				161,957				146,500				97,100
Net interest income after provision for credit losses			1,498,281				1,277,817				1,043,671				1,013,116				957,182
Total non-interest income			646,472				482,298				521,576				430,185				414,403
General and administrative expenses			1,089,204				942,661				852,364				813,784				777,285
Other expenses(2)			163,429				236,232				157,984				162,962				454,430
Income/(loss) before income taxes			892,120				581,222				554,899				466,555				139,870
Income tax provision (benefit)			215,960				127,670				153,048				124,570				23,049
Net Income/(loss)(3) (4)		$	676,160			$	453,552			$	401,851			$	341,985			$	116,821
Share Data
Common shares outstanding at end of period (in thousands)			358,018				345,775				293,111				261,624				247,470
Basic earnings/(loss) per share(3) (4)		$	1.86			$	1.41			$	1.45			$	1.32			$	.48
Diluted earnings/(loss) per share(3) (4)		$	1.77			$	1.36			$	1.38			$	1.23			$	.45
Common share price at end of period		$	21.62			$	22.55			$	23.75			$	14.05			$	12.24
Dividends declared per common share		$	.170			$	.115			$	.10			$	.10			$	.10
Selected Financial Ratios
Book value per common share(5)		$	16.21			$	14.41			$	11.12			$	10.57			$	8.90
Dividend payout ratio(6)			9.02	%			8.21	%			6.99	%			7.62	%			21.10	(9)
Return on average assets(7)			1.11	%			.90	%			.97	%			.91	%			.34	(9)
Return on average equity(8)			11.92	%			10.74	%			13.41	%			13.50	%			5.51	(9)
Average equity to average assets(9)			9.34	%			8.36	%			7.24	%			6.71	%			6.15	%

Management’s Discussion and Analysis

Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)

EXECUTIVE SUMMARY

Sovereign, is a $64 billion financial institution with community banking offices, operations and team members located principally in Pennsylvania, Massachusetts, New Jersey, Connecticut, New Hampshire, New York, Rhode Island, and Maryland. Sovereign gathers substantially all of its deposits in these market areas. We use these deposits, as well as other financing sources, to fund our loan and investment portfolios. We earn interest income on our loans and investments. In addition, we generate non-interest income from a number of sources including, deposit and loan services, sales of residential loans and investment securities, capital markets products and bank owned life insurance. Our principal non-interest expenses include employee compensation and benefits, occupancy and facility related costs, technology and other administrative expenses. Our volumes, and accordingly our financial results, are affected by the economic environment, including interest rates, consumer and business confidence and spending, as well as the competitive conditions within our franchise.

We are one of the top 20 largest banking institutions in the United States. Our customers select Sovereign for banking and other financial services based on our ability to assist customers by understanding and anticipating their individual financial needs and providing customized solutions. Our major strengths include: strong franchise value in terms of market share and demographics; a stable, low cost core deposit base; diversified loan portfolio and products; a strong service culture and the ability to cross sell multiple product lines to our customers resulting in higher fee based revenues; and the ability to internally generate equity through earnings. Our weaknesses have included return on assets and loan yields being lower than certain of our peers, and being unable to repurchase any substantial amounts of stock from 1999 through 2004 due to lower than average capital ratios in those time periods. Additionally, we do not possess desired market share in some of our geographic micro-markets.

     Management has implemented strategies to address these weaknesses. With respect to our capital position which has prevented us from buying back any significant amount of stock for the past several years, we have strengthened our ratios significantly over the last several years through the generation of earnings. Sovereign’s capital ratios meet all of the quantative thresholds necessary to be classified as well capitalized under regulatory guidelines. As a result of these earnings and increased equity levels and capital availability, Sovereign was able to repurchase twenty one million shares of common stock through December 31, 2005 under previously announced stock repurchase programs. Additionally, we have been able to increase our cash dividend payout ratios. Management will continue to evaluate the optimum allocation of capital and our future allocations of capital depend in large part to the future interest rate environment.

     With regards to our return on assets and loan yields being lower than our peers, in the first quarter of 2005, we realigned our reporting structure with our strategy of combining the best of a large bank with the best of a small community bank. We divided our footprint into smaller community banking groups in both our large markets – New England and Mid-Atlantic. Within each market, we have created six local markets, each with a Market CEO responsible for servicing the needs of their market while meeting profitability and revenue goals focused on achieving 1) higher growth in loans, deposits, and fees through local decision making and higher quality service, 2) improving margins and returns on assets, 3) increasing fee income, 4) increasing the number of services being sold to or used by a customer and 5) expanding Sovereign’s presence in the marketplace.

     To strengthen our position in certain micro-markets, we continue to investigate strategic acquisitions. In February 2004, we completed the acquisition of First Essex Bancorp, Inc. (“First Essex”). On July 23, 2004, we completed the acquisition of Seacoast Financial Services Corporation (“Seacoast”) and on January 21, 2005, we completed the acquisition of Waypoint Financial Corp. (“Waypoint”). On October 24, 2005, Sovereign entered into a definitive agreement to purchase Independence Community Bank Corp. (“Independence”) a $19.1 billion financial institution that we expect will fortify our presence in the Northeast and strengthen our franchise value. The majority of the proceeds to finance this acquisition will be received from an equity investment that Santander will make in Sovereign common stock. See Note 28 for further details. Sovereign also may develop and construct new community banking offices to strengthen our market position. The ability to grow through acquisition is significantly dependent upon our capital levels, stock price and the merger and acquisition environment for banking institutions.

Our critical success factors include management of interest rate risk and credit risk, superior service delivery, and productivity and expense control.

We experienced a successful year in 2005 as the Company generated net income of $676.2 million compared with $453.6 million in 2004. Our net interest margin was under continued pressure in 2005 as a result of the interest rate environment. In 2005, our net interest margin declined to 3.09% from 3.24% in 2004 due largely to the flattening interest rate yield curve and the impact of slower than anticipated core deposit growth rates. The average interest rate spread between the 3-month Treasury bill and the 10-year Treasury note compressed from 202 basis points in 2004 to 33 in 2005 illustrating the relative pressure between shorter term and longer-term funding costs and loan asset and investment security reinvestment opportunities. Despite these challenges, Sovereign’s net interest income increased $183.5 million to $1.59 billion in 2005. The increase in net interest income was driven by the increase in earning assets that were funded, in part, with low cost core deposits. Fee income reached record levels in 2005 as a result of the growth of our franchise, as well as expanded product offerings and significant growth in mortgage banking revenue. Our provision for credit losses decreased due primarily to continued low charge-off levels in our loan portfolio. Our operating expense levels remained within management’s target levels in 2005. We experienced an improvement in our efficiency ratio (defined as all general and administrative expenses as a percentage of net interest income and total fees and other income) from 50.33% in 2004 to 49.00% in 2005. See “Results of Operations for December 31, 2005 and 2004” in this MD&A for more details as to the factors, which affect year-over-year performance.

RECENT INDUSTRY CONSOLIDATION IN OUR GEOGRAPHIC FOOTPRINT

The Banking industry has experienced significant consolidation in recent years. Consolidation may affect the markets in which Sovereign operates as new or restructured competitors integrate acquired businesses, adopt new business practices or change product pricing as they attempt to maintain or grow market share. Recent merger activity involving national, regional and community banks and specialty finance companies in the northeastern United States, including acquisitions by Sovereign, have affected the competitive landscape in the markets we serve. As noted above, Sovereign recently completed the acquisitions of First Essex, Seacoast and Waypoint and has a pending acquisition with Independence. We believe these acquisitions have strengthened our franchise. Management continually monitors the environment in which it operates to assess the impact of the industry consolidation on Sovereign, as well as the practices and strategies of our competition, including loan and deposit pricing, customer expectations and the capital markets.

CURRENT INTEREST RATE ENVIRONMENT

Net interest income represents approximately seventy to seventy-five percent of the Company’s revenues. Accordingly, the interest rate environment has a substantial impact on Sovereign’s earnings. Sovereign currently has a neutral risk rate position. As previously discussed, the impact of the flattening yield curve that was experienced in 2005 has negatively impacted our margin since the spread between our longer-term assets and our shorter-term liabilities has contracted. We would expect to benefit from any substantial sustained increase in long-term interest rates if continued growth in low cost core deposits occurs. See our discussion of Asset and Liability Management practices in a later section of this MD&A, including the estimated impact of changes in interest rates on Sovereign’s net interest income.

CREDIT RISK ENVIRONMENT

The credit quality of our loan portfolio has a significant impact on our operating results. We have experienced positive trends in certain key credit quality performance indicators over the past several quarters which has resulted in lower provisions for credit losses in 2005 compared to prior periods. In addition to our credit risk mitigation programs, the improvement is due, in part, to the economic conditions in our geographic footprint. We believe the credit risk with respect to our investment portfolio is low. Any significant change in the credit quality of our loan portfolio would have a significant effect on our financial position and results of operations. While credit quality metrics have remained strong throughout 2005, these metrics are at historical lows and as a result Sovereign does not expect this type of credit performance to continue in future periods.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004

		YEAR ENDED DECEMBER 31,
(Dollars in thousands, except per share data)		2005				2004
Net interest income		$	1,588,281			$	1,404,817
Provision for credit losses			90,000				127,000
Total non-interest income			646,472				482,298
General and administrative expenses			1,089,204				942,661
Other expenses			163,429				236,232
Net income		$	676,160			$	453,552
Basic earnings per share		$	1.86			$	1.41
Diluted earnings per share		$	1.77			$	1.36

The major factors affecting comparison of earnings and diluted earnings per share between 2005 and 2004 were:

	•		The growth in net interest income was driven by the increase in the balance of earning assets, which were primarily related to business acquisitions and organic balance sheet growth, offset by a decline in net interest margin to 3.09% in 2005 from 3.24% in 2004. The decline in margin was due to the flattening yield curve, which has contracted the spread between our longer-term assets and shorter–term liabilities.
	•		The debt extinguishment charges of $63.8 million in 2004. We felt it was prudent to redeem these high cost borrowings, even in light of the significant charges we incurred, since the borrowings could be replaced with lower cost borrowings which would improve net interest margin and net income in subsequent periods.
	•		Included in net gains on investment securities for 2004 is an other-than-temporary impairment charge of $32.1 million on FNMA and FHLMC Preferred Stock.
	•		The merger-related charges of $46.4 million incurred in 2004 related to the First Essex and Seacoast acquisitions, compared to net after tax merger related charges of $12.7 million incurred in 2005.
	•		The decrease in provision for credit losses in 2005 of $37 million resulting from the improving credit quality of our loan portfolio in 2005 compared to 2004, as average charge-off rates declined to 0.20% in 2005 compared with 0.36% in 2004.
	•		The continued growth in fee income in consumer and commercial banking due to loan and deposit growth.
	•		The increase in mortgage banking revenues in 2005 of $66.7 million due primarily to increased sales of residential and home equity loans.
	•		Increases in general and administrative expenses to supporting the growth in Sovereign’s franchise and continued investment in human resources and systems and increases related to business acquisitions.

     Net Interest Income. Net interest income for 2005 was $1.59 billion compared to $1.40 billion for 2004, or an increase of 13%. The increase in net interest income in 2005 was due to an increase in average interest-earning assets of $8.6 billion, which was related to the full year impact of our Seacoast acquisition and to a lesser extent, the First Essex acquisition, the 2005 Waypoint acquisition and organic loan growth primarily in the commercial and consumer secured by real estate portfolios. The increase in our assets was funded principally by the increase in core deposits, repurchase agreements and other borrowings. Net interest margin (net interest income on a tax equivalent basis divided by average interest-earning assets) was 3.09% for 2005 compared to 3.24% for 2004. The decline in margin was driven by the flattening yield curve experienced in 2005 and 2004, which has contracted the spread between our longer-term assets and shorter-term liabilities.

Interest on investment securities was $567 million for 2005 compared to $654 million for 2004. The decrease in interest income was due to a decrease in the average balance of investment securities from $14.1 billion in 2004 to $12.1 billion in 2005, partially offset by higher yields in 2005 which averaged 5.12% compared to 4.91%.

Interest on loans was $2.34 billion and $1.57 billion for 2005 and 2004, respectively. The average balance of loans was $41.5 billion with an average yield of 5.66% for 2005 compared to an average balance of $30.9 billion with an average yield of 5.08% for 2004. The increase in average yields year to year is due to the increase of market rates experienced during 2005 due to increases in interest rates by the Federal Reserve Bank. The overall growth in loans from $36.6 billion at December 31, 2004 to $43.8 billion at December 31, 2005 resulted from the Waypoint acquisition and from origination activity in commercial loans and purchases of bulk and correspondent loans, principally in the consumer and mortgage loan portfolios. At December 31, 2005, approximately 17% of our loan portfolio reprices monthly or more frequently.

Interest on total deposits was $625 million for 2005 compared to $303 million for 2004. The average balance of deposits was $31.2 billion with an average cost of 2.0% for 2005 compared to an average balance of $25.3 billion with an average cost of 1.20% for 2004. Additionally, the average balance of non-interest bearing deposits increased to $5.3 billion in 2005 from $4.7 billion in 2004. The increase in the average balance was due to the full year impact of our Seacoast acquisition and to a lesser extent, the First Essex acquisition, the 2005 Waypoint acquisition and an increase in time deposit funding which has recently become a more favorable funding alternative to shorter-term borrowings due to rising market rates. The increase in the average cost of deposits in 2005 is the result of increases in short-term interest rates which were partially passed on to our customers.

Interest on borrowings and other debt obligations was $706 million for 2005 compared to $516 million for 2004. The average balance of total borrowings and other debt obligations was $17.7 billion with an average cost of 3.99% for 2005 compared to an average balance of $15.6 billion with an average cost of

3.31% for 2004. The increase in the cost of funds on borrowings and other debt obligations resulted principally from the higher rates on short-term sources of funding including repurchase agreements and overnight FHLB advances due to an increase in short-term interest rates.

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 for the years indicated (in thousands):

Table 1: Net Interest Margin

		YEAR ENDED DECEMBER 31,
		2005												2004												2003
		Average								Yield/				Average								Yield/				Average								Yield/
		Balance				Interest				Rate				Balance				Interest				Rate				Balance				Interest				Rate
Interest-earning assets:
Interest-earning deposits		$	155,672			$	5,717				3.67	%		$	135,338			$	2,153				1.59	%		$	135,827			$	2,141				1.58	%
Investment securities(1)
Available for sale			7,404,848				385,158				5.20				10,320,377				521,084				5.05				11,060,525				601,445				5.44
Held to maturity			4,062,700				217,889				5.36				3,309,530				167,455				5.06				487,260				27,190				5.58
Other			623,005				18,058				2.90				477,010				8,789				1.84				342,301				7,216				2.11
Loans:
Commercial loans			15,904,425				971,626				6.11				12,530,293				613,541				4.90				10,619,491				530,968				5.00
Consumer:
Residential mortgages			10,588,935				567,690				5.36				6,215,557				328,625				5.29				4,520,506				266,808				5.90
Home equity loans and lines of credit			10,157,824				544,641				5.36				7,828,671				392,450				5.01				5,718,369				306,861				5.37
Total consumer loans secured by real estate			20,746,759				1,112,331				5.36				14,044,228				721,075				5.13				10,238,875				573,669				5.60
Auto loans			4,356,121				225,359				5.17				3,891,325				203,472				5.23				3,147,480				191,049				6.07
Other			535,616				40,468				7.56				465,908				34,107				7.32				316,296				23,769				7.51
Total Consumer			25,638,496				1,378,158				5.38				18,401,461				958,654				5.21				13,702,651				788,487				5.75
Total loans			41,542,921				2,349,784				5.66				30,931,754				1,572,195				5.08				24,322,142				1,319,455				5.42
Allowance for loan losses			(420,879	)			—				—				(359,920	)			—				—				(302,335	)			—				—
Net loans(1)(2)			41,122,042				2,349,784				5.72				30,571,834				1,572,195				5.15				24,019,807				1,319,455				5.50
Total interest-earning assets			53,368,267				2,976,606				5.58				44,814,089				2,271,676				5.07				36,045,720				1,957,447				5.43
Non-interest-earning assets			7,363,707				—				—				5,744,518				—				—				5,370,184				—				—
Total assets		$	60,731,974			$	2,976,606				4.90	%		$	50,558,607			$	2,271,676				4.49	%		$	41,415,904			$	1,957,447				4.73	%
Interest-bearing liabilities:
Deposits:
NOW accounts		$	8,732,791			$	153,277				1.76	%		$	6,744,813			$	56,503				0.84	%		$	5,986,218			$	50,399				0.84	%
Customer repurchase agreements			887,614				24,230				2.73				834,636				7,462				0.89				989,401				7,153				0.72
Savings accounts			3,779,333				25,347				0.67				3,498,539				19,417				0.56				3,109,844				22,403				0.72
Money market accounts			8,244,406				131,354				1.59				7,633,932				81,992				1.07				6,286,992				68,458				1.09
Certificates of deposits			9,581,336				290,382				3.03				6,599,223				137,671				2.09				6,513,741				172,276				2.64
Total deposits			31,225,480				624,590				2.00				25,311,143				303,045				1.20				22,886,196				320,689				1.40
Total borrowings and other debt obligations(3)			17,707,167				705,908				3.99				15,591,901				516,282				3.31				10,291,088				403,434				3.92
Total interest-bearing liabilities			48,932,647				1,330,498				2.72				40,903,044				819,327				2.00				33,177,284				724,123				2.18
Non-interest-bearing DDA(4)			5,294,135				—				—				4,698,584				—				—				4,087,652				—				—
Non-interest-bearing liabilities			831,296				—				—				733,856				—				—				1,155,225				—				—
Total liabilities			55,058,078				1,330,498				2.42				46,335,484				819,327				1.77				38,420,161				724,123				1.89
Stockholders’ equity			5,673,896				—				—				4,223,123				—				—				2,995,743				—				—
Total liabilities and stockholders’ equity		$	60,731,974			$	1,330,498				2.19	%		$	50,558,607			$	819,327				1.62	%		$	41,415,904			$	724,123				1.62	%
Net interest spread(5)											2.71	%											3.07	%											3.25	%
Taxable equivalent interest income/net interest margin							1,646,108				3.09	%							1,452,349				3.24	%							1,233,324				3.42	%
Tax equivalent basis adjustment							(57,827	)											(47,531	)											(27,696	)
Net interest income						$	1,588,281											$	1,404,818											$	1,205,628
Ratio of interest-earning assets to interest-bearing liabilities											1.09	x											1.10	x											1.09	x

(1)		The average balance of our non-taxable investment securities for the year-ended December 31, 2005, 2004, and 2003 were $1.9 billion, $1.5 billion and $850 million, respectively. Tax equivalent adjustments to interest on investment securities available for sale for the years ended December 31, 2005, 2004, and 2003 were $51.3 million, $40.6 million and $24.0 million, respectively. Tax equivalent adjustments to loans for the years ended December 31, 2005, 2004, and 2003, were $6.6 million, $6.9 million and $3.7 million, respectively. Tax equivalent interest income is based upon an effective tax rate of 35%.
(2)		Amortization of premiums and discounts on purchased loans and amortization of deferred loan fees, net of origination costs, of $136.3 million, $61.3 million and $25.6 million for the years ended December 31, 2005, 2004, and 2003, respectively, are included in interest income. Average loan balances include non-accrual loans and loans held for sale.
(3)		Effective July 1, 2003, management elected to change its accounting policy to treat its Trust Preferred Security obligations as liabilities and the associated dividends on the trust preferred securities as interest expense. Previously, this cost was recorded in other expenses since the obligation was

		classified on the consolidated balance sheet as Company – Obligated Mandatorily Redeemable Preferred Securities. See Note 12 to the Consolidated Financial Statements for further discussion. Periods prior to July 1, 2003, have not been reclassified to conform with the new presentation.
(4)		In the third quarter of 2005, Sovereign reclassified its non-interest earning deposits to be shown as a separate component of other liabilities to be consistent with industry practice. This change had no impact to Sovereign’s historically reported net interest margin.
(5)		Represents the difference between the yield on total earning assets and the cost of total funding liabilities.

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 not solely due to changes in volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each (in thousands):

Table 2: Volume/Rate Analysis

		YEAR ENDED DECEMBER 31,
						2005 VS. 2004												2004 VS. 2003
		INCREASE/(DECREASE)												INCREASE/(DECREASE)
		Volume				Rate				Total				Volume				Rate				Total
Interest-earning assets:
Interest-earning deposits		$	368			$	3,196			$	3,564			$	(8	)		$	20			$	12
Investment securities available for sale			(151,220	)			15,294				(135,926	)			(38,856	)			(41,505	)			(80,361	)
Investment securities held to maturity			39,918				10,516				50,434				143,034				(2,769	)			140,265
Investment securities other			3,227				6,042				9,269				2,569				(996	)			1,573
Net loans (1)			588,747				188,842				777,589				340,610				(87,870	)			252,740
Total interest-earning assets											704,930												314,229
Interest-bearing liabilities:
Deposits			83,082				238,463				321,545				31,895				(49,539	)			(17,644	)
Borrowings			75,747				113,879				189,626				183,002				(70,154	)			112,848
Total interest-bearing liabilities											511,171												95,204
Net change in net interest income		$	322,211			$	(128,452	)		$	193,759			$	232,452			$	(13,427	)		$	219,025

(1) Includes non-accrual loans and loans held for sale.

     Provision for Credit Losses. The provision for credit losses is based upon actual credit loss experience, growth or contraction of specific segments of the loan portfolio, and the estimation of losses inherent in the current loan portfolio. The provision for credit losses for 2005 was $90 million compared to $127 million for 2004. Included in 2004 results was a $6 million provision recorded in connection with the acquisition of First Essex to conform to Sovereign’s reserving methodology. The lower provision in 2005 was driven by continued favorable credit quality statistics in our loan portfolio, combined with a reduction in net loan charge-offs, which declined from $110.3 million, or 0.36% of average loan outstandings in 2004, to $81.7 million, or 0.20% of average loan outstandings in 2005. The overall allowance for credit losses as a percentage of loans outstanding has declined from 1.12% in 2004 to 1.00% in 2005. This is reflective of the quality of the loan portfolios, improved credit risk identification, analysis, and loss estimation, as well as residential loan growth where reserve requirements are generally lower than in commercial loan portfolios. As a result of continued improved credit risk identification, analysis and loss estimation, certain class allowance factors, primarily commercial, were adjusted during 2005 to more accurately project loss rates resulting in a reduction of the allowance for loan losses. Management regularly evaluates the risk inherent in its loan portfolio and adjusts its allowance for loan losses as deemed necessary.

Sovereign’s net charge-offs for 2005 were $81.7 million and consisted of charge-offs of $137.0 million and recoveries of $55.3 million. This compares to 2004 net charge-offs of $110.3 million consisting of charge-offs of $153.2 million and recoveries of $42.9 million. The decrease in charge-offs was driven by the performance of our commercial loan portfolios where net charge-offs decreased from $64.7 million in 2004 to $27.8 million in 2005.

The ratio of net loan charge-offs to average loans, including loans held for sale, was .20% for 2005, compared to .36% for 2004. Commercial loan net charge-offs as a percentage of average commercial loans were .18% for 2005, compared to .52% for 2004. The consumer loans secured by real estate net charge-off rate was .08% for 2005, compared to .05% for 2004. The consumer loans not secured by real estate net charge-off rate was .75% for 2005 and .89% for 2004.

Table 3 presents the activity in the allowance for credit losses for the years indicated (in thousands):

Table 3: Reconciliation of the Allowance for Credit Losses

		2005				2004				2003				2002				2001
Allowance for loan losses, beginning of period		$	391,003			$	315,790			$	288,018			$	255,153			$	241,974
Allowance acquired in acquisitions			28,778				64,105				—				14,877				—
Provision for loan losses (2)			89,501				121,391				160,585				145,282				101,968
Allowance released in connection with dealer floor plan securitization			(8,010	)			—				—				—				—
Charge-offs:
Commercial			40,935				77,499				101,597				85,931				46,214
Consumer secured by real estate			24,125				12,219				16,685				21,205				29,403
Consumer not secured by real estate			71,906				63,530				47,106				55,509				45,323
Total charge-offs (1)			136,966				153,248				165,388				162,645				120,940
Recoveries:
Commercial			13,100				12,825				7,531				6,082				3,177
Consumer secured by real estate			7,085				5,395				6,405				4,826				11,259
Consumer not secured by real estate			35,108				24,745				18,639				24,443				17,715
Total recoveries			55,293				42,965				32,575				35,351				32,151
Charge-offs, net of recoveries			81,673				110,283				132,813				127,294				88,789
Allowance for loan losses, end of period		$	419,599			$	391,003			$	315,790			$	288,018			$	255,153
Reserve for unfunded lending commitments, beginning of period			17,713				12,104				10,732				9,514				14,382
Provision for unfunded lending commitments (2)			499				5,609				1,372				1,218				(4,868	)
Reserve for unfunded lending commitments, end of period (3)			18,212				17,713				12,104				10,732				9,514
Total Allowance for credit losses			437,811			$	408,716			$	327,894			$	298,750			$	264,667
Net charge-offs to average loans			.20	%			.36	%			.55	%			.58	%			.42	%

(1)

The 2002 consumer secured by real estate charge-offs include $4.6 million of charge-offs incurred as part of accelerated dispositions of non-performing residential loans sold during the first and fourth quarters of 2002.

(2)

The provision for credit losses on the consolidated statement of operations consists of the sum of the provision for loan losses and the provision for unfunded lending commitments.

(3)

The reserve for unfunded commitments is classified on other liabilities on the consolidated balance sheet.

See Note 1 for Sovereign’s charge-off policy with respect to its various loan types.

     Non-interest Income. Total non-interest income was $646 million for 2005 compared to $482 million for 2004. Several factors contributed to the increase as discussed below.

Consumer banking fees were $287.4 million for 2005 compared to $242.6 million in 2004. This increase was primarily due to increased loan and deposit fees which increased 50% and 10%, respectively, resulting from growth in average loan and deposit balances which increased 34% and 23%, respectively. The Company continues to aggressively promote demand deposit products, which, in exchange for favorable minimum balance requirements and convenience for the customer, generally produce higher fee revenues than time deposit products.

Commercial banking fees were $161.1 million for 2005 compared to $123.8 million in 2004. This increase was due to growth in both commercial loans and expanded cash management capabilities and product offerings. Commercial banking loan fees increased by $26.9 million to $81.8 million while commercial deposit fees decreased slightly by $1.0 million to $46.7 million, in 2005. Included in commercial banking fees were gains of $9.4 million related to the 2005-1 dealer floor plan securitizations executed in the third and fourth quarter of 2005. See Note 22 for further details.

Mortgage banking revenues were $89.3 million for 2005 compared to $22.5 million for 2004. The principal components of mortgage banking revenues are: gains or losses from the sale or securitization of mortgage and home equity loans or mortgage-backed securities that were related to loans originated or purchased and held by Sovereign; gains or losses on mortgage banking derivative and hedging transactions; servicing fees; amortization of mortgage servicing rights; and changes in the valuation allowance for recoveries or impairments related to mortgage servicing rights. The primary factor contributing to the increase in mortgage banking revenues was increased loan sales resulting from high levels of origination and loan purchase activity. The table below summarizes the components of net mortgage banking revenues (in thousands):

		Twelve-months ended December 31,
		2005				2004
Recoveries / (impairments) to mortgage servicing rights		$	5,944			$	(1,792	)
Mortgage servicing fees			21,517				19,411
Amortization of mortgage servicing rights			(17,578	)			(18,895	)
Net (losses) gains under SFAS 133			645				(2,020	)
Sales of mortgage loans, mortgage backed securities and home equity loans			78,730				25,805
Total		$	89,258			$	22,509

There were a number of transactions in 2005 that caused the increase of $52.9 million in gains on sales of mortgage loans, mortgage backed securities and home equity loans from the 2004 levels. Included in 2005 results is $2.9 billion of mortgage loans that were sold in the three-month period ended June 30, 2005 where Sovereign recorded gains of $28.4 million. Additionally, in September 2005 and December 2005, Sovereign sold $503 million and $898 million of home equity loans and recorded net gains of $13.1 million and $19.0 million, respectively. Included in mortgage banking revenue for 2005 is a $5.9 million mortgage servicing rights impairment reversal primarily because of slower prepayment speed assumptions compared to a $1.8 million impairment charge in 2004. The most important assumptions in the valuation of mortgage servicing rights are anticipated loan prepayment rates (CPR speed) and the positive spread we receive on holding escrow related balances. Increases in prepayment speeds (which are generally driven by lower long term interest rates) result in lower valuations of mortgage servicing rights, while lower prepayment speeds result in higher valuations. The escrow related credit spread is the estimated reinvestment yield earned on the serviced loan escrow deposits. Increases in escrow related credit spreads result in higher valuations of mortgage servicing rights while lower spreads result in lower valuations. For each of these items, Sovereign must make assumptions based on future expectations. All of the assumptions are based on standards that we believe would be utilized by market participants in valuing mortgage servicing rights and are consistently derived and/or benchmarked against independent public sources. Additionally, an independent appraisal of the fair value of our mortgage servicing rights is obtained at least annually and is used by management to evaluate the reasonableness of our discounted cash flow model.

Capital Markets revenues were $17.8 million in 2005 and $19.9 million in 2004. Capital markets revenues declined in 2005 compared to 2004 because of challenging market conditions in 2005 related to the low interest rate environment which reduced demand for our broker dealer products and services.

Net gains on sales of investment securities were $11.7 million for 2005, compared to $14.2 million for 2004. Included in 2005 and 2004 results were impairment charges of $2.7 million and $0.9 million, respectively, related to our retained interests in securitizations. See Note 22 in the consolidated financial statements for a discussion of our retained interests in securitized assets.

In the fourth quarter of 2004, Sovereign determined that certain unrealized losses on perpetual preferred stock of FNMA and FHLMC was other-than-temporary in accordance with SFAS 115 “Accounting for Certain Investments in Debt and Equity Securities” and the SEC’s Staff Accounting Bulletin No. 59 “Accounting for Non-current Marketable Equity Securities”. The Company’s assessment considered the duration and severity of the unrealized loss, the financial condition and near term prospects of the issuers, and the likelihood of the market value of these instruments increasing to our initial cost basis within a reasonable period of time. Based on the anticipated interest rate environment expected in the near term at the time and certain negative developments at these issuers, we concluded that the unrealized losses were other-than-temporary and recorded an impairment charge of $32.1 million ($20.9 million after-tax or $0.06 per diluted share) to writedown these investments to their fair values. No other than temporary impairment changes were recorded in 2005 related to these investments securities. See Note 6 for further discussion and analysis of our determination that the unrealized losses in the investment portfolio at December 31, 2005 were considered temporary.

The reduction in gross gains on sales of investment securities in 2005 is a result of the increasing interest rate environment in 2005 which reduced the amount of unrealized gains in our investment portfolio.

Miscellaneous income was $31.8 million in 2005 compared with $19.9 million in 2004. The 2005 results included $4.0 million of premium income recognized on written call options related to mortgage-backed securities and $3.7 million of revenues from a benefit consulting practice that was acquired in

2005. Also included in the 2005 results was a $1.9 million gain on the sale of a marketing trademark to a third party.

     General and Administrative Expenses. Total general and administrative expenses were $1.1 billion for 2005 compared to $943 million in 2004, or an increase of 15.5%. The increase in 2005 is primarily related to the Waypoint acquisition and the full year effect of the Seacoast acquisition, as well as increased compensation and benefit costs associated with the hiring of additional team members. At December 31, 2005, Sovereign had total employees of 10,174 compared to 9,330 in 2004, a 9.0% increase. In addition, marketing and other administrative expenses have increased to support the growth in our franchise. Although general and administrative expenses have increased, Sovereign’s efficiency ratio, (all general and administrative expenses as a percentage of net interest income and total fees and other income) for 2005 was 49.0% compared to 50.3% for 2004, as net interest income and fees and other income have risen at a faster rate than general and administrative expenses.

     Other Expenses. Total other expenses were $163.4 million for 2005 compared to $236.2 million for 2004. Other expenses included amortization expense of core deposit intangibles of $73.8 million for 2005 compared to $72.6 million for 2004. As previously discussed, in 2004 Sovereign incurred debt extinguishment losses of $63.8 million and net merger related expenses of $46.4 million. In 2005, net merger related expenses were $12.7 million.

     Other expense related to equity method investments includes an investment that Sovereign has in a synthetic fuel partnership that generates Section 29 tax credits for the production of fuel from a non-conventional source (“the Synthetic Fuel Partnership”). Our investment balance totaled $32.4 million at December 31, 2005. Sovereign is amortizing this investment through December 31, 2007, which is the period through which we expect to receive alternative energy tax credits. Reductions in the investment value and our allocation of the partnership’s earnings or losses totaled $28.2 million and $20.9 million for 2005 and 2004, respectively and are included as expense in the line “Equity method investments” in our consolidated statement of operations, while the alternative energy tax credits we receive are included as a reduction of income tax expense. We anticipate receiving tax credits in excess of our recorded investment over the remaining life of the partnership. The alternative energy tax credit is reduced and ultimately eliminated based on a formula tied to the annual average wellhead price per barrel of domestic crude oil which is not subject to regulation by the United States. To the extent that the average price of crude oil exceeds certain levels resulting in a phase out and/or an elimination of the alternative energy tax credits, Sovereign’s investment in the synthetic fuel partnership could become impaired. The alternative energy tax credit has never been subject to a phase out. However, volatility in oil prices have raised the possibility of a phase out in future periods. Sovereign will continue to monitor oil price increases in the future and their related impact on our investment and recognition of alternative energy tax credits.

In December 2005, Sovereign commenced litigation in the United States District Court for the Southern District of New York against Relational Investors, LLC (“Relational”), seeking a declaratory judgment that, under Sovereign’s articles of incorporation and the Pennsylvania Business Corporation Law, directors of Sovereign may only be removed from office by shareholders for cause. In January 2006, this action was combined with certain outstanding claims by Relational, including claims seeking a declaratory judgment that shareholders can remove directors without cause, claims relating to the issuance of shares of Sovereign common stock in the pending transaction with Santander and claims relating to the timing of Sovereign’s 2006 annual meeting of shareholders. There is additional outstanding class action and derivative litigation which relates to Sovereign’s pending transactions with Santander and Independence Community Bank Corp. Sovereign’s management believes that all of these claims are without merit and intends to defend against the claims vigorously in court. Sovereign incurred $5.8 million of costs in the fourth quarter of 2005 to defend itself against the claims and the actions of Relational, and anticipates incurring additional costs in 2006. On March 2, 2006, the judge in the District Court action in the Southern District of New York issued a ruling that Sovereign’s directors may be removed without cause; Sovereign disagrees with the District Court’s ruling under Pennsylvania law and Sovereign’s articles of incorporation, and intends to seek prompt review of the ruling by the United States Court of Appeals for the Second Circuit. Sovereign cannot predict with reasonable certainty the eventual outcome of such appeal or, if the ruling is upheld, the extent of the adverse impact of the ruling on Sovereign’s financial condition or results of operations.

Also impacting other expenses were lease and contract termination charges of $4.0 million recorded in 2005. See Note 29 for additional discussion.

     Income Tax Provision. The income tax provision was $216 million for 2005 compared to a provision of $128 million for 2004. The effective tax rate for 2005 was 24.2% compared to 22.0% for 2004. The current year tax rate differs from the statutory rate of 35% due principally to income from tax-exempt investments, non-taxable income related to bank-owned life insurance and tax credits received on low income housing partnerships and the Synthetic Fuel Partnership. The increase in the effective tax rate in 2005 was due to a reduction in the proportion of permanent favorable tax differences to pre-tax book income in 2005 compared to 2004.

Sovereign is subject to the income tax laws of the U.S., its states and municipalities and certain foreign countries. These tax laws are complex and subject to different interpretations by the taxpayer and the relevant Governmental taxing authorities. In establishing a provision for income tax expense, the Company must make judgments and interpretations about the application of these inherently complex tax laws.

Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. Sovereign reviews its tax balances quarterly and as new information becomes available, the balances are adjusted, as appropriate. Sovereign believes that its recorded tax liabilities adequately provide for the probable outcome of these assessments; however, revisions of our estimate of accrued income taxes could materially effect our operating results for any given quarter. For additional information with respect to Sovereign’s income taxes, see Note 18 in the Notes to Consolidated Financial Statements.

     Line of Business Results. Effective January 1, 2005, Sovereign reorganized its reporting structure in keeping with its strategy of offering local community banking decision making combined with the broad product and service offerings that are normally only available at a large bank. The Company’s reportable segments have changed to the Mid-Atlantic Banking Division, the New England Banking Division, Shared Services Consumer, Shared Services Commercial, and Other. The results of 2004 have been restated to reflect Sovereign’s new segments. The Company’s segments are focused principally around the customers Sovereign serves and the geographies in which those customers are located. The Mid-Atlantic Banking Division is comprised of our branch locations in New Jersey, Pennsylvania, and Maryland. The New England Banking Division is comprised of our branch locations in Massachusetts, Rhode Island, Connecticut and New Hampshire. Both areas offer a wide range of products and services to customers and each attracts deposits by offering a variety of deposit instruments including demand and NOW accounts, money market and savings accounts, certificates of deposits and retirement savings plans. The Shared Services Consumer segment is primarily comprised of our mortgage banking group, our correspondent home equity business, our indirect automobile group and our consumer lending group. The Shared Services Commercial segment provides cash management and capital markets services to Sovereign customers, as well as asset backed lending products, commercial real estate loans, automobile dealer floor plan loans, leases to commercial customers, and small business loans. Other includes earnings from the investment portfolio, interest expense on Sovereign’s borrowings and other debt obligations, minority interest expense, amortization of intangible assets, merger-related and integration charges and certain unallocated corporate income and expenses. For additional discussion of these business lines and the Company’s related accounting policies, see Note 26 to the Notes to the Consolidated Financial Statements.

Segment results are derived from the Company’s business unit profitability reporting system by specifically attributing managed balance sheet assets, deposits and other liabilities and their related interest income or expense. Funds transfer pricing methodologies are utilized to allocate a cost for funds used or a credit for funds provided to business line deposits, loans and selected other assets using a matched funding concept. The provision for credit losses recorded by each segment is primarily based on the net charge-offs of each line of business. The difference between the provision for credit losses recognized by the Company on a consolidated basis and the provision recorded by the business lines at the time of charge-off is included in the Other segment. Other income and expenses directly managed by each business line, including fees, service charges, salaries and benefits, and other direct expenses as well as certain allocated corporate expenses are accounted for within each segment’s financial results. Designations, assignments and allocations may change from time to time. Where practical, the results are adjusted to present consistent methodologies for the segments. Accounting policies for the lines of business are the same as those used in preparation of the consolidated financial statements with respect to activities specifically attributable to each business line. However, the preparation of business line results requires management to establish methodologies to allocate funding costs and benefits, expenses and other financial elements to each line of business.

The Mid-Atlantic Banking Division’s net interest income increased $140.7 million to $584.2 million in 2005. The increase in net interest income was principally due to loan growth, which was funded primarily by an increase in the balance of time deposits. The average balance of Mid-Atlantic Banking Division’s loans was $6.3 billion with a yield of 6.03% versus $4.4 billion at a yield of 4.98% during 2005 and 2004, respectively. The average balance of deposits was $15.0 billion at a cost of 1.60% in 2005 compared to $12.9 billion at an average cost of 1.01% in 2004. The increase in fees and other income of $11.4 million to $131.6 million for 2005 was generated by deposit fees and loan fees, which grew with the increased level of deposits and loans. The provision for credit losses decreased in 2005 to $21.1 million from $29.3 million in 2004 due to decreased net loan charge-offs in 2005 due to the improving credit quality of our loan portfolio. General and administrative expenses (including allocated corporate and direct support costs) increased from $316.4 million for 2004 to $376.4 million for 2005. The increase in general and administrative expenses is due principally to Sovereign’s continued investment in people and processes to support its expanding franchise, which included the acquisition of Waypoint.

The New England Banking Division’s net interest income increased $159.4 million to $665.5 million in 2005. The increase in net interest income was principally due to loan growth, because of the full year impact of the Seacoast and First Essex acquisitions. The average balance of New England Banking Division’s loans was $5.4 billion with a yield of 5.98% versus $4.4 billion at a yield of 5.01% during 2005 and 2004, respectively. The average balance of deposits was $17.6 billion at a cost of 1.41% in 2005 compared to $16.0 billion at an average cost of 0.98% in 2004. The increase in fees and other income of $10.7 million to $162.9 million for 2005 was generated by deposit fees and loan fees, which grew with the increased level of deposits and loans. The provision for credit losses decreased in 2005 to $7.1 million from $14.0 million in 2004 due to decreased net loan charge-offs in 2005 and the improving credit quality of our loan portfolio. General and administrative expenses (including allocated corporate and direct support costs) increased from $378.2 million for 2004 to $423.6 million for 2005. The increase in general and administrative expenses is due principally to Sovereign’s continued investment in people and processes to support its expanding franchise, which included the full year impact of the 2004 acquisitions of First Essex and Seacoast.

Shared services consumer segment net interest income increased $24.6 million to $312.7 million in 2005. The increase in net interest income was principally due to loan growth. The average balance of Shared services consumer loans was $21.1 billion with a yield of 5.29% versus $15.1 billion at a yield of 5.29% during 2005 and 2004, respectively. The average balance of deposits was $389.1 million at a cost of 1.29% in 2005 compared to $349.0 million at an average cost of 0.70% in 2004. The increase in fees and other income of $98.5 million to $151.7 million for 2005 was primarily generated by increased mortgage banking revenues from the sale of mortgage and home equity loans. These gains increased to $78.7 million in 2005 from $25.8 million in 2004. Mortgage banking revenue is contingent upon loan growth and market conditions. Due to strong loan originations, increased loan purchases, and favorable market conditions, Sovereign experienced a higher level of gains from the sale of loans in 2005 compared to 2004. Other fees increased $31.7 million from 2004. These fees increased primarily due to the growth in the loan portfolio. The provision for credit losses increased in 2005 to $50.0 million from $41.5 million in 2004 due to loan growth. General and administrative expenses (including allocated corporate and direct support costs) increased from $106.0 million for 2004 to $150.5 million for 2005. The increase in general and administrative expenses is due principally to Sovereign’s continued investment in people and processes to support its expanding franchise.

Shared services commercial segment net interest income increased $54.2 million to $227.8 million for 2005 compared to 2004. The increase in net interest income was principally due to loan growth. The average balance of Shared services commercial loans was $8.7 billion with a yield of 6.07% in 2005 versus $7.0 billion at a yield of 4.74% during 2004. Fees and other income have increased by $32.3 million to $128.5 million principally from an increase in loan fees of $26.9 million. Included in 2005 results were $9.4 million of gains related to the 2005-1 dealer floor plan securitization. The provision for credit losses decreased by $21.7 million in 2005 to $3.7 million compared to 2004 due to a lower level of net charge-offs in 2005. General and administrative expenses (including allocated corporate and direct support costs) decreased slightly from $115.8 million for 2004 to $108.2 million in 2005.

The net loss before income taxes for the Other segment increased from $211.9 million in 2004 to $311.8 million in 2005. Net interest expense increased from $6.4 million in 2004 to $201.9 million for 2005 due to tightening margins between our investment and borrowing obligations in the current year due to the flattening yield curve. The Other segment includes net gains on securities of $14.3 million in 2005, as compared to $15.1 million recorded in 2004. The previously discussed impairment charges related to our retained interests in consumer loan securitizations are recorded in the Consumer Bank segment; however, the other-than-temporary impairment charge on the FNMA and FHLMC preferred stock in our investment portfolio was recorded in the Other segment. The 2005 results included proxy and related professional expenses and lease and contract termination charges of $5.8 million and $4.0 million, respectively. See Note 29 for additional details. The 2004 results also include pre-tax losses of $63.8 million on the extinguishment of debt. The 2005 and 2004 results also included net charges of $12.7 million and $46.4 million for merger and integration charges. Finally, the Other segment included $28.2 million and $20.9 million of expense associated with the Synthetic Fuel Partnership, as well as amortization of intangibles of $73.8 million and $72.6 million in 2005 and 2004, respectively.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003

		YEAR ENDED DECEMBER 31,
		2004				2003
(Dollars in thousands, except per share data)
Net interest income		$	1,404,817			$	1,205,628
Provision for credit losses			127,000				161,957
Total non-interest income			482,298				521,576
General and administrative expenses			942,661				852,364
Other expenses			236,232				157,984
Net income		$	453,552			$	401,851
Basic earnings per share		$	1.41			$	1.45
Diluted earnings per share		$	1.36			$	1.38

The major factors affecting comparison of earnings and diluted earnings per share between 2004 and 2003 were:

	•		The decrease in net interest margin from 3.42% in 2003 to 3.24% in 2004 due primarily to the flattening yield curve experienced in 2004 since replacement yields on new asset production are lower than yields on maturing assets. The growth in net interest income was driven by the increase in the balance of earning assets, which were primarily related to business acquisitions.
	•		The adoption of EITF 04-8 “Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings per Share”. This EITF was announced in draft form in the second quarter of 2004 and became effective in the fourth quarter of 2004. It required the potential dilution from contingently convertible debt be included in the calculation of diluted earnings per share upon the issuance of the debt and the after-tax impact of the interest expense on this debt be added back to net income for diluted earnings per share purposes. Sovereign issued redeemable securities in the first quarter of 2004. Prior period earnings per share were restated to the date of the issuance of this debt.
	•		The debt extinguishment charges of $63.8 million and $29.8 million in 2004 and 2003, respectively. We felt it was prudent to redeem these high cost borrowings, even in light of the significant charges we incurred, since the borrowings could be replaced with lower cost borrowings which would improve net interest margin and net income in subsequent periods.
	•		The other-than-temporary impairment charge of $32.1 million on FNMA and FHLMC Preferred Stock. This was one of the primary reasons net gains on securities was lower in 2004 compared with 2003.
	•		The merger-related and integration charges of $46.4 million incurred in 2004 related to the First Essex and Seacoast acquisitions.
	•		The decrease in provision for credit losses in 2004 of $35.0 million due to improved loan quality.
	•		The continued growth in fee income in consumer and commercial banking due to loan and deposit growth.
	•		The decreases in mortgage banking and capital markets revenues in 2004 of $34.6 million due primarily to the interest rate environment experienced in 2004 compared to the rate environment in 2003.
	•		Increases in general and administrative expenses to support the growth in Sovereign’s franchise and continued investments in human resources and systems and increases related to business acquisitions.

     Net Interest Income. Net interest income for 2004 was $1.40 billion compared to $1.21 billion for 2003, or an increase of 16%. The increase in net interest income in 2004 was due to an increase in interest-earning assets, which were primarily related to business acquisitions. The increase in our assets was funded principally by the increase in low cost core deposits, repurchase agreements and other borrowings. Net interest margin (net interest income on a tax equivalent basis divided by average interest-earning assets) was 3.24% for 2004 compared to 3.42% for 2003. The decline in margin was driven by the flattening yield curve experienced in 2004 which resulted in reinvestment yields being lower than the yields on maturing assets, and to a lesser extent the reclassification of trust preferred securities expense to net interest margin. This margin compression was partially offset by lower funding costs from downward re-pricing of deposits and a reduced cost of borrowings.

Interest on investment securities was $654 million for 2004 compared to $612 million for 2003. The increase in interest income was due to an increase in the average balance of investment securities from $12.0 billion in 2003 to $14.1 billion in 2004, partially offset by lower yields due to declining market interest rates.

Interest on loans was $1.57 billion and $1.32 billion for 2004 and 2003, respectively. The average balance of loans was $30.6 billion with an average yield of 5.15% for 2004 compared to an average balance of $24.0 billion with an average yield of 5.50% for 2003. The decline in average yields year to year is due to the decrease of market rates experienced during 2004 and 2003. In addition, the decrease in market interest rates also resulted in higher prepayment experience on fixed rate loans with proceeds being reinvested by Sovereign in lower yielding assets. The overall growth in loans from $26.1 billion at December 31, 2003 to $36.6 billion at December 31, 2004 resulted from business acquisitions and from origination activity and purchases of bulk and correspondent loans, principally in the consumer and mortgage loan portfolios.

Interest on total deposits was $303 million for 2004 compared to $321 million for 2003. The average balance of interest bearing deposits was $25.3 billion with an average cost of 1.20% for 2004 compared to an average balance of $22.9 billion with an average cost of 1.40% for 2003. Additionally, non-interest bearing deposits increased to an average balance of $4.7 billion in 2004 from $4.1 billion in 2003. The increase in the average balance was due primarily to business acquisitions and Sovereign’s ability to grow deposits as rates started to increase in mid-year. The decrease in average cost of deposits in 2004 is the result of Sovereign’s ability to reduce deposit rates in the declining interest rate environment.

Interest on borrowings and other debt obligations was $516 million for 2004 compared to $403 million for 2003. The average balance of total borrowings and other debt obligations was $15.6 billion with an average cost of 3.31% for 2004 compared to an average balance of $10.3 billion with an average cost of 3.92% for 2003. The reduction in the cost of funds on borrowings and other debt obligations resulted principally from the lower rates on short-term sources of funding including repurchase agreements and overnight FHLB advances. In addition, Sovereign retired certain high cost term funding in 2004. See Note 12 in the Notes to the Consolidated Financial Statements for additional discussion.

     Provision for Credit Losses. The provision for credit losses is based upon actual credit loss experience, growth or contraction of specific segments of the loan portfolio, and the estimation of losses inherent in the current loan portfolio. The provision for credit losses for 2004 was $127.0 million compared to $162.0 million for 2003. Included in 2004 results was a $6 million provision recorded in connection with the acquisition of First Essex to conform to Sovereign’s reserving methodology. The lower provision was driven by improving credit quality statistics in our loan portfolio, such as a 28% decline in non-performing loans, a decline in criticized loans, and a decline in performing classified loans compared to 2003. Additionally, net loan charge-offs have declined to $110.3 million or 17% compared to the prior year. The overall allowance as a percentage of loans outstanding has declined from 1.25% in 2003 to 1.12% in 2004. This is reflective of improvement in credit quality of the loan portfolios, reductions in classified and past due loans, as well as, loan growth that slightly favored consumer and residential loans portfolios where reserve requirements are generally lower than in commercial loan portfolios. Management regularly evaluates the risk inherent in its loan portfolio and adjusts its allowance for loan losses as deemed necessary.

Sovereign’s net charge-offs for 2004 were $110.3 million and consisted of charge-offs of $153.2 million and recoveries of $42.9 million. This compares to 2003 net charge-offs of $132.8 million consisting of charge-offs of $165.4 million and recoveries of $32.6 million. The decrease in charge-offs was driven by the performance of our commercial loan portfolios where net charge-offs decreased from $94.1 million in 2003 to $64.7 million in 2004.

The ratio of net loan charge-offs to average loans, including loans held for sale, was .36% for 2004, compared to .55% for 2003. Commercial loan net charge-offs as a percentage of average commercial loans were .52% for 2004, compared to .89% for 2003. The consumer loans secured by real estate net charge-off rate was .05% for 2004, compared to .10% for 2003. The consumer loans not secured by real estate net charge-off rate was .89% for 2004 and .82% for 2003.

     Non-interest Income. Total non-interest income was $482 million for 2004 compared to $522 million for 2003. Several factors contributed to the decrease as discussed below.

Consumer banking fees were $242.6 million for 2004 compared to $208.8 million in 2003. This increase was primarily due to an increase in deposit fees of $23.7 million to $198.2 million in 2004 from expansion of our overall deposit base along with a favorable shift in mix from time to core deposit products, increased cross selling initiatives with existing customers and our First Essex and Seacoast acquisitions. During 2004, the Company continued to aggressively promote demand deposit products, which, in exchange for favorable minimum balance requirements and convenience for the customer, generally produce higher fee revenues than time deposit products.

Commercial banking fees were $123.8 million for 2004 compared to $108 million in 2003. This increase was due to growth in both commercial loans and commercial core deposits, as well as expanded cash management capabilities and product offerings. Commercial banking loan fees increased by $10.4 million to $54.8 million while commercial deposit fees increased by $1.5 million to $47.7 million, in 2004.

Mortgage banking revenues were $22.5 million for 2004 compared to $50.0 million for 2003. The principal components of mortgage banking revenues are: gains or losses from the sale or securitization of mortgage loans or mortgage-backed securities that were related to loans originated or purchased and held by Sovereign; gains or losses on mortgage banking derivative and hedging transactions; servicing fees; amortization of mortgage servicing rights; and changes in the valuation allowance for recoveries or impairments related to mortgage servicing rights. The primary factor contributing to the decrease in mortgage banking revenues was decreased loan origination activity since 2003, which had high levels of origination activity from record-level mortgage refinancings generated from the historic low rates experienced in 2003. The table below summarizes the components of net mortgage banking revenues (in thousands):

		Twelve-months ended December 31,
		2004				2003
Impairments to mortgage servicing rights		$	(1,792	)		$	(795	)
Mortgage servicing fees			19,411				15,278
Amortization of mortgage servicing rights			(18,895	)			(27,398	)
Gain on loan purchase commitments			—				3,420
Net (losses) gains under SFAS 133			(2,020	)			1,709
Sales of mortgage loans and mortgage backed securities			25,805				57,804
Total		$	22,509			$	50,018

Capital Markets revenues were $19.9 million in 2004 and $27.0 million in 2003. Capital markets revenues declined in 2004 compared to 2003 because of challenging market conditions in 2004 related to the interest rate environment.

Net gains on sales of investment securities were $14.2 million for 2004, compared to $66.1 million for 2003. Included in 2004 and 2003 results were impairment charges of $0.9 million and $7.4 million, respectively, related to our retained interests in securitizations. See Note 22 in the consolidated financial statements for a discussion of our retained interests in securitized assets.

In the fourth quarter of 2004, Sovereign determined that certain unrealized losses on perpetual preferred stock of FNMA and FHLMC was other-than-temporary in accordance with SFAS 115 “Accounting for Certain Investments in Debt and Equity Securities” and the SEC’s Staff Accounting Bulletin No. 59 “Accounting for Non-current Marketable Equity Securities”. The Company’s assessment considered the duration and severity of the unrealized loss, the financial condition and near term prospects of the issuers, and the likelihood of the market value of these instruments increasing to our initial cost basis within a reasonable period of time. Based on the recent events at these issuers and the anticipated interest rate environment expected in the near term, we concluded that the unrealized losses were other-than-temporary and recorded an impairment charge of $32.1 million ($20.9 million after-tax or $0.06 per diluted share) to writedown these investments to their fair values.

     General and Administrative Expenses. Total general and administrative expenses were $943 million for 2004 compared to $852 million in 2003, or an increase of 11%. The increase in 2004 is primarily related to the First Essex and Seacoast acquisitions, as well as increased compensation and benefit costs associated with the hiring of additional team members. In addition, marketing and other administrative expenses have increased to support the growth in our franchise. Although general and administrative expenses have increased, Sovereign’s efficiency ratio, (all general and administrative expenses as a percentage of net interest income and fees and other income) for 2004 was 50.3% compared to 51.3% for 2003, as net interest income and fees and other income have risen at a faster rate than general and administrative expenses.

     Other Expenses. Total other expenses were $236.2 million for 2004 compared to $158.0 million for 2003. Other expenses included amortization expense of core deposit intangibles of $72.6 million for 2004 compared to $73.8 million for 2003. Also the Company changed its method of accounting for trust preferred securities expenses beginning on July 1, 2003, to include these costs in interest expense and to classify these obligations in borrowings and other debt obligations on its consolidated balance sheet (see Note 1 to the Consolidated Financial Statements). Prior period amounts were not reclassified. As previously discussed, Sovereign incurred debt extinguishment losses of $63.8 million and $29.8 million in 2004 and 2003, respectively, and merger related expenses in connection with the acquisitions of First Essex and Seacoast of $46.4 million in 2004.

Additionally, during 2004 Sovereign recorded $20.9 million of expense related to its investment in the Synthetic Fuel Partnership which was recorded in equity method investments in our consolidated statement of operations. The Company also has other investments in entities accounted for under the equity method including low-income housing tax credit partnerships. As a result of the increasing significance of our equity method investment portfolio, Sovereign reclassified the income statement effects of these investments to other expenses in 2004. Prior period amounts were reclassified to conform to the 2004 presentation.

     Income Tax Provision. The income tax provision was $128 million for 2004 compared to a provision of $153 million for 2003. The effective tax rate for 2004 was 22.0% compared to 27.6% for 2003. The current year tax rate differs from the statutory rate of 35% due principally to income from tax-exempt investments, non-taxable income related to bank-owned life insurance and tax credits received on low income housing partnerships and the Synthetic Fuel Partnership. The decrease in the effective tax rate in 2004 was due to an increase in tax free income from municipal investments, increased tax credits from our low income housing partnerships and our Synthetic Fuel Partnership and tax benefits recorded on Sovereign’s merger-related, debt extinguishment and other charges. For additional information with respect to Sovereign’s income taxes, see Note 18 in the Notes to Consolidated Financial Statements.

     Line of Business Results. Effective January 1, 2005, Sovereign reorganized its reporting structure in keeping with its strategy of offering local community banking decision making combined with the broad product and service offerings that are normally only available at a large bank. The Company’s reportable segments have changed to the Mid-Atlantic Banking Division, the New England Banking Division, Shared Services Consumer, Shared Services Commercial, and Other. The 2004 and 2003 results have been restated to reflect Sovereign’s new segments. For additional discussion of these business lines and the Company’s related accounting policies, see Note 26 to the Notes to the Consolidated Financial Statements.

Mid-Atlantic Banking Division net interest income increased $44.1 million to $443.4 million in 2004. The increase in net interest income was principally due to loan growth, which was funded by an increase in the balance of low-cost deposits. The average balance of Mid-Atlantic loans was $4.4 billion with a yield of 4.98% versus $4.1 billion at a yield of 5.31% during 2004 and 2003, respectively. The average balance of deposits was $12.9 billion at a cost of 1.01% in 2004 compared to $13.0 billion at an average cost of 1.29% in 2003. The increase in non-interest income of $9.1 million to $120.2 million for 2004 was generated by deposit fees and loan fees, which grew in tandem with the increased level of deposits and loans. The provision for credit losses increased in 2004 to $29.3 million from $26.4 million in 2003 due to a higher level of charge-offs recorded in 2004. General and administrative expenses (including allocated corporate and direct support costs) increased from $302.2 million for 2003 to $316.4 million for 2004. The increase in general and administrative expenses is due principally to Sovereign’s continued investment in people and processes to support its expanding franchise.

New England Banking Division net interest income increased $134.4 million to $506.1 million in 2004. The increase in net interest income was principally due to loan growth, which was funded by an increase in the balance of low-cost deposits both of which were partially resulted from Sovereign’s 2004 acquisitions of Seacoast and First Essex. The average balance of New England Banking Division loans was $4.4 billion with a yield of 5.01% versus $3.1 billion at a yield of 4.95% during 2004 and 2003, respectively. The average balance of deposits was $15.9 billion at a cost of 0.98% in 2004 compared to $13.3 billion at an average cost of 1.12% in 2003. The increase in non-interest income of $32.5 million to $152.3 million for 2004 was generated by deposit fees and loan fees, which grew in tandem with the increased level of deposits and loans. The provision for credit losses declined in 2004 to $14.0 million from $15.3 million in 2003 due to the lower level of consumer loan charge-offs. General and administrative expenses (including allocated corporate and direct support costs) increased from $310.0 million for 2003 to $378.2 million for 2004. The increase in general and administrative expenses is due principally to Sovereign’s acquisition of Seacoast and First Essex in 2004 and continued investment in people and processes to support its expanding franchise.

Shared Services Consumer net interest income decreased $19.4 million to $288.2 million for 2004 compared to 2003. The decrease in net interest income was principally due to the flattening yield curve that was experienced in 2004. The average balance of Shared Services Consumer loans was $15.1 billion with a yield of 5.29% in 2004 versus $11.6 billion at a yield of 5.66% during 2003. Non-interest income has decreased by $9.0 million to $41.5 million principally from a decrease in loan fees and capital markets revenues. The provision for credit losses increased by $9.0 million in 2004 to $41.5 million compared to 2003 due to a higher level of net charge-offs in 2004. Mortgage banking revenues were lower in 2004 compared to 2003 due to decreased loan origination activity, since 2003 had high levels of origination activity from record-level mortgage refinancings generated from the historic low rates experienced in 2003. General and administrative expenses (including allocated corporate and direct support costs) increased from $105.3 million for 2003 to $106.0 million in 2004. The increase was due in part to increased costs to support the Shared Services Commercial Segment’s loan growth, as well as additional investment in the cash management and capital markets businesses.

Shared Services Commercial net interest income increased $21.5 million to $173.5 million in 2004. The increase in net interest income was principally due to loan growth, which was funded by an increase in the balance of low-cost deposits. The average balance of Shared Services Commercial loans was $7.0 billion with a yield of 4.74% versus $6.0 billion at a yield of 4.84% during 2004 and 2003, respectively. The average balance of deposits was $64.0 million at a cost of 4.08% in 2004 compared to $33.9 million at an average cost of 3.75% in 2003. The increase in non-interest income of $7.2 million to $96.2 million for 2004 was generated by deposit fees and loan fees, which grew in tandem with the increased level of deposits and loans. The provision for credit losses declined in 2004 to $25.5 million from $58.6 million in 2003 due to the lower level of loan charge-offs. General and administrative expenses (including allocated corporate and direct support costs) increased from $102.2 million for 2003 to $115.8 million for 2004. The increase in general and administrative expenses is due principally to Sovereign’s continued investment in people and processes to support its expanding franchise.

The net loss before income taxes for Other increased from $107.6 million in 2003 to $211.9 million in 2004. Net interest expense decreased from $25.0 million in 2003 to $6.4 million for 2004 due to the increase in average balances on the investment portfolio. The Other segment includes net gains on securities of $15.1 million in 2004, as compared to $73.5 million recorded in 2003. The previously discussed impairment charges related to our retained interests in consumer loan securitizations are recorded in the Consumer Bank segment. The 2004 and 2003 results also include a pre-tax loss of $63.8 million and $29.8 million on the extinguishment of debt. The 2004 results also include merger charges of $46.4 million related to the Seacoast and First Essex acquisitions. Finally, the Other segment included $20.9 million of expense associated with the Synthetic Fuel Partnership in 2004.

Critical Accounting Policies

MD&A is based on the consolidated financial statements and accompanying notes that have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). Our significant accounting policies are described in Note 1 to the consolidated financial statements. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments, and, as such, have a greater possibility of producing results that could be materially different than originally reported. However, the Company is not currently aware of any reasonably likely events or circumstances that would result in materially different results. We have identified accounting for the allowance for loan losses, securitizations, goodwill and derivatives and hedging activities as our most critical accounting policies and estimates in that they are important to the portrayal of our financial condition and results, and they require management’s most difficult, subjective or complex judgments as a result of the need to make estimates about the effects of matters that are inherently uncertain.

The Company’s senior management has reviewed these critical accounting policies and estimates with its audit committee. Information concerning the Company’s implementation and impact of new accounting standards issued by the Financial Accounting Standards Board (FASB) is discussed in Note 2.

     Allowance for Loan Losses and Reserve for Unfunded Lending Commitments. The allowance for loan losses and reserve for unfunded lending commitments represent management’s best estimate of probable losses inherent in the loan portfolio. The adequacy of Sovereign’s allowance for loan losses and reserve for unfunded lending commitments are regularly evaluated. This evaluation process is subject to numerous estimates and applications of judgment. Management’s evaluation of the adequacy of the allowance to absorb 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, and industry trends. Changes in these estimates could have a direct impact on the provision for credit losses recorded in the income statement and could result in a change in the recorded allowance and reserve for unfunded lending commitments. The loan portfolio also represents the largest asset on our consolidated balance sheet. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for loan losses and reserve for unfunded lending commitments and a discussion of the factors driving changes in the amount of the allowance for loan losses and reserve for unfunded lending commitments is included in the Credit Risk Management section of this MD&A.

     Securitizations. Securitization is a process by which a legal entity issues certain securities to investors, which pay a return based on the cash flows from a pool of loans or other financial assets. Sovereign has securitized mortgage loans, home equity loans, and other consumer loans, as well as automotive floor plan loans that it originated and/or purchased from certain other financial institutions. After receivables or loans are securitized, the Company continues to maintain account relationships with its customers. As a result, the Company continues to consider these securitized assets to be part of the business it manages. Sovereign may provide administrative, liquidity facilities and/or other services to the resulting securitization entities, and may continue to service the financial assets sold to the securitization entity.

In the case where Sovereign transferred financial assets to a special purpose entity, a decision must be made as to whether that transfer should be considered a sale and whether the assets transferred to the special purpose entity should be consolidated into the Company’s financial statements or whether the non-consolidation criteria have been met according to generally accepted accounting principles. The accounting guidance governing sale and consolidation of securitized financial assets is included in SFAS No. 140.

Accounting for the valuation of retained interests in securitizations requires management judgment since these assets are established and accounted for based on discounted cash flow modeling techniques that require management to make estimates regarding the amount and timing of expected future cash flows, including assumptions about loan repayment rates, credit loss experience, and servicing costs, as well as discount rates that consider the risk involved.

Because the values of these assets are sensitive to changes to assumptions, the valuation of retained interests is considered a critical accounting estimate. Note 1 and Note 22 to the consolidated financial statements include further discussion on the accounting for these assets and provide sensitivity analysis showing how the fair value of these assets would respond to adverse changes in the key assumptions utilized to value these assets.

     Goodwill. The purchase method of accounting for business combinations requires the Company to make use of estimates and judgments to allocate the purchase price paid for acquisitions to the fair value of the assets acquired and liabilities assumed. The excess of the purchase price of an acquired business over the fair value of the identifiable assets and liabilities represents goodwill. Goodwill totaled $2.7 billion at December 31, 2005.

The Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” on January 1, 2002. This statement provides that goodwill and other indefinite lived intangible assets will no longer be amortized on a recurring basis, but rather will be subject to periodic impairment testing. Other than goodwill, Sovereign has no indefinite lived intangible assets.

The impairment test for goodwill requires the Company to compare the fair value of business reporting units to their carrying value including assigned goodwill. SFAS No. 142 required an initial impairment test within six months after adoption and annually thereafter. In addition, goodwill is tested more frequently if changes in circumstances or the occurrence of events indicate impairment potentially exists. No charge for impairment of goodwill has been required under the provisions of SFAS No. 142 in 2005, 2004 or 2003.

Determining the fair value of its reporting units requires management to allocate assets and liabilities to such units and make certain judgments and assumptions related to various items, including discount rates, future estimates of operating results, etc. If alternative assumptions or estimates had been used, the fair value of each reporting unit determined by the Company may have been different. However, management believes that the estimates or assumptions used in the goodwill impairment analysis for its business units were reasonable.

     Derivatives and Hedging Activities. Sovereign uses various derivative financial instruments to assist in managing interest rate risk. Sovereign accounts for these derivative instruments in accordance with the provisions of Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” as amended (SFAS No. 133). Under SFAS No. 133, derivative financial instruments are recorded at fair value as either assets or liabilities on the balance sheet. The accounting for changes in the fair value of a derivative instrument is determined by whether it has been designated and qualifies as part of a hedging relationship and on the type of hedging relationship. Transactions hedging changes in the fair value of a recognized asset, liability, or firm commitment are classified as fair value hedges. Derivative instruments hedging exposure to variable cash flows of

recognized assets, liabilities or forecasted transactions are classified as cash flow hedges.

     Fair value hedges result in the immediate recognition in earnings of gains or losses on the derivative instrument, as well as corresponding losses or gains on the hedged item, to the extent they are attributable to the hedged risk. The effective portion of the gain or loss on a derivative instrument designated as a cash flow hedge is reported in accumulated other comprehensive income, and reclassified to earnings in the same period that the hedged transaction affects earnings. The ineffective portion of the gain or loss, if any, is recognized in current earnings for both fair value and cash flow hedges. Derivative instruments not qualifying for hedge accounting treatment are recorded at fair value and classified as trading assets or liabilities with the resultant changes in fair value recognized in current earnings during the period of change.

During 2005 and 2004, Sovereign had both fair value hedges and cash flow hedges recorded in the consolidated balance sheet as “other assets” or “other liabilities” as applicable. For both fair value and cash flow hedges, certain assumptions and forecasts related to the impact of changes in interest rates on the fair value of the derivative and the item being hedged must be documented at the inception of the hedging relationship to demonstrate that the derivative instrument will be effective in hedging the designated risk. If these assumptions or forecasts do not accurately reflect subsequent changes in the fair value of the derivative instrument or the designated item being hedged, Sovereign might be required to discontinue the use of hedge accounting for that derivative instrument. Once hedge accounting is terminated, all subsequent changes in the fair market value of the derivative instrument must be recorded in earnings, possibly resulting in greater volatility in Sovereign’s earnings. If Sovereign’s outstanding derivative positions that qualified as hedges at December 31, 2005 were no longer considered effective, and thus did not qualify as hedges, the impact in 2005 would have been to lower pre-tax earnings by approximately $34.3 million.

Recent Acquisitions

On January 21, 2005, Sovereign acquired Waypoint for approximately $953 million and the results of Waypoint are included in the accompanying financial statements subsequent to the acquisition date. A cash payment of $269.9 million was made in connection with the transaction with the remaining consideration consisting of the issuance of 29.8 million shares of common stock and stock options (to convert outstanding Waypoint stock options into Sovereign stock options). The value of the common stock for accounting purposes was determined based on the average price of Sovereign’s shares over the three day period preceding and subsequent to the announcement date of the acquisition. Waypoint was a bank holding company headquartered in Harrisburg, Pennsylvania, with assets of approximately $4.3 billion and deposits of $2.9 billion. Waypoint operated 66 community banking offices in ten counties in south-central Pennsylvania and northern Maryland. This acquisition has increased Sovereign’s market presence in many counties in Pennsylvania and has created new leading markets in certain counties in Maryland. Sovereign recorded merger related and intergration charges of $16.7 million pre-tax ($10.9 million after-tax), or $0.03 per diluted share in 2005.

On February 6, 2004, Sovereign closed the acquisition of First Essex for approximately $418 million and the results of First Essex are included in the accompanying financial statements subsequent to the acquisition date. A cash payment of $208 million was made in connection with the transaction with the remaining consideration consisting of the issuance of 12.7 million shares of Sovereign’s common stock and the exchange of Sovereign stock options for existing First Essex options. The value of the common stock for accounting purposes was based on the average price of Sovereign’s shares over the three day period preceding and subsequent to the announcement date of the acquisition. First Essex had approximately $1.7 billion in assets and was headquartered in Andover, Massachusetts, with 20 community banking offices throughout 2 counties in Massachusetts and 3 counties in New Hampshire. This acquisition fortified our presence in both of these states and gave us greater leverage in commercial and retail banking in these markets. Sovereign recorded merger-related and integration charges of $22.7 million pre-tax ($14.8 million after-tax), or $.04 per diluted share, in 2004. The majority of these charges related to closing Sovereign branch and office locations which will be serviced by acquired First Essex properties.

On July 23, 2004, Sovereign completed the acquisition of Seacoast, a commercial bank holding company headquartered in New Bedford, Massachusetts, and the results of Seacoast’s operations are included in the accompanying financial statements subsequent to the acquisition date. Sovereign issued 36.2 million shares of common stock and exchanged Sovereign stock options for existing Seacoast options, with a combined value of $817.5 million and made cash payments of $256.2 million, to acquire and convert all outstanding Seacoast shares and employee stock options and pay associated fees. The value of the common stock was determined based on the average price of Sovereign’s shares over the three-day period preceding and subsequent to the closing date of the acquisition since the final consideration was subject to change based upon the value of Sovereign’s stock price immediately preceding the closing date of the transaction. The Seacoast acquisition added 67 banking offices throughout Southeastern Massachusetts. This acquisition has increased Sovereign’s market presence in the New England market place. Sovereign recorded merger related and integration charges of $23.7 million pre-tax ($15.4 million after-tax) or $.05 per diluted share in 2004. See Note 27 for additional details on the merger-related charges recorded by Sovereign on the First Essex, Seacoast and Waypoint acquisitions.

Pending Transactions

On October 24, 2005, Sovereign and Santander announced that they had entered into an Investment Agreement, dated as of October 24, 2005 (the “Investment Agreement”), which sets forth the terms and conditions pursuant to which, among other things, (i) Santander will purchase from Sovereign approximately 88 million shares of Sovereign’s common stock for $2.4 billion in cash, (ii) Santander can increase its ownership during the first two years following the closing, subject to certain standstill restrictions and regulatory limitations, and (iii) Santander can, after two years, subject to certain exceptions, acquire 100% of Sovereign in a negotiated transaction, subject to shareholder approval. On November 22, 2005, Sovereign and Santander approved certain amendments to the Investment Agreement. We expect this agreement to close in 2006. The proceeds of the investment will be used to acquire the common stock of Independence Community Bank Corp. (“Independence”) as discussed below. Additionally, Santander has also agreed to provide nonvoting equity and debt financing in an aggregate amount not to exceed $1.2 billion at prevailing market rates if requested by Sovereign in order to assist Sovereign with the funding of its acquisition of Independence.

Santander is the ninth largest bank in the world by market capitalization. It has over 10,000 offices and a presence in over 40 countries. It is the largest financial group in Spain and Latin America, and has a significant presence elsewhere in Europe, including the United Kingdom through its Abbey subsidiary and Portugal, where it is the third largest banking group. It also operates a leading consumer finance franchise in Germany, Italy, Spain and nine other European countries.

On October 24, 2005, Sovereign and Independence announced that they had entered into an Agreement and Plan of Merger, dated as of October 24, 2005 (the “Merger Agreement”), which sets forth the terms and conditions pursuant to which Independence will be merged with and into Sovereign (the “Merger”).

Under the terms of the Merger Agreement, shareholders of Independence will be entitled to receive $42.00 in cash, in exchange for each share of Independence common stock.

Independence has approximately $19.1 billion in assets, $12.2 billion in net loans, $3.6 billion in investments, $10.9 billion in deposits, $5.6 billion of borrowings and other debt obligations and $2.3 billion of stockholders’ equity. Independence is headquatered in Brooklyn, New York, with 125 branches located in the greater New York City metropolitan area, which includes the five boroughs of New York City, Nassau and Suffolk Counties and New Jersey. Management expects that this acquisition will fortify our presence as a leading banking company in the Northeast by connecting our Mid-Atlantic geographic footprint to New England and create new markets in certain areas of New York. Sovereign expects to complete the merger in 2006; however, completion of the merger is subject to a number of customary conditions, including but not limited to, the receipt of required regulatory approvals. Shareholders of Independence approved the Merger Agreement on January 25, 2006.

Financial Condition

     Loan Portfolio. Sovereign’s loan portfolio at December 31, 2005 was $43.8 billion, compared to $36.6 billion at December 31, 2004, and was comprised of $16.6 billion of commercial loans, $22.3 billion of consumer loans secured by real estate and $4.9 billion of consumer loans not secured by real estate. This compares to $13.9 billion of commercial loans, $18.1 billion of consumer loans secured by real estate, and $4.7 billion of consumer loans not secured by real estate at December 31, 2004.

Commercial loans grew by 20% during 2005 to $16.6 billion principally due to the Waypoint acquisition and loan origination activity. Consumer loans secured by real estate grew by 23% in 2005 to $22.3 billion as a result of business acquisitions, loan origination activity and loan purchases.

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,
		2005								2004								2003								2002								2001
		BALANCE				PERCENT				BALANCE				PERCENT				BALANCE				PERCENT				BALANCE				PERCENT				BALANCE				PERCENT
Commercial real estate loans		$	7,209,180				16.5	%		$	5,824,133				15.9	%		$	4,702,046				18.0	%		$	4,386,522				18.9	%		$	3,211,062				15.7	%
Commercial and industrial loans			9,426,466				21.5				8,040,107				21.9				6,361,640				24.3				5,940,234				25.6				5,402,971				26.4
Total Commercial Loans			16,635,646				38.0				13,864,240				37.8				11,063,686				42.3				10,326,756				44.5				8,614,033				42.1
Residential mortgages			12,462,802				28.4				8,497,496				23.2				5,074,684				19.4				4,347,512				18.7				5,005,219				24.5
Home equity loans and lines of credit			9,793,124				22.4				9,577,656				26.2				6,457,682				24.7				5,165,834				22.3				3,756,391				18.4
Total Consumer Loans secured by real estate (1)			22,255,926				50.8				18,075,152				49.4				11,532,366				44.1				9,513,346				41.0				8,761,610				42.8
Auto loans			4,434,021				10.1				4,205,547				11.5				3,240,383				12.4				3,038,976				13.1				2,733,106				13.4
Other			478,254				1.1				486,140				1.3				312,224				1.2				314,356				1.4				341,265				1.7
Total Consumer Loans			27,168,201				62.0				22,766,839				62.2				15,084,973				57.7				12,866,678				55.5				11,835,981				57.9
Total Loans		$	43,803,847				100.0	%		$	36,631,079				100.0	%		$	26,148,659				100.0	%		$	23,193,434				100.0	%		$	20,450,014				100.0	%
Total Loans with:
Fixed rates		$	26,141,411				59.7	%		$	21,145,915				57.7	%		$	15,171,129				58.0	%		$	13,599,898				58.6	%		$	12,875,742				63.0	%
Variable rates			17,662,436				40.3				15,485,164				42.3				10,977,530				42.0				9,593,536				41.4				7,574,272				37.0
Total Loans		$	43,803,847				100.0	%		$	36,631,079				100.0	%		$	26,148,659				100.0	%		$	23,193,434				100.0	%		$	20,450,014				100.0	%