Santander Holdings USA, Inc. - Annual Report: 2007 (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, 2007, 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		23-2453088
(State or other Jurisdiction		(I.R.S. Employer Identification No.)
of Incorporation or Organization)
1500 Market Street, Philadelphia, Pennsylvania		19102
(Address of Principal Executive Offices)		(Zip Code)

(267) 256-8601

Registrant’s Telephone Number

Title		Name of Exchange on Which Registered
Common stock, no par value		NYSE
Depository Shares for Series C non-cumulative preferred stock		NYSE
7.75% Capital Securities (Sovereign Capital Trust V)		NYSE
8.50% Cumulative Trust Preferred Securities (Seacoast Capital Trust I)		NASDAQ

(Sovereign Capital Trust IV) PIERS Units

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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act Yes 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. o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ      Accelerated filer o      Non-accelerated filer o      Smaller reporting company 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 $10,094,102,958 at June 30, 2007. As of February 14, 2008, the Registrant had 481,772,254 shares of Common Stock outstanding.

 

 

Form 10-K Cross Reference Index

		Page
Forward-Looking Statements			3
PART I
Item 1 — Business			4-7
Item 1A — Risk Factors			8-9
Item 1B — Unresolved Staff Comments			9
Item 2 — Properties			9
Item 3 — Legal Proceedings			10
Item 4 — Submission of Matters to a Vote of Security Holders			10
Item 4A — Executive Officers of the Registrant			10
PART II
Item 5 — Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			11
Item 6 — Selected Financial Data			12
Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations			13-52
Item 7A — Quantitative and Qualitative Disclosures About Market Risk			52
Item 8 — Financial Statements and Supplementary Data			52-110
Item 9 — Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			111
Item 9A — Controls and Procedures			111
Item 9B — Other Information			111
PART III
Item 10 — Directors, Executive Officers and Corporate Governance			111
Item 11 — Executive Compensation			111
Item 12 — Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			111-115
Item 13 — Certain Relationships and Related Transactions, and Director Independence			115
Item 14 — Principal Accounting Fees and Services			116
PART IV
Item 15 — Exhibits and Financial Statement Schedules			116-119
Signatures			120-121
SUBSIDIARIES OF REGISTRANT
CONSENT OF ERNST & YOUNG LLP
CEO CERTIFICATION PURSUANT TO RULE 13A-14(A) AND RULE 15D-14(A)
CFO CERTIFICATION PURSUANT TO RULE 13A-14(A) AND RULE 15D-14(A)
CEO CERTIFICATION PURSUANT SECTION 1350
CFO CERTIFICATION PURSUANT 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” or the “Company”). Sovereign may from time to time make forward-looking statements in Sovereign’s filings with the Securities and Exchange Commission (the “SEC” or the “Commission”) (including this Annual Report on Form 10-K and the Exhibits hereto), in its reports to shareholders (including its 2007 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 statements made 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. Although Sovereign believes that the expectations reflected in these forward-looking statements are reasonable, these statements are not guarantees of future performance and involve risks and uncertainties which are subject to change based on various important factors (some of which are beyond Sovereign’s control). Among the factors, which could cause Sovereign’s financial performance to differ materially from that expressed in the forward-looking statements are:

	•		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 in the securities markets, including those related to the financial condition of significant issuers in our investment portfolio;
	•		revenue enhancement initiatives may not be successful in the marketplace or may result in unintended costs;
	•		changing market conditions may force us to alter the implementation or continuation of cost savings or revenue enhancement strategies;
	•		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 in the United States;
	•		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;
	•		the outcome of ongoing tax audits by federal, state and local income tax authorities may require additional taxes be paid by Sovereign as compared to what has been accrued or paid as of period end.
	•		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 is 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 is the parent company of Sovereign Bank (“Sovereign Bank” or “the Bank”), a federally chartered savings bank. Sovereign had approximately 750 community banking offices, over 2,300 ATMs and about 12,000 team members as of December 31, 2007 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, multi-family loans, residential mortgage loans, home equity loans and lines of credit, and auto and other consumer loans in the communities served by those offices.

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 was incorporated in 1987 as a holding company for Sovereign Bank. 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 has acquired 28 financial institutions, branch networks and/or related businesses since 1990. Eighteen of these acquisitions, with assets totaling approximately $52 billion, have been completed since 1995. Sovereign’s latest acquisition was Independence Community Bank Corp. (“Independence”) effective June 1, 2006 for $42 per share in cash, representing an aggregate transaction value of $3.6 billion. Sovereign funded this acquisition using the proceeds from the $2.4 billion equity offering to Banco Santander Central Hispano (“Santander”), net proceeds from issuances of perpetual and trust preferred securities, and cash on hand. Sovereign issued 88.7 million shares to Santander, in connection with the equity offering which made Santander Sovereign’s largest shareholder. Independence was headquartered in Brooklyn, New York, had assets which totaled $17 billion and deposits of $11 billion and 125 community banking offices in the five boroughs of New York City, Nassau and Suffolk Counties and New Jersey. Sovereign acquired Independence to connect their Mid-Atlantic geographic footprint to New England and create new markets in certain areas of New York.

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. We believe that our institution has these characteristics.

Subsidiaries

Sovereign had three direct consolidated wholly-owned subsidiaries at December 31, 2007: Sovereign Bank is the only material subsidiary.

Employees

At December 31, 2007, Sovereign had 10,427 full-time and 1,549 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, Boston and New York, which are part 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.

As a result of the investment in Sovereign by Santander in May, 2006 as described below under “Control of Sovereign,” Sovereign is also now considered a subsidiary of a bank holding company for purposes of the Bank Holding Company Act of 1956, as amended. As such, Sovereign is prohibited from engaging in any activity, directly or through a subsidiary, that is not permissible for subsidiaries of bank holding companies. Generally, financial activities are permissible, while commercial and industrial activities are not.

     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.

Because Sovereign is also considered a subsidiary of Santander for Bank Holding Company Act purposes, Santander may be required to obtain approval from the Federal Reserve if Sovereign were to acquire shares of any depository institution (bank or savings institution) or any holding company of a depository institution. In addition, Santander may have to provide notice to the Federal Reserve if Sovereign acquires any financial entity that is not a depository institution, such as a lending company.

     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.

In May 2006, Sovereign and Santander entered into an Investment Agreement, pursuant to which, among other things, Santander purchased from Sovereign 88.7 million shares of Sovereign’s common stock for $2.4 billion in cash. In general the Investment Agreement contains a number of important restrictions on both Sovereign and Santander, including (i) certain standstill provisions that restrict Santander from purchasing securities of Sovereign, making an offer to purchase securities of Sovereign, or taking certain other actions, in each case unless certain conditions are satisfied and (ii) restrictions on the ability of Sovereign to solicit any acquisition proposals and on the manner in which Sovereign may respond to unsolicited acquisition proposals and obligations to provide Board representation to Santander. The proceeds of Santander’s investment were used to acquire the common stock of Independence. This investment was approved by the OTS. If Santander acquires 25% or more of Sovereign’s stock, Sovereign will no longer be a savings and loan holding company and will no longer be regulated by the OTS, although Sovereign Bank will continue to be regulated by the OTS as long as it remains a federal savings bank. For a more detailed description of the Investment Agreement, please see Part III — Item12 of this Form 10-K.

Santander is one of the largest banks 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, 2007, 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 Deposit 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 Deposit Insurance Fund. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OTS 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.

In February 2006, the Federal Deposit Insurance Reform Act (the “Reform Act”) was enacted. The new law merged the old Bank Insurance Fund and Savings Insurance Fund into the single Deposit Insurance Fund, increased deposit insurance coverage for IRAs to $250,000, provided for the further increase of deposit insurance on all accounts by indexing the coverage to the rate of inflation, authorized the FDIC to set the reserve ratio of the combined Deposit Insurance Fund at a level between 1.15% and 1.50%, and permitted the FDIC to establish assessments to be paid by insured banks to maintain the minimum ratios.

In November 2006, the FDIC adopted final regulations to implement the Reform Act. The final regulations included the annual assessment rates that went into effect at the beginning of 2007. The new assessment rates for nearly all banks vary between five and eight cents for every $100 of domestic deposits. Prior to 2007, most banks, including Sovereign, had not been required to pay any deposit insurance premiums since 1995. As part of the Reform Act, Congress provided credits to institutions that paid high deposit insurance premiums in the past to bolster the FDIC’s insurance reserves. The assessment credit for Sovereign was calculated at $29 million. This credit was recognized in 2007 to reduce deposit insurance premiums. The level of annual deposit premiums is dependent on the amount of Sovereign’s deposit assessment base. However, assuming our 2008 deposit base remains consistent with our 2007 deposit base our annual deposit premium would increase by $29 million.

In addition to deposit insurance premiums, 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. In 2007, Sovereign paid Finance Corporation Assessments of $6.0 million. The annual rate (as of the first quarter of 2008) for all insured institutions is $0.122 for every $1,000 in domestic deposits which is consistent with what was paid in 2007. These assessments are revised quarterly and will continue until the bonds mature in the year 2017.

     Federal Restrictions on Transactions with Affiliates and Insiders. All 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 or the Home Owners Loan Act (HOLA), 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 shareholders, 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 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 20% of its total assets in commercial loans not secured by real estate, however, only 10% can be large commercial loans not secured by real estate (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 total risk-based 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.

In late 2006 and in the first quarter of 2007, Sovereign completed a balance sheet restructuring which involved the sale of approximately $8 billion of assets consisting of correspondent home equity loans, purchased residential loans, multi-family loans, and certain investments. These sales were completed to enable Sovereign to reduce lower yielding and/or higher credit risk assets classes and pay down higher cost borrowings. Additionally, Sovereign began to focus on increasing the amount of higher yielding commercial loans which is expected to improve profitability. Although, Sovereign continues to originate residential and multi-family loans, the loans are primarily sold after origination into the secondary markets. As a result of this change in strategy, Sovereign commercial loans in total and as a percentage of assets have increased in 2007.

Although Sovereign is currently in compliance with the loan limitation statutes described above, Sovereign has had to temporarily increase the amount of assets throughout the latter half of 2007 that were not considered large commercial loans in order to comply with the above loan limitations. This temporary increase in assets was funded by increasing short-term borrowings with FHLB. The Company is working on a more permanent solution with the OTS to maintain compliance with this regulation in future periods and expects to have a permanent solution in place by the end of 2008. However, if we are not successful in these efforts we may need to take certain actions to reduce the amount of commercial loans not secured by real estate that are held on our balance sheet. These actions could include reducing the growth rate of our commercial loans not secured by real estate, selling commercial loans not secured by real estate or increasing the amount of residential or multi-family loans and /or investments that are retained on our balance sheet. Each of these actions is inconsistent with our current strategy and could adversely impact future earnings and capital levels.

     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 reduce an institution’s asset yields.

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 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. Sovereign Bank is a member of FHLB Pittsburgh, Boston, and New York and has utilized advances from the FHLB to fund balance sheet growth and provide liquidity. Sovereign had access to advances with the FHLB of up to $24 billion and had outstanding advances of $19.7 billion at December 31, 2007. The level of borrowings capacity Sovereign Bank has with the FHLB is contingent upon the level of qualified collateral the Bank holds at a given time.

     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.

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 with the 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 Sovereign’s Web site at www.sovereignbank.com as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. 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 associated provision for credit losses and legal 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 and could cause elevated levels of losses on our commercial and consumer loans.

•

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 the allowance for credit losses. Due to the inherent 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.

•

The Preparation of Sovereign’s Tax Returns Requires the Use of Estimates & Interpretations of Complex Tax Laws and Regulations and Are Subject to Review By Taxing Authorities.

     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 and filing returns, 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. The Company is subject to ongoing tax examinations and assessments in various jurisdictions.

•

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, and increase the amount that we must pay to attract deposits and borrow funds. 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 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 20% of our total assets in commercial loans that are not secured by real estate, however, only 10% can be large commercial loans not secured by real estate, more than 10% in small business loans, or more than four times our risk based capital in commercial real estate loans. A small business loan is one with an original amount of $2 million or less, and a large commercial loan is a loan with an original loan amount of more than $2 million. Our existing strategy is to focus loan growth on commercial loans which generally have higher yields and profitability. We may be limited in the amount of commercial loan growth that we can achieve based on the above regulations.

•

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.

•

We Rely on Third Parties for Important Products and Services.

     Third party vendors provide key components of our business infrastructure such as loan and deposit servicing systems, internet connections and network access. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delays and expense.

•

Our Framework for Managing Risks May Not be Effective in Mitigating Risk and Loss to Our Company.

     Our risk management framework is made up of various processes and strategies to manage our risk exposure. Types of risks to which we are subject include liquidity risk, credit risk, market risk, interest rate risk, operational risk, legal risk, compliance risk, reputation risk and fiduciary risk, among others. Our framework to manage risk, including the framework’s underlying assumptions, may not be effective under all conditions and circumstances. If our risk management framework proves ineffective, we could suffer unexpected losses and could be materially adversely affected.

•

Our Disclosure Controls and Procedures May Not Prevent or Detect All Errors or Acts of Fraud.

     Our disclosure controls and procedures are designed to reasonably assure that information required to be disclosed by us in reports we file or submit under the Exchange Act is accumulated and communicated to management, and recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.

     These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by any unauthorized override of the controls. Accordingly, because of the inherent limitations in our control system, misstatements due to error or fraud may occur and not be detected.

Item 1B — Unresolved Staff Comments

None.

Item 2 — Properties

Sovereign Bank utilizes 841 buildings that occupy a total of 6.3 million square feet, including 240 owned properties with 1.8 million square feet and 601 leased properties with 4.5 million square feet. Eight major buildings contain 1.3 million square feet, which serve as the headquarters or house significant operational and administrative functions:

     Columbia Park Operations Center — Dorchester, Massachusetts

     195 Montague Street Regional Headquarters for New York Metro — Brooklyn, New York

     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 8 properties of Sovereign outlined above are utilized by our Shared Services Consumer Bank segment and for general corporate purposes by our Other segment. The remaining 833 properties consist primarily of bank branches and lending offices used by our Mid-Atlantic, New England and Metro New York segments.

Item 3 — Legal Proceedings

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.

In January 2008, the Company received a letter from a purported shareholder demanding an investigation into the Board of Director’s oversight of several public disclosures made by the Company from June 2006 through January 2008, contending primarily that the Company inadequately disclosed its exposure to changes in the consumer credit market. The Board is currently analyzing the demand letter from the purported shareholder and will respond in due course after completing its consideration of the issues raised therein.

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 the date of this filing are set forth below:

Joseph P. Campanelli — Age 51. Mr. Campanelli became President and Chief Executive Officer of Sovereign and Sovereign Bank in October 2006. He 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 44. In May 2005, Mr. McCollom was named Chief Financial Officer of Sovereign. 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.

Salvatore J. Rinaldi — Age 53. Mr. Rinaldi was appointed Executive Vice President and Chief of Staff to Sovereign’s Chief Executive Officer in 2007. As Chief of Staff, he oversees Sovereign Bank’s administrative activities, including the company’s technology, operations, legal, CRA, and security groups. In addition, he is responsible for overseeing the bank’s conversion and integration management activities. In this role Mr. Rinaldi also supervises the operations, documentation, collections, and risk review processes for the bank’s middle market, specialty lending and auto finance groups. Prior to joining Sovereign in 1997, Rinaldi served nearly 24 years in a variety of senior positions with Fleet and Shawmut Banks. His responsibilities included dealer floorplan and indirect auto finance operations, collections, underwriting, audit, strategic planning and budgeting.

Robert M. Rose — Age 56. Mr. Rose has served as Credit Risk Management Officer and Executive Vice President of Sovereign since May 2004 and Executive Vice President and Regulation O Officer of Sovereign Bank since May 2004. Previously, Mr. Rose had served as Chief Credit Policy Officer and Executive Vice President of Sovereign from May 2002 until May 2004 and Chief Credit Officer and Senior Vice President of Sovereign from 2000 until May 2002.

Patrick J. Sullivan — Age 52. Mr. Sullivan was appointed to the position of Managing Director of Commercial Banking in 2008. Prior to being promoted to Managing Director of Commercial Banking, Mr. Sullivan was President and CEO of Massachusetts and New Hampshire. Mr. Sullivan has 30 years of experience in the banking industry and has held a variety of executive and management positions. He joined Sovereign in June of 2000 as Executive Vice President, Managing Director of Commercial Banking and Specialized Lending. Previously, he was President and Chief Executive Officer of Howard Bank.

Matthew A. Kerin — Age 53. Mr. Kerin was appointed Managing Director, Corporate Specialties Group in January 2008 assuming responsibility for Consumer Lending, Mortgage Banking and Global Services. Mr. Kerin joined the company in 2007 as Executive Vice President and Managing Director for Capital Markets and Wealth Management after having served in an advisory capacity to the CEO and executive management of Sovereign Bank since 2006. Previously, Kerin spent twenty years with Bank of America, FleetBoston Financial and predecessor entities, in various executive and senior management roles in asset management, strategic development, and corporate finance.

Roy J. Lever — Age 56. Mr. Lever was appointed to the position of Managing Director of Retail Banking in 2008. Prior to joining Sovereign, Mr. Lever served nearly 33 years in a variety of senior positions with Bank of America and Fleet Bank. Most recently, he was a Senior Vice President for Global Consumer and Small Business Banking at Bank of America and where he had responsibility for the bank’s compliance, risk and operations at more than 6,000 branches.

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 14, 2008, the total number of record holders of Sovereign’s common stock was 22,073.

Market and dividend information for Sovereign’s common stock appear in Item 7 — Table 13 “Selected Consolidated Financial Data” of this Form 10-K.

On January 24, 2008 Sovereign announced that it was discontinuing its quarterly dividend to common stock holders to help bolster capital and mitigate risk during the ongoing challenges facing the financial services industry. Sovereign’s Board of Directors will review whether to reinstate the common stock dividend in future periods. 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, 2007:

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)

10/1/07 through 10/31/07

390

$

18.48

Not Applicable

19,500,000

11/1/07 through 11/30/07

22

$

14.53

Not Applicable

19,500,000

12/1/07 through 12/31/07

1,545

$

12.28

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 1,957 shares outside of publicly announced repurchase programs during the fourth quarter of 2007.

Item 6 — Selected Financial Data

		SELECTED FINANCIAL DATA
		AT OR FOR THE YEAR ENDED DECEMBER 31,
		2007				2006				2005				2004				2003
(Dollars in thousands, except per share data)
Balance Sheet Data
Total assets		$	84,746,396			$	89,641,849			$	63,678,726			$	54,489,026			$	43,517,433
Loans held for investment, net of allowance			56,522,575				54,505,645				43,072,670				36,102,598				25,695,715
Loans held for sale(1)			547,760				7,611,921				311,578				137,478				137,154
Investment securities			15,142,392				14,877,640				12,557,328				11,546,877				12,618,971
Deposits and other customer accounts			49,915,905				52,384,554				37,977,706				32,555,518				27,344,008
Borrowings and other debt obligations			26,126,082				26,849,717				18,720,897				16,140,128				12,197,603
Stockholders’ equity		$	6,992,325			$	8,644,399			$	5,810,699			$	4,988,372			$	3,260,406
Summary Statement of Operations
Total interest income		$	4,656,256			$	4,326,404			$	2,962,587			$	2,255,917			$	1,951,888
Total interest expense			2,792,234				2,504,856				1,330,498				819,327				724,123
Net interest income			1,864,022				1,821,548				1,632,089				1,436,590				1,227,765
Provision for credit losses(1)			407,692				484,461				90,000				127,000				161,957
Net interest income after provision for credit losses(5)			1,456,330				1,337,087				1,542,089				1,309,590				1,065,808
Total non-interest income(1)			354,396				285,574				602,664				450,525				499,439
General and administrative expenses			1,345,838				1,289,989				1,089,204				942,661				852,364
Other expenses(1) (2)			1,874,600				313,541				163,429				236,232				157,984
(Loss)/Income before income taxes			(1,409,712	)			19,131				892,120				581,222				554,899
Income tax provision (benefit)			(60,450	)			(117,780	)			215,960				127,670				153,048
Net (Loss)/Income(3)		$	(1,349,262	)		$	136,911			$	676,160			$	453,552			$	401,851
Share Data
Common shares outstanding at end of period (in thousands)(3)			481,404				473,755				358,018				345,775				293,111
Basic (loss)/earnings per share(3)		$	(2.85	)		$	0.30			$	1.77			$	1.34			$	1.38
Diluted (loss)/earnings per share(3)		$	(2.85	)		$	0.30			$	1.69			$	1.29			$	1.32
Common share price at end of period		$	11.40			$	25.39			$	20.59			$	21.48			$	22.62
Dividends declared per common share		$	.320			$	.300			$	.170			$	.115			$	.100
Selected Financial Ratios
Book value per common share(4)		$	14.12			$	17.83			$	15.46			$	13.74			$	10.59
Common dividend payout ratio(5)			N/A				92.11	%			9.02	%			8.21	%			6.99	%
Return on average assets(6)			(1.62)	%			0.17	%			1.11	%			.90	%			.97	%
Return on average equity(7)			(15.40)	%			1.82	%			11.92	%			10.74	%			13.41	%
Average equity to average assets(8)			10.52	%			9.46	%			9.34	%			8.36	%			7.24	%

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 an $85 billion financial institution as of December 31, 2007, 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 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 geographic footprint.

Balance Sheet Restructuring and Expense Savings Initiatives

Our financial results for 2007 were significantly impacted by a number of factors. In the first half of 2007 we were focused on completing the balance sheet restructuring initiated at the end of 2006 and expense savings initiatives. During 2007, we completed a comprehensive review of Sovereign’s operating cost structure and began implementing the restructuring plan that was formulated late in 2006. The restructuring plan focused on the following three goals which we believed would help improve the quality of earnings, improve our financial performance, provide greater transparency and understanding of Sovereign’s businesses and strategy, and better position Sovereign for sustainable growth:

1.		Improve productivity and expense management
2.		Improve the capital position and quality of earnings
3.		Improve the customer experience

Our productivity and expense management initiative focused on eliminating functional redundancies and improving operating inefficiencies by deemphasizing products/business lines not meeting profit or strategic goals, leveraging economies of scale with vendor supply and service contracts, optimizing capacity utilization and expenses associated with facilities, consolidating departments and optimizing retail delivery channels while minimizing the impact on customer facing activities and organic revenue generation. Management identified approximately $100 million of expense reductions involving consolidation of support groups, exit of business lines performing below expectations, contract renegotiations, and a reduction in workforce.

In December 2006, Sovereign notified approximately 360 employees that their positions had been eliminated. Additionally, several members of executive management were terminated and/or resigned in the fourth quarter of 2006, including the Company’s former Chief Executive Officer. Sovereign incurred severance charges of $63.9 million in 2006 resulting from these events. In 2007, we terminated additional employees which resulted in severance charges of $13.7 million. Sovereign’s executive management team and Board of Directors also decided to freeze the Company’s Employee Stock Ownership Plan (ESOP). In 2007, the debt owed by the ESOP was repaid with the proceeds from the sale of a portion of the unallocated shares held by the ESOP and all remaining shares were allocated to the eligible participants. During 2007, Sovereign recorded a non-deductible non-cash charge of $40.1 million in connection with this action.

We also closed approximately 40 underperforming branch locations in 2007. In connection with the decision to close these locations, Sovereign recorded charges of $22.5 million in 2007. We intend to continue to make investments in our retail franchise and we have opened or relocated 16 new branches in 2007 and are targeting the opening or relocation of up to 20 branch offices during 2008.

In order to improve our capital position, Sovereign sold approximately $8.0 billion of low margin and/or high credit risk assets (which included the $3.4 billion of correspondent home equity loans, $2.9 billion of residential mortgage loans, $1.2 billion of multi-family loans, and $0.5 billion of investments) and reduced our wholesale funding significantly in the first quarter of 2007 with the proceeds from the sales. These loan sales enhanced the quality of our balance sheet, improved the quality of our earnings, and enhanced our capital ratios. The sale of these assets also helped to stabilize our net interest margin which was 2.73% for 2007 compared to 2.60% for the fourth quarter of 2006 and 2.75% for all of 2006.

The decision to sell the $8.0 billion of assets was made late in 2006 and as a result all of the loans to be sold were classified as held for sale and reported at the lower of cost or market at December 31, 2006. Approximately $4.3 billion of the assets included correspondent home equity loans which were written down to their estimated fair market value which resulted in a pretax charge of $296 million in the fourth quarter of 2006 that was recorded as additional provision for credit losses due to the determination that this reduction in fair value was primarily associated with credit factors and not interest rates. The majority of the correspondent home equity loans were non prime in nature and were held by customers outside of Sovereign’s branch footprint.

We sold $3.4 billion of the correspondent home equity loans in the first quarter of 2007. However, due to adverse market conditions for non-prime loans we decided not to sell $658 million of correspondent home equity loans. At the end of the first quarter of 2007, Sovereign transferred these remaining loans back into our held for investment loan portfolio. Before transferring these loans back into the held for investment loan portfolio, Sovereign marked this portfolio to market as of March 31, 2007 which resulted in a lower of cost or market write-down of $84.2 million. In addition to this charge, Sovereign also established a reserve for the $3.4 billion of correspondent home equity loans that were sold to cover any loans that may need to be repurchased from the buyers of these loans if any breaches of certain representation and warranty clauses contained within the sale agreement are discovered in future periods. We also were required to further write down the $3.4 billion of correspondent home equity loans that we sold in the first quarter due to lower pricing on the execution of the sales as a result of the deterioration in the loan portfolio and lower pricing in the market place for non-prime loans. The total charge recorded in connection with these two items was $35.7 million for the three-month period ended March 31, 2007. The total charge related to the correspondent home equity loan sale of $119.9 million for 2007 is reflected in mortgage banking income/(loss).

As a part of the restructuring plan, Sovereign also redeemed certain asset backed floating rate notes totaling $2.0 billion and junior subordinated debentures due to Capital Trust Entities totaling approximately $286 million. In connection with these transactions, Sovereign incurred debt extinguishment charges of $14.7 million in 2007.

Market Conditions and Credit

In the second half of 2007, conditions in the housing market continued to deteriorate and there was a significant tightening of available credit in the marketplace. Declining real estate values and financial stress on borrowers resulted in higher delinquencies and greater charge-offs in 2007 compared to 2006. Several companies that specialized in non prime residential real estate lending declared bankruptcy in 2007 or significantly curtailed their operations. Credit spreads significantly widened on various asset classes in the secondary marketplace which has led to a reduction in liquidity for these asset classes.

These changing market conditions impacted our financial results in the third and fourth quarters of 2007 in a number of ways. We began to see higher levels of losses on our remaining correspondent home equity portfolio due to a reduction in housing values and limited availability of credit in the marketplace which reduced refinancing options for these loan customers. Because the actual losses on the remaining correspondent home equity portfolio were higher than initially anticipated, Sovereign increased its provision for credit losses by an additional $47 million during the third quarter of 2007 for this portfolio.

In addition to our correspondent home equity portfolio, we saw elevated levels of losses in our auto loan portfolio in the second half of 2007. During the second half of 2006, Sovereign expanded its indirect auto loan business in the Southeastern and Southwestern United States (“the Southeast and Southwest production offices”). When we decided to expand our auto loan business into the Southeast and Southwest, we expected to see higher levels of losses than what we had historically experienced for our auto loan business in our geographic footprint given that it was a new market and economic conditions were different in these markets as compared to the Northeast. However, our pricing was adjusted to consider this expected difference in risk. The Southeast and Southwest production offices experienced significant growth in auto loan balances in 2007 with auto loan originations of approximately $2.8 billion or 57% of our 2007 total auto loan originations. The average yield on these loan originations was 8.04% in 2007 compared to 7.61% on our originations within our geographic footprint. However, credit losses were significantly higher than our expectations and were the primary reasons for additional provisions for credit losses that were recorded in the second half of 2007. Charge-offs on our auto portfolio totaled $76.2 million during 2007 compared to $30.5 million in 2006. However, 71% of our 2007 credit losses were recorded in the second half of the year. Additionally, more than half of these losses were related to the Southeast and Southwest production offices. At December 31, 2007, $2.6 billion of our auto loan portfolio consisted of loans originated in the Southeast and Southwest production offices.

In late December 2007, management decided to cease originating new loans in the Southeast and Southwest production offices effective January 31, 2008. Management also strengthened its underwriting standards in the third and fourth quarters of 2007 on its entire auto loan portfolio. We believe these two decisions will lower loss rates in future periods; however losses are anticipated to remain at elevated levels during the first half of 2008 as the newly originated loans continue to season. We believe the additional provisions responds to the increased risk in our auto loan portfolio. However, deterioration in the economy of the regions where we extended these loans could have a significant adverse impact on the amount of credit losses we experience in 2008.

In addition to increasing the provision for credit losses for the auto loan and correspondent home equity portfolios, Sovereign also increased the provision for credit losses to cover exposures in its commercial portfolio, as well as increased charge-offs. Our commercial reserves as a percentage of commercial loans increased to 1.40% at December 31, 2007, from 1.23% at December 31, 2006. This was due to an increase in the level of criticized and non-performing loans from the prior year and weakening market conditions. Additionally, we recorded additional provisions in 2007 due to growth of $2 billion on our commercial real estate and commercial and industrial loan portfolios.

Our total allowance for credit losses as a percentage of total loans increased to 1.28% at December 31, 2007 compared to 0.88% at December 31, 2006. We believe the reserves we have established are adequate to provide for inherent losses in our portfolio at this time. Although the credit quality of our loan portfolio will most likely have the most significant impact on our financial performance in 2008, we believe the recent steps we have taken with regards to our auto loan portfolio will reduce the credit risk in our consumer portfolio. Additionally, our residential and in-market consumer home equity loan portfolios have continued to perform well due to our high underwriting standards in these portfolios and the historical decision to not originate certain residential mortgage products that led to significant industry problems in 2007, such as teaser rate adjustable rate mortgages and negative amortization mortgage loans.

The disruption in the non-prime residential lending sector also negatively impacted the ability of some of our customers to repay certain financing agreements that Sovereign extended through our capital markets group. During the third and fourth quarters of 2007, we recorded $46.9 million of pre-tax losses on repurchase agreements and other financings that Sovereign provided to a number of mortgage companies who declared bankruptcy and/or defaulted on their agreements.

The disruption in the residential real estate market also had a significant impact on Fannie Mae (FNMA) and Freddie Mac (FHLMC) and caused credit spreads on preferred stock issuances of these companies to increase dramatically in the fourth quarter of 2007. Credit spreads on these securities increased by over 200 basis points in the fourth quarter which resulted in unrealized losses of $180.5 million on the $803 million of preferred stock that Sovereign held in these entities at December 31, 2007. At September 30, 2007, the unrealized loss on these same securities was $9.5 million. We recorded the unrealized loss of $180.5 million at December 31, 2007 as an other-than-temporary impairment in accordance with generally accepted accounting principles (GAAP). The FNMA and FHLMC preferred securities are investment grade and part of our available-for-sale investment portfolio. While Sovereign continues to believe that the market value of these securities will improve in the future, the company cannot say with certainty that this recovery will occur in the near-term; thus, an other-than-temporary impairment charge was recorded in the fourth quarter of 2007 as a component of non-interest income.

Goodwill Impairment

The market conditions and related concerns surrounding credit caused valuations for banking and other financial services companies to decrease significantly during the fourth quarter of 2007. The market price of our common stock decreased from a high of $25.16 during the second quarter of 2007 to a low of $10.08 in the fourth quarter of 2007, a 60% decrease. The significant drop in value caused our book value per common share to be significantly higher than our market stock price.

During the fourth quarter of 2007, we completed our annual assessment of goodwill using a third party valuation firm who considered the impact of current credit conditions, our 2007 actual results, expected results for 2008, as well as current market valuations. We evaluated goodwill for impairment for each of our reporting units under 3 different valuation approaches (transaction market approach, guideline company approach, and discounted net income approach) to ensure that the fair value of our reporting units was in excess of net book value including goodwill. Based on this analysis, we concluded that we had goodwill impairment in our Shared Services Consumer and Metro New York segments of $634 million and $943 million, respectively.

Our Shared Services Consumer segment primarily consists of our residential real estate lending and auto lending businesses. The impairment in our Shared Services Consumer segment was impacted by the negative events in the fourth quarter surrounding our auto portfolio. In the third quarter of 2007, the annual loss run rate for our auto loans was $76.4 million or 116 points. During the fourth quarter losses for the auto loan portfolio increased significantly beyond what was expected with an annual loss run rate of $135.8 million or 206 basis points. The majority of these losses related to loans originated in the Southeast and Southwest production offices. This led to our decision to cease originating loans from the Southeast and Southwest production offices effective January 31, 2008. The closing of these operations and the higher levels of consumer loan losses, had a significant negative impact on our anticipated future earnings for the Shared Services Consumer Segment. These facts, in addition to, the decrease in market valuations for all banks during the quarter of 2007 had a significant impact on the fair value of our consumer reporting unit. As a result we determined the Shared Services Consumer segment’s goodwill was impaired, resulting in a writedown of $634 million as of December 31, 2007.

In connection with our acquisition of Independence Bancorp in June 2006, Sovereign created a Metro New York segment. This segment is primarily comprised of the net assets of Independence and substantially all of Sovereign’s New Jersey banking offices. Total goodwill recorded in this segment was approximately $2.7 billion. Due to the significant drop in market valuations for financial institutions during the fourth quarter, as well as lower than anticipated revenue and deposit growth for this segment, Sovereign was required to record a goodwill impairment charge of $943 million related to its Metro New York segment. See Note 4 in our Consolidated Financial Statements for further discussion on our goodwill impairment charges recorded in 2007.

Profitability

The impact of all of the above items on Sovereign’s 2007 financial results was significant as Sovereign reported a net loss of $1.35 billion in 2007 compared to net income of $136.9 million in 2006.

Although Sovereign was negatively impacted by the events above, management was able to carry out many of its initiatives in 2007 including the balance sheet restructuring and expense savings initiative. We also believe that the timing of the $3.4 billion sale of correspondent home equity loans in the first quarter of 2007 was fortunate due to the adverse developments in the U.S. residential real estate market subsequent to our decision to sell these loans. If we had decided to sell these loans later in 2007, we believe our loss would have been materially higher. Despite our disappointing 2007 financial results, we are encouraged by certain core financial metrics. Net interest income, consumer and commercial fees, and operating expenses have been in line with our expectations and have increased from the prior year. In the fourth quarter of 2007, we piloted a new retail deposit strategy called “Customer First” in certain markets within our footprint. The goal of Customer First is to increase deposit retention and growth rates and increase the number of products and services our customers maintain and use at Sovereign. The results of this initial rollout were positive and we have begun the process of implementing Customer First throughout our entire branch network. The implementation of Customer First is an important initiative for Sovereign which we hope will help increase our profitability towards the end of 2008 and beyond.

RECENT INDUSTRY CONSOLIDATION IN OUR GEOGRAPHIC FOOTPRINT

The Banking industry has experienced significant consolidation in recent years, which is likely to continue in future periods. 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. Sovereign acquired Independence on June 1, 2006 which extended our operations to New York, a major market in the Northeast where we did not have significant operations previously. 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 a significant portion of the Company’s revenues. Accordingly, the interest rate environment has a substantial impact on Sovereign’s earnings. Sovereign currently has a mildly liability sensitive interest rate risk position. Sovereign restructured its balance sheet and sold approximately $8.0 billion of low margin and/or high credit risk assets in early 2007. We utilized the proceeds to pay off higher cost borrowings. These actions benefited our net interest margin in 2007 which increased to 2.73% compared to 2.60% in the fourth quarter of 2006. Net interest margin in future periods will be impacted by several factors such as but not limited to, our ability to grow and retain core deposits, the future interest rate environment, and loan and investment prepayment rates. We would expect our net interest margin to benefit from any substantial sustained expansion between long-term and short-term interest rates, and if we are able to grow low-cost core deposits. 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 had a significant impact on our operating results for 2007. Any significant change in the credit quality of our loan portfolio would have a significant effect on our financial position and results of operations. We have experienced a deterioration in certain key credit quality performance indicators in the second half of 2007. We had charge-offs of $143.8 million in 2007 compared to $529.1 million in 2006. However, charge-offs for 2006 were impacted by our decision to sell our correspondent home equity loan portfolio in 2006. As discussed earlier, Sovereign transferred $4.3 billion of correspondent home equity loans on December 31, 2006 to held for sale which resulted in a charge-off of $382.5 million. Prior to this, Sovereign had recorded charge-offs of $50.9 million on these loans in 2006. Therefore, after removing the impact of these losses, Sovereign’s credit losses for 2006 would have been $95.7 million.

During the first quarter of 2007, Sovereign sold $3.4 billion of correspondent home equity loans but decided to retain $658 million due to adverse market conditions. We wrote the loans that we retained down to fair value. This write-down included an estimate of future credit losses associated with the loans based on current market conditions at that time. Therefore, as losses have been experienced on these retained loans they have been recorded against our lower of cost or market adjustment which we established in the first quarter. The initial credit reserves which we established in the first quarter of 2007 are anticipated to be completely utilized in 2008 as this reserve totals only $11.9 million at December 31, 2007. Sovereign will begin recording charge-offs in 2008 against the allowance for loan loss beginning in the first quarter on this retained portfolio. However, as a result of conditions in the housing market and higher levels of losses on these retained loans Sovereign recorded additional provisions for credit losses of $50.5 million in 2007 which we believe is adequate to cover inherent losses in this portfolio. Although we believe our credit reserves at December 31, 2007 of $62.4 million are adequate to cover inherent losses, further deterioration in the economy of the regions we extended these loans and/or declines in residential real estate prices could result in Sovereign recording additional provisions for credit losses in future periods. As of December 31, 2007, Sovereign has $367.5 million of first lien and $131 million of second lien correspondent home equity loans.

Additionally, during 2007, Sovereign aggressively expanded its indirect auto loan portfolio via our Southeast and Southwest production offices. However credit losses were higher than our expectations and were the primary reasons for an additional $85 million of incremental provisions for credit losses that were recorded in the second half of 2007. Charge-offs on our auto portfolio totaled $76.2 million during 2007 compared to $30.5 million in 2006. However, 71% of our 2007 credit losses were recorded in the second half of the year. Additionally, 54% of these losses related to the Southeast and Southwest production offices.

In late December 2007, management decided to cease originating new loans in the Southeast and Southwest production offices effective January 31, 2008. Management also strengthened its underwriting standards in the second half of 2007 on its entire auto loan portfolio. We believe these two decisions will lower loss rates in future periods, however losses are anticipated to remain at elevated levels during the first half of 2008 as the newly originated loans continue to season. Additionally, deterioration in the economy of the regions where we extended these loans could have a significant adverse impact on the amount of credit losses we experience in 2008.

As discussed previously, conditions in the housing market significantly impacted certain areas of our business in 2007. Certain segments of our consumer and commercial loan portfolios have exposure to the housing market. Sovereign has residential real estate loans totaling $13.3 billion at December 31, 2007. However, credit losses on these loans have been quite low and totaled $7.5 million during 2007. Our fourth quarter loss rate did increase to 10 basis points which would equate to annualized 2008 losses of $14.5 million. However, these amounts are quite favorable compared to the industry. This can be attributed to Sovereign’s conservative underwriting approach for this portfolio as we did not originate any negative amortization loans nor did we offer any adjustable rate mortgages with below market rates during an introductory period (i.e. teaser rate loans). Although we do have Alt-A loans, (loans that provide customers reduced documentation requirements in return for quicker decisioning and higher interest rates) these loans are generally of a high quality and have a weighted average FICO at origination of 719 and average loan to values of 67%. However, given the recent trends in the residential real estate market, we believe that the loss trend on our residential loan portfolio will continue to increase. As a result we added additional reserves of $4.9 million in the fourth quarter of 2007 and have total reserves of $38.3 million for our residential loans portfolio. Future losses in our residential loan portfolio will continue to be significantly influenced by home prices in the residential real estate market. Sovereign also has $6.2 billion of home equity loans and lines of credit. Credit losses on these loans for 2007 were $8.1 million. This portfolio consists of loans with an average FICO at origination of 785 and average loan to values of 62%. We believe that declining house values and real estate conditions could cause losses on this portfolio to increase in future periods. Therefore, we added additional reserves for the portfolio in the fourth quarter of 2007 of $7.1 million and have total reserves of $28.5 million for our home equity portfolio.

The homebuilder industry has been impacted by a decline in new home sales and a reduction in the value of residential real estate which has decreased the profitability and liquidity of these companies. Declines in real estate prices in 2007 have been the most pronounced in certain states where previous increases were the most pronounced, such as California, Florida and Nevada. Additionally, foreclosures have increased sharply in certain midwest states due to increasing levels of unemployment. Sovereign provides financing to various homebuilder companies which is included in our commercial loan portfolio. At December 31, 2007 this portfolio totaled $1.2 billion and 80% of the loans are to builders in our geographic footprint. We believe our existing reserve levels are adequate to cover losses for these loans. However, we will continue to monitor this portfolio in future periods given recent market conditions and determine the impact, if any, on the allowance for loan losses related to these homebuilder loans.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

		YEAR ENDED DECEMBER 31,
(Dollars in thousands, except per share data)		2007				2006
Net interest income		$	1,864,022			$	1,821,548
Provision for credit losses			407,692				484,461
Total non-interest income			354,396				285,574
General and administrative expenses			1,345,838				1,289,989
Other expenses			1,874,600				313,541
Net (loss)/income		$	(1,349,262	)		$	136,911
Basic (loss)/earnings per share		$	(2.85	)		$	0.30
Diluted (loss)/earnings per share		$	(2.85	)		$	0.30

The major factors affecting comparison of earnings and diluted earnings per share between 2007 and 2006 were:

	•		Net interest income increased 2% during 2007 due to the full year impact of the Independence acquisition as well as organic balance sheet growth, which was offset by the impact of our balance sheet restructuring in the first quarter of 2007.
	•		Included in non-interest income:

	(1)		Net losses on investment securities of $176.4 million and $312.0 million in 2007 and 2006, respectively. Our 2007 and 2006 results included other-than-temporary impairment charges of $180.5 million and $67.5 million, respectively, on FNMA and FHLMC preferred stock. Net losses on investment securities in 2006 also included losses of $238.3 million on the sale of investment securities in the second quarter of 2006 and a $43.0 million loss on the sale of $1.5 billion of available for sale investments as part of the balance sheet restructuring in the fourth quarter of 2006. See Note 6 for additional details.
	(2)		An increase in consumer and commercial fee income in 2007 of $43.1 million. The continued growth in fee income in consumer and commercial banking is due to loan and deposit growth as a result of the full year impact of the Independence acquisition as well as strong growth in commercial loans.
	(3)		A decrease in capital markets revenues of $36.8 million due to charges of $46.9 million related to customers who defaulted on repurchase agreements and other financing obligations during 2007.
	(4)		A decrease in mortgage banking revenues in 2007 of $92.0 million due to a $119.9 million lower of cost or market adjustment related to the previously mentioned correspondent home equity loan transactions in the first quarter of 2007. In 2006, Sovereign also sold $2.9 billion of residential real estate loans and recorded a lower of cost or market adjustment of $28.2 million.

	•		Other expenses have increased due primarily to non-deductible goodwill impairment charges of $943 million in our Metro New York reporting unit and $634 million in our Shared Services Consumer reporting unit. See Note 4 for additional details on this charge. Sovereign also recorded restructuring and ESOP termination charges of $102.1 million in 2007 compared to $78.7 million in 2006. Additionally, merger-related charges of $2.2 million were incurred in 2007 compared to $42.4 million in 2006.
	•		The decrease in provision for credit losses in 2007 is related to the previously mentioned $296 million lower of cost or market adjustment for the correspondent home equity portfolio in the fourth quarter of 2006. This decline was partially offset by incremental provision for credit losses in 2007 for our indirect auto, correspondent home equity loans and commercial lending portfolios.
	•		Sovereign recorded an income tax benefit of $60.5 million in 2007 compared to a benefit of $117.8 million in 2006. Both 2007 and 2006 taxes were significantly impacted by the aforementioned restructuring and other significant charges which have magnified the impact of our favorable permanent tax-free items. See a later section of the MD&A for further discussion
	•		Increases in general and administrative expenses were due primarily to the full year impact of the Independence acquisition which closed on June 1, 2006, partially offset by cost savings from our expense reduction initiatives that were implemented in 2007.

     Net Interest Income. Net interest income for 2007 was $1.86 billion compared to $1.82 billion for 2006, or an increase of 2.3%. The increase in net interest income in 2007 was due to an increase in average interest-earning assets of $2.3 billion, which was related to the full year impact of the 2006 Independence acquisition and organic loan growth primarily in the commercial and auto portfolios offset by our balance sheet restructuring that was completed in the first quarter of 2007 in which we sold approximately $8.0 billion of low margin and/or high risk assets to reduce higher cost wholesale liabilities.

Interest on investment securities and interest-earning deposits was $792 million for 2007 compared to $775 million for 2006. The increase in interest income was due to higher yields in 2007 which averaged 6.15% compared to 5.82% in 2006. The increase in yield is primarily due to a rise in market interest rates and due to the investment restructurings Sovereign executed in the second and fourth quarters of 2006. This increase in yield in 2007 was offset by a decrease in average investments of $420 million during 2007 as a result of the balance sheet restructuring.

Interest on loans was $3.86 billion and $3.55 billion for 2007 and 2006, respectively. The average balance of loans was $58.0 billion with an average yield of 6.69% for 2007 compared to an average balance of $55.2 billion with an average yield of 6.45% for 2006. The overall growth in total loans resulted from the Independence acquisition and from origination activity in commercial and auto loans. The increase in average yields year to year is due primarily to increased yields on our auto loan portfolios. Auto loan yields have increased 102 basis points due to the previously mentioned expansion resulting from our Southeast and Southwest production offices. The Southeast and Southwest auto loans totaled $2.6 billion at the end of 2007 compared to $0.4 billion at December 31, 2006. At December 31, 2007, approximately 34% of our total loan portfolio reprices monthly or more frequently.

Interest on total deposits was $1.63 billion for 2007 compared to $1.37 billion for 2006. The average balance of deposits was $44.4 billion with an average cost of 3.67% for 2007 compared to an average balance of $41.2 billion with an average cost of 3.33% for 2006. Additionally, the average balance of non-interest bearing deposits increased to $6.4 billion in 2007 from $6.0 billion in 2006. The increase in the average balance of deposits was due to the acquisition of Independence.

Interest on borrowings and other debt obligations was $1.16 billion for 2007 compared to $1.13 billion for 2006. The average balance of total borrowings and other debt obligations was $22.2 billion with an average cost of 5.24% for 2007 compared to an average balance of $23.4 billion with an average cost of 4.85% for 2006. 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. The decrease in average balances is the result of the balance sheet restructuring.

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,
		2007												2006												2005
		Average								Yield/				Average								Yield/				Average								Yield/
		Balance				Interest				Rate				Balance				Interest				Rate				Balance				Interest				Rate
Interest-earning assets:
Interest-earning deposits		$	307,596			$	16,562				5.38	%		$	285,382			$	13,897				4.87	%		$	155,672			$	5,717				3.67	%
Investment securities(1)
Available for sale			12,971,273				804,025				6.20				11,217,296				658,966				5.87				7,404,848				385,158				5.20
Held to maturity			—				—				—				2,248,565				125,886				5.60				4,062,700				217,889				5.36
Other			901,197				51,645				5.73				849,040				51,414				6.06				623,005				18,058				2.90
Total investments			14,180,066				872,232				6.15				14,600,283				850,163				5.82				12,246,225				626,822				5.12
Loans:
Commercial loan			25,422,607				1,823,144				7.17				20,833,022				1,489,484				7.15				15,904,425				983,461				6.18
Multifamily			4,657,978				296,126				6.36				3,612,737				224,290				6.21				—				—				—
Consumer:
Residential mortgage			14,525,467				825,685				5.68				15,770,676				888,546				5.63				10,588,935				568,831				5.37
Home equity loans and lines of credit			6,868,727				469,760				6.84				10,119,375				654,760				6.47				10,157,824				567,548				5.59
Total consumer loans secured by real estate			21,394,194				1,295,445				6.06				25,890,051				1,543,306				5.96				20,746,759				1,136,379				5.48
Auto loans			6,187,487				433,172				7.00				4,457,932				266,806				5.98				4,356,121				233,283				5.36
Other			360,486				31,248				8.67				452,029				37,201				8.23				535,616				40,468				7.56
Total Consumer			27,942,167				1,759,865				6.30				30,800,012				1,847,313				6.00				25,638,496				1,410,130				5.50
Total loans			58,022,752				3,879,135				6.69				55,245,771				3,561,087				6.45				41,542,921				2,393,591				5.76
Allowance for loan losses			(533,263	)			—				—				(489,775	)			—				—				(420,879	)			—				—
Net loans(1)(2)			57,489,489				3,879,135				6.75				54,755,996				3,561,087				6.50				41,122,042				2,393,591				5.82
Total interest-earning assets			71,669,555				4,751,367				6.63				69,356,279				4,411,250				6.36				53,368,267				3,020,413				5.66
Non-interest-earning assets			11,646,477				—				—				10,139,116				—				—				7,363,707				—				—
Total assets		$	83,316,032			$	4,751,367				5.70	%		$	79,495,395			$	4,411,250				5.55	%		$	60,731,974			$	3,020,413				4.97	%
Interest-bearing liabilities:
Deposits:
NOW accounts		$	5,682,868			$	61,599				1.08	%		$	5,580,571			$	50,991				0.91	%		$	5,224,350			$	30,896				0.59	%
NOW accounts – government and wholesale			4,022,516				203,411				5.06				4,293,111				215,557				5.02				3,435,963				120,045				3.49
Customer repurchase agreements			2,545,304				108,137				4.25				1,639,453				74,470				4.54				960,092				26,566				2.77
Savings accounts			4,258,897				27,839				0.65				4,286,355				29,660				0.69				3,779,333				25,347				0.67
Money market accounts			9,902,914				347,077				3.50				8,346,033				225,167				2.70				7,900,301				119,341				1.51
Money market accounts- wholesale			2,443,111				130,807				5.35				2,558,549				137,802				5.39				344,105				12,013				3.49
Certificates of deposits			11,383,634				531,994				4.67				9,870,673				405,215				4.11				6,662,657				176,136				2.64
Certificates of deposits – wholesale			4,112,903				216,451				5.26				4,590,768				233,335				5.08				2,918,679				114,246				3.91
Total deposits			44,352,147				1,627,315				3.67				41,165,513				1,372,197				3.33				31,225,480				624,590				2.00
Total borrowings and other debt obligations			22,247,100				1,164,919				5.24				23,377,692				1,132,659				4.85				17,707,167				705,908				3.99
Total interest bearing liabilities			66,599,247				2,792,234				4.19				64,543,205				2,504,856				3.88				48,932,647				1,330,498				2.72
Non-interest-bearing DDA			6,386,359				—				—				6,020,184				—				—				5,294,135				—				—
Non-interest-bearing liabilities			1,568,869				—				—				1,412,368				—				—				831,296				—				—
Total liabilities			74,554,475				2,792,234				3.75				71,975,757				2,504,856				3.48				55,058,078				1,330,498				2.42
Stockholders’ equity			8,761,557				—				—				7,519,638				—				—				5,673,896				—				—
Total liabilities and stockholders’ equity		$	83,316,032			$	2,792,234				3.35	%		$	79,495,395			$	2,504,856				3.15	%		$	60,731,974			$	1,330,498				2.19	%
Net interest spread(3)											2.44	%											2.48	%											2.94	%
Taxable equivalent interest income/net interest margin							1,959,133				2.73	%							1,906,394				2.75	%							1,689,915				3.17	%
Tax equivalent basis adjustment							(95,111	)											(84,846	)											(57,826	)
Net interest income						$	1,864,022											$	1,821,548											$	1,632,089
Ratio of interest-earning assets to interest-bearing liabilities											1.08	x											1.07	x											1.09	x

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,
		2007 VS. 2006												2006 VS. 2005
		INCREASE/(DECREASE)												INCREASE/(DECREASE)
		Volume				Rate				Total				Volume				Rate				Total
Interest-earning assets:
Interest-earning deposits		$	1,130			$	1,535			$	2,665			$	5,879			$	2,301			$	8,180
Investment securities available for sale			107,239				37,820				145,059				218,809				54,999				273,808
Investment securities held to maturity			(62,943	)			(62,943	)			(125,886	)			(101,182	)			9,179				(92,003	)
Investment securities other			3,068				(2,837	)			231				8,335				25,021				33,356
Net loans(1)			182,149				135,899				318,048				862,362				305,134				1,167,496
Total interest-earning assets											340,117												1,390,837
Interest-bearing liabilities:
Deposits			110,871				144,246				255,117				241,660				505,948				747,608
Borrowings			(56,435	)			88,696				32,261				255,166				171,584				426,750
Total interest-bearing liabilities											287,378												1,174,358
Net change in net interest income		$	176,207			$	(123,468	)		$	52,739			$	497,377			$	(280,898	)		$	216,479

     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 2007 was $407.7 million compared to $484.5 million for 2006. Our provision for credit losses in 2006 includes the previously mentioned provision of $296.0 million on the transfer of $4.3 billion of correspondent home equity loans to held for sale status at December 31, 2006. See Note 7 for additional details. The provision in 2007 was impacted by the following items discussed below.

During 2007, Sovereign’s outstanding auto loan portfolio increased from $4.8 billion at December 31, 2006 to $7.0 billion at December 31, 2007. The majority of this growth was obtained through the Southwest and Southeast production offices, which had total originations of $2.8 billion in 2007. The average yield on this portfolio was 8.04%, compared to 7.61% on our 2007 loan originations within our geographic footprint. Although credit losses were expected to be higher in the Southeast and Southwest, we saw an increase in losses during the second half of 2007 in excess of what was expected. Management has decided to cease originations in the Southeast and Southwest auto lending business effective January 31, 2008 as a result of the low profitability on these loans. We increased the overall allowance for loan loss on the auto loan portfolio by $85 million during the second half of 2007 to provide for additional credit losses anticipated to be incurred on our auto loan portfolio.

In 2007, Sovereign recorded $50.5 million of additional reserves to cover higher expected losses on the correspondent home equity portfolio that was not sold due to adverse market conditions in the housing market. In 2007, Sovereign also experienced further deterioration in the credit quality of certain commercial loans due to weakening market conditions. As a result of market conditions, an increase in criticized and non-accrual loans and growth of $2 billion in our commercial real estate loans and commercial industrial loans, Sovereign increased the provision for credit losses by approximately $59 million for our commercial portfolio. Although we believe current levels of reserves are adequate to cover the inherent losses for these loans, future changes in housing values, interest rates and economic conditions could impact the provision for credit losses for these loans in future periods.

Finally, weakening credit conditions increased charge-offs in 2007 by $48.1 million (after removing the impact our correspondent home equity loan portfolio had on credit losses in 2006). The majority of our loan portfolios had higher loss rates in the current year compared to the prior year. This necessitated Sovereign to increase its credit reserves in 2007 to provide for the increased inherent credit risk in our loan portfolio.

Sovereign’s net charge-offs for 2007 were $143.8 million and consisted of charge-offs of $218.8 million and recoveries of $75.0 million. This compares to 2006 net charge-offs of $529.1 million consisting of charge-offs of $594.8 million and recoveries of $65.7 million. The decrease in charge-offs was driven by our correspondent home equity loan portfolio where net charge-offs decreased from $454.0 million in 2006 to an immaterial amount in 2007. The majority of this decrease was related to a $382.5 million charge-off we recorded when we reclassified $4.3 billion of loans to held for sale in 2006. Sovereign sold the majority of this portfolio in the first quarter of 2007 and the remaining loans in the portfolio were written down to fair value. As previously discussed, we will begin to have charge-offs on this portfolio in the first quarter of 2008 against the allowance for loan loss as the reserves established in connection with the lower of cost or fair value adjustment at the end of the first quarter of 2007 will be completely utilized in 2008 as this reserve totals only $11.9 million at December 31, 2007. However, we do not anticipate additional provisions for credit losses in 2008 since we have $50.5 million of reserves recorded in the allowance for loan loss for this portfolio. Although we believe our credit reserves at December 31, 2007 of $62.4 million are adequate to cover inherent losses, further deterioration in the economy of the regions we extended these loans and/or declines in residential real estate prices could result in Sovereign recording additional provisions for credit losses in future periods.

The ratio of net loan charge-offs to average loans, including loans held for sale, was 0.25% for 2007, compared to 0.96% for 2006. 2006 results were significantly impacted by the classifying of our correspondent home equity portfolio and certain residential loans as held for sale and recording them at the lower of cost or market. The consumer loans secured by real estate net charge-off rate was 0.07% for 2007, compared to 1.75% for 2006. Excluding $389.6 million of charge-offs associated with the correspondent home equity loans ($382.5 million) and purchased residential mortgage loans ($7.1 million) classified as held for sale at December 31, 2006, our consumer loans secured by real estate net charge-off rate would have been 0.25% in 2006. The consumer loans not secured by real estate net charge-off rate was 1.19% for 2007 and 0.66% for 2006. Commercial loan net charge-offs as a percentage of average commercial loans were 0.20% for 2007, compared to 0.21% for 2006. Charge-off trends for our entire portfolio have been increasing throughout 2007 and were 0.42% in the fourth quarter.

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

		2007				2006				2005				2004				2003
Allowance for loan losses, beginning of period		$	471,030			$	419,599			$	391,003			$	315,790			$	288,018
Allowance acquired in acquisitions			—				97,824				28,778				64,105				—
Provision for loan losses (2)			394,646				487,418				89,501				121,391				160,585
Allowance released in connection with loan sales or securitizations			(12,409	)			(4,728	)			(8,010	)			—				—
Charge-offs:
Commercial			65,670				56,916				40,935				77,499				101,597
Consumer secured by real estate			26,809				463,902				24,125				12,219				16,685
Consumer not secured by real estate			126,385				73,958				71,906				63,530				47,106
Total charge-offs (1)			218,864				594,776				136,966				153,248				165,388
Recoveries:
Commercial			15,187				14,097				13,100				12,825				7,531
Consumer secured by real estate			11,193				9,933				7,085				5,395				6,405
Consumer not secured by real estate			48,661				41,663				35,108				24,745				18,639
Total recoveries			75,041				65,693				55,293				42,965				32,575
Charge-offs, net of recoveries			143,823				529,083				81,673				110,283				132,813
Allowance for loan losses, end of period		$	709,444			$	471,030			$	419,599			$	391,003			$	315,790
Reserve for unfunded lending commitments, beginning of period			15,255				18,212				17,713				12,104				10,732
Provision for unfunded lending commitments (2)			13,046				(2,957	)			499				5,609				1,372
Reserve for unfunded lending commitments, end of period (3)			28,301				15,255				18,212				17,713				12,104
Total Allowance for credit losses		$	737,745			$	486,285			$	437,811			$	408,716			$	327,894
Net charge-offs to average loans (1)			.25	%			.96	%			.20	%			.36	%			.55	%

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

     Non-interest Income. Total non-interest income was $354.4 million for 2007 compared to $285.6 million for 2006. Several factors contributed to this change as discussed below.

Consumer banking fees were $295.8 million for 2007 compared to $276.0 million in 2006. This increase was primarily due to the growth in our investment services business where fees increased $12.0 million from $37.5 million in 2006 to $49.5 million in 2007, as well as the full year impact of the Independence acquisition which closed on June 1, 2006.

Commercial banking fees were $202.3 million for 2007 compared to $179.1 million in 2006. This increase of 13% was due to growth in average commercial loans which increased 22% in 2007 and expanded cash management capabilities and product offerings. Additionally, commercial banking fees were benefited by the full year impact of the Independence acquisition.

Mortgage banking results consist of fees associated with servicing loans not held by Sovereign, as well as amortization and changes in the fair value of mortgage servicing rights. Mortgage banking results also include gains or losses on the sales of mortgage, home equity loans and lines of credit and multifamily loans and mortgage-backed securities that were related to loans originated or purchased and held by Sovereign, as well as gains or losses on mortgage banking derivative and hedging transactions. Mortgage banking derivative instruments include principally interest rate lock commitments and forward sale commitments. Sovereign had a mortgage banking loss of $67.8 million for 2007 compared to net revenues of $24.2 million for 2006. The table below summarizes the components of net mortgage banking revenues (in thousands):

		Twelve-months ended December 31,
		2007				2006
Impairments to mortgage servicing rights		$	(1,415	)		$	(7,123	)
Mortgage servicing fees			42,197				30,799
Amortization of mortgage servicing rights			(36,806	)			(19,987	)
Net gains under SFAS 133			51				825
Net gain recorded on commercial mortgage backed securitization			4,475				—
Gain on sales of mortgages			18,295				1,965
Gain on sales of multifamily loans			26,203				17,760
Loss related to correspondent home equity portfolio			(120,792	)			—
Total		$	(67,792	)		$	24,239

During 2007, Sovereign sold $3.7 billion of multi-family loans and recorded gains of $26.2 million in connection with the sales compared to $1.6 billion of multi-family loans and related gains of $17.8 million for the seven month period in 2006, which began with the acquisition of Independence Community Bank in June of 2006. Sovereign also sold $7.6 billion of mortgage loans with related gains of $2.0 million in 2006. 2006 results were negatively impacted by a charge of $23 million on the decision to sell $2.9 billion of residential loans as part of our previously discussed balance sheet restructuring. In 2007, Sovereign sold $3.1 billion of mortgage loans and recorded gains of $18.3 million. Mortgage banking revenues declined from the prior year due to the previously discussed losses on the correspondent home equity portfolio.

In 2007, Sovereign securitized $687.7 million and $327.0 million of multi-family and commercial real estate loans, respectively and retained certain subordinated certificates in this transaction. In connection with the $1.0 billion securitization, Sovereign recorded a net gain of $10.5 million. This gain was determined based on the carrying amount of the loans sold, including any related allowance for loan loss, and was allocated to the loans sold and the retained interests, based on their relative fair values at the sale date. Additionally, Sovereign recorded hedge losses of $7.8 million during 2007 related to certain multifamily and commercial real estate loans held for sale.

At December 31 2007, Sovereign serviced approximately $11.2 billion of residential mortgage loans for others and our net mortgage servicing asset was $141.1 million, compared to $9.2 billion of loans serviced for others and a net residential mortgage servicing asset of $117.4 million, at December 31, 2006. 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. For 2007, Sovereign recorded mortgage servicing right impairment charges of $1.4 million due to an increase in prepayment speed assumptions and changes in interest rates compared to impairment charges of $7.1 million in 2006.

     Listed below are the most significant assumptions that were utilized by Sovereign in its evaluation of mortgage servicing rights for the periods presented.

		December 31, 2007				December 31, 2006				December 31, 2005
CPR speed			14.70	%			14.23	%			12.42	%
Escrow credit spread			5.12	%			4.85	%			4.16	%

Sovereign will periodically sell qualifying mortgage loans to FHLMC, GNMA, and FNMA (“Fannie Mae”) in return for mortgage-backed securities issued by those agencies. Sovereign reclassifies the net book balance of the loans sold to such agencies from loans to investment securities available for sale. For those loans sold to the agencies in which Sovereign retains servicing rights, Sovereign allocates the net book balance transferred between servicing rights and investment securities based on their relative fair values. If Sovereign sells the mortgage-backed securities which relate to underlying loans previously held by the Company, the gain or loss on the sale is recorded in mortgage banking income in the accompanying consolidated statement of operations.

The gain or loss on the sale of all other mortgage-backed securities is recorded in gains on sales of investment securities on the consolidated statement of operations.

Sovereign originates and sells multi-family loans in the secondary market to Fannie Mae while retaining servicing. Generally, the Company can originate and sell loans to Fannie Mae for not more than $20.0 million per loan. Under the terms of the sales program with Fannie Mae, we retain a portion of the credit risk associated with such loans. As a result of this agreement with Fannie Mae, Sovereign retains a 100% first loss position on each multi-family loan sold to Fannie Mae under such program until the earlier to occur of (i) the aggregate losses on the multifamily loans sold to Fannie Mae reaching the maximum loss exposure for the portfolio as a whole or (ii) until all of the loans sold to Fannie Mae under this program are fully paid off. The maximum loss exposure is available to satisfy any losses on loans sold in the program subject to the foregoing limitations.

The maximum loss exposure of the associated credit risk related to the loans sold to Fannie Mae under this program is calculated pursuant to a review of each loan sold to Fannie Mae. A risk level is assigned to each such loan based upon the loan product, debt service coverage ratio and loan to value ratio of the loan. Each risk level has a corresponding sizing factor which, when applied to the original principal balance of the loan sold, equates to a recourse balance for the loan. The sizing factors are periodically reviewed by Fannie Mae based upon its ongoing review of loan performance and are subject to adjustment. The recourse balances for each of the loans are aggregated to create a maximum loss exposure for the entire portfolio at any given point in time. The Company’s maximum loss exposure for the entire portfolio of sold loans is periodically reviewed and, based upon factors such as amount, size, types of loans and loan performance, may be adjusted downward. Fannie Mae is restricted from increasing the maximum exposure on loans previously sold to it under this program as long as (i) the total borrower concentration (i.e., the total amount of loans extended to a particular borrower or a group of related borrowers) as applied to all mortgage loans delivered to Fannie Mae since the sales program began does not exceed 10% of the aggregate loans sold to Fannie Mae under the program and (ii) the average principal balance per loan of all mortgage loans delivered to Fannie Mae since the sales program began continues to be $4.0 million or less.

The Company has established a liability which represents the fair value of the retained credit exposure. This liability represents the amount that the Company estimates that it would have to pay a third party to assume the retained recourse obligation. The estimated liability represents the present value of the estimated losses that the portfolio is projected to incur based upon an industry-based default curve with a range of estimated losses. At December 31, 2007, Sovereign had a $23.5 million liability related to the fair value of the retained credit exposure for loans sold to Fannie Mae under this sales program.

At December 31, 2007 and December 31, 2006, Sovereign serviced $10.9 billion and $8.0 billion, respectively, of loans for Fannie Mae that had been sold to Fannie Mae pursuant to this program with a maximum potential loss exposure of $206.8 million and $152.3 million, respectively. As a result of retaining servicing, the Company had loan servicing assets of $20.4 million at December 31, 2007 and 2006. Sovereign recorded servicing asset amortization of $10.7 million and $4.2 million related to the multi-family loans sold to Fannie Mae for 2007 and recognized servicing assets of $10.8 million.

Capital markets revenues decreased to a loss of $19.3 million for 2007 compared to net gains of $17.6 million in 2006. In 2007, we recorded charges of $46.9 million within capital markets revenue related to losses on repurchase agreements and other financing obligations that Sovereign provided to a number of mortgage companies who declared bankruptcy and/or defaulted on their agreements. These mortgage companies have been impacted by adverse developments in the non-prime sector. The repurchase agreements and other financing obligations are secured by rated and non-rated investment securities and/or mortgage loans. The charge Sovereign recorded on the repurchase agreements and other financing obligations was necessary since the value of the underlying collateral was less than the outstanding amount of the repurchase agreement. The realization of the amounts due under the repurchase agreements and other financing obligations is dependant on the value of the underlying collateral. Although we believe that this collateral has been appropriately valued based on current conditions, future market value changes may impact our results in 2008 if the collateral is liquidated and sold for less than our fair value estimates.

Income related to bank owned life insurance increased to $85.9 million for 2007 compared to $67.0 million in 2006. This $18.9 million, or 28% increase, was due to the acquisition of Independence, which increased bank owned life insurance assets by $343 million, as well as increased death benefits in 2007.

Net losses on sales of investment securities were $176.4 million for 2007, compared to $312.0 million for 2006. Included in 2007 was an other-than-temporary impairment charge of $180.5 million on FNMA and FHLMC preferred stock. In the fourth quarter of 2007, FNMA and FHLMC announced a number of significant charges which impacted their financial results, and FHLMC and FNMA also announced reductions in their common stock dividends and raised additional capital via preferred stock issuances at rates in excess of what we are receiving on our investments. These events caused the unrealized losses on our FNMA and FHLMC preferred stock portfolio to increase significantly in the fourth quarter to $180.5 million from $9.5 million at September 30, 2007. As a result, we recorded an other-than-temporary impairment charge. Included in 2006 was an investment restructuring charge of $238.3 million and an other-than-temporary impairment charge of $67.5 million on FNMA and FHLMC preferred stock in the second quarter and a $43.0 million loss on the sale of $1.5 billion of available for sale investments as part of the balance sheet restructuring in the fourth quarter of 2006. See Note 6 for further discussion and analysis of our determination that the unrealized losses in the investment portfolio at December 31, 2007 were considered temporary.

     General and Administrative Expenses. Total general and administrative expenses were $1.35 billion for 2007 compared to $1.29 billion in 2006, or an increase of 4.7%. The increase in 2007 is primarily related to the full year effect of the Independence acquisition, partially offset by savings associated with our 2007 cost saving initiative. At December 31, 2007, Sovereign had total employees of 11,976 compared to 12,513 in 2006, a 4% decrease. Sovereign’s efficiency ratio, (all general and administrative expenses as a percentage of net interest income and total fees and other income) for 2007 was 56.2% compared to 53.3% for 2006. The increase is primarily due to a reduction in revenue in 2007 compared to 2006 due to the impact of the previously discussed capital market and correspondent home equity charges which negatively impacted fee income.

     Other Expenses. Total other expenses were $1.9 billion for 2007 compared to $313.5 million for 2006. In 2007, we recorded a $1.58 billion goodwill impairment charge related to the Company’s Metro New York and Consumer reporting units. See Note 4 for details on this impairment charge. Other expenses included amortization expense of core deposit intangibles of $126.7 million for 2007 compared to $109.8 million for 2006. This increase is due to the full year effect of amortization expense associated with core deposit intangible established in connection with the Independence acquisition. In 2007, net merger-related expenses were $2.2 million, compared to $42.4 million in 2006 which was primarily associated with the Independence acquisition. In 2007, Sovereign recorded restructuring charges of $62.0 million, compared to $78.7 million in 2006 which was associated with executive and other employee severance arrangements and other restructuring charges activities. See Note 28 for details on these charges.

During 2007, Sovereign’s executive management team and Board of Directors decided to freeze the Company’s Employee Stock Ownership Plan (ESOP). The debt owed by the ESOP was repaid with the proceeds from the sale of a portion of the unallocated shares held by the ESOP and all remaining shares were allocated to the eligible participants. Sovereign recorded a non-deductible, non-cash charge of $40.1 million during 2007 based on the value of its common stock on the date that the ESOP was repaid.

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”). Reductions in the investment value and our allocation of the partnership’s earnings or losses totaled $26.2 million and $26.3 million for 2007 and 2006, respectively, and are included as expense in the line “Minority interest expense and equity method investment expense” in our consolidated statement of operations, while the alternative energy tax credits we receive are included as a reduction of income tax expense. This investment matured at the end of 2007; therefore, Sovereign will not incur any expenses or receive any tax credits related to the Synthetic Fuel Partnership in future periods.

During the fourth quarter of 2005, Sovereign terminated $211.3 million of receive fixed-pay variable interest rate swaps that were hedging the fair value of $211.3 million of junior subordinated debentures due to capital trust entities. The fair value adjustment to the basis of the debt was $11.6 million at the date of termination. Sovereign had utilized the short-cut method of assessing hedge effectiveness under SFAS No. 133 when this hedge was in place. On July 21, 2006, in connection with the SEC’s review of the Company’s filings, it was determined that this hedge did not qualify for the short-cut method due to the fact that the junior subordinated debentures contained an interest deferral feature. As a result, Sovereign recorded a pretax charge of $11.4 million in 2006 to write-off the remaining fair value adjustment.

Also impacting other expenses in 2006 were proxy and related professional fees of $14.3 million related to the Relational Investors LLC (“Relational”) matter which was settled. During 2007, Sovereign recouped $0.5 million of this charge from insurance carriers. We do not anticipate any material impact to future results due to our settlement with Relational on this matter.

     Income Tax Benefit. The income tax benefit was $60.5 million for 2007 compared to a benefit of $117.8 million for 2006. The effective tax rate for 2007 was (4.3)% compared to (615.8)% for 2006. The current year tax rate differs from the statutory rate of 35% due to the fact that the $1.58 million goodwill charge and the ESOP charge of $40.1 million are both not deductible for tax purposes. The impact of this on the effective tax rate is slightly mitigated by our favorable permanent tax-free items which are principally due 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.

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. The Company is subject to ongoing tax examinations and assessments in various jurisdictions. The Internal Revenue Service (the “IRS”) is currently examining the Company’s federal income tax returns for the years 2002 through 2005. The Company anticipates that the IRS will complete this review in 2008. Included in this examination cycle are two separate financing transactions with an international bank, totaling $1.2 billion which are discussed in Note 12. As a result of these transactions, Sovereign was subject to foreign taxes of $154.0 million during the years 2003 through 2005 and claimed a corresponding foreign tax credit for foreign taxes paid during those years. In 2006 and 2007, Sovereign accrued an additional $87.6 million and $22.9 million of foreign taxes from these financing transactions and claimed a corresponding foreign tax credit. It is possible that the IRS may challenge the Company’s ability to claim these foreign tax credits and could disallow the credits and assess interest and penalties related for this transaction. Sovereign believes that it is entitled to claim these foreign tax credits and also believes that its recorded tax reserves for this position of $56.9 million adequately provides for any liabilities to the IRS related to foreign tax credits and other tax assessments. However, the completion of the IRS review and their conclusion on Sovereign’s tax positions included in the tax returns for 2002 through 2005 could result in an adjustment to the tax balances and reserves that have been recorded and may materially affect Sovereign’s income tax provision in future periods.

     Line of Business Results. 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, Pennsylvania, and Maryland. The New England Banking Division is comprised of our branch locations in Massachusetts, Rhode Island, Connecticut and New Hampshire. The Metro New York Banking Division is comprised of our branch locations in New York and New Jersey. All 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, and our indirect automobile 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. The Other segment 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 of 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 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 allocated to each business line based on a risk profile of their loan portfolio. 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. 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 decreased $12.8 million to $305.8 million in 2007. The decrease in net interest income was principally due to margin compression on a matched funded basis. The net spread on a match funded basis for this segment was 2.37% in 2007 compared to 2.53% in 2006. The average balance of Mid-Atlantic Banking Division’s loans was $5.0 billion and $4.6 billion during 2007 and 2006, respectively. The average balance of deposits was $8.2 billion in 2007 compared to $8.3 billion in 2006. The provision for credit losses increased in 2007 to $31.7 million from $11.1 million in 2006 due to increased net loan charge-offs in 2007. General and administrative expenses (including allocated corporate and direct support costs) decreased from $284.8 million for 2006 to $283.1 million for 2007. The reduction in general and administrative expenses is due to the 2007 cost savings initiative which was implemented by Sovereign’s management team.

The New England Banking Division’s net interest income decreased $26.1 million to $630.4 million in 2007. The decrease in net interest income was principally due to margin compression on a matched fund basis. The net spread on a match funded basis for this segment was 2.61% in 2007 compared to 2.88% in 2006. The average balance of New England Banking Division’s loans was $6.4 billion and $5.6 billion during 2007 and 2006, respectively. The average balance of deposits was $18.3 billion in 2007 compared to $17.7 billion in 2006. The increase in fees and other income of $1.7 million to $169.7 million for 2007 was due to an increase in deposit fees, which reflects the increase in average deposits. The provision for credit losses increased in 2007 to $30.2 million from $12.7 million in 2006 due to increased net loan charge-offs in 2007. General and administrative expenses (including allocated corporate and direct support costs) decreased from $490.9 million for 2006 to $477.5 million for 2007. The reduction in general and administrative expenses is due to the 2007 cost savings initiative which was implemented by Sovereign’s management team.

The Metro New York Banking Division’s net interest income increased $114.5 million to $568.6 million in 2007. The increase in net interest income was principally due to the full year impact of the Independence acquisition which closed on June 1, 2006. The average balance of loans was $11.8 billion versus $8.9 billion during 2007 and 2006, respectively. The average balance of deposits was $16.2 billion in 2007 compared to $13.1 billion in 2006. The increase in fees and other income of $31.7 million to $139.6 million was primarily generated by increased mortgage banking revenues which was primarily due to increased gains on sales of mortgages and multifamily loans in 2007 as well as increased deposit fees which reflects the increase in average deposits. The provision for credit losses increased $15.5 million to $37.7 million in 2007 due to higher levels of charge-offs in the commercial loan portfolio in 2007 which was due to the full year impact of the Independence acquisition. Included in the 2006 provision is the $12.5 million charge recorded at June 30, 2006 to increase reserves on Independence’s multifamily loan portfolio. General and administrative expenses (including allocated corporate and direct support costs) increased from $314.2 million for 2006 to $435.3 million for 2007. The increase in general and administrative expenses is principally due to the full year impact of the Independence acquisition. The net income before income taxes for the Metro New York segment decreased from $200.2 million in 2006 to a loss of $707.5 million in 2007 due to the previously discussed $943 million goodwill impairment charge attributable to this segment.

Shared Services Consumer segment net interest income decreased $6.8 million to $317.0 million in 2007. The decrease in net interest income was principally due to the reduction in our loan portfolio. The net spread on a match funded basis for this segment was 1.51% in 2007 compared to 1.34% in 2006. The average balance of Shared Services Consumer loans was $22.5 billion and $25.5 billion during 2007 and 2006, respectively. The average balance of deposits was $152.7 million in 2007 compared to $140.0 million in 2006. The decrease in fees and other income of $96.1 million to $(79.3) million for 2007 was primarily generated by decreased mortgage banking revenues which was primarily due to the previously mentioned charge of $119.9 million on our correspondent home equity loan portfolio. The provision for credit losses decreased in 2007 to $233.4 million from $411.9 million in 2006 due primarily to the $296.0 million additional provision for our correspondent home equity portfolio in 2006. However, 2007 losses on our indirect auto portfolio totaled $76.2 million in 2007, compared with $30.5 million in 2006. Credit losses in this segment were much higher than anticipated due primarily to auto loans that were originated by our Southeast and Southwest production offices. General and administrative expenses (including allocated corporate and direct support costs) decreased from $119.8 million for 2006 to $111.6 million for 2007. The reduction in general and administrative expenses is due to the 2007 cost savings initiative. The net loss before income taxes for the Shared Services Consumer segment increased from $207.2 million in 2006 to $761.8 million in 2007 due to the previously discussed $634 million goodwill impairment charge attributable to this segment.

Shared Services Commercial segment net interest income increased $25.7 million to $263.2 million for 2007 compared to 2006 due to increases in average commercial assets. The average balance of Shared Services Commercial loans was $12.3 billion in 2007 versus $10.6 billion during 2006. The net spread on a match funded basis for this segment was 2.17% in 2007 compared to 2.36% in 2006. Fees and other income have decreased by $29.6 million to $119.3 million principally due to the $46.9 million charge within capital markets revenues, partially offset by an increase in investment services fee income. The provision for credit losses increased by $48.0 million in 2007 to $74.8 million due to higher levels of commercial charge-offs in 2007 which was due to an increase in criticized assets, primarily in the construction lending, commercial real estate and commercial industrial lending portfolios. General and administrative expenses (including allocated corporate and direct support costs) increased slightly from $138.7 million for 2006 to $149.4 million in 2007.

The net loss before income taxes for the Other segment decreased from $620.9 million in 2006 to $465.6 million in 2007. Net interest expense increased from $168.8 million in 2006 to $220.9 million for 2007. The Other segment includes net losses on securities of $176 million and $312 million in 2007 and 2006, respectively. The 2007 loss resulted from the previously discussed $180.5 million other-than-temporary impairment charge on FNMA and FHLMC preferred stock. The 2006 loss resulted from the previously discussed $67.5 million other-than-temporary impairment charge on the FNMA and FHLMC preferred stock in our investment portfolio, as well as the $238.3 million and $43.0 million of securities losses recorded in the second and fourth quarters of 2006. The 2007 and 2006 results included charges associated with executive and other employee severance arrangements and certain other restructuring activities of $62.0 million and $78.7 million, respectively. The 2007 and 2006 results also included net charges of $2.2 million and $42.4 million for merger and integration charges, respectively. Finally, the Other segment included $26.2 million and $26.3 million of expense associated with the Synthetic Fuel Partnership, as well as amortization of intangibles of $126.7 million and $109.8 million in 2007 and 2006, respectively.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005

		YEAR ENDED DECEMBER 31,
(Dollars in thousands, except per share data)		2006				2005
Net interest income		$	1,821,548			$	1,632,089
Provision for credit losses			484,461				90,000
Total non-interest income			285,574				602,664
General and administrative expenses			1,289,989				1,089,204
Other expenses			313,541				163,429
Net income		$	136,911			$	676,160
Basic earnings per share		$	0.30			$	1.77
Diluted earnings per share		$	0.30			$	1.69

The major factors affecting comparison of earnings and diluted earnings per share between 2006 and 2005 were:

	•		The growth in net interest income was driven by the increase in the balance of earning assets, as a result of the Independence acquisition as well as organic balance sheet growth, partially offset by a decline in net interest margin to 2.75% in 2006 from 3.17% in 2005. The decline in margin was due to the flattening yield curve, which contracted the spread between our longer-term assets and shorter–term liabilities and lower than expected low cost core deposit growth which forced the Company to fund asset growth with higher cost borrowings and wholesale deposit obligations.
	•		Included in non-interest income:

	(1)		Net losses on investment securities of $238.3 million on the sale of investment securities and an other-than-temporary impairment charge of $67.5 million on FNMA and FHLMC preferred stock in the second quarter of 2006 and a $43.0 million loss on the sale of $1.5 billion of available for sale investments as part of the balance sheet restructuring in the fourth quarter of 2006. See Note 6 for additional details.
	(2)		An increase in consumer and commercial fee income in 2006 of $49.1 million. The continued growth in fee income in consumer and commercial banking is due to loan and deposit growth as a result of Independence acquisition as well as strong growth in commercial loans.
	(3)		A decrease in mortgage banking revenues in 2006 of $63.9 million is due to a $28.2 million lower of cost or market adjustment related to the previously mentioned $2.9 billion residential real estate portfolio that is classified as held for sale. In 2005, Sovereign also sold $1.4 billion of home equity loans and recognized a gain of $32.1 million. Sovereign did not recognize any gains associated with sales of home equity loans in 2006.

	•		Other expenses increased due primarily to employee severance and restructuring charges of $78.7 million in 2006 compared to only $4.0 million in 2005. Additionally, merger-related charges of $42.4 million were incurred in 2006 compared to charges of $12.7 million in 2005.
	•		The increase in provision for credit losses in 2006 is primarily related to the previously mentioned lower of cost or market adjustment for the correspondent home equity portfolio in the fourth quarter. Since the loss was determined to be solely related to credit deterioration, Sovereign recorded an additional provision of $296 million.
	•		Sovereign recorded an income tax benefit of $117.8 million in 2006 compared to an income tax provision of $216.0 million in 2005. The reason for the variance was due to the low level of pre-tax earnings in 2006 due to the aforementioned restructuring and other significant charges in 2006 which have magnified the impact of our favorable permanent tax-free items.
	•		Increases in general and administrative expenses were due primarily to the Independence acquisition.

     Net Interest Income. Net interest income for 2006 was $1.82 billion compared to $1.63 billion for 2005, or an increase of 11.6%. The increase in net interest income in 2006 was due to an increase in average interest-earning assets of $16.0 billion, which was related to the 2006 Independence acquisition and organic loan growth primarily in the commercial and residential mortgage portfolios. The increase in our assets was funded principally by time deposits and other borrowings. Net interest margin (net interest income divided by average interest-earning assets) was 2.75% for 2006 compared to 3.17% for 2005. The decline in margin was driven by the flattening yield curve experienced in 2006 and 2005, which has contracted the spread between our longer-term assets and shorter-term liabilities and a shift to higher-cost wholesale deposits and borrowing obligations.

Interest on investment securities and interest-earning deposits was $775 million for 2006 compared to $576 million for 2005. The increase in interest income was due to an increase in the average balance of investment securities from $12.2 billion in 2005 to $14.6 billion in 2006, as well as higher yields in 2006 which averaged 5.82% compared to 5.12% in 2005.

Interest on loans was $3.55 billion and $2.39 billion for 2006 and 2005, respectively. The average balance of loans was $55.2 billion with an average yield of 6.45% for 2006 compared to an average balance of $41.5 billion with an average yield of 5.76% for 2005. The increase in average yields year to year is due to the increase of market rates experienced during 2006. The overall growth in total loans resulted from the Independence acquisition and from origination activity in commercial loans. At December 31, 2006, approximately 30% of our loan portfolio reprices monthly or more frequently.

Interest on total deposits was $1.37 billion for 2006 compared to $625 million for 2005. The average balance of deposits was $41.2 billion with an average cost of 3.33% for 2006 compared to an average balance of $31.2 billion with an average cost of 2.00% for 2005. Additionally, the average balance of non-interest bearing deposits increased to $6.0 billion in 2006 from $5.3 billion in 2005. The increase in the average balance of deposits was due to the acquisition of Independence.

Interest on borrowings and other debt obligations was $1.13 billion for 2006 compared to $706 million for 2005. The average balance of total borrowings and other debt obligations was $23.4 billion with an average cost of 4.85% for 2006 compared to an average balance of $17.7 billion with an average cost of 3.99% for 2005. 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.

     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 2006 was $484.5 million compared to $90.0 million for 2005. The higher provision in 2006 was driven by the previously mentioned $296.0 million lower of cost or market adjustment in our correspondent home equity loan portfolio in the fourth quarter, loan portfolio growth and higher net loan charge-offs. The provision increased from $90.0 million, or 0.22% of average loan outstandings in 2005, to $484.5 million, or 0.88% of average loan outstandings in 2006. The overall allowance for credit losses as a percentage of loans held for investment outstanding has declined from 1.01% in 2005 to 0.88% in 2006. This is reflective of the addition of $5.6 billion of multi-family loans from the Independence acquisition which has historically had very low loss experience and therefore have lower reserve requirements, as well as the reclassification of our correspondent home equity loan portfolio to loans held for sale as these loans carried higher reserve requirements than our blended loan portfolio. 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 2006 were $529.1 million and consisted of charge-offs of $594.8 million and recoveries of $65.7 million. This compares to 2005 net charge-offs of $81.7 million consisting of charge-offs of $137.0 million and recoveries of $55.3 million. The increase in charge-offs was driven by our correspondent home equity loan portfolio where net charge-offs increased from $17.0 million in 2005 to $454.0 million in 2006. The majority of this increase was related to a $382.5 million charge-off we recorded when we reclassified $4.3 billion of loans to held for sale.

The ratio of net loan charge-offs to average loans, including loans held for sale, was 0.96% for 2006, compared to 0.20% for 2005. Commercial loan net charge-offs as a percentage of average commercial loans were 0.21% for 2006, compared to 0.18% for 2005. The consumer loans secured by real estate net charge-off rate was 1.75% for 2006, compared to 0.08% for 2005. The consumer loans not secured by real estate net charge-off rate was 0.66% for 2006 and 0.75% for 2005. Excluding $389.6 million of charge-offs associated with the correspondent home equity loans ($382.5 million) and purchased residential mortgage loans ($7.1 million) classified as held for sale at December 31, 2006, our net loan charge-offs to average loans would have been 0.25% and our consumer loans secured by real estate net charge-off rate would have been 0.25% in 2006. The deterioration in these ratios in 2006 is principally due to the correspondent home equity loan portfolio.

     Non-interest Income. Total non-interest income was $285.6 million for 2006 compared to $602.7 million for 2005. Several factors contributed to this change as discussed below.

Consumer banking fees were $276.0 million for 2006 compared to $256.6 million in 2005. This increase was primarily due to increased deposit fees which increased 6.3%, resulting from growth in average core deposit balances which increased 23% primarily as a result of the Independence acquisition. 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 $179.1 million for 2006 compared to $149.3 million in 2005. This increase of 20% was due to growth in average commercial loans which increased 31% in 2006 and expanded cash management capabilities and product offerings.

Mortgage banking revenues were $24.2 million for 2006 compared to $88.1 million for 2005. The principal components of mortgage banking revenues are: gains or losses from the sale or securitization of mortgage, home equity and multifamily loans, 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 table below summarizes the components of net mortgage banking revenues (in thousands):

		Twelve-months ended December 31,
		2006				2005
Impairments to mortgage servicing rights		$	(7,123	)		$	5,944
Mortgage servicing fees			30,799				20,376
Amortization of mortgage servicing rights			(19,987	)			(17,578	)
Net (losses) gains under SFAS 133			825				645
Sales of mortgage loans and mortgage backed securities			19,725				78,730
Total		$	24,239			$	88,117

There were a number of transactions in 2006 that caused the decrease of $63.9 million in mortgage banking revenues from the 2005 levels. Included in 2006 results is $2.9 billion of residential mortgage loans transferred to held for sale in the fourth quarter where Sovereign recorded a loss of $28.2 million. 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. Sovereign did not record any gains associated with home equity loans in 2006. In 2006, Sovereign sold multi-family loans totaling $1.58 billion and recorded gains related to these sales of approximately $17.8 million. Additionally due primarily to changes in prepayment speeds a $7.1 million impairment charge was recorded in 2006 compared to a recovery of $5.9 million in 2005. 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.

Income related to bank owned life insurance increased to $67.0 million for 2006 compared to $47.3 million in 2005. This $19.7 million, or 42% increase, was due to the acquisition of Independence which increased bank owned life insurance assets by $343 million as well as purchases of additional bank owned life insurance by Sovereign of approximately $300 million during 2006.

Net gains/ (losses) on sales of investment securities were $(312.0) million for 2006, compared to $11.7 million for 2005. Included in 2006 was an investment restructuring charge of $238.3 million and an other-than-temporary impairment charge of $67.5 million on FNMA and FHLMC preferred stock in the second quarter and a $43.0 million loss on the sale of $1.5 billion of available for sale investments as part of the balance sheet restructuring in the fourth quarter of 2006.

     General and Administrative Expenses. Total general and administrative expenses were $1.3 billion for 2006 compared to $1.1 billion in 2005, or an increase of 18.4%. The increase in 2006 is primarily related to the Independence acquisition and the full year effect of the Waypoint acquisition, as well as increased compensation and benefit costs associated with the hiring of additional team members. At December 31, 2006, Sovereign had total employees of 12,513 compared to 10,174 in 2005, a 23% increase. In addition, marketing and other administrative expenses increased to support the growth in our franchise. Sovereign’s efficiency ratio, (all general and administrative expenses as a percentage of net interest income and total fees and other income) for 2006 was 53.3% compared to 49.0% for 2005. The increase was primarily due to net interest margin compression as well as the impact of the number of large adjustments recorded in 2006 discussed previously.

     Other Expenses. Total other expenses were $313.5 million for 2006 compared to $163.4 million for 2005. Other expenses included amortization expense of core deposit intangibles of $109.8 million for 2006 compared to $73.8 million for 2005. This increase is due to the additional intangible amortization expense associated with core deposit and other intangible assets of $394.2 million recorded in connection with the Independence acquisition. In 2006, net merger-related expenses were $42.4 million primarily associated with the Independence acquisition, compared to $12.7 million in 2005. In 2006, Sovereign recorded charges of $78.7 million associated with executive and other employee severance arrangements and other restructuring charges activities, as discussed previously.

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”). Reductions in the investment value and our allocation of the partnership’s earnings or losses totaled $26.3 million and $28.2 million for 2006 and 2005, respectively and are included as expense in the line “Minority interest expense and equity method investment expense” in our consolidated statement of operations, while the alternative energy tax credits we receive are included as a reduction of income tax expense.

During the fourth quarter of 2005, Sovereign terminated $211.3 million of receive fixed-pay variable interest rate swaps that were hedging the fair value of $211.3 million of junior subordinated debentures due to capital trust entities. The fair value adjustment to the basis of the debt was $11.6 million at the date of termination. Sovereign had utilized the short-cut method of assessing hedge effectiveness under SFAS No. 133 when this hedge was in place. On July 21, 2006, in connection with the SEC’s review of the Company’s filings, it was determined that this hedge did not qualify for the short-cut method due to the fact that the junior subordinated debentures contained an interest deferral feature. As a result, Sovereign recorded a pretax charge of $11.4 million in the second quarter of 2006 to write-off the remaining fair value adjustment.

Also impacting other expenses were proxy and related professional fees of $14.3 million recorded in the three-month period ended March 31, 2006.

     Income Tax Provision/(Benefit). Sovereign recorded an income tax benefit of $117.8 million for 2006 compared to a provision of $216.0 million for 2005. The effective tax rate for 2006 was (615.8)% compared to 24.2% for 2005. The current year tax rate differs from the statutory rate of 35% due to the significant charges recorded in 2006 which has magnified the impact of our favorable permanent tax-free items which are principally due 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.

Line of Business Results. The Mid-Atlantic Banking Division’s net interest income decreased $11.4 million to $318.6 million in 2006. The decrease in net interest income was principally due to margin compression on a matched funded basis. The net spread on a match funded basis for this segment was 2.53% in 2006 compared to 2.59% in 2005. The average balance of Mid-Atlantic Banking Division’s loans was $4.6 billion and $4.5 billion during 2006 and 2005, respectively. The average balance of deposits was $8.3 billion in 2006 compared to $8.4 billion in 2005. General and administrative expenses (including allocated corporate and direct support costs) increased from $261.8 million for 2005 to $284.8 million for 2006.

The New England Banking Division’s net interest income decreased $7.9 million to $656.5 million in 2006. The decrease in net interest income was principally due to margin compression on a matched fund basis. The net spread on a match funded basis for this segment was 2.88% in 2006 compared to 2.92% in 2005. The average balance of New England Banking Division’s loans was $5.6 billion and $5.4 billion during 2006 and 2005, respectively. The average balance of deposits was $17.7 billion in 2006 compared to $17.6 billion in 2005. The increase in fees and other income of $7.3 million to $168.1 million for 2006 was generated by deposit fees and loan fees, which grew with the increased level of deposits and loans. The provision for credit losses increased in 2006 to $12.7 million from $8.4 million in 2005 due to increased net loan charge-offs in 2006. General and administrative expenses (including allocated corporate and direct support costs) increased from $467.8 million for 2005 to $490.9 million for 2006.

The Metro New York Banking Division’s net interest income increased $201.5 million to $454.1 million in 2006. The increase in net interest income was principally due to the acquisition of Independence on June 1, 2006. The average balance of loans was $8.9 billion versus $1.7 billion during 2006 and 2005, respectively. The average balance of deposits was $13.1 billion in 2006, compared to $6.7 billion in 2005. The increase in fees and other income of $57.7 million to $107.9 million was due primarily due to the acquisition of Independence on June 1, 2006. The provision for credit losses increased $17.4 million to $22.1 million in 2006. Included in the 2006 provision is the $12.5 million charge recorded at June 30, 2006 to increase reserves on Independence’s multifamily loan portfolio. General and administrative expenses (including allocated corporate and direct support costs) increased from $144.6 million for 2005 to $314.2 million for 2006. The increase in general and administrative expenses is principally due to the acquisition of Independence on June 1, 2006.

Shared Services Consumer segment net interest income decreased $13.3 million to $323.8 million in 2006. The decrease in net interest income was principally due to spread compression on a matched funded basis. The net spread on a match funded basis for this segment was 1.34% in 2006 compared to 1.55% in 2005. The average balance of Shared Services Consumer loans was $25.5 billion and $21.1 billion during 2006 and 2005, respectively. The average balance of deposits was $140.0 million in 2006 compared to $150.1 million in 2005. The decrease in fees and other income of $86.3 million to $16.8 million for 2006 was primarily generated by decreased mortgage banking revenues from the sale of mortgage and home equity loans. These gains decreased to $1.5 million in 2006 from $78.7 million in 2005 due to the previously discussed reduction in mortgage banking revenues in 2006 compared to 2005. Mortgage banking revenue is contingent upon loan growth and market conditions. The provision for credit losses increased in 2006 to $411.9 million from $52.7 million in 2005 due primarily to the $296.0 million additional provision for our correspondent home equity portfolio. Additionally, our correspondent home equity loan charge-offs were $60.4 million in 2006 (excluding the year-end held for sale charge-off) compared to $21.4 million in 2005. General and administrative expenses (including allocated corporate and direct support costs) decreased from $129.9 million for 2005 to $119.8 million for 2006.

Shared Services Commercial segment net interest income increased $1.3 million to $237.4 million for 2006 compared to 2005 due to increases in average commercial assets. The average balance of Shared Services Commercial loans was $10.6 billion in 2006 versus $8.9 billion during 2005. The net spread on a match funded basis for this segment was 2.36% in 2006 compared to 2.63% in 2005. Fees and other income have increased by $10.4 million to $148.9 million principally from increases in income related to our precious metals business. The provision for credit losses increased by $20.1 million in 2006 to $26.7 million compared to 2005 due to higher levels of commercial charge-offs in 2006 which was due in part to one large commercial charge-off of $14 million recorded in December 2006. General and administrative expenses (including allocated corporate and direct support costs) increased slightly from $135.9 million for 2005 to $138.7 million in 2006.

The net loss before income taxes for the Other segment increased from $209.1 million in 2005 to $620.9 million in 2006. Net interest expense decreased from $188.1 million in 2005 to $168.8 million for 2006. The Other segment includes net losses on securities of $312 million in 2006, as compared to a net gain of $11.7 million recorded in 2005. This resulted from the previously discussed $67.5 million other-than-temporary impairment charge on the FNMA and FHLMC preferred stock in our investment portfolio as well as the $238.3 million and $43.0 million of securities losses recorded in the second and fourth quarters of 2006. The 2006 results included $78.7 million of charges associated with executive and other employee severance arrangements and certain other restructuring activities. The 2006 and 2005 results also included net charges of $42.4 million and $12.7 million for merger and integration charges. Finally, the Other segment included $26.3 million and $28.2 million of expense associated with the Synthetic Fuel Partnership, as well as amortization of intangibles of $109.8 million and $73.8 million in 2006 and 2005, respectively.

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 and reserve for unfunded lending commitments, securitizations, goodwill, derivatives and hedging activities and income taxes 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 is 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. During 2007, we recorded significant increases to the provision for credit losses and the allowance for loan losses and reserve for unfunded lending commitments as a result of higher credit losses and deterioration in asset quality statistics for the commercial and consumer loan portfolios. Changes in these estimates could have a direct material 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. For example, a change in the estimate resulting in a 5% to 10% difference in the allowance for loan losses and reserve for unfunded lending commitments would have resulted in an additional provision for credit losses of $36.9 million to $73.8 million as of December 31, 2007. 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, multifamily and commercial real estate 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, after our goodwill impairment charge of $1.58 billion recorded in 2007, totaled $3.4 billion at December 31, 2007.

The Company follows SFAS No. 142, “Goodwill and Other Intangible Assets,” to account for its goodwill. This statement provides that goodwill and other indefinite lived intangible assets will not 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 requires an annual impairment test. In addition, goodwill is tested more frequently if changes in circumstances or the occurrence of events indicate impairment potentially exists. During 2007, Sovereign’s financial results were impacted by an increase in credit losses, slower than anticipated growth in low cost core deposits, and a continued unfavorable interest rate environment. Sovereign recorded a number of significant charges in 2007 as previously discussed which caused current year results to be less than our internal plan. These events, as well as decreases in valuations for all banks and the decision to cease originating loans from our Southeast and Southwest production offices, had a negative impact on the fair value of our segments.

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. Additionally, management engaged a valuation specialist to assist management in its fair value assessment of its reporting units. As a result of the finalization of our 2007 goodwill impairment analysis, Sovereign recorded a goodwill impairment charge of $1.58 billion related to our Shared Services Consumer and Metro New York segments. See Note 4 for details on this charge.

Our Shared Services Consumer segment primarily consists of our residential real estate lending and auto loan businesses. The impairment in our Shared Services Consumer segment was impacted by the negative events in the fourth quarter surrounding our auto portfolio. In the third quarter of 2007, the annual loss run rate for our auto loans was $76.4 million or 116 basis points. During the fourth quarter losses for the auto loan portfolio continued to increase significantly beyond what was expected and the annual loss run rate was $135.8 million or 206 basis points. The majority of these losses came from loans originated in the Southeast and Southwest production offices. This led to our decision to cease originating loans from the Southeast and Southwest production offices in late December 2007, effective January 31, 2008. The closing of these operations and the higher levels of consumer loan losses had a significant negative impact on our anticipated future earnings for the Shared Services Consumer Segment. These facts, in addition to the decrease in market valuations for all banks during the fourth quarter of 2007, had a significant impact on the fair value of our Shared Services Consumer reporting unit. As a result we concluded that fair value was less than net book value and determined the Shared Services Consumer segment’s goodwill impairment was $634 million.

In connection with our acquisition of Independence Bancorp in June 2006, Sovereign created a Metro New York segment. This segment is primarily comprised of the net assets of Independence and substantially all of Sovereign’s New Jersey banking offices. Total goodwill recorded in this segment was approximately $2.7 billion. Due to the significant drop in market valuations for financial institutions during the fourth quarter, as well as lower than anticipated revenue and deposit growth for this segment, Sovereign was required to record a goodwill impairment charge of $943 million related to its Metro New York segment. See Note 4 in our Consolidated Financial Statements for further discussion on our goodwill impairment charges recorded in 2007.

     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 2007 and 2006, 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, 2007, were no longer considered effective, and thus did not qualify as hedges, the impact in 2007 would have been to lower pre-tax earnings by approximately $216.4 million.

     Income Taxes. The Company accounts for income taxes in accordance with SFAS No. 109 “Accounting for Income Taxes”. Under this pronouncement, deferred taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates that will apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date. See Note 18 for details on the Company’s income taxes.

Sovereign is subject to the income tax laws of the U.S., its states and municipalities as well as certain foreign countries. These tax laws are complex and subject to different interpretations by the taxpayer and the relevant Governmental taxing authorities. Sovereign adopted the provisions of Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, an interpretation of SFAS 109, Accounting for Income Taxes on January 1, 2007. FIN 48 prescribes a comprehensive model for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return. Under FIN 48, tax positions shall initially be recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions shall initially and subsequently be measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and all relevant facts. FIN 48 also revises disclosure requirements to include an annual tabular rollforward of unrecognized tax benefits. In establishing a provision for income tax expense, the Company must make judgments and interpretations about the application of these inherently complex tax laws within the framework of FIN 48 and SFAS 109.

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.

The Internal Revenue Service (the “IRS”) is currently examining the Company’s federal income tax returns for the years 2002 through 2005. The Company anticipates that the IRS will complete this review in 2008. Included in this examination cycle are two separate financing transactions with an international bank, totaling $1.2 billion which are discussed in Note 12. As a result of these transactions, Sovereign was subject to foreign taxes of $154.0 million during the years 2003 through 2005 and claimed a corresponding foreign tax credit for foreign taxes paid during those years. In 2006 and 2007, Sovereign accrued an additional $87.6 million and $22.9 million of foreign taxes from these financing transactions and claimed a corresponding foreign tax credit. It is possible that the IRS may challenge the Company’s ability to claim these foreign tax credits and could disallow the credits and assess interest and penalties related for this transaction. Sovereign believes that it is entitled to claim these foreign tax credits and also believes that its recorded tax reserves for this position of $56.9 million adequately provides for any liabilities to the IRS related to foreign tax credits and other tax assessments. However, the completion of the IRS review and their conclusion on Sovereign’s tax positions included in the tax returns for 2002 through 2005 could result in an adjustment to the tax balances and reserves that have been recorded and may materially affect Sovereign’s income tax provision in future periods.

Recent Acquisitions

On June 1, 2006, Sovereign acquired Independence for $42 per share in cash, representing an aggregate transaction value of $3.6 billion and the results of their operations are included in the accompanying financial statements subsequent to the acquisition date. Sovereign funded this acquisition using the proceeds from the $2.4 billion equity offering to Santander, net proceeds from issuances of perpetual and trust preferred securities and cash on hand. Sovereign issued 88.7 million shares to Santander, which made Santander its largest shareholder. Independence was headquartered in Brooklyn, New York, with 125 community banking offices in the five boroughs of New York City, Nassau and Suffolk Counties and New Jersey and had total assets and deposits of $17.1 billion and $11.0 billion, respectively. Sovereign’s acquisition of Independence connected our Mid-Atlantic and New England geographic footprints and created new markets in certain areas of New York. Sovereign recorded merger-related and integration charges of $42.8 million pre-tax ($27.8 million after-tax), or $0.06 per diluted share, in 2006.

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 markets in certain counties in Maryland. Sovereign recorded merger related and integration charges of $16.7 million pre-tax ($10.9 million after-tax), or $0.03 per diluted share in 2005.

Financial Condition

     Loan Portfolio. Sovereign’s loan portfolio at December 31, 2007 was $57.8 billion (including $548 million of loans held for sale), compared to $62.6 billion (including $7.6 billion of loans held for sale) at December 31, 2006, and was comprised of $30.9 billion of commercial loans (includes $4.2 billion of multifamily loans), $19.5 billion of consumer loans secured by real estate and $7.3 billion of consumer loans not secured by real estate. This compares to $30.5 billion of commercial loans (including $5.8 billion of multifamily loans), $26.8 billion of consumer loans secured by real estate, and $5.3 billion of consumer loans not secured by real estate at December 31, 2006.

Commercial real estate loans and commercial and industrial loans grew by 8% or $2.0 billion during 2007 to $26.7 billion. The increase in commercial loans has been driven by organic loan growth, offset by the sale of $327 million of commercial real estate loans as part of a securitization in the second quarter. The increase in commercial loans as a percentage of the total loan portfolio is consistent with management’s restructuring plan to deemphasize lower yielding residential and multi-family loans and increase our commercial loan portfolio. Our ability to continue to increase our commercial loan portfolio may be adversely affected by certain regulatory limitations under HOLA. See Part I – Item 1 – Business – Supervision and Regulation.

Multifamily loans decreased by 26% or $1.5 billion in 2007 to $4.2 billion. The decrease from the prior year is due to initiatives to reduce the percentage of this asset class that is held on balance sheet and increase the amount that can be sold to Fannie Mae or the secondary markets. In the second quarter of 2007, Sovereign sold $687.7 million of this loan portfolio as part of a commercial mortgage backed securitization. In the first quarter of 2007, Sovereign sold $1.3 billion of this loan portfolio as part of the Company’s previously discussed balance sheet restructuring plan.

Consumer loans secured by real estate decreased by 27% or $7.3 billion in 2007 to $19.5 billion as a result of the sale of $3.4 billion of correspondent home equity loans and $2.9 billion of residential loans that occurred during the first quarter of 2007 in connection with the balance sheet restructuring. We also sold more of our residential real estate loans in 2007 versus 2006 to reduce the amount of residential loans held for investment.

Consumer loans not secured by real estate increased by 39% in 2007 to $7.3 billion as a result of organic in-market growth and expansion in production offices in the Southeastern and Southwestern United States. The Southeast and Southwest production offices significantly contributed to the growth in auto loan balances in 2007, and these loans comprise approximately 36% of our outstanding auto loan portfolio and approximately 57% of our 2007 auto loan originations, however credit losses were higher than our expectations and were the primary reason for an additional $85 million of incremental provisions in excess of charge-offs that were recorded in the second half of 2007. In late December 2007, management decided to cease originating new loans in the Southeast and Southwest production offices effective January 31, 2008.

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,
		2007								2006								2005								2004								2003
		BALANCE				PERCENT				BALANCE				PERCENT				BALANCE				PERCENT				BALANCE				PERCENT				BALANCE				PERCENT
Commercial real estate loans		$	12,306,914				21.3	%		$	11,514,983				18.4	%		$	7,209,180				16.5	%		$	5,824,133				15.9	%		$	4,702,046				18.0	%
Commercial and industrial loans			14,359,688				24.9				13,188,909				21.1				9,426,466				21.5				8,040,107				21.9				6,361,640				24.3
Multifamily (1)			4,246,370				7.3				5,768,451				9.2				—				—				—				—				—				—
Total Commercial Loans			30,912,972				53.5				30,472,343				48.7				16,635,646				38.0				13,864,240				37.8				11,063,686				42.3
Residential mortgages			13,341,193				23.1				17,404,730				27.8				12,462,802				28.4				8,497,496				23.2				5,074,684				19.4
Home equity loans and lines of credit			6,197,148				10.7				9,443,560				15.1				9,793,124				22.4				9,577,656				26.2				6,457,682				24.7
Total Consumer Loans secured by real estate			19,538,341				33.8				26,848,290				42.9				22,255,926				50.8				18,075,152				49.4				11,532,366				44.1
Auto loans			7,028,894				12.2				4,848,204				7.7				4,434,021				10.1				4,205,547				11.5				3,240,383				12.4
Other			299,572				0.5				419,759				0.7				478,254				1.1				486,140				1.3				312,224				1.2
Total Consumer Loans			26,866,807				46.5				32,116,253				51.3				27,168,201				62.0				22,766,839				62.2				15,084,973				57.7
Total Loans		$	57,779,779				100.0	%		$	62,588,596				100.0	%		$	43,803,847				100.0	%		$	36,631,079				100.0	%		$	26,148,659				100.0	%
Total Loans with:
Fixed rates		$	33,450,767				57.9	%		$	39,716,958				63.5	%		$	26,141,411				59.7	%		$	21,145,915				57.7	%		$	15,171,129				58.0	%
Variable rates			24,329,012				42.1				22,871,638				36.5				17,662,436				40.3				15,485,164				42.3				10,977,530				42.0
Total Loans		$	57,779,779				100.0	%		$	62,588,596				100.0	%		$	43,803,847				100.0	%		$	36,631,079				100.0	%		$	26,148,659				100.0	%